<PAGE>
Filed Pursuant to Rule 424(b)(4)
Registration No. 333-87501
[DIGIMARC LOGO]
4,000,000 Shares
Common Stock
Digimarc Corporation is offering 4,000,000 shares of its common stock. This
is our initial public offering and no public market currently exists for our
shares. Our common stock has been approved for quotation on the Nasdaq National
Market under the symbol "DMRC." The initial public offering price is $20.00.
----------------
Investing in our common stock involves risks.
See "Risk Factors" beginning on page 4.
----------------
<TABLE>
<CAPTION>
Per
Share Total
------ -----------
<S> <C> <C>
Public Offering Price....................................... $20.00 $80,000,000
Underwriting Discounts and Commissions...................... $ 1.40 $ 5,600,000
Proceeds to Digimarc........................................ $18.60 $74,400,000
</TABLE>
The Securities and Exchange Commission and state securities regulators have
not approved or disapproved these securities, or determined if this prospectus
is truthful or complete. Any representation to the contrary is a criminal
offense.
Digimarc has granted the underwriters a 30-day option to purchase up to an
additional 600,000 shares of common stock to cover any over-allotments.
----------------
Robertson Stephens
Hambrecht & Quist
U.S. Bancorp Piper Jaffray
The date of this Prospectus is December 1, 1999.
<PAGE>
[THE DIGIMARC CORPORATION LOGO WITH THE TEXT "DIGITAL WATERMARKING."]
<PAGE>
[OUR MEDIABRIDGE TRADEMARK WITH A SERIES OF PHOTOGRAPHS DEPICTING THE PROCEDURE
THROUGH WHICH A USER IS CONNECTED TO AN INTERNET DESTINATION USING OUR
MEDIABRIDGE APPLICATION, CONNECTED BY ARROWS AND A PHOTOGRAPH OF AN INDIVIDUAL
USING OUR MEDIABRIDGE APPLICATION THAT INCLUDES THE FOLLOWING TEXT: "BRIDGING
TRADITIONAL AND ONLINE MEDIA," "PRINTED MATERIALS BECOME PORTALS TO THE
INTERNET."]
<PAGE>
You should rely only on the information contained in this prospectus. We have
not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of our common stock.
Until December 26, 1999, all dealers that buy, sell or trade our common
stock, whether or not participating in this offering, may be required to
deliver a prospectus. This requirement is in addition to the dealers'
obligation to deliver a prospectus when acting as underwriters and with respect
to their unsold allotments or subscriptions.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Summary.................................................................. 1
Risk Factors............................................................. 4
You Should Not Rely on Forward-Looking Statements Because They Are
Inherently Uncertain.................................................... 14
Use of Proceeds.......................................................... 15
Dividend Policy.......................................................... 15
Dilution................................................................. 16
Capitalization........................................................... 17
Selected Financial Data.................................................. 18
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 19
Business................................................................. 32
Management............................................................... 48
Related Party Transactions............................................... 58
Principal Stockholders................................................... 60
Description of Capital Stock............................................. 62
Shares Eligible for Future Sale.......................................... 66
Underwriting............................................................. 68
Legal Matters............................................................ 70
Experts.................................................................. 70
Where You Can Find Additional Information................................ 71
Index to Financial Statements............................................ F-1
</TABLE>
----------------
"Digimarc" and "MarcSpider" are registered trademarks, and "Paper-as-Portal,"
"MarcCentre" and "MediaBridge" are trademarks, of Digimarc Corporation. This
prospectus also contains other product names, trade names and trademarks of
Digimarc Corporation and of other organizations.
i
<PAGE>
SUMMARY
You should read the following summary together with the more detailed
information in this prospectus, including risk factors, regarding our company
and the common stock being sold in this offering.
Digimarc Corporation
Digimarc is a leading provider of patented digital watermarking technologies
that allow imperceptible digital code to be embedded in the printed or digital
versions of visual content, such as magazine ads, catalogs and product packages
and valuable documents like financial instruments, passports and event tickets.
In addition to code which can be embedded within various types of visual
content, our technologies include reader software which, as a resident
application on PCs, allows PCs to recognize these codes. We believe these
technologies have many potential uses. We are developing products and services
to address what we believe are our two largest near-term market opportunities:
the deterrence of digital counterfeiting or piracy and the enhancement of
Internet access and navigation.
Recent advances in multimedia, digital imaging and printing technologies have
given computer users at every level of sophistication access to highly advanced
image manipulation and reproduction capabilities. This access has led to new
challenges in the areas of document security, counterfeiting and piracy
deterrence by allowing virtually any user to create expert-quality copies of
traditional and digital content. At the same time advances in technology have
introduced millions of people to the Internet, the growth of the Internet has
allowed the Web to become a global distribution channel for unauthorized
reproductions of proprietary content. Our reader software can render scanners,
digital cameras and PCs ineffective for use in duplicating or distributing
proprietary content into which our digital code has been embedded. One area of
critical concern in the field of digital counterfeiting is the protection of
currency where the cost of failure is extremely high and the standards for
imperceptibility and reliability are equally important. Digimarc has been
awarded a multi-year contract by a global consortium of leading central banks
to develop a system to deter the use of PCs in the counterfeiting of currency.
We believe the same core tchnologies can be used to enhance e-commerce. The
increasing volume of Internet content and number of Web destinations has made
Internet navigation and information retrieval more challenging. Despite the
availability of numerous search methods, research indicates that users often
experience difficulty when retrieving information on desired products or
services, causing a loss of potential e-commerce revenue. To address these
issues, we are also using our technologies to develop products we call Paper-
as-Portal applications, the first of which, named MediaBridge, is planned for
release in the second half of 2000. This application is intended to enable
imperceptible digital code to be embedded within magazine advertisements,
articles, direct mailers, coupons, catalogs, bank cards and business cards.
When recognized by PC cameras enabled by our patented reader software, the code
will automatically launch the user to the specific Internet destination chosen
by the producer of the printed content. In this way, we believe that
MediaBridge will deliver more efficient Internet navigation and access to
consumers and more effective means for print advertisers to link readers
directly to a targeted e-commerce point-of-sale. We have entered letters of
Intent with PC camera vendors such as Logitech and 3Com and agreements with
leading magazines and magazine publishers like Wired Magazine and Hearst which
we believe will further our MediaBridge initiative.
1
<PAGE>
We believe that our applications offer strong advantages over other image
commerce and secure documents approaches because our digital watermark codes
are imperceptible, persistent and format-independent, allowing them to operate
in both analog and digital environments. Our applications are relevant to a
wide variety of Internet, computing and communications solutions because
virtually any visual content can contain our imperceptible digital watermarking
code.
We will continue to address both the security and the access problems
increasingly arising as the world grows more dependent on multimedia computing
and the Internet. Our core goals are to establish our patented technologies as
basic components of industry standards for controlling the use of visual
content and to establish Paper-as-Portal as a leading means of Internet access
and navigation. We intend to achieve these objectives by encouraging widespread
adoption of our reader software through marketing and strategic relationships
with leading publishers or advertisers and leading manufacturers of PC cameras
or other personal computer peripheral devices. To this end, we are working with
Logitech and 3Com to bundle our reader software into their PC camera software
packages. We also plan to continue to develop new applications that rely upon
our technology for other potential applications customers in communications,
image processing and electronic commerce. We believe that successful new
applications would further increase demand for our reader technology.
We intend to maintain our technology leadership in digital watermarking
through continued innovation and rigorous intellectual property development and
protection. By broadly licensing our technologies for deterring copyright
infringement, counterfeiting and piracy, and for linking digital content with
the physical world, we intend to build long-term demand for our technologies
and promote public awareness of our brand.
We derived 51% of our total revenue in 1998 and 92% of our total revenue for
the nine months ended September 30, 1999 from an agreement with a consortium of
leading central banks, and any change in, or early termination of, our
relationship with this customer could seriously harm our business. We
anticipate that this agreement will account for most of our revenue until we
are able to generate revenue from the introduction of other new products and
services that we are currently developing, including MediaBridge. We are not
profitable and we expect to continue to incur losses for the foreseeable
future.
We were incorporated in Oregon on January 3, 1995, and reincorporated in
Delaware on December 1, 1999. Our principal executive offices are located at
19801 S.W. 72nd Avenue, Tualatin, Oregon 97062, and our telephone number is
(503) 885-9699. Our Web site is located at www.digimarc.com. Information
contained on our Web site does not constitute part of this prospectus.
Unless otherwise indicated, the information in this prospectus assumes the
automatic conversion of all outstanding shares of preferred stock into
5,584,786 shares of common stock effective automatically upon the closing of
this offering and no exercise by the underwriters of their option to purchase
additional shares of common stock.
2
<PAGE>
The Offering
<TABLE>
<C> <S>
Common stock offered............................ 4,000,000 shares
Common stock to be outstanding after this
offering....................................... 11,983,255 shares
Use of proceeds................................. For repayment of indebtedness
and for general corporate
purposes, including working
capital, expansion of our
sales and marketing efforts,
product development,
expansion of our customer
support organization and
capital expenditures. See
"Use of Proceeds."
Nasdaq National Market Symbol................... DMRC
</TABLE>
The number of shares of common stock to be outstanding after this offering is
based on the number of shares outstanding as of September 30, 1999 and
excludes:
. 30,000 shares of common stock issued subsequent to September 30, 1999
upon exercise of options;
. 2,530,711 shares of common stock issuable upon exercise of options
outstanding as of November 30, 1999 at a weighted average exercise price
of $1.34 per share;
. 1,967,356 shares of common stock reserved for future issuance under our
1999 stock incentive plan and our 1999 employee stock purchase plan; and
. 150,000 shares of common stock issuable upon exercise of warrants
outstanding as of November 30, 1999 at an exercise price equal to the
initial public offering price.
Summary Financial Data
The pro forma basic and diluted net loss per share data in the statement of
operations data below and the pro forma data in the balance sheet data below
reflect the automatic conversion of all outstanding preferred stock into common
stock effective upon the closing of this offering. The pro forma as adjusted
data reflects adjustments to the pro forma data to show our receipt of the net
proceeds of $73.1 million from the sale of 4,000,000 shares of our common stock
in this offering at the initial public offering price of $20.00 per share,
after deducting underwriting discounts and commissions and estimated offering
expenses.
<TABLE>
<CAPTION>
Nine Months Ended
Period from September 30,
January 3, 1995 Year Ended December 31, (unaudited)
(inception) to ------------------------------- --------------------
December 31, 1995 1996 1997 1998 1998 1999
----------------- --------- --------- --------- --------- ---------
(in thousands, except share and per share data)
<S> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Total revenue........... $ -- $ 236 $ 186 $ 984 $ 691 $4,185
Gross margin............ -- 229 60 (596) (177) 2,309
Total operating
expenses............... 840 1,900 3,999 2,890 2,201 3,142
Operating loss.......... (840) (1,671) (3,939) (3,486) (2,378) (833)
Net loss................ $ (874) $(1,578) $(3,979) $(3,442) $(2,321) $ (824)
Basic and diluted net
loss per share......... $(1.01) $ (0.71) $ (1.88) $ (1.50) $ (1.02) $ (0.35)
Weighted average shares
used in basic and
diluted net loss per
share.................. 869,478 2,226,519 2,120,477 2,288,442 2,284,642 2,342,732
Pro forma basic and
diluted net loss per
share.................. $ (0.53) $ (0.12)
Weighted average shares
used in pro forma basic
and diluted net loss
per share.............. 6,447,228 6,793,518
</TABLE>
<TABLE>
<CAPTION>
September 30, 1999
(unaudited)
------------------------------
Pro Forma
Actual Pro Forma As Adjusted
------- --------- -----------
<S> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents....................... $ 8,039 $ 8,039 $81,113
Working capital................................. 7,219 7,219 80,293
Total assets.................................... 11,274 11,274 84,348
Long term obligations, net of current portion... 182 182 182
Redeemable convertible preferred stock.......... 17,266 -- --
Total stockholders' equity (deficit)............ (9,753) 7,513 80,587
</TABLE>
3
<PAGE>
RISK FACTORS
An investment in our shares involves risks and uncertainties. You should
carefully consider the factors described below before making an investment in
our securities. In addition, you should keep in mind that the risks described
below are not the only risks that we face. The risks described below are the
risks that we currently believe are material risks of our business, the
industry in which we compete and this offering. However, risks not presently
known to us, or risks that we currently believe are immaterial, may also harm
our business.
Our business, operating results and financial condition could be adversely
affected by any of the following risks. If we are adversely affected by these
risks, then the trading price of our common stock could decline and you could
lose all or part of your investment.
Risks Related to Our Business
We have a limited operating history and are subject to the risks encountered by
early-stage companies
We incorporated in January 1995. Accordingly, we have a limited operating
history, and our business and prospects must be considered in light of the
risks and uncertainties to which early-stage companies in new and rapidly
evolving markets, such as digital watermarking, are exposed. These risks
include the following:
. our developing revenue models and anticipated products and services may
fail to attract or retain customers;
. the intense competition and rapid technological change in our industry
could adversely affect the market's acceptance of our products and
services;
. we may be unable to build and maintain our brand;
. we may be unable to develop and maintain the strategic relationships upon
which we currently rely for our revenue; and
. our quarterly operating results may fluctuate significantly.
We cannot assure you that our business strategy will be successful or that we
will successfully address these risks and the risks described below.
We have a history of losses, expect future losses and cannot assure you that we
will achieve profitability
We have incurred significant net losses since inception. We incurred net
losses of $874,000 in 1995, $1.6 million in 1996, $4.0 million in 1997, $3.4
million in 1998 and $824,000 in the nine months ended September 30, 1999. We
have not been profitable and cannot assure you that we will realize sufficient
revenue to achieve profitability. Our accumulated deficit as of September 30,
1999 was approximately $10.8 million. We anticipate that we will increase our
research and development, sales and marketing, product development and general
and administrative expenses in the remainder of 1999 and for the foreseeable
future. In order to achieve profitability, we will need to generate
significantly higher revenue than we have in prior years. Even if we ultimately
do achieve profitability, we may not be able to sustain or increase our
profitability. If our revenue grows more slowly than we anticipate, or if our
operating expenses exceed our expectations, our operating results will be
harmed.
4
<PAGE>
Most of our significant revenue models are under development, and the
corresponding anticipated products and services may fail to attract or retain
customers
Our business involves embedding digital watermarks in traditional and digital
media, including secure documents, images on the Internet and video
merchandise. Our current applications include image commerce and counterfeiting
and piracy deterrence. To date, our revenue stream has been based primarily on
a combination of development, consulting, subscription and license fees from
copyright communication, and in recent periods, from secure document
applications. In the future, we anticipate that an increasing share of our
revenue will be from sales of our Paper-as-Portal applications, such as
MediaBridge, and sales of other applications of our digital watermarking
technologies. We have not fully developed a revenue model for our Paper-as-
Portal products, including MediaBridge, or for our other future applications.
In addition, because we have not yet sold these products in the marketplace and
because these products will be sold in new and undeveloped markets, we cannot
be certain that the pricing structure and product marketing that we are
currently developing for these new products will be accepted. We must complete
the development of MediaBridge and obtain revenue from its commercial launch in
order to meet our revenue objectives. If we do not successfully develop, market
and support MediaBridge, it is likely that our future revenue would fall below
our targeted objectives. Any shortfall in revenue from MediaBridge or our other
future applications could reduce the trading price of our common stock. We
believe that it is too early to determine whether revenue from these
initiatives will meet our objectives, and whether the revenue models that we
are currently developing and may develop in the future will be successful or
require changes after adoption. We cannot assure you that our anticipated
products and services will be able to compete effectively against other
alternative technologies in our target markets or that we will be able to
compete effectively against current or future digital watermark companies in
terms of price, performance, applications or other features of their
technologies. In addition, as we develop models for generating revenue, they
may not be sustainable over time, and as a result, our operating results and
financial condition may be harmed.
Because we currently receive 92% of our revenue from a single customer, the
loss of this customer would seriously harm our business, operating results and
financial condition
We have derived a substantial portion of our revenue from a consortium of
leading central banks with whom we have a development and license agreement
related to banknote counterfeit deterrence. Revenue from products and services
provided to this significant customer accounted for 51% of our total revenue in
1998 and 92% of our total revenue for the first nine months of 1999. We
anticipate that this relationship will account for most of our revenue until we
are able to generate revenue from the introduction of other new products and
services that we are developing, including MediaBridge. The customer has a
discretionary right of early termination with respect to the agreement. Unless
the customer exercises this right, the Company expects revenues under the
agreement to continue at or above current levels for the next two years.
Under the terms of our agreement with this customer, we are obliged to keep
the identity of the participating banks, design of the system and timetable for
deployment confidential. Any change in our relationship with this customer,
including any actual or alleged breach of the contract by either party or the
early termination of, or any other material change in, the agreement would
seriously harm our business, operating results and financial condition.
5
<PAGE>
Our future growth will depend on the successful implementation of our solutions
by third-party providers
We are currently developing MediaBridge and our other Paper-as-Portal
technologies and applications. These technologies and other applications and
services which we plan on providing in the future will rely on the successful
implementation of our product solutions, including our reader technology, by
third party software developers and original equipment manufacturers. We
anticipate maintaining and entering into new agreements with major third-party
vendors to create and promote products that incorporate, embed, integrate or
bundle our technologies. If we fail to obtain partners that will incorporate,
embed, integrate or bundle our technologies or these partners are unsuccessful
in these efforts, our business, operating results and financial condition could
be seriously harmed. In addition, if our technologies do not perform according
to market expectations, our business will be seriously harmed.
Our future quarterly operating results may not meet analysts' expectations and
may fluctuate significantly in the future, which could adversely affect our
stock price
We expect that our quarterly operating results will fluctuate significantly
in the future. Accordingly, you should not rely on quarter-to-quarter
comparisons of our historical results as an indication of future performance.
If our quarterly operating results do not meet the expectations of analysts or
investors, the market price of our common stock will likely decline.
Our quarterly results may fluctuate in the future as a result of many
factors, some of which are outside our control, including:
. the timing, introduction and successful commercialization of our new
products and services, including MediaBridge;
. the timing and success of our brand-building and marketing campaigns;
. the loss of or reduction in revenue from the customer that currently
accounts for 92% of our total revenue or any other significant customer;
. the market's acceptance of our products and services, including
MediaBridge;
. our ability to establish and maintain strategic relationships;
. the potential costs of litigation and intellectual property protection;
. the operating costs and capital expenditures related to the expansion of
our business operations and infrastructure, domestically and
internationally, including the hiring of key personnel and new employees;
. the introduction of similar or substitute technologies by our
competitors;
. the timing of future licensing revenue; and
. the marketing arrangements that we enter into during early market
development.
In addition, because the markets for our products and services are new and
rapidly evolving, it is difficult for us to predict our future financial
results. Our research and development, sales and marketing efforts and business
expenditures are based in part on our expectations regarding developments in
counterfeiting and piracy, and our estimates as to the use of digital
watermarking as a solution to those problems. To the extent that these
predictions prove inaccurate, our revenue and operating results will fluctuate
from our anticipated results.
6
<PAGE>
The markets for digital watermark applications are new and developing
Digital watermarking is a new and developing technology. Our success depends
on the acceptance of this technology and the adoption of applications in areas
such as digital image commerce, counterfeiting and piracy deterrence and self-
authentication of documents. The markets for products and services using
digital watermarks are rapidly evolving and are characterized by an increasing
number of market entrants who have introduced or developed products and
services using digital watermarking or alternative technologies. As is typical
in a new and rapidly evolving industry, demand and market acceptance of
recently introduced products and services are subject to a high level of
uncertainty. Our products and services are currently used by only a limited
number of customers. It is difficult to predict the future growth rate, if any,
and ultimate size of these markets or our anticipated future markets. We cannot
assure you that markets for our products and services will develop.
We may not be able to adequately protect our intellectual property, and we may
be subject to infringement claims
Our success depends on our proprietary technologies. We rely on a combination
of patent, copyright, trademark and trade secret rights, confidentiality
procedures and licensing arrangements to establish and protect our proprietary
rights. As a result, we face risks associated with our patent position,
including the potential need to engage in significant legal proceedings to
enforce our patents, the possibility that the validity or enforceability of our
patents may be denied, the possibility that third parties will be able to
compete against us without infringing our patents and the possibility that our
products may infringe patent rights of third parties. If we fail to protect our
intellectual property rights and proprietary technologies adequately, if there
are changes in applicable laws that are adverse to our interests, or if we
become involved in litigation relating to our intellectual property rights and
proprietary technologies or relating to the intellectual property rights of
others, our business could be harmed.
As part of our confidentiality procedures, we generally enter into non-
disclosure agreements with our employees, consultants and corporate partners
and attempt to control access to and distribution of our technologies,
documentation and other proprietary information. Despite these procedures,
third parties could copy or otherwise obtain and make unauthorized use of our
technologies or independently develop similar technologies. The steps we have
taken may not prevent misappropriation of our solutions or technologies,
particularly in foreign countries where laws or law enforcement practices may
not protect our proprietary rights as fully as in the United States.
Effective protection of intellectual property rights may be unavailable or
limited, both in the United States and in foreign countries. Patent protection
throughout the world is generally established on a country-by-country basis. We
have applied for patent protection both inside the United States and in various
countries outside the United States. However, we cannot assure you that pending
patents will issue or that issued patents will be valid or enforceable. We
cannot assure you that the protection of our proprietary rights will be
adequate or that our competitors will not independently develop similar
technologies, duplicate our services or design around any patents or other
intellectual property rights we hold.
We license some rights management technology from a third party, and may need
the assistance of this third party to enforce our rights to this technology.
Although we do not currently rely on this
7
<PAGE>
technology for our core products, we may in the future. The cooperation of any
third party in enforcement of patent rights we may license cannot be assured.
We have registered "Digimarc" as a trademark in the United States and other
countries, and are pursuing registration in additional countries. However, our
tradename or trademark may be registered by third parties in other countries,
impairing our ability to enter and compete in these markets. In the United
States, the trademark "Digimark" and the domain name "Digimark.com" have been
registered by an unrelated company. While we have successfully co-existed for
several years with this other company, we cannot assure you that this state of
affairs will continue. If we were forced to change our name, we would lose a
significant amount of our brand equity.
As more companies enter the digital watermark marketplace and develop
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 subject us to costly
litigation, divert management resources and result in the invalidation of our
intellectual property rights. These claims may require us to pay significant
damages, cease production of infringing products, terminate our use of
infringing technologies or develop non-infringing technologies. In these
circumstances, continued use of our technologies may require that we acquire
licenses to the intellectual property that is the subject 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 technologies may result in
liability that threatens our continuing operation.
The security systems that we use in our proprietary technologies may be
circumvented by third parties, which could damage our reputation and disrupt
our business
Our products and services involve the embedding of imperceptible digital data
in visual content that is imperceptible in normal use but that can be read by
digitally-enabled devices. The success of our products and services depends on
the security of our image commerce, anti-counterfeiting and piracy systems and
self-authentication solutions. Security breaches of these systems and solutions
could damage our reputation and expose us to a risk of loss or litigation and
possible liability. The security measures that we use in our products and
services may not prevent security breaches, and failure to prevent these
security breaches may disrupt our business. A party who is able to circumvent
our security measures could misappropriate proprietary information or cause
interruptions or otherwise damage our products and services and the properties
of our customers. If unintended parties obtain sensitive data and information,
or create bugs or viruses in an attempt to sabotage the functionality of our
products and services, we may receive negative publicity, incur liability to
our customers or lose the confidence of our customers, any of which may cause
the termination or modification of our contracts.
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. However, protection may not be available at
a reasonable price or at all.
Our products could have unknown defects
Products as complex as those we offer or develop frequently contain
undetected defects or errors. Despite testing, defects or errors may occur in
existing or new products, which could result in loss of revenue or market
share, failure to achieve market acceptance, diversion of development
resources, injury to our reputation, increased insurance costs and increased
service and warranty
8
<PAGE>
costs, any of which could materially harm our business. Furthermore, we often
provide implementation, customization, consulting and other technical services
in connection with the implementation and ongoing maintenance of our products.
The performance of these products typically involves working with sophisticated
software, computing and communications systems. Our failure to meet customer
expectations or project milestones in a timely manner could also result in a
loss of, or delay in, revenue, loss of market share, failure to achieve market
acceptance, injury to our reputation and increased costs.
Because customers rely on our products for critical security applications,
defects or errors in our products might discourage customers from purchasing
our products. These defects or errors could also result in product liability or
warranty claims. Although we attempt to reduce the risk of losses resulting
from these claims through warranty disclaimers and liability limitation clauses
in our sales agreements, these contractual provisions may not be enforceable in
every instance. Furthermore, although we maintain errors and omissions
insurance, this insurance coverage may not adequately cover these claims. If a
court refused to enforce the liability-limiting provisions of our contracts for
any reason, or if liabilities arose that were not contractually limited or
adequately covered by insurance, our business could be materially harmed.
We may encounter difficulties managing our planned growth and expansion that
may harm our business
As of November 30, 1999, we had 73 employees. In addition, we expect that we
need to hire approximately 50 additional employees in all areas in the rest of
1999 and 2000. We also expect to continue to expand our business and develop
current and new products using our Paper-as-Portal technologies. To manage the
future growth we currently expect to experience, our management must continue
to improve our operational and financial systems and expand, train, retain and
manage our growing employee base. In addition, any additional growth of our
product lines or business will place an even more significant strain on our
managerial and financial resources. If we cannot manage our growth effectively,
we may not be able to coordinate the activities of our technical, accounting
and marketing staffs, and our business could be harmed.
We depend on our key employees for our future success
Our success depends to a significant extent on the performance and continued
service of our senior management. None of our senior management has an
employment agreement. Although our employees have executed agreements
containing non-competition clauses, there is no assurance that a court would
enforce all of the terms of these clauses or the clauses generally. If these
clauses were not fully enforced, our employees would be freely able to join our
competitors. In addition, we currently have key person life insurance only on
Bruce Davis, our president and chief executive officer, and Geoffrey Rhoads,
our chief technology officer. The loss of the services of any of our senior
management or any of our other key employees could harm our business.
If we are not able to hire, integrate or retain qualified personnel, our
business may be harmed
The recent growth in our business has resulted in an increase in the
responsibilities for both existing and new management personnel. Many of our
personnel are presently serving in more than one capacity. In addition, we
expect that we will need to hire approximately 50 additional employees in all
areas in the rest of 1999 and in 2000, including general managers for new
operations in key market segments. Competition for experienced personnel in our
market segments is intense. We may
9
<PAGE>
not be able to retain our current key employees or attract, integrate or retain
other qualified personnel in the future. If we do not succeed in attracting new
personnel or in integrating, retaining and motivating our current personnel,
our business could be harmed. In addition, because our business is based on our
patented technology, which is unique and not generally known, new employees
will require substantial training, which will require substantial resources and
management attention.
Our promotion of the Digimarc brand must be successful in order for us to
attract users as well as advertisers and other strategic partners
We believe that establishing and maintaining our brand is critical to our
success and that the importance of brand recognition will increase due to the
growing number of technologies that compete with our watermarking technologies
and the increasing number of competitors offering technologies similar to ours.
We intend to increase our marketing and branding expenditures in our effort to
increase awareness of our brand. If our brand-building strategy is
unsuccessful, these expenses may never be recovered, we may be unable to
increase our future revenue and our business could be materially harmed.
We may need to raise additional funds, which may not be available
We believe that our current cash resources, combined with the net proceeds
from this offering, will be sufficient to meet our presently anticipated
working capital and capital expenditure requirements for at least the next 12
months following the date of this prospectus. We may need to raise additional
funds, however, to do the following:
. research and develop new applications for digital watermarking, and new
products and services;
. respond to competitive pressures; and
. acquire complementary businesses or technologies.
Our future liquidity and capital requirements will depend on numerous
factors, including the success of our existing and future products and services
and potentially competing technological and market developments. We may be
required to raise additional funds through public or private financing,
strategic relationships or other arrangements. Raising additional equity
capital would have a dilutive effect on existing stockholders. We cannot assure
you that additional funding, if needed, will be available on terms acceptable
to us or at all. If adequate funds are not available on acceptable terms, our
ability to develop or enhance our products and services, take advantage of
future opportunities or respond to competitive pressures would be significantly
limited. Any of these limitations could harm our business, operating results
and financial condition.
Risks Related to Our Industry
If we are unable to respond to regulatory or industry standards effectively,
our operating results could be harmed
Our future success will depend in part on our ability to enhance and improve
the responsiveness, functionality and features of our products and services in
accordance with newly-imposed regulatory or industry standards. Our ability to
remain competitive will depend in part on our ability to influence and respond
to emerging industry standards, including any standards that may be adopted for
the protection of digital photography or video on DVD, in a timely and cost-
effective manner. For instance, our video copy prevention solution is competing
with another solution to become the
10
<PAGE>
industry standard for DVD copy protection. In addition, our MediaBridge
application competes against companies that provide Internet portals, and other
Internet companies that provide search and directory services. If we are unable
to influence or respond to these standards effectively, our operating results
could be harmed.
If we are unable to integrate new technologies effectively, our business could
be harmed
Our target markets are characterized by new and evolving technologies. The
success of our business will depend on our ability to address the increasingly
sophisticated technological needs of our customers in a timely and cost-
effective manner. Our ability to remain competitive will depend, in part, on
our ability to:
. enhance and improve the responsiveness, functionality and other features
of the products and services we offer or plan to offer;
. 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 cannot assure you that we will be successful in responding to these
technological and industry challenges in a timely and cost-effective manner. If
we are unable to integrate new technologies effectively or respond to these
changing needs, our business could be harmed.
Our markets are highly competitive
The markets for digital watermarking applications are new, intensely
competitive and rapidly evolving. We expect competition to continue to increase
from both existing competitors and new market entrants. We face competition
from other companies using digital watermarking technologies and from
alternative technologies. As we expand the applications for our digital
watermarking technologies, we will experience more competition from products
and services that are substitutes for our digital watermarking products.
Because our business model is new and emerging, we may face competition from
unexpected sources. Alternative technologies that may directly or indirectly
compete with certain applications of our watermarking technologies include:
. encryption--securing data during distribution using a secret code so it
cannot be accessed except by authorized users;
. containers--inserting a media object in a "wrapper," which prevents the
media object from being duplicated;
. dataglyphs--a visible modification of the characteristics of an image
that is machine-readable;
. scrambled indicia--optical refraction-based data-hiding technique that is
inserted into an image and can be read with a glass;
. traditional anti-counterfeiting technologies--a number of solutions used
currently by many governments that compete for budgetary outlays designed
to deter counterfeiting, including optically sensitive ink, magnetic
"threads" and other materials used in the printing of currencies;
. radio frequency tags--embedding a chip that emits a signal when in close
proximity with a receiver, which is being used in photo identification,
labels and tags;
11
<PAGE>
. Internet technologies--numerous existing and potential Internet access
and search methods will be potentially competitive with MediaBridge and
other Paper-as-Portal applications; and
. bar codes--visible data-carrying code.
In addition, as we apply our technologies to the Internet through the
anticipated introduction of MediaBridge and other Paper-as-Portal applications,
we may begin to compete with a wide range of other companies. Many of the
companies that currently compete with us, as well as other companies with whom
we may compete in the future, are national or international in scope and may
have greater resources than we do. These resources could enable these companies
to initiate severe price cuts or take other measures in an effort to gain
market share in our target markets. We cannot assure you that digital
watermarking technologies, and our products and services using these
technologies, will gain widespread market acceptance.
We cannot assure you that we will be able to compete successfully against
current or future participants in our markets or against alternative
technologies, nor can we assure you that the competitive pressures we face will
not harm our business, operating results and financial condition.
Our business may be negatively affected by Year 2000 issues
Many currently installed computer systems and software products are coded to
accept only two-digit entries in the date code field. These date code fields
will need to accept four-digit entries to distinguish 21st century dates from
20th century dates. As a result, many companies' software and computer systems
may need to be upgraded or replaced in order to comply with Year 2000
requirements. We utilize third-party equipment and software that may not be
Year 2000 compliant. Failure of this third-party equipment or software to be
Year 2000 compliant could require us to incur unanticipated expenses to remedy
any problems, which could harm our business, operating results and financial
condition. Furthermore, the purchasing patterns of customers or potential
customers may be affected by Year 2000 issues as companies expend significant
resources to correct their current systems for Year 2000 compliance. These
expenditures may result in reduced funds being available to purchase products
and services we offer, which could harm our business, operating results and
financial condition.
Risks Related to This Offering
Our stock price may be volatile
The market price of our common stock is likely to be highly volatile and
fluctuate significantly in response to a number of factors, most of which are
beyond our control, including:
. fluctuations in quarterly operating results;
. changes in our relationship with the consortium of central banks, which
is our primary customer;
. announcements of significant contracts, strategic relationships,
acquisitions or capital commitments;
. technological developments in digital watermarking and other forms of
document security, and technological shifts in accessing the Internet;
. the rapidly evolving nature of our business and the digital watermarking
industry;
. the timing and manner of announcement of new products by us or our
competitors;
12
<PAGE>
. changes in the marketing methods used by advertisers;
. the launch of significant new products and lines of business, which as of
yet are unreleased and untested in the marketplace;
. changes in financial estimates by securities analysts;
. changes in our intellectual property position or the adoption of industry
standards applicable to our technology;
. failure to obtain patents or defend them successfully;
. failure to complete significant license transactions;
. additions or departures of key personnel;
. trading characteristics that develop in the market for our common stock,
which may include low trading volume and other factors that affect the
liquidity of trading; and
. stock market price and volume fluctuations, which are particularly common
among highly volatile securities of high-technology and software
companies.
In the past, securities class action litigation has often been instituted
against a company following periods of volatility in the company's stock price.
This type of litigation could result in substantial costs and could divert our
management's attention and resources.
67% of our common stock is held by existing stockholders and may be sold into
the public market in the future, which may cause our stock price to decline
Sales of a substantial number of shares of common stock after this offering
could adversely affect the market price of our common stock and could impair
our ability to raise capital through the sale of additional equity securities.
After the closing of this offering, we will have outstanding 11,983,255 shares
of common stock, assuming no exercise of outstanding options or warrants after
September 30, 1999 and no exercise of the underwriters' over-allotment option.
The 4,000,000 shares of common stock sold in this offering, which would be
4,600,000 shares if the underwriters' over-allotment option to purchase
additional shares is exercised in full, will be freely tradeable without
restriction or further registration under the federal securities laws unless
purchased by persons who are considered affiliates under the federal securities
laws. The remaining 7,983,255 shares of common stock outstanding upon the
closing of this offering will be considered restricted securities under the
federal securities laws.
Many of our stockholders, option holders and warrant holders are subject to
agreements that limit their ability to sell their shares of common stock.
Subject to limited exceptions, these securityholders cannot sell or otherwise
dispose of any shares of common stock for a period of at least 180 days after
the date of this prospectus without the prior written approval of BancBoston
Robertson Stephens. When these agreements expire, these shares and the shares
underlying the options will become eligible for sale, in some cases only in
accordance with the volume, manner of sale and notice requirements of the
federal securities laws. See "Shares Eligible for Future Sale" and
"Underwriting."
Our management will retain broad discretion in the use of proceeds from this
offering and may use the proceeds in ways with which you do not agree
We intend to use the net proceeds from this offering for the repayment of
indebtedness, working capital and general corporate purposes, including market
expansion, acquisitions and product and
13
<PAGE>
technology development. Accordingly, our management will have significant
flexibility in applying the net proceeds from this offering and may use the net
proceeds in ways with which you do not agree. Until the net proceeds are
needed, we plan to invest them in investment-grade, interest-bearing
securities. We cannot assure you that investment of the net proceeds will yield
a favorable or any return. The inability of our management to apply these funds
effectively could harm our business.
Anti-takeover provisions in our charter documents could prevent or delay
transactions that could be profitable for our stockholders from occurring
The anti-takeover provisions of Delaware law and our certificate of
incorporation and bylaws may make a change of control of us more difficult,
even if a change of control would be beneficial to our stockholders. These
provisions may allow our board of directors to prevent changes in management
and control of us. Under Delaware law, our board may adopt additional anti-
takeover measures in the future.
We have adopted the following anti-takeover provisions, each effective as of
December 1, 1999:
. our board of directors will be divided into three classes of directors,
with a separate class of directors being elected at each successive
annual meeting for a term of three years;
. special meetings of the stockholders may be called only by our president,
our secretary or at the discretion of our board of directors;
. vacancies on our board of directors may be filled by a majority of
directors in office, and not by the stockholders; and
. our board of directors may issue preferred stock and determine the price,
rights, preferences and privileges of those shares without any vote or
further action by the stockholders.
These provisions could have the effect of discouraging a third party from
making a tender offer or otherwise attempting to gain control of us. In
addition, these provisions could limit the price that investors might be
willing to pay in the future for shares of our common stock.
YOU SHOULD NOT RELY ON FORWARD-LOOKING
STATEMENTS BECAUSE THEY ARE INHERENTLY UNCERTAIN
This prospectus contains forward-looking statements that involve risks and
uncertainties. We use words such as "expect," "anticipate," "intend," "plan,"
"believe," "seek," "estimate" and similar expressions to identify forward-
looking statements. This prospectus also contains forward-looking statements
attributed to third parties relating to their estimates regarding the
prevalence and growth of the number of incidences of copyright infringement,
counterfeiting and piracy. Readers are cautioned not to place undue reliance on
any of these forward-looking statements, which reflect our management's views
as of the date of this prospectus. Our actual results could differ materially
from those anticipated in these forward-looking statements for many reasons,
including the risks faced by us and described in "Risk Factors" and elsewhere
in this prospectus.
14
<PAGE>
USE OF PROCEEDS
We will receive net proceeds of approximately $73.1 million from the sale of
the 4,000,000 shares of common stock in this offering, at an initial public
offering price of $20.00 per share and after deducting underwriting discounts
and commissions, and estimated offering expenses. If the underwriters' over-
allotment option is exercised in full, our net proceeds will be approximately
$84.2 million.
We intend to use a portion of the net proceeds to repay in full the principal
of and interest, which has been accruing at 7% per annum, on unsecured notes
payable to some of our founding common stockholders, incurred several years ago
as part of our early efforts to finance our business development. The principal
and interest balance on the notes was $386,000 at September 30, 1999. As of the
date of this prospectus, we have not made any specific allocations with respect
to the remainder of the net proceeds. Therefore, we cannot specify with
certainty the particular uses for the net proceeds to be received upon
consummation of this offering. Accordingly, our management will have
significant flexibility in applying the net proceeds.
We expect to use the net proceeds of this offering for:
. additional working capital;
. creating a public market for our common stock; and
. facilitating future access by Digimarc to public equity markets.
Pending our use of these funds, the net proceeds from this offering will be
invested in short-term, interest-bearing, investment grade instruments.
DIVIDEND POLICY
We have never declared or paid any cash dividends on shares of our common
stock. We currently intend to retain future earnings, if any, to support the
development of our business and do not anticipate paying any cash dividends in
the foreseeable future. Our board of directors will have discretion as to
whether future dividends will be paid, after taking into account factors such
as our financial condition, operating results and current and anticipated cash
needs.
15
<PAGE>
DILUTION
As of September 30, 1999, our pro forma net tangible book value was
approximately $7.5 million or $0.93 per share of common stock. Pro forma net
tangible book value per share represents the amount of our total tangible
assets less total liabilities, divided by the pro forma number of shares of
common stock outstanding. After giving effect to the sale of the 4,000,000
shares of common stock we are offering at the initial public offering price of
$20.00, our pro forma net tangible book value as of September 30, 1999 would
have been $80.5 million or $6.72 per share of common stock. This represents an
immediate increase in net tangible book value of $5.79 per share to existing
stockholders and an immediate dilution of $13.28 per share to new investors.
The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share........................... $20.00
Pro forma net tangible book value per share as of September 30,
1999............................................................ $0.93
Increase per share attributable to new investors................. 5.79
-----
Pro forma net tangible book value per share after this offering... 6.72
------
Dilution per share to new investors............................... $13.28
======
</TABLE>
The following table summarizes, on a pro forma basis as of September 30,
1999, the number of shares of common stock purchased, the total consideration
paid and the average price per share paid by the existing stockholders and the
new investors purchasing shares of common stock in this offering. The
information presented is based upon an initial public offering price of $20.00
per share, before deducting underwriting discounts and commissions, and
estimated offering expenses of this offering:
<TABLE>
<CAPTION>
Shares Purchased Total Consideration
------------------ ------------------- Average Price
Number Percent Amount Percent Per Share
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders...... 7,983,255 66.6% $18,370,000 18.7% $ 2.30
New investors.............. 4,000,000 33.4 80,000,000 81.3 20.00
---------- ----- ----------- -----
Total.................... 11,983,255 100.0% $98,370,000 100.0%
========== ===== =========== =====
</TABLE>
The information presented with respect to existing stockholders includes
4,520,286 shares of preferred stock, which will be automatically converted into
5,584,786 shares of common stock upon the closing of this offering. The above
information is as of September 30, 1999 and excludes:
. 30,000 shares of common stock issued subsequent to September 30, 1999
upon exercise of options;
. 2,530,711 shares of common stock issuable upon exercise of options
outstanding as of November 30, 1999 at a weighted average exercise price
of $1.34 per share;
. 1,967,356 shares of common stock reserved for future issuance under our
1999 stock incentive plan and our 1999 employee stock purchase plan; and
. 150,000 shares of common stock issuable upon exercise of warrants
outstanding as of November 30, 1999 at an exercise price equal to the
initial public offering price.
Giving effect to the full vesting of all options and warrants outstanding as
of November 30, 1999 and the stock issued subsequent to September 30, 1999, the
pro forma net tangible book value per share after this offering as of September
30, 1999 would be $5.92, the dilution per share to the new investors would be
$14.08, and the consideration paid by the existing shareholders and the new
investors would represent 23.6% and 76.4%, respectively. If holders of
outstanding options exercise these options, or if we grant additional options
with low exercise prices in the future, there will be further dilution to new
investors.
16
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of September 30, 1999 on
an actual basis, on a pro forma basis to give effect to the conversion of all
outstanding shares of preferred stock into common stock and on a pro forma as
adjusted basis to give effect to the conversion of all outstanding shares of
our preferred stock into common stock and the receipt of the net proceeds from
the sale of 4,000,000 shares of common stock offered in this offering at an
initial public offering price of $20.00 per share and after deducting
underwriting discounts and commissions, and estimated offering expenses.
The actual, pro forma and pro forma as adjusted information below is
unaudited and should be read in conjunction with our financial statements and
the notes to those financial statements appearing at the end of this
prospectus.
<TABLE>
<CAPTION>
September 30, 1999
(unaudited)
--------------------------------
Pro Forma
Actual Pro Forma As Adjusted
-------- --------- -----------
(dollars in thousands)
<S> <C> <C> <C>
Mandatorily redeemable preferred stock, $0.001
par value, 10,874,000 shares authorized,
4,357,786 shares issued and outstanding,
actual; no shares authorized, issued or
outstanding, pro forma and pro forma as
adjusted...................................... $ 17,266 $ -- $ --
Stockholders' equity (deficit):
Convertible preferred stock, $0.001 par
value; 325,000 shares authorized, 162,500
shares issued and outstanding, actual; no
shares issued and outstanding, pro forma and
pro forma as adjusted....................... -- -- --
Common stock, $0.001 par value; 12,500,000
shares authorized; 2,398,469 shares issued
and outstanding, actual; 7,983,255 shares
issued and outstanding, pro forma; and
11,983,255 shares issued and outstanding,
pro forma as adjusted....................... 3 8 12
Additional paid in capital................... 4,509 21,770 94,840
Deferred compensation........................ (3,466) (3,466) (3,466)
Accumulated deficit.......................... (10,799) (10,799) (10,799)
-------- -------- --------
Total stockholders' equity (deficit)....... (9,753) 7,513 80,587
-------- -------- --------
Total capitalization..................... $ 7,513 $ 7,513 $ 80,587
======== ======== ========
</TABLE>
The number of shares of common stock to be outstanding after this offering is
based on the number of shares outstanding as of September 30, 1999 and
excludes:
. 30,000 shares of common stock issued subsequent to September 30, 1999
upon exercise of options;
. 2,530,711 shares of common stock issuable upon exercise of options
outstanding as of November 30, 1999 at a weighted average exercise price
of $1.34 per share;
. 1,967,356 shares of common stock reserved for future issuance under our
1999 stock incentive plan and our 1999 employee stock purchase plan; and
. 150,000 shares of common stock issuable upon exercise of warrants
outstanding as of November 30, 1999 at an exercise price equal to the
initial public offering price.
17
<PAGE>
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with our
financial statements and related notes and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in this
prospectus. The statement of operations data for the years ended December 31,
1996, 1997 and 1998, and the balance sheet data at December 31, 1997 and 1998,
are derived from our financial statements that KPMG LLP, independent certified
public accountants, have audited and are included in this prospectus. The
statement of operations data for the period from January 3, 1995 (inception)
through December 31, 1995 and the balance sheet data at December 31, 1995 and
1996 are derived from our audited financial statements not included in this
prospectus. The statement of operations data for the nine-month periods ended
September 30, 1998 and 1999, and the balance sheet data at September 30, 1999,
are derived from unaudited interim financial statements included in this
prospectus. The unaudited financial statements have been prepared on
substantially the same basis as the audited financial statements and, in the
opinion of management, include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the results of
operations for these periods. Historical results are not necessarily indicative
of the results to be expected in the future, and results of interim periods are
not necessarily indicative of results for the entire year.
<TABLE>
<CAPTION>
Period from
January 3, 1995 Nine Months Ended
(inception) September 30,
through Year Ended December 31, (unaudited)
December 31, ------------------------------- --------------------
1995 1996 1997 1998 1998 1999
--------------- --------- --------- --------- --------- ---------
(in thousands, except share and per share data)
<S> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenue:
License and
subscription......... $ -- $ 186 $ 161 $ 484 $ 379 $ 175
Service............... -- 50 25 500 312 4,010
------- --------- --------- --------- --------- ---------
Total revenue........ -- 236 186 984 691 4,185
Cost of revenue:
License and
subscription......... -- 7 126 114 93 62
Service............... -- -- -- 1,466 775 1,814
------- --------- --------- --------- --------- ---------
Total cost of
revenue............. -- 7 126 1,580 868 1,876
------- --------- --------- --------- --------- ---------
Gross margin.......... -- 229 60 (596) (177) 2.309
Operating expenses:
Sales and marketing... 36 376 1,330 825 742 731
Research and
development.......... 327 690 934 658 546 450
Impairment charge..... -- -- 453 -- -- --
General and
administrative....... 477 834 1,282 1,407 913 1,961
------- --------- --------- --------- --------- ---------
Total operating
expenses............ 840 1,900 3,999 2,890 2,201 3,142
------- --------- --------- --------- --------- ---------
Operating loss.......... (840) (1,671) (3,939) (3,486) (2,378) (833)
Other income (expense).. (34) 93 (40) 44 57 9
------- --------- --------- --------- --------- ---------
Loss before income
taxes.................. (874) (1,578) (3,979) (3,442) (2,321) (824)
Provision for income
taxes.................. -- -- -- -- -- --
------- --------- --------- --------- --------- ---------
Net loss.............. $ (874) $ (1,578) $ (3,979) $ (3,442) $ (2,321) $ (824)
======= ========= ========= ========= ========= =========
Basic and diluted net
loss per share......... $ (1.01) $ (0.71) $ (1.88) $ (1.50) $ (1.02) $ (0.35)
======= ========= ========= ========= ========= =========
Weighted average shares
outstanding used in
basic and diluted net
loss per share
calculation............ 869,478 2,226,519 2,120,477 2,288,442 2,284,642 2,342,732
</TABLE>
<TABLE>
<CAPTION>
September 30,
December 31, (unaudited)
-------------------------------- -------------
1995 1996 1997 1998 1999
----- ------- ------- ------- -------------
(in thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents..... $ 46 $ 3,113 $ 5,638 $ 2,137 $ 8,039
Working capital............... (244) 2,782 4,631 1,196 7,219
Total assets.................. 63 3,376 6,168 2,978 11,274
Long-term obligations, net of
current portion.............. 438 396 395 469 182
Redeemable convertible
preferred stock.............. -- 4,441 10,185 10,185 17,266
Total stockholders' deficit... (690) (1,885) (5,680) (9,095) (9,753)
</TABLE>
18
<PAGE>
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the financial
statements and related notes included in this prospectus. This discussion
contains forward-looking statements that involve risks and uncertainties. Our
actual results could differ materially from those anticipated in these forward-
looking statements as a result of factors described within this prospectus. We
refer you also to the section "You Should Not Rely on Forward-Looking
Statements Because They Are Inherently Uncertain."
Overview
Digimarc is a leading provider of patented digital watermarking technologies
that allow imperceptible digital code to be embedded in traditional and digital
content, including movies, photographic or artistic images and valuable
documents such as financial instruments, passports and event tickets. Our
technologies protect copyrights and deter counterfeiting or piracy by enabling
information related to copyright ownership to be communicated easily. In
addition, our MediaBridge product will offer advertisers, for the first time, a
direct link between physical content and the Internet. This link will be
accomplished by a PC recognizing the embedded digital code within a
MediaBridge-enabled image and, as a result, automatically executing an
instruction to take the user directly to a particular Internet destination
without any mouse clicks or keyboard strokes.
From our inception in January 1995 through late 1996, we devoted
substantially all of our efforts to product development, raising capital and
recruiting personnel. We first generated licensing revenue in the third quarter
of 1996 through the licensing of our software plug-ins to Adobe Systems. In the
fourth quarter of 1996, we introduced a subscription-based service for
communicating copyrights of digital images across the Internet. This product
offering was followed by the introduction in mid-1997 of MarcSpider, our
service that searches the Internet for images containing Digimarc watermarks
and produces reports on the locations of these images. In late 1997, we began
expanding the use of our digital watermarking technologies to counterfeiting
and piracy deterrence.
In 1998, we began working with a consortium of leading central banks to
develop a system to deter the use of personal computer systems in the
counterfeiting of currency. Providing services relating to the development of
this anti-counterfeiting system accounted for 51% of our total revenue in 1998
and 92% of our total revenue for the first nine months of 1999. This increase
in the share of total revenue resulted from our securing a contractual
relationship with the consortium. We anticipate that this development project
will account for most of our revenue until we are able to generate substantial
revenue from the introduction of new products that we are developing relating
to document security and our Paper-as-Portal applications.
In early 1999, we began to place increasing emphasis on developing
MediaBridge, the first of our Paper-as-Portal applications. Our efforts to
develop and introduce MediaBridge and related Paper-as-Portal applications will
require significant continuing investment. To date, we have not derived any
revenue from MediaBridge or any other Paper-as-Portal application. We expect to
begin marketing MediaBridge in the second half of 2000. We currently expect to
develop new products and services, which we anticipate selling to customers
through a variety of pricing plans, including annual license fees and license
fees per document from issuers of valuable documents other than banknotes and
from magazine advertisers and publishers. Successful introduction and marketing
of these new products and services, including MediaBridge and other Paper-as-
Portal applications, if achieved, would significantly change the mix and the
concentration of our future revenue.
19
<PAGE>
To date, we have derived our revenue from licensing software products,
delivering subscription-based services and providing development and consulting
services to the consortium of central banks. We license our software products
to owners of digital images. Revenue is recognized on delivery of software,
assuming no significant obligations or customer acceptance rights exist. We
provide subscription services to users for tracking of their watermarked images
across the Internet. Subscriptions are paid in advance, and revenue is
recognized ratably over the term of the subscription. We also provide
development and consulting services related to the customization, integration
and installation of our technologies. This revenue is recognized as services
are performed, unless completion is subject to customer acceptance. Revenue
from our international sales has primarily been denominated in U.S. dollars.
Therefore, fluctuations in foreign currency exchange rates have not had a
material effect on our business.
We intend to increase our revenue through the marketing of new digital
watermarking applications and the licensing of MediaBridge and other Paper-as-
Portal applications. We expect to target, among other sources of revenue,
publishers, advertisers and other producers of printed materials. Our aim is to
license our technologies to those content producers so that they may embed our
digital watermarks in their print media, such as magazine ads or articles,
direct mail coupons or catalogs and credit or business cards. Our current and
anticipated products are intended to enable them to control reproduction and
alteration of their content, as well as to enable their print materials to
provide a link to relevant Web destinations. Revenue from our new applications
may include one-time licenses, time-based or usage-based fees, royalties and
revenue-sharing. We anticipate that the calculation of fees and royalties will
be based at least in part on the size of the installed base of PCs, cameras,
scanners, digital image capture and output devices, and software carrying our
patented reader technology as well as the nature of the use, and the nature and
amount of licensed content carrying our MediaBridge digital watermarks.
We believe that development of our business will require increasing levels of
expenditures in future periods, including a significant increase in our sales
and marketing efforts for the launch of new products, including MediaBridge and
other applications of our Paper-as-Portal technology. Accordingly, we
anticipate that we will continue to invest significantly in sales and marketing
for the foreseeable future and that the dollar amount of sales and marketing
expenses is likely to increase in the future. We believe that a significant
increase in our research and development investment will be necessary for the
development of additional applications of our technologies. We anticipate that
we will continue to invest significantly in product research and development
for the foreseeable future and that research and development expenses are
likely to increase in the future. Due to the short development period between
achievement of technological feasibility and the general availability of our
software to customers, software development costs qualifying for capitalization
have been insignificant, and as a result, are expensed as they are incurred. We
also believe that our general and administrative expenses will continue to
increase as a result of the continued expansion of our administrative staff and
the expenses associated with becoming a public company, including annual and
other public-reporting costs, directors' and officers' liability insurance,
investor-relations programs and professional-service fees.
Since inception, we have invested in attracting top senior management, in
developing products and in building our sales and marketing organizations. We
have a limited operating history upon which investors may evaluate our business
and prospects. We have incurred significant losses to date, and as of September
30, 1999, we had an accumulated deficit of approximately $10.8 million. We
intend to continue to expend significant financial and management resources on
developing additional
20
<PAGE>
products and services, increasing sales and marketing activities, improving our
technologies and expanding our operations. As a result, we expect to continue
to incur additional losses and negative cash flow through 2001 and possibly
beyond. Our revenue may not increase or even continue at its current levels and
we may not achieve or maintain profitability or generate cash from operations
in future periods. Our prospects must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in their early
stages of development, particularly companies deploying new technologies and
applications, such as our efforts to develop our Paper-as-Portal technology as
a new means of using the Internet.
Results of Operations
The following table presents our statement of operations data for the periods
indicated as a percentage of total revenue.
<TABLE>
<CAPTION>
Nine Months
Ended
September
30,
Year Ended December 31, (unaudited)
----------------------------- --------------
1996 1997 1998 1998 1999
------- --------- ------- ------ -----
<S> <C> <C> <C> <C> <C>
Revenue:
License and subscription.... 79% 87% 49% 55% 4%
Service..................... 21 13 51 45 96
------- --------- ------- ------ -----
Total revenue............. 100 100 100 100 100
------- --------- ------- ------ -----
Cost of revenue:
License and subscription.... 3 68 12 14 2
Service..................... -- -- 149 112 43
------- --------- ------- ------ -----
Total cost of revenue..... 3 68 161 126 45
------- --------- ------- ------ -----
Gross margin.............. 97 32 (61) (26) 55
Operating expenses:
Sales and marketing......... 159 715 84 107 17
Research and development.... 292 502 67 79 11
Impairment charge........... -- 244 -- -- --
General and administrative.. 353 689 143 132 47
------- --------- ------- ------ -----
Total operating expenses.. 804 2150 294 318 75
------- --------- ------- ------ -----
Operating loss.............. (707) (2,118) (355) (344) (20)
Other Income (Expense)...... 39 (21) 5 8 --
------- --------- ------- ------ -----
Loss before income taxes.... (668) (2,139) (350) (336) (20)
Provision for income taxes.. -- -- -- -- --
------- --------- ------- ------ -----
Net loss.................. (668)% (2,139)% (350)% (336)% (20)%
======= ========= ======= ====== =====
</TABLE>
Nine Months Ended September 30, 1998 and 1999
Revenue
Total revenue was $691,000 and $4.2 million for the nine months ended
September 30, 1998 and 1999, respectively, representing an increase of $3.5
million. This increase was primarily the result of increased service revenue
which we earned through securing a relationship with a consortium of leading
central banks. One customer (the consortium of banks) accounted for
approximately 45% and 92% of our total revenue for the nine months ended
September 30, 1998
21
<PAGE>
and 1999, respectively. The customer has a discretionary right of early
termination with respect to the agreement. Unless the customer exercises this
right, the Company expects revenues under the agreement to continue at or above
current levels for the next two years. The Company intends to pursue further
business with this customer and may be able to achieve other sources of revenue
in future periods by providing additional products and services to them and
related institutions. We currently expect to develop new products and services,
which we anticipate selling to customers through a variety of pricing plans,
including license fees and license fees per document from issuers of valuable
documents other than banknotes and from magazine advertisers and publishers.
Successful introduction and implementation of these new products and services,
including self-authenticating documents, MediaBridge and other Paper-as-Portal
applications, if achieved, would significantly change the mix and concentration
of our future revenue.
License and subscription. License and subscription revenue was $379,000 and
$175,000 for the nine months ended September 30, 1998 and 1999, respectively,
representing a decrease of $204,000. This decrease was the result of an
increased use of our sales, marketing and research and development personnel to
provide education, outreach and product definition services to our anti-
counterfeiting system customer.
Service. Service revenue was $312,000 and $4.1 million for the nine months
ended September 30, 1998 and 1999, respectively, representing an increase of
$3.7 million. This increase was the direct result of our securing a
relationship with a consortium of leading central banks under which we are
developing a system to deter the use of personal computer systems in the
counterfeiting of currency.
Cost of Revenue
License and subscription. Cost of license and subscription revenue includes
compensation for operations personnel, cost of outsourced customer support,
Internet service provider connectivity charges and image search data fees to
support our services. Cost of license and subscription revenue was $93,000 and
$62,000 for the nine months ended September 30, 1998 and 1999, respectively.
Service. Cost of service revenue primarily includes compensation for software
developers, quality assurance personnel, product managers and business
development personnel, outside contractors and travel costs directly
attributable to certain service and development contracts. Cost of service
revenue was $775,000 and $1.8 million for the nine months ended September 30,
1998 and 1999, respectively, representing an increase of $1.0 million. This
increase was the result of an increased use of our research and development and
sales and marketing personnel to provide services to our anti-counterfeiting
system customer under the development contract. Cost of service revenue as a
percentage of service revenue decreased from 248% in the nine months ended
September 30, 1998 to 45% in the nine months ended September 30, 1999.
Operating Expenses
Sales and marketing. Sales and marketing expenses consist primarily of
compensation, benefits and related costs of sales and marketing personnel,
product managers and sales engineers, as well as recruiting, travel, market
research and costs associated with marketing programs, such as trade shows,
public relations and new product launches. Sales and marketing expenses were
$742,000 and $731,000 for the nine months ended September 30, 1998 and 1999,
respectively, representing a decrease of $11,000. This decrease resulted from
increased costs of $711,000 from salaries, other
22
<PAGE>
related employee costs and travel, offset by a decrease in advertising,
promotional activities and other marketing costs of $132,000 and an increased
allocation of $590,000 to cost of service revenue associated with sales and
marketing personnel who provide education, outreach and product definition
services to our anti-counterfeiting system customer. Sales and marketing
employees totaled seven and 15 as of September 30, 1998 and 1999, respectively.
We believe that a significant increase in our sales and marketing effort is
essential for the introduction of new products, including additional secure
document applications, and MediaBridge and other Paper-as-Portal applications.
Accordingly, we anticipate that we will continue to invest significantly in
sales and marketing for the foreseeable future, and that sales and marketing
expenses are likely to increase in the future.
Research and development. Research and development expenses consist primarily
of compensation, benefits and related costs of software developers and quality
assurance personnel and payments to outside contractors. Research and
development expenses were $546,000 and $450,000 for the nine months ended
September 30, 1998 and 1999, respectively, representing a decrease of $96,000.
Increased use of research and development personnel to provide services to our
anti-counterfeiting system customer resulted in an additional $710,000 of these
expenses being allocated to cost of service revenue, while salaries and other
employee related costs increased $626,000. Research and development personnel
totaled 14 and 28 as of September 30, 1998 and 1999, respectively. We believe
that a significant increase in our research and development investment is
essential for us to maintain our market position, to continue to expand our
product lines and to enhance our technologies and intellectual property rights.
Accordingly, we anticipate that we will continue to invest significantly in
product research and development for the foreseeable future, and that research
and development expenses are likely to increase in the future.
General and administrative. General and administrative expenses consist
primarily of compensation, benefits and related costs of executive, finance and
administrative personnel, facilities costs, legal and other professional fees
and depreciation expense. General and administrative expenses were $913,000 and
$2.0 million for the nine months ended September 30, 1998 and 1999,
respectively, representing an increase of $1.0 million. $810,000 of this
increase was the result of increased executive compensation and travel
expenses, as well as executive recruiting fees and professional fees related to
our recent growth. General and administrative employees totaled four and nine
as of September 30, 1998 and 1999, respectively. We believe that our general
and administrative expenses will continue to increase as a result of the
continued expansion of our administrative staff and expenses associated with
being a public company, including annual and other public-reporting costs,
directors' and officers' liability insurance, investor-relations programs and
professional-services fees.
Stock Compensation Expense. Compensation expense includes costs relating to
stock-based employee compensation arrangements. Stock compensation expense is
based on the difference between the fair market value of our common stock and
the exercise price of options to purchase that stock on the date of the grant,
and is being recognized over the vesting periods of the related options,
usually four years. Stock compensation expense of $121,000 was recorded for the
nine months ended September 30, 1999. The total unearned compensation recorded
by us from inception to September 30, 1999 was $3.6 million. The fair value per
share used to determine unearned compensation was derived by reference to the
preferred stock values reduced by a discount factor. We expect to record at
least an additional $4.8 million of total unearned compensation for the
fourth quarter ended December 31, 1999 related to stock grants. The actual
amount will depend on the number of options granted and their exercise price.
At current estimates, additional deferred compensation amortization related to
these stock option grants, as well as grants made since
23
<PAGE>
inception will be approximately $380,000 for the fourth quarter of 1999 and
approximately $2.1 million for each of 2000 and 2001.
Years Ended December 31, 1997 and 1998
Revenue
Total revenue was $186,000 and $984,000 in 1997 and 1998, respectively,
representing an increase of $798,000. This increase was caused by increased
service revenue in 1998. We had two customers (Micrographx and the consortium
of central banks) that accounted for more than 10% of our revenue, representing
in aggregate approximately 30% of our total revenue for the year ended December
31, 1997; and one customer (the consortium of central banks) that accounted for
more than 10% of our revenue, representing approximately 51% of our total
revenue for the year ended December 31, 1998.
License and subscription. License and subscription revenue was $161,000 and
$484,000 in 1997 and 1998, respectively, representing an increase of $323,000.
$241,000 of this increase was the result of our introduction and the market's
acceptance of our subscription-based services designed to address the needs of
customers that distribute and promote their image collections on the Internet.
Service. Service revenue was $25,000 and $500,000 in 1997 and 1998,
respectively, representing an increase of $475,000. This increase was a result
of our completion of an anti-counterfeiting feasibility study in 1998. This has
since led to the award of a contract to develop a system to deter the use of
personal computers in the counterfeiting of currency.
Cost of Revenue
License and subscription. Cost of license and subscription revenue was
$126,000 and $114,000 in 1997 and 1998, respectively, representing a decrease
of $12,000. $7,000 of this decrease was the result of cost savings associated
with providing customer technical support in-house, which had previously been
provided by a third party.
Service. We recorded cost of service revenue of $1.5 million in 1998 as a
result of the use of our product managers, sales, marketing and research and
development personnel in our performance of a feasibility study for a
consortium of leading central banks which led to a contract to develop a system
to deter the use of personal computer systems in the counterfeiting of
currency. Cost of service revenue was 293% of service revenue for the year
ended 1998.
Operating Expenses
Sales and marketing. Sales and marketing expenses were $1.3 million and
$825,000 in 1997 and 1998, respectively, representing a decrease of $505,000.
This decrease was the result of devoting sales and marketing personnel to
provide education, outreach and product definition services to our anti-
counterfeiting system customer at a cost of $498,000. Sales and marketing
employees totaled ten and eight at December 31, 1997 and 1998, respectively. We
believe that a significant increase in our sales and marketing efforts is
essential for the introduction of new products, including self-authenticating
documents, MediaBridge and other Paper-as-Portal applications.
Research and development. Research and development expenses were $934,000 and
$658,000 in 1997 and 1998, respectively, representing a decrease of $276,000.
Increased use of our research and development personnel to provide services to
our anti-counterfeiting system customer resulted in $968,000 of these expenses
being allocated to cost of service revenue, while salaries and other employee
related costs increased $594,000. Research and development personnel totaled
ten and
24
<PAGE>
fourteen for 1997 and 1998, respectively. We believe that a significant
increase in our research and development investment is essential for us to
maintain our market position, to continue to expand our product line and to
enhance our technologies and associated intellectual property. Accordingly, we
anticipate that we will continue to invest significantly in product research
and development for the foreseeable future, and research and development
expenses are likely to increase in the future. In the development of our new
products such as self-authenticating documents, MediaBridge and other Paper-as-
Portal applications and enhancements of existing products, the technological
feasibility of the software is not established until substantially all product
development is complete.
General and administrative. General and administrative expenses were $1.3
million and $1.4 million in 1997 and 1998, respectively, representing an
increase of $125,000. $64,000 of this increase was the result of more frequent
domestic and international travel and $81,000 was the result of increased
depreciation expense as our fixed asset base grows. General and administrative
employees totaled three and four at December 31, 1997 and 1998, respectively.
Asset Impairment. Asset impairment expense relates to certain assets we
acquired in July 1997 from NetRights, LLC. The assets acquired included certain
office equipment, trademarks and tradenames, and all engineering drawings,
designs and documentation, including patent applications. We originally
intended to use the technology to expand and potentially enhance the delivery
of information to our customers in connection with a reevaluation of our
business strategy.
Prior to consummating the acquisition, we realized that NetRights' technology
did not have the features and functionality previously believed, and that
results could be achieved in a more simple way. Despite proceeding with the
legally binding terms that had been agreed by the parties, a decision was made
prior to consummating the transaction not to use the purchased technology. As a
result, the purchased technology totaling $453,000 was considered impaired and
written off during the year ended December 31, 1997. The fixed assets, the
pending patent and tradenames were retained as acquired assets.
Years Ended December 31, 1996 and 1997
Revenue
Total revenue was $236,000 and $186,000 in 1996 and 1997, respectively,
representing a decrease of $50,000. The decrease in revenue was caused by
higher licensing fees, most of which were received from Adobe Systems and Corel
Corporation, in 1996. We had three customers (Adobe Systems, Corel Corporation
and Motorola, Inc.) that each accounted for more than 10% of our revenue,
representing in aggregate approximately 100% of our total revenue, for the year
ended December 31, 1996; and two customers (Micrographx and the consortium of
central banks) that accounted for more than 10% of our revenue, representing in
aggregate approximately 30% of our total revenue for the year ended December
31, 1997.
License and subscription. License and subscription revenue was $186,000 and
$161,000 in 1996 and 1997, respectively, representing a decrease of $25,000.
This decrease was the result of lower one-time licensing fees in 1997
($155,000), offset by increased subscription sales of $93,000.
Service. We recorded service revenue of $50,000 and $25,000 in 1996 and 1997,
respectively, representing a decrease of $25,000. In both years, service
revenue was derived from one-time consulting projects.
25
<PAGE>
Cost of Revenue
License and subscription. Cost of license and subscription revenue was $7,000
and $126,000 in 1996 and 1997, respectively, representing an increase of
$119,000. All of this increase was caused by the growth of our service
department and related costs to support our software product and service
introductions made in the fourth quarter of 1996.
Operating Expenses
Sales and marketing. Sales and marketing expenses were $376,000 and $1.3
million in 1996 and 1997, respectively, representing an increase of $954,000.
$553,000 of this increase resulted from the hiring of sales management and
sales and marketing personnel, and $324,000 for increased travel and enhanced
promotional programs. Sales and marketing employees totaled five and ten at
December 31, 1996 and 1997, respectively.
Research and development. Research and development expenses were $690,000 and
$934,000 in 1996 and 1997, representing an increase of $244,000. Increased
salaries and other employee related costs of software development and quality-
assurance personnel resulted in an increase of $302,000 offset in part by a
decrease of $96,000 in outside contractors. Research and development personnel
totaled eight and ten for the years ended December 31, 1996 and 1997,
respectively.
General and administrative. General and administrative expenses were $834,000
and $1.3 million in 1996 and 1997, respectively, representing an increase of
$448,000. $377,000 of this increase was the result of increased salary expense
and related payroll taxes and benefits from hiring new personnel. General and
administrative employees totaled four and three at December 31, 1996 and 1997,
respectively.
Asset Impairment. Asset impairment expense relates to certain assets we
acquired in July 1997 from NetRights, LLC. As discussed above, some of the
purchased technology assets, totaling $453,000, were considered impaired and
written off during the year ended December 31, 1997.
Provision for Income Taxes
We have recognized operating losses since inception and as such have not
incurred income tax expense. As of December 31, 1998, we had operating loss
carryovers for federal and state income tax reporting purposes of approximately
$8.6 million and research and development tax credit carryforwards of $113,000,
the last of which will expire through 2018 if not utilized. Under the Tax
Reform Act of 1986, the amounts of and benefits from net operating loss
carryforwards may be impaired or limited in certain circumstances, including a
change of more than 50% in ownership. Such a change in ownership occurred with
the sale of preferred stock in June 1996 and again in July 1996. Accordingly,
we estimate that the approximately $915,000 of net operating loss carryforwards
generated from inception through July of 1996 will be limited.
26
<PAGE>
Quarterly Results of Operations
The following table presents unaudited statement of operations data for the
seven quarters ended September 30, 1999 in dollars. In our management's
opinion, this unaudited information has been prepared on the same basis as the
audited annual financial statements and includes all adjustments, consisting
only of normal recurring adjustments, necessary for fair presentation of the
unaudited information for the quarters presented. You should read this
information in conjunction with the financial statements and the related notes
included elsewhere in this prospectus. The results of operations for any
quarter are not necessarily indicative of results that we might achieve for any
subsequent periods.
<TABLE>
<CAPTION>
Quarter Ended
(unaudited)
-----------------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30,
1998 1998 1998 1998 1999 1999 1999
-------- -------- --------- -------- -------- -------- ---------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations
Revenue:
License and
subscription......... $ 161 $ 121 $ 97 $ 105 $ 74 $ 42 $ 59
Service............... -- 125 187 188 985 954 2,071
----- ----- ----- ------- ----- ----- ------
Total revenue....... 161 246 284 293 1,059 996 2,130
----- ----- ----- ------- ----- ----- ------
Cost of revenue:
License and
subscription......... 31 31 31 21 21 22 19
Service............... 128 339 308 691 459 433 922
----- ----- ----- ------- ----- ----- ------
Total cost of
revenue............ 159 370 339 712 480 455 941
----- ----- ----- ------- ----- ----- ------
Gross margin........ 2 (124) (55) (419) 579 541 1,189
Operating expenses:
Sales and marketing... 294 204 244 83 131 263 337
Research and
development.......... 236 179 131 112 107 140 203
General and
administrative....... 275 331 307 494 459 569 933
----- ----- ----- ------- ----- ----- ------
Total operating
expense............ 805 714 682 689 697 972 1,473
----- ----- ----- ------- ----- ----- ------
Operating loss...... (803) (838) (737) (1,108) (118) (431) (284)
Other income (expense).. 16 16 25 (13) (11) (17) 37
----- ----- ----- ------- ----- ----- ------
Loss before provision
for income taxes..... (787) (822) (712) (1,121) (129) (448) (247)
Provision for income
taxes.................. -- -- -- -- -- -- --
----- ----- ----- ------- ----- ----- ------
Net loss............ $(787) $(822) $(712) $(1,121) $(129) $(448) $ (247)
===== ===== ===== ======= ===== ===== ======
</TABLE>
We expect operating results to fluctuate significantly in the future as a
result of a variety of factors, many of which are outside of our control. See
"Risk Factors--Our future quarterly operating results may not meet analysts'
expectations and may fluctuate significantly in the future, which could
adversely affect our stock price" for more information on quarterly
fluctuations and how they affect our business.
We believe that comparisons of our historical quarterly operating results
will not necessarily be meaningful, and you should not rely on them as an
indication of future performance. It is possible that in some future periods
our operating results may fail to meet the expectations of analysts and
investors. In such event, the trading price of our common stock may decline.
27
<PAGE>
Liquidity and Capital Resources
Since inception, we have financed our operations primarily through the
private placement of our preferred stock, equipment financings, lines of credit
and long-term loans from shareholders. As of September 30, 1999, we had raised
approximately $17.9 million through the sale of our preferred stock.
As of September 30, 1999, we had cash and cash equivalents of $8.0 million,
representing an increase of $5.9 million from $2.1 million at December 31,
1998. Our working capital at September 30, 1999 was $7.2 million, compared to
working capital of $1.2 million at December 31, 1998. This increase in working
capital is attributable primarily to a $6.3 million and $800,000 sale of our
preferred stock in June 1999 and August 1999, respectively, and an increase in
our trade accounts receivable due to increased revenue from a single customer.
Our operating activities resulted in net cash outflows of $2.3 million and
$644,000 for the nine months ended September 30, 1998 and 1999, respectively.
This $1.6 million decrease in operating cash outflows from the nine months
ended September 30, 1998 to the nine months ended September 30, 1999 was due
primarily to improved operating results in the nine months ended September 30,
1999. Operating activities resulted in net cash outflows of $1.5 million in
1996, $3.1 million in 1997, and $3.2 million in 1998. The $1.6 million increase
in operating cash outflows from 1996 to 1997 was attributable primarily to an
increase in operating losses, offset by an increase in deferred revenue. The
$68,000 increase in operating cash outflows from 1997 to 1998 resulted from
further growth of deferred revenue and accrued payroll and related costs,
offset by lower operating losses.
Investing activities used cash of $60,000 and $209,000 for the nine months
ended September 30, 1998 and 1999, respectively. This $149,000 increase in cash
used in investing activities related to the acquisition of property and
equipment. In addition, investing activities used cash of $165,000 in 1996,
$440,000 in 1997 and $58,000 in 1998. Net cash used in investing activities in
1996 was related primarily to the acquisition of property and equipment. Net
cash used in investing activities in 1997 was related primarily to the
acquisition of selected assets, including technology, patent applications and
some fixed assets of NetRights LLC. Net cash used in investing activities in
1998 was related primarily to the purchase of patents. We anticipate that we
will experience an increase in our capital expenditures consistent with our
anticipated growth in operations, infrastructure and personnel.
Financing activities used net cash of $67,000 and provided cash of $6.8
million for the nine months ended September 30, 1998 and 1999, respectively.
Financing activities provided cash of $4.8 million in 1996 and $6.1 million in
1997 and used cash of $233,000 in 1998. Net cash provided by, or used in,
financing activities in each of these periods was related primarily to the
sales of shares of our preferred stock in 1996, 1997 and the first nine months
of 1999 and proceeds from borrowing in 1997, offset by principal payments on
our bank line of credit and equipment lease obligations in 1998 and the first
half of 1999.
We have computers and office equipment financed under long-term capital
leases that expire over the next 36 months. As of September 30, 1999, we had an
outstanding balance of $301,000 of capital lease obligations. We had unsecured
notes payable to common stockholders totaling $308,000 at September 30, 1999
which bear interest at 7% per annum. We intend to repay these notes in full
from the net proceeds of this offering. Other significant commitments consist
of obligations under non-cancelable operating leases, which totaled $2.0
million as of September 30, 1999, and are payable in monthly installments
through 2004.
28
<PAGE>
We currently anticipate that we will continue to experience significant
growth in our operating expenses for the foreseeable future. These operating
expenses will consume a material amount of our cash resources, including a
portion of the net proceeds from this offering. We believe that the net
proceeds from this offering, together with our existing cash and cash
equivalents and available bank borrowings, will be sufficient to meet our
anticipated capital needs for at least the next 12 months, although we may seek
to raise additional capital during that period. If additional funds are raised
through the issuance of equity securities, stockholders may experience
additional dilution, and such equity securities may have rights, preferences or
privileges senior to those of the holders of our common stock. There can be no
assurance that additional financing will be available on acceptable terms or at
all. If adequate funds are not available or are not available on acceptable
terms, we may be unable to develop or enhance our products, take advantage of
future opportunities or respond to competitive pressures or unanticipated
requirements, which could harm our business, operating results and financial
condition.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily
to the increase or decrease in the amount of interest income we can earn on our
investment portfolio and on the increase or decrease in the amount of any
interest expense we must pay with respect to outstanding debt instruments. The
risk associated with fluctuating interest expense is limited, however, to the
exposure related to those debt instruments and credit facilities which are tied
to market rates. We do not plan to use derivative financial instruments in our
investment portfolio. We plan to ensure the safety and preservation of its
invested principal funds by limiting default risks, market risk and investment
risk. We plan to mitigate default risk by investing in low-risk securities. At
December 31, 1998, we had an investment portfolio of money market funds,
commercial securities and U.S. Government securities, including those
classified as short-term investments, of $2.1 million. We had loans outstanding
of $548,000 at December 31, 1998. If market interest rates were to increase
immediately and uniformly by 10% from levels as of December 31, 1998, the
decline of the fair market value of the fixed income portfolio and loans
outstanding would not be material.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes methods for
derivative financial instruments and hedging activities related to those
instruments, as well as other hedging activities. Because we do not currently
hold any derivative instruments and do not currently engage in hedging
activities, we expect that the adoption of SFAS No. 133 will not have a
material impact on our financial position or results of operations. In June
1999, the FASB issued Statement No. 137, "Accounting for Derivative Instruments
and Hedging Activities--Deferral of the Effective Date of FASB Statement No.
133, an Amendment of FASB Statement No. 133." Statement No. 137 defers the
effective date of Statement No. 133 for one year. Statement No. 133, as
amended, is now effective for all fiscal quarters of all fiscal years beginning
after June 15, 2000.
In December 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position 98-9, "Modification of SOP 97-2, Software
Revenue Recognition, with Respect to Certain Transactions." SOP 98-9 amends SOP
97-2 and SOP 98-4, extending the deferral of the application of certain
provisions of SOP 97-2 amended by SOP 98-4 through fiscal years beginning on or
before March 15, 1999. All other provisions of SOP 98-9 are effective for
29
<PAGE>
transactions entered into in fiscal years beginning after March 15, 1999.
Before 1998, we recognized software license revenue in accordance with the
AICPA SOP 91-1, "Software Revenue Recognition." Beginning in 1998, we have
recognized software license revenue in accordance with AICPA SOP 97-2,
"Software Revenue Recognition," and related amendments and interpretations
contained in the AICPA's SOP 98-4, "Deferral of the Effective Date of a
Provision of SOP 97-2." Although these pronouncements apply to our subscription
and license revenue and service revenue, we do not expect the adoption of SOP
98-9 to have a material effect on our results of operations or financial
condition or to materially impact our revenue recognition practices.
Year 2000 Readiness
Many currently installed computer systems and software products worldwide are
coded to accept only two-digit entries to identify a year in the date code
field. Consequently, on January 1, 2000, these systems could fail or
malfunction because they are not able to distinguish between the year 1900 and
the year 2000. Accordingly, many companies, including ourselves and our
customers, potential customers, vendors and strategic partners, may need to
upgrade their systems to comply with applicable Year 2000 requirements.
Risks of Year 2000 Issues
Because we and our customers depend to a very substantial degree upon proper
functioning of computer systems, a failure of these systems to correctly
recognize dates beyond January 1, 2000 could disrupt operations. Any
disruptions could harm our business. Additionally, our failure to provide Year
2000 compliant solutions to our customers could result in financial loss, harm
of reputation and legal liability to us. We believe that our products and
services are Year 2000 compliant; however, our products and services are often
integrated with other systems that may not be compliant.
Our State of Readiness
We have reviewed our internal management information and other critical
business systems to identify any Year 2000 problems. Our review consisted of:
. quality assurance testing of our applications;
. assessing repair or replacement requirements;
. implementing repair or replacement as necessary; and
. creating contingency plans in the event of Year 2000 failures.
We have tested our software products and have determined that the currently
shipping versions of all of our software products are Year 2000 compliant. We
have also investigated the Year 2000 readiness of external vendors that supply
us with material software and information. In the course of these
investigations, we have not encountered any material Year 2000 problems with
these third-party products. We continue to monitor these third parties for
updates to their products as part of our ongoing Year 2000 effort. We have not
made a full assessment of the extent to which our customers might be vulnerable
to Year 2000 issues. Likewise, we have not made a full assessment of the extent
to which other third parties with which we transact business have determined
their vulnerability to Year 2000 issues.
30
<PAGE>
We believe that the Year 2000 risk will not present significant operational
problems for us. However, there can be no assurance that our Year 2000 program
will prevent any harm to our business.
Contingency Plan
Although we have regular data back-up procedures that would assist us in the
recovery of lost business information, we have not yet developed a contingency
plan for handling Year 2000 problems that are not detected and corrected prior
to their occurrence. Any failure to address any unforeseen Year 2000 issue
could harm our business.
Costs to Address Year 2000 Issues
We expect that costs directly related to Year 2000 issues will not exceed
approximately $50,000 for both costs incurred to date and future costs,
including cases where non-compliant third-party products have been or need to
be replaced. We would have incurred the replacement cost of non-compliant
third-party products regardless of the Year 2000 issue due to technology
obsolescence and/or our growth. We have expensed and continue to expense all
costs arising from Year 2000 issues as incurred, funding them from working
capital.
If our Year 2000 program is inadequate and our business operations are
materially impacted, we could incur additional costs to recover any lost
information and replace affected systems. We believe that these systems could
be replaced without significant difficulties, as replacement systems are
generally available on commercially reasonable terms.
31
<PAGE>
BUSINESS
Overview
Digimarc is a leading provider of patented digital watermarking technologies
that allow imperceptible digital code to be embedded in the printed or digital
versions of visual content, such as magazine ads, catalogs and product packages
and valuable documents like financial instruments, passports and event tickets.
In addition to code which can be embedded within various types of visual
content, our technologies include reader software which, as a resident
application on PCs, allows PCs to recognize these codes. We believe these
technologies have many potential uses. We are developing products and services
to address what we believe are our two largest near-term market opportunities:
the deterrence of digital counterfeiting or piracy and the enhancement of
Internet access and navigation.
Since the introduction of our first product in 1996, we have built a broad
technology platform that we believe has a range of applications. Our initial
products allowed copyright owners to deter the use of advanced digital imaging
tools in producing unauthorized high-quality copies of their images. We later
developed image commerce applications that allowed customers to persistently
identify their protected properties and locate these properties across the
Internet, which further discourages their unauthorized distribution and use.
Today, our business focuses on providing image commerce solutions, including
copyright protection, and counterfeiting and piracy deterrence. We are
currently developing additional applications to address other forms of visual
media such as DVD and video, and other distribution channels such as the
Internet. We are also using our technologies to develop products we call Paper-
as-Portal applications, the first of which, named MediaBridge, is being
developed and is planned for release as a resident application in PC camera
software in the second half of 2000. MediaBridge is intended to enable
imperceptible digital code to be embedded within print media, such as magazine
advertisements or articles, direct mail coupons or catalogs and bank cards or
business cards. When recognized by PC cameras enabled by our patented reader
technology, that code will automatically launch the user directly to the
specific Internet destination chosen by the producer of the print media. In
this way, we believe that MediaBridge will deliver more efficient Internet
navigation and access to consumers and more effective means for print
advertisers to link readers directly to targeted e-commerce points-of-sale.
Industry Background
The Proliferation of Advanced Computing and the Internet
Computing systems widely available today are more powerful than ever before,
incorporating high-resolution scanning, streaming media and data compression as
well as significant increases in processing power, bandwidth and memory.
Advances in multimedia, digital imaging and printing technologies have given
users of every level of sophistication access to highly advanced image
manipulation and printing capabilities. Higher scanner and printer resolution,
now typically at 600 dots per inch or higher, have enabled users to digitally
capture and subsequently print images more quickly and precisely. Very high-
resolution digital camera technology, with over one million pixels per image,
has become standard in consumer digital camera products, giving users the
ability to capture images that approach photo quality. International Data
Corporation, or IDC, estimates that worldwide scanner shipments will increase
at 23.3% per year to 39.5 million units by 2003 and worldwide PC camera
shipments will grow from approximately 600,000 in 1997 to more than 9.2 million
units by 2002.
32
<PAGE>
These advances in computing performance, coupled with computer system price
decreases, are also enabling millions of people to participate in the growth of
activity on the Internet. IDC estimates that the number of Internet users
worldwide will grow from 104 million in 1998 to 320 million by 2002. The
Internet represents a fundamental change in the way people conduct business and
access or distribute information and contributes to an increase in the
conversion of traditional media and other forms of content to electronic
digital format. NEC estimates that the number of Web pages will increase from
320 million in 1997 to 9.1 billion in 2002 and IDC estimates that the number of
users who will make purchases on the Web will increase from 18 million in 1997
to over 128 million in 2002. The rapid growth in the Internet, Internet-based
business activities and the growing use of the digital format for media content
are all contributing to the growing obsolescence of analog media content
control systems, creating new technological challenges in media content
protection.
Web Interface, Internet Navigation and e-Commerce
As advances in technology are transforming the Internet into a ubiquitous
platform for commerce, traditional "bricks and mortar" businesses are being
challenged to bridge their existing methods for marketing and selling with new
on-line marketing models. According to Forrester Research, U.S. per capita
advertising spending, including print, TV, radio and the Internet, will be over
$700 this year, and the U.S. per capita online advertising portion will grow
from $40 in 1999 to $195 in 2004. A MarketFacts survey indicates that in 1998
approximately 62% of current Internet users visited a Web site after seeing it
mentioned in a magazine or newspaper and approximately 53% visited a site
because of a product's packaging. Currently these users must use search
engines, which only provide an uncategorized listing of Internet addresses, or
at best look for an advertiser's Internet address within the fine print at the
bottom of the page, to find their intended Web destination. The current forms
of print advertising such as magazine ads, couponing, packaging and direct mail
does not fully tap the communications capabilities of the Internet, because
these approaches do not provide a direct link driving potential customers to
the e-commerce point-of-sale.
The growth of the Internet has created a large amount of unstructured
information which, according to eMarketer, consists of hundreds of millions of
Web sites and hundreds of millions of Web pages, with 1.5 million Web pages
being added per day. Many corporate Web sites now have thousands of pages,
which often makes finding relevant information within a particular site
frustrating and time-consuming. As a result, Internet users using conventional
search and directory services often experience difficulty in retrieving
information relevant to specific products and services, potentially causing
e-commerce vendors to lose sales opportunities. According to a study conducted
by the Georgia Institute of Technology, approximately 70% of online shoppers
abandon a Web site because they have problems locating specific products or
services. Search engines currently available are generally inefficient.
According to data gathered by NEC, the most comprehensive search engine indexes
less than 16% of the Web, a decrease from previous periods. NEC also estimates
that the top 11 search engines combined currently index only 42% of the Web.
Counterfeiting and Piracy in the Digital Age
The access to advanced technology that allows users to easily create high-
quality digital content has lowered the barriers to entry for professional
counterfeiters, counterfeiters engaged in crimes of opportunity and unknowing
copyright infringers. This has exacerbated the difficulties of tracking and
managing proprietary content such as movies and photographic or artistic
images. The International Intellectual Property Alliance estimates that U.S.
copyright industries lost at least $12.4 billion worldwide due to copyright
piracy in 1998. Traditional commercial merchandise or services, financial
33
<PAGE>
instruments and government-issued documents are also affected. The European
Commission estimates that more than 5% of world trade is lost to
counterfeiting. The expediency and reach of the Internet fuels the rate at
which this harm is being done.
The first visual content providers to utilize our digital watermarking for
protection of their copyrights were photographers. Shortly thereafter, the
movie industry formed an anti-piracy initiative focused on digital watermarking
technologies. The lack of an effective DVD security method led major motion
picture studios, including Universal Studios, Warner Brothers, The Walt Disney
Company, Paramount Pictures, Columbia TriStar, 20th Century Fox, Metro-Goldwyn-
Mayer and United Artists, as well as the Motion Picture Association of America,
to engage in their own multi-year digital watermarking specifications program
that is still underway. To our knowledge no contracts have yet been awarded
under this program. Although current Internet speeds are not fast enough to
support the practical transmission of video, future broadband technology
improvements may allow for this transmission. Currently, the Motion Picture
Association of America estimates that American motion picture companies lose
approximately $2.5 billion per year to video piracy, and the potential loss
after Internet distribution of movies becomes widely available could be much
greater.
Financial instruments and government-issued documents are frequent targets of
illegal counterfeiting enabled by digital technology. In recent Congressional
testimony, the U.S. Treasury Department attributed the alarming increases in
counterfeiting activity primarily to high-quality graphic devices such as color
scanners and printers. The U.S. Treasury Department reported that the advanced
technology of today's PCs and peripheral devices was responsible for 43% of all
counterfeit banknotes passed and seized in 1998, up from 0.5% in 1995. The U.S.
Treasury Department also reported that the amount of U.S. counterfeit banknotes
produced increased over 30% during the twelve months ended September 1998.
Currency counterfeiting has wide-ranging implications that may involve, among
other issues, undermining the confidence in a currency's stability, causing
losses far greater than the aggregate face amount of the currency
counterfeited. We believe that digital imaging has contributed to a portion of
the $615 million lost by U.S. banks each year due to fraudulent and counterfeit
checks but are unable to quantify the portion of the loss attributable to
digital imaging. We believe that the rise of digital counterfeiting and forgery
of passports, driver's licenses and other photo identification is also
responsible for substantial losses related to increases in identity theft and
falsification of other valuable documents. Easy access to duplication
technology has also put other high-value documents such as stocks, bonds,
government obligations, traveler's checks, commercial checks, credit and debit
cards and food stamps at risk for counterfeiting and substantial losses.
Many other forms of printed materials are also at risk. Counterfeiters have
targeted traditional commercial merchandise and services by using high-quality
scanners and laser printers to reproduce packaging, stamps, gift certificates
and event tickets. These copies can be distributed over the Internet or on hard
copy, CDs or disks. Event tickets in particular can be successfully duplicated
and sold. Concerned over counterfeit tickets, organizers of the World Cup and
Super Bowl recently adopted currency and check security techniques that
required costly design and printing alterations. Product counterfeiting of
branded clothing, perfumes, luxury items and other items is widespread, causing
label and tag manufacturers to explore and implement similar security printing
methods. For instance, manufacturers of expensive retail items, such as
computer software and branded clothing, have redesigned their packaging and
identification tags to incorporate security techniques such as holograms and
microtext to deter counterfeiting and enhance authentication of genuine
articles. So far, none of these vendors have used our solutions.
34
<PAGE>
Existing solutions to combat counterfeiting and piracy have had limited
success against advanced digital technology. Traditional analog security
solutions for printed documents, such as special printing techniques, embedded
holograms and microthreads, and the use of optically-variable inks, generally
do not provide sufficient protection from digital counterfeiting. Network
security measures, such as encryption, digital signatures, conditional access
and digital containers, control access to digital content during electronic
transmission but are ineffective for situations in which encryption or format
conversion are involved. These measures also fail to communicate information
regarding content copyright and are unable to operate outside of the digital
environment. Digital certificates, which are specially prepared software files
that act as verifiable electronic credentials, provide authentication and
privacy capabilities for consumers and businesses conducting commerce over the
Internet, but also do not convert to a non-digital format and do not identify
copyright ownership. Without effective solutions that combat counterfeiting and
piracy by communicating copyright ownership within the digital landscape, there
can be no foundation for the management and efficient licensing of proprietary
content across the Internet.
Solutions
We are developing a fundamentally new way to access and use the Internet by
embedding imperceptible digital code in traditional and digital media,
including printed materials such as magazine advertisements, articles, covers
and subscription cards; direct mailers; packaging; debit and credit cards;
greeting cards; coupons; catalogues; tickets; business cards; and digital
content such as video, images and other creative properties in digital form.
This embedded code creates a bridge between those materials and the Internet
that permits users to link directly to relevant Web destinations without any
typing or mouse clicks. Thus, our patented technologies will give digital
capabilities to physical media and allow new forms of interaction with the
digital world, enhancing publishing, advertising and e-commerce.
We first used our patented digital watermarking technologies in a variety of
applications that protect copyrights, promote image commerce and deter
counterfeiting, piracy and other unauthorized uses of all forms of traditional
and digital visual content. We believe that ours have become the most widely
employed digital watermarking technologies in the image commerce and secure
documents markets. We believe our applications offer strong advantages over
other approaches because our digital watermarks are imperceptible, format
independent and survive format changes such as scanning, printing and some
types of copying, allowing them to operate in both analog and digital
environments.
Paper-as-Portal: Bridging the Physical and Digital Worlds and Enhancing the
Use of the Internet
Our technologies allow owners of visual content, such as printed materials
and movies, to embed imperceptible digital code into the content itself. We
have designed our reader technology to detect and read this code by cameras,
scanners and other image capture devices connected to personal computers and
other digital devices. When the code is read, our software is designed to
initiate the display of Web destinations or launch Web-based applications
specified by the creators of the visual content. We believe these Paper-as-
Portal applications will benefit users by providing "no click" direct access to
Internet-based information and e-commerce opportunities. For example, a
magazine advertisement that has been embedded with our digital code will enable
a user to hold the magazine page up to a digital camera enabled with our
proprietary reader technology and be taken directly to the Web destination
specified by the advertiser.
As online business models evolve and the amount of business transacted on the
Internet increases, enterprises are seeking new Internet solutions that will
enable them to develop, maintain
35
<PAGE>
and leverage relationships with consumers, users and affiliates. We believe our
Paper-as-Portal applications will bridge the two separate commerce systems in
place right now: traditional commerce and e-commerce. We believe Digimarc-
enabled images will facilitate cost-effective integrated marketing by linking
traditional marketing materials to the Internet, allowing print materials to
become direct portals to the Internet and other digital processing
environments. Through our technologies, advertisers will be able to address
both online and offline audiences through one marketing effort, and easily link
readers of traditional print material to an advertiser's Internet or e-commerce
presence.
We believe our ability to embed imperceptible digital code in traditional and
digital visual content will benefit consumers, businesses and institutions in
the following areas:
. Benefits to Businesses. We believe our solutions will enable marketers to
improve the return on their investment in conventional and Internet
advertising. Because our embedded codes will direct users to a specified
Web destination, we believe advertisers can expect a higher percentage of
their intended audience to respond to an advertisement, and ultimately,
to become purchasers. In addition, our solutions are intended to improve
customer satisfaction and retention as customers will be less frustrated
with searches and complicated Web sites. We intend to provide advertisers
the flexibility to alter the Web destination linked by the embedded code
in a particular advertisement, allowing them to remotely redirect a
marketing campaign without having to update their print advertisements.
We believe businesses can lessen the need for, and therefore lower the
internal costs of, call and e-mail centers by establishing self-service
Web pages on proper use and maintenance that are linked to embedded
content. Moreover, imperceptible digital code can be embedded without any
visible design changes or additional material costs.
. Benefits to Consumers. We believe consumers will benefit from our
solutions through improved convenience and assured success in reaching
the relevant Web destination. We intend to offer a direct path from a
consumer's interest in an advertisement, editorial, package or label to
an online research and buying opportunity, thus avoiding misdirected or
overly broad searches on traditional search engines or portals.
Protecting Visual Content and Valuable Documents
We also provide solutions to deter the counterfeiting, piracy and
unauthorized alteration of media content. Major industries have endorsed
digital watermarking generally as an important technology in controlling visual
content and valuable documents, including commercial photography, movies,
video, music, traditional merchandise and services, financial instruments and
other high-value documents. Our digital watermarking solutions are compatible
with a variety of Internet, computing and communications solutions because
virtually any piece of visual content can contain our imperceptible digital
watermarking code. We are able to digitally mark a diverse set of sensitive,
high-value materials, including identity documents such as passports and
drivers' licenses, commercial and traveler's checks, credit and debit cards,
video or print images, currencies, stock certificates, stamps, personal checks,
event tickets and clothing brand labels. Our solutions also provide the means
to link an embedded code to human- and machine-readable information about a
document to establish its authenticity, control its use and link it to the
rightful owner. Our digital watermarking technologies can be applied to various
types of applications for protecting content, including:
. Counterfeiting Deterrence. One customer (the consortium of banks) has
accounted for nearly all of our revenue to date in the area of
counterfeiting deterrence. We intend to pursue further development of our
relationship with this customer and develop other sources of revenue by
36
<PAGE>
proposing additional products and services over time. We also intend to
use our digital watermarking technologies to provide other issuers of
high-value documents with the ability both to deter illegal or prohibited
reproduction, subject to approval by the consortium, and to verify
authenticity of photo identification documents. We are forming
partnerships with computer, software and peripheral vendors with the aim
of having these entities embed or bundle our reader technology into their
products. Once incorporated into their products, our reader technology
will detect each of our digital watermarks embedded in images or documents
the user attempts to process. Detection of the watermark can deter
attempts to counterfeit high-value documents by preventing the computer
processing of those documents.
. Piracy Prevention. Our digital watermarking technologies provide the
ability to prevent unauthorized reproduction of copyrighted or otherwise
proprietary content. Our digital watermarks can be embedded in almost any
form of visual content and can survive file and format changes to provide
persistent identification of the content. By enabling applications with
our embedding and reader technologies, the imperceptible identity created
by a digital watermark facilitates the communication of copyright and
ownership information. Ultimately, these anti-piracy applications help
owners of visual content to retain attribution and compensation for their
proprietary content.
. Document Integrity. We are developing applications using our digital
watermarking technologies to deter unauthorized alteration of
confidential or proprietary content and to ensure document integrity. Our
self-authenticating technology will allow an access control device
enabled with our reader technology to check for digital watermarking
consistency in documents like passports to determine if a document has
been altered. For instance, this capability could allow a plane ticket or
travel document to be checked for authenticity. By checking to see if the
code in the digital watermark matches information such as a ticket
number, an access control device can determine if a document is
authentic.
. Image Commerce. Any form of visual intellectual property that can be put
into a digital format can be marked with our digital watermarking
technologies. Our digital watermarks represent a new feature in visual
content because they can enhance any type of content, both as a form of
protection that allows an owner of intellectual property to discourage
its unauthorized distribution and as a method for owners to locate their
property on the Internet. In this manner, we provide a fundamental
component of image commerce systems and facilitate e-commerce.
Strategy
Our strategy focuses on establishing our technologies as the industry
standard for all forms of visual content, contributing to systems designed to
control its consumption and use, and enabling numerous new communications
functions to enhance its value for producers and consumers. The key elements of
our strategy are as follows:
Become the De Facto Standard for Digital Watermarking
We believe that our proprietary technologies will emerge as standard digital
watermarking technologies for anti-counterfeiting and for linking digital
visual content with the physical world because of the advantages they offer
over existing security and communications-enabling technologies. We intend to
leverage our expertise, our customer and OEM relationships and our strong
intellectual property position derived from our first-to-market position and
robust portfolio of
37
<PAGE>
digital watermarking patents to extend our leadership position into other areas
of opportunity for digital watermarking, including movies and video,
traditional merchandise and services and high-value documents. We plan to
leverage our relationship with a consortium of leading central banks to
encourage manufacturers and developers to install our reader software in
multiple personal computer system components including in computers, digital
cameras, scanners and software. Digimarc has the right to use these readers to
protect documents other than banknotes, subject to prior approval by our
customer (the consortium of central banks). We also actively participate in a
number of initiatives for establishing industry standards, including the Copy
Protection Technical Working Group for video copy protection and the Digital
Imaging Group for promotion of digital imaging solutions in general. Through
our participation in these groups, we hope to promote the role that digital
watermarking technologies play in each of these industries. We believe the
following characteristics provide a competitive advantage for establishing our
technologies as standards:
. Imperceptibility. The imperceptible nature of our digital watermark
distinguishes it from most other security technologies because it does
not require a visible or audible change in content, preserving the
aesthetic value of the object.
. Persistence and Format Independence. Our digital watermark survives file
and format changes, including printing and scanning, to provide
persistent identity. In addition, the embedded image is not restricted to
specific channels or media.
Achieve Market Penetration Through an Integrated Focus on Infrastructure and
Applications
We are attempting to build long-term demand for our technologies by fostering
broad proliferation of our reader technology software as a resident application
on personal computers and in software applications and image processing
peripherals, like digital cameras, printers and scanners. We plan to leverage
our relationship with a consortium of leading central banks to encourage
manufacturers and developers to install our reader software in multiple
personal computer system components, adding to our infrastructure development.
Simultaneously, we are aggressively pursuing the development of applications
that utilize our digital watermarking technologies. Our success in driving the
proliferation of infrastructure enabled by our digital watermarking reader
technology will reinforce our technology's applicability to, and is expected to
generate demand for, related applications. In a complementary fashion, the
successful implementation of applications should drive the availability and
demand for our reader technology. We plan to focus efforts in each of these key
areas as follows:
. Drive Proliferation of Our Reader Technology. We are working with major
infrastructure companies, including Adobe, Be Incorporated, 3Com,
Logitech and Hewlett-Packard, to broaden and extend the penetration of
our reader technology into scanners, digital cameras, graphics editing
and photo-processing software, printers, Web browsers and other areas of
the digital infrastructure. Our reader technology is currently bundled
with image-editing applications from leading vendors. To drive adoption,
we will continue working with these and other leading infrastructure
companies through joint research and development efforts and assistance
in product development to influence the establishment of technical
standards.
. Develop New Applications. We intend to continue developing applications
for our digital watermarking technologies through strategic relationships
and consulting efforts with leading consumer and business brands and
governmental agencies. Through our efforts with consumer brand leaders,
we hope to incorporate our watermarking technologies into applications
that span all forms of content, including still images and video.
38
<PAGE>
Establish Paper-as-Portal as a Leading Internet Access and Navigation
Technology
We believe our MediaBridge solution will serve as a fundamental new interface
to digital devices and the Internet, while also enhancing e-commerce. Our
Paper-as-Portal technology is intended to bridge the analog and digital formats
by embedding imperceptible digital code in printed materials, making those
materials Web-enabled. To promote our Paper-as-Portal applications, we intend
to establish strategic relationships with leading consumer brands and
publishers of printed media as well as infrastructure partners. We believe that
our applications offer distinct advantages over existing Internet-based
alternatives for facilitating e-commerce, including ease of use,
disintermediation of directories and search engines and enhanced market
research. We also intend to facilitate e-commerce through our Paper-as-Portal
applications by: enabling licensing and distribution of content; promoting e-
commerce through digital and printed imagery; protecting the financial
instruments used to pay for Internet goods and services; and establishing
greater confidence in personal identity systems.
Continue Intellectual Property Leadership
We were an early developer of the core technologies that we believe will
become the standard in both digital image commerce and other e-commerce
enabling applications. Since our patent filings commenced in 1993, we believe
that we have established one of the world's most extensive patent portfolios in
the field of digital watermarking. We hold 15 U.S. issued patents, and have an
additional 59 U.S. patent applications pending of which 2 have received a
notice of allowance, indicating that the allowed applications are entitled to
issue as patents subject to completion of all formalities, and at least 17
foreign patent applications pending, including Patent Cooperation Treaty
applications. We intend to maintain our technology leadership by creating new
products and services, concentrating heavily on research and development, and
emphasizing intellectual property protection in all of our activities. We
believe our dedication to innovation will also enable us to respond to the
challenges presented by the ever-increasing access to sophisticated technology
in the areas of piracy and counterfeiting, as well as address the opportunities
emerging from the growth of e-commerce.
Promote Our Brand
To enhance industry and public awareness of our solutions, we are pursuing an
aggressive brand development strategy through mass market and targeted
advertising, promotions and public relations. Our industry branding strategy
promotes the broad utility of our technologies across numerous content types,
distribution channels and applications. We believe that building our brand will
foster continued adoption of our solutions by leading companies in relevant
markets and, as appropriate, educate consumers about the new features in media
content that we enable. We also believe that a strong brand will increase
licensing opportunities with corporate customers, contributing to revenue
growth and diversification.
Products
We offer patented digital watermarking solutions, including software, tools
and services that allow users to embed, and subsequently read, imperceptible
digital code in visual content. This embedded data is imperceptible during
normal use but detectable by our software or hardware. We believe that this
embedded code can be used to identify, authenticate, track, manage and enhance
content, as well as facilitate traditional and e-commerce.
39
<PAGE>
Our initial products addressed the growing concerns of photographers,
illustrators and graphic designers who began to use the Web and CD-ROM as
central marketing and distribution tools for their portfolios, but who had
become increasingly concerned by the use of digital imaging tools to produce
high fidelity copies of their images. Our initial products addressed the
copyright concerns of these image owners, and ultimately fostered commercial
relations between them, by communicating ownership information and helping an
image owner to retain attribution and compensation for a copyrighted work. The
Advertising Photographers of America expressed concern to Adobe and other major
vendors that tools like Photoshop were providing greater availability of new
forms of copyright infringement. In response, vendors began to bundle our
digital watermarking applications in Photoshop and other leading imaging
applications. In addition, by working with the Picture Agency Council of
America, and leading agencies such as MasterFile, we developed products to
address the needs of stock photo agencies, which use CD-ROM technology for
image distribution and the Web for marketing their image collections, but which
often do not directly hold image copyrights.
We have worked closely with our customers to develop applications for our
digital watermarking technologies with other media forms, distribution channels
and applications like DVD and the Internet. For instance, our initial customers
sought to track uses of copyrighted images. This market demand led us to
develop MarcSpider, our service to track images on the Internet. Other
industries, including media companies such as Time Inc. and National Geographic
Television, began to use digital means to distribute and promote large image
collections, and as a result, they also sought to develop a system of image
asset management. For instance, Time used our watermarking technologies to mark
images that were published in the online version of Teen People. Our image
asset management applications allow customers to use our digital watermarks as
a de facto digital asset tag, discouraging an image's unauthorized distribution
and ultimately generating revenue and extending brand recognition by increasing
the likelihood of the licensing of marked images.
The dual goals of copyright protection and revenue and brand enhancement
inspired two system improvements: the addition of transactional watermarking
and the construction of an image commerce platform. Working with large stock
photo collections, notably Corbis and Getty Images, we developed and licensed
systems to dynamically embed digital watermarks in images as they are
downloaded to customers. Corbis marked more than a million images, many of
which became available through AltaVista's search engine. Getty added our
digital watermarks to the Tony Stone Web site, the online source for their
premium images. National Geographic Television began using our digital
watermarks for advertising images used with partners. In addition, we are
continuing to develop the image commerce system in cooperation with our
customers and business partners, reaching further into the image publishing
work flow. By using our digital watermarks to link an image to a server,
distributors can offer licensing and image search functions within products
like Photoshop. Virtual content bundling being contemplated will further extend
the reach for distributors while adding substantial value to an image user.
Our products continue to adapt to the technological needs of our customers.
Applications like MediaBridge are intended to allow our customers to link
virtually any physical content with the online world of computing, multimedia
and the Internet. We believe that this new method for Web-enabling printed
materials will have many potential product applications in direct marketing,
merchandising and promotion, packaging, service and support, community
building, brand enhancement, news, entertainment and education.
Together with the evolution of our product offerings, we believe that our
fundamental embedding and reader technologies will continue to find increased
applicability. For example, counterfeiting
40
<PAGE>
constitutes a growing threat to the security of the world's currencies. The
proliferation of high-resolution color copiers, scanners and printers, and
increasingly powerful computers and image-processing software has made it
possible for relatively unsophisticated users to produce counterfeit banknotes
that pass as authentic in many environments. These developments have made
casual counterfeiting a more attractive crime of opportunity, leading to a
substantially increased burden on law agencies. In response to these threats, a
number of leading central banks have decided to add new anti-counterfeiting
features to their currencies using our digital watermarking technologies.
Our current and planned products are grouped along three lines of business:
secure documents, copyright protection and image commerce, and Paper-as-Portal.
Each product line consists of embedders to place our digital watermarks into
content, and reader technology to detect, read and respond to the embedded
code.
Secure Documents
Our planned document security products will use digital watermarking to
authenticate original documents, detect fraudulent documents and deter
unauthorized duplication or alteration of high-value documents such as
passports, tax stamps, tickets and financial instruments like securities,
traveler's checks and currencies. We have relationships with a number of
financial institutions that are involved in the creation or protection of high-
value documents. These relationships include a development and license
agreement with a consortium of leading central banks related to anti-
counterfeiting of currencies that has accounted for more than half of our
revenue in 1998 and is expected to account for substantially all of our revenue
until we develop new sources of revenue from new products like MediaBridge. We
also intend to pursue further development of our relationship with the
consortium of central banks to develop other sources of revenue by proposing
additional products and services to this customer over time and by offering the
benefits of the anti-counterfeiting system to, and developing new product
applications for, the issuers of other high value documents.
Copyright Protection and Image Commerce
Our copyright protection and image commerce products provide a range of
solutions, including copyright communication, asset management and business-to-
business image commerce solutions. Our solutions are enabled by digital
watermarking tools provided to content owners, and software modules provided to
manufacturers and software vendors for reading the embedded code and
facilitating the appropriate responses to them. Our products and services
include those listed below.
. Still Images. Copyright protection solution customers can benefit from
our solutions by using a number of applications. Image creators can use
Digimarc plug-ins that are bundled with a number of leading image editing
applications from companies such as Adobe Systems, Corel, Micrografx and
JASC Software. The Digimarc batch embedder is a stand-alone tool that
processes the embedding of digital watermarks in large collections of
digital images. The Digimarc digital watermarking software development
kit (SDK) provides a programmatic interface to digital watermark
embedding, detection and reading, designed for integration into client
and server products. Our SDK application includes real-time server-based
watermarking, where digital watermarks carrying transactional data are
added to images as they are delivered to customers. Our MarcCentre
service is a central repository of registered ownership information that
is accessible by a Web user who views Digimarc-enhanced proprietary
content with our patented reader technology. This service allows any user
to view the information that
41
<PAGE>
the content owner wishes to register in MarcCentre. Our MarcSpider service
searches the public Web for images containing our digital watermarks and
produces reports on where and when such images are found. This service
allows Web content developers, photographers, stock photography agencies
and publishers of entertainment, sports and news images to track their
works on the Web.
. Video. Using a unique approach to digital watermarking, Digimarc,
Macrovision and Philips engineers have developed prototypes of technology
that can protect program material on videocassettes, DVDs, cable or
satellite transmissions from unauthorized copying to recordable DVDs,
DVHS and multimedia personal computers. The resulting system would
complement Macrovision's widely-adopted existing video copy protection
technology. Detectors can be cost effectively deployed in hardware or
software to meet real-time play and record control requirements in a wide
range of DVD platforms.
Paper-as-Portal
We anticipate that our Paper-as-Portal products will provide the ability for
printed documents to be identified by personal computers and similar devices
through digital images in the documents enhanced with our watermarks that are
generally imperceptible to users which will link the computer to a targeted
Web destination. We believe that these enhanced images and associated reader
technology will enable a variety of potential applications, the first of which
is MediaBridge.
. MediaBridge is an application we are developing based on our patented
core technology. MediaBridge will create new communications capabilities
for visual content that promote and enhance e-commerce. MediaBridge will
be a fundamentally new way to access and use the Internet by embedding
imperceptible digital code in printed materials, including, among other
things, magazine advertisements, articles, covers and subscription cards,
direct mailers, packaging, debit and credit cards, greeting cards,
coupons, catalogues, tickets and business cards that can be read by
digital devices enabled by our patented reader technology. We expect to
begin marketing MediaBridge in the second half of 2000. The same
technology can be used to permit video, images and other creative
properties in digital form to interact with the digital world.
Technology and Intellectual Property
Digimarc's watermarking technologies embed digital code in images and video
that is imperceptible during normal use but readable by computers and
software. The science of creating these imperceptible codes is known as
digital watermarking. We are a leading owner of intellectual property relating
to digital watermarks and pioneer in the commercial application of digital
watermarking. Our technologies are supported by a broad patent portfolio
covering a wide range of methods and applications for digital watermarking.
Our core technology incorporates a method for embedding code within visual
images in digital formats, such as computer files, and physical
representations, such as print or film. Our primary system embeds a message in
an image by making subtle changes to the brightness of the pixels, creating a
message that can be detected and decoded by hardware that has been enabled
with our patented reader technology. Our embedding process adjusts to the
unique characteristics of the content, placing a stronger watermark signal in
areas with rich detail and a weaker watermark signal in areas with little
detail. Because the message is carried by the image's pixels, it is file-
format
42
<PAGE>
independent. The message can survive most normal image edits, rotation,
scaling, file-format transformations, copying, scanning and printing.
The structure of the information in our digital watermark is modeled along
the lines of a network protocol. The watermark protocol consists of protocol
structure information, such as the type of message and protocol version, the
actual message data and error correction data. The protocol can be upgraded to
readily accommodate new message types in the future, and is designed so that
later versions of our reader software will be able to read previously created
watermarks. The message in our watermarked content can carry identifying
information, attributes and instructions. This message is typically short in
length so that it can be replicated throughout the image content many times.
The information in the message can uniquely identify the content, link to Web
destinations or databases, communicate information about the content, enable
tracking of the content or convey instructions for software or devices.
Our technologies allow messages in our watermarked images to survive through
a variety of changes to the underlying image, including scaling and rotation of
the image. The ability to be rotation independent is particularly important for
images that are acquired through digital scanners or cameras because the input
image is rarely at the exact same orientation as the original image. We achieve
rotation independence through a patented process that incorporates orientation
information into our digital watermarks, which allows our watermarks to be read
regardless of their orientation relative to the scanner or camera. Using this
orientation information, our patented reader technology can recover an image's
embedded message after scale changes of as much as .6x to 2x the original image
size. We believe these features will be important for communicating the
embedded messages through changes from digital to physical form and back again.
We believe these features will be especially critical for applications that
include printing and scanning, or recording a digital video to VHS and back to
DVD.
To protect our significant efforts in creating these technologies, we have
implemented an extensive intellectual property protection program that relies
upon a combination of patent, copyright, trademark and trade secret laws,
nondisclosure agreements and other contractual provisions. We have adopted an
aggressive patent strategy. We believe that we have established one of the
world's most extensive patent portfolios in the field of digital watermarking,
holding 15 U.S. issued patents, with at least 59 U.S. patent applications
currently on file, of which 2 have received a notice of allowance, and at least
17 foreign patent applications pending, including Patent Cooperation Treaty
applications. We also believe, based on published patents, that we hold some of
the earliest invention dates on issued patents in the field of digital
watermarking and that some of these early patents may be of significant value
to our competitive position. We also own registered trademarks in both the U.S.
and other countries and have applied for other trademarks and have licensed
rights to other technologies. We seek to protect new product applications
through both existing patents and filings for new patents.
We are not currently involved in any proceedings and are not currently aware
of any claims regarding our intellectual property rights. Although we devote
significant resources to developing and protecting our technologies, and
periodically evaluate potential competitors of our technologies for
infringement of our intellectual property rights, these infringements may
nonetheless go undetected or may arise in the future. We expect that
infringement claims may increase as companies become more concerned with
protecting their content from electronic copying.
43
<PAGE>
Customers and Strategic Relationships
Since the introduction of our first product in 1996, we have built a broad
technology platform that we believe has a range of applications. Our initial
customers were copyright owners concerned with the use of digital imaging tools
in producing unauthorized high-quality copies of their images. We have helped
corporate users to generate revenue and extend their brands through image
commerce initiatives. We later developed image commerce applications allowing
customers to persistently identify their protected properties or locate those
properties on the Internet and, ultimately, discourage the unauthorized
distribution or use of those properties. Our strategic partners use our image
commerce applications to offer licensing and image search functions within
image-editing products. While our applications continue to develop to address
changing technological trends, our fundamental embedding and reader
technologies continue to find increased applicability.
Customers
Digimarc has been awarded a multi-year contract to develop a system to deter
the use of personal computer systems in the counterfeiting of currency. The
contract is funded by a consortium of leading central banks. The identities of
the participating banks, design of the system and timetable for deployment are
confidential. The central banks have acquired an exclusive license to
Digimarc's technologies for deterring the counterfeiting of currency. Digimarc
has retained the exclusive right to use the technologies developed for the
system in other applications, subject to approval by the banks.
Digimarc's current customers also include leaders in the sports,
entertainment, news and publishing fields, as well as leading image creators,
such as National Geographic Television, Corbis, Getty Communications, Time,
Inc. and Fox Broadcasting. Our target markets include photographers, Web
designers and OEMs, such as Adobe, Corel and Micrografx. Our stock photo agency
customers account for 75% of all stock photo collections, which include more
than 60 million high-quality photographs.
The following case studies provide illustrations of how selected customers
have used our products and services to address their copyright concerns:
. NASA's Lunar and Planetary Institute (LPI). LPI was looking for a way to
announce its copyrights on the unique images in its 3-D Tour of the Solar
System CD-ROM. LPI also wanted to remind viewers that these images could
not be copied without permission. After much study, LPI took a dual
approach by adding a "do not copy" warning to the packaging and Digimarc-
enhancing all of the images. LPI used the Digimarc Plug-ins bundled with
Adobe Photoshop to mark the images on the CD-ROM, as well as the images
on the LPI Web site. To date, LPI has discovered no misuse of the images,
and it has indicated to us that it plans to use Digimarc-enhanced images
on future projects to communicate image copyrights.
. National Geographic Television. National Geographic Television uses
Digimarc software to add "digital asset tags" to assist with tracking and
management of the computer-generated original content it uses in its
television programming. National Geographic Television's graphic
designers Digimarc-enhance digital art used in their productions prior to
sharing the work with outside production facilities or other groups
within the National Geographic Society.
Strategic Relationships
. Macrovision and Philips. In 1997, we entered a joint marketing and
development agreement with Macrovision, our largest shareholder, aimed at
addressing the absense of an effective DVD security method. Under this
arrangement, we have agreed to develop with Macrovision
44
<PAGE>
a system to control the copying and unauthorized playing of video content
in all forms of distribution, with an initial focus on DVD video. In 1998,
Philips NV joined the partnership. Macrovision and Philips have been
developing the video copy prevention and play control solution, with
Digimarc contributing intellectual property and technical assistance. In
addition, Macrovision has exclusive marketing rights for the video copy
prevention and playback control solution for a number of years, subject to
payment of minimum royalties. Between December 1997 and June 1999,
Macrovision purchased shares of our preferred stock that upon the closing
of this offering will be converted into 924,475 shares of our common
stock.
. Hearst. In October 1999, we entered into a binding letter agreement with
Hearst Communications, Inc. Under this agreement, Hearst and Digimarc
will jointly promote and market MediaBridge by enhancing the editorial
content of participating Hearst magazines and by enabling advertisements
in Hearst magazines to be compatible with MediaBridge. In connection with
these marketing efforts, we have agreed to provide a non-exclusive
license to Hearst to enable its editorial content to be compatible with
MediaBridge and to sublicense MediaBridge to its advertisers. We will
also provide Hearst with all reasonable and necessary development tools
and related training to enable it to create and publish Digimarc-enabled
content for its magazines. Under the letter agreement, we have granted
Hearst a warrant to purchase up to 150,000 shares of our common stock at
an exercise price equal to our initial public offering price, 87,500 of
which are subject to vesting based upon events as set forth in the letter
agreement. In addition to marketing MediaBridge to publishers of its
magazines and their advertisers, Hearst has agreed to promote MediaBridge
to readers of its publications and to remit to Digimarc a portion of
revenues it receives from MediaBridge-enabled advertising.
. Wired. In October 1999, we entered into a binding letter agreement with
Wired magazine. Under this agreement, Digimarc and Wired have each agreed
to encourage advertisers to use MediaBridge for their advertisements in
issues of Wired magazine beginning in the summer of 2000. In addition,
Wired has agreed to jointly promote and market in Wired magazine and to
remit to us a portion of the revenue it receives for MediaBridge-enabled
advertising. Under this agreement, we have agreed to provide a non-
exclusive license to Wired to enable its editorial content to be
compatible with MediaBridge, as well as to provide Wired with all
reasonable and necessary development tools, training, software and
cameras for it to comply with its obligations under the agreement. We
have also agreed to refrain from granting a license to distribute a
MediaBridge-enabled publication to any other publisher until at least
30 days after the first issue of Wired is published under this agreement.
. Logitech. In September 1999, we entered into a non-binding letter of
intent to establish a strategic partnership with Logitech, Inc. In this
letter of intent, Logitech expressed its intention to enter into an
agreement with Digimarc to include MediaBridge with Logitech's tethered
PC camera software and to prominently mark each package with the Digimarc
logo beginning no later than six months after the first commercial
availability of MediaBridge.
. 3Com. In September 1999, we entered a non-binding letter of intent to
establish a strategic partnership with 3Com Corporation. In this letter
of intent, 3Com expressed its intention to enter a bundling agreement
with Digimarc that will provide for the bundling of MediaBridge with
3Com's tethered PC cameras and to prominently mark each package with the
Digimarc logo beginning no later than six months after Digimarc's first
commercial shipment of MediaBridge.
45
<PAGE>
. Be Incorporated. In August 1999, we entered a non-binding letter of
intent to establish a strategic partner relationship with Be Incorporated
for use of our MediaBridge software as a standard feature of their
operating system. In exchange, Digimarc will grant a royalty free, non-
exclusive license to Be Incorporated to offer MediaBridge to licensees of
its operating system.
. Adobe. In 1996, Digimarc granted a ten-year license to Adobe to use
Digimarc's watermarking technologies in its Photoshop application, a
leading professional image editing application. Simultaneously, Adobe
granted Digimarc a ten-year license which allows us to use their software
code to develop new applications that are compatible with Adobe's
technology. In the same year, Adobe incorporated Digimarc's technology
into Adobe's ImageReady application, an image processing application
designed specifically for the needs of Web publishers. Between July 1996
and June 1999, Adobe Ventures L.P. purchased shares of our preferred
stock that upon consummation of this offering will be converted into
846,692 shares of our common stock.
. Hewlett-Packard. In June 1999, Hewlett-Packard made an investment in
Digimarc by purchasing $1.5 million of our preferred stock to help us
foster new advancements in our digital watermarking technologies and
image commerce applications. Upon the closing of this offering, Hewlett-
Packard's preferred stock will be converted into 300,000 shares of our
common stock.
. Corbis. In 1998, Digimarc granted a three-year enterprise-wide license to
Corbis for the use of Digimarc image commerce solutions across Corbis'
image collections. Since that time, Corbis and Digimarc have cooperated
in defining market requirements and advancing standards that promote the
industry-wide use of Digimarc watermarking. In addition, in 1998,
Digimarc purchased certain intellectual property relating to digital
watermarking from Corbis.
Competition
The markets in which we compete are emerging, highly competitive, fragmented
and characterized by rapidly changing technology and evolving standards. We
face competition in the overall digital watermarking market as well as in each
of the market segments where our products and services compete. We believe that
the principal competitive factors in the markets for our products are
functionality, interoperability with major hardware and software platforms, and
the costs, time to implementation and support services associated with the
installation of new products and services. We have experienced and expect to
continue to experience increased competition from enterprises in high-
technology industries that are developing watermarking capabilities of their
own, many of whom have significantly greater financial, technical and marketing
resources than we have.
Digimarc's major competition comes from the internal development efforts at
high-technology companies. Internal technology departments have staffed
projects to build their own watermarking systems utilizing a variety of tools.
In some cases, these internal-development projects have been successful in
satisfying the needs of an organization. The competitive factors in this area
require that we generate a product that conforms to the customer's technology
standards, scales to meet the needs of large enterprises, operates globally and
costs less than the results of an internal development effort.
Our video copy prevention and play control solution for DVD faces intense
competition. Our consortium, comprised of Digimarc, Macrovision and Philips,
directly competes with a larger consortium comprised of IBM, NEC, Sony, Hitachi
and Pioneer.
46
<PAGE>
Most competition in the secure documents market comes from traditional
security features, such as holograms, security threads, special inks, and
laminates which compete for the portion of the production budget reserved for
security features, and machine-readable features, such as Scrambled Indicia,
two dimensional barcodes, Glyphs from Xerox and data-carrying magnetic stripes.
Our Internet-based technology faces competition from companies that provide
Internet portals, and search and directory services. For example, we compete
with search engines, including Excite@Home, Inktomi and AltaVista, for the
traffic generated by Internet users seeking links to third-party content to
address their online information needs. We also compete with directory
services, such as Yahoo! and LookSmart, because they provide alternative ways
for users to obtain the desired information.
Our current and potential competitors, irrespective of the technology they
use or intend to use, may have well-established relationships with current and
potential customers of ours, extensive knowledge of the markets targeted by us,
better name recognition than us and more extensive financial, development,
sales and marketing resources than us. Therefore, our competitors' products may
achieve greater market acceptance than those offered by us. The development and
marketing of competing software may reduce the marketability of our products
and therefore may harm our business, operating results and financial condition.
Our business is characterized by extensive research efforts and rapid
technological progress. To remain competitive, we will be required to expand
and enhance the functionality of our watermarking software and reader
technologies. New developments are expected to continue, and there can be no
assurance that discoveries by others, including current and potential
competitors and internal development efforts, will not render our services and
products noncompetitive. Because of rapid technological change, we may be
required to expend greater amounts in the development of each new product than
currently anticipated, which in turn will require greater revenue to recoup
such expenditures.
Employees
As of November 30, 1999, we had 73 full-time employees, including 19 in sales
and marketing, 34 in research and development and 20 in finance,
administration, legal and corporate communications. Our future success will
depend, in part, on our ability to continue to attract, retain and motivate
highly qualified technical and management personnel, for whom competition is
intense. Our employees are not covered by any collective bargaining agreement,
and we have never experienced a work stoppage. We believe that our relations
with our employees are good.
Facilities
Our principal administrative, sales, marketing, support and research and
development facility is currently located in Tualatin, Oregon, under a lease
that expires in December 2004. This facility occupies a total of approximately
16,500 square feet. We will likely require additional space before the end of
2000, but believe that securing additional suitable space to accomodate our
growth will not be difficult.
Legal Proceedings
We may from time to time become a party to various legal proceedings arising
in the ordinary course of our business. However, we are not currently subject
to any material legal proceedings.
47
<PAGE>
MANAGEMENT
Officers and Directors
The following table sets forth certain information regarding our executive
officers, corporate officers and directors as of December 1, 1999:
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Executive Officers
Bruce Davis............. 47 President, Chief Executive Officer and Director
Geoffrey Rhoads......... 37 Chief Technology Officer and Director
E. K. Ranjit............ 49 Chief Financial Officer and Secretary
J. Scott Carr........... 37 Vice President and General Manager, Secure Documents
Indraneel Paul.......... 43 Vice President and General Manager, Paper-as-Portal
Corporate Officers
Burt W. Perry........... 45 Vice President of Engineering
Kathy S. Brogdon........ 46 Vice President of Finance and Operations
William Y. Conwell...... 40 Vice President of Intellectual Property
Directors
Philip J. Monego, Sr.... 52 Chairman of the Board
Brian J. Grossi......... 49 Director
John Taysom............. 45 Director
</TABLE>
Executive Officers
Bruce Davis has served as our president, chief executive officer and director
since December 1997. Prior to joining us, Mr. Davis served as president of
Titan Broadband Communications, a provider of information technology and
satellite communications systems and services, from April 1997 to December
1997. Prior to that, Mr. Davis served as president of Prevue Networks, Inc., a
supplier of electronic program guides and program promotion services for the
cable and satellite television markets, from July 1996 to February 1997. Prior
to that, Mr. Davis founded and served as president of TV Guide On Screen, a
joint venture of News Corporation and TCI which supplied electronic program
guides and navigational software for the cable television market, from January
1993 to July 1996. Mr. Davis received a B.S. in accounting and psychology and
an M.A. in criminal justice from the State University of New York at Albany,
and a J.D. from Columbia University.
Geoffrey Rhoads founded Digimarc in 1995 and now serves as chief technology
officer, secretary and director. Previously, Mr. Rhoads served as our interim
president from September to November 1995, and as chairman of the board of
directors from January 1995 to March 1996. Prior to that, Mr. Rhoads was the
founder and president of Pinecone Imaging Corporation, a company which develops
imaging systems for telescopes, since 1992. Mr. Rhoads received his B.A. in
physics from the University of Oregon.
E. K. Ranjit has served as our chief financial officer since August 1999.
Prior to that, he served as vice president of finance and treasurer of TriQuint
Semiconductor, Inc., a supplier of integrated circuits for the wireless
communications, telecommunications, data communications and aerospace markets
from July 1996 to August 1999, and as its corporate controller from May 1991 to
June 1996. Mr. Ranjit received a B.S. from the University of Texas at Dallas
and an M.B.A. from Pepperdine University.
48
<PAGE>
J. Scott Carr has served as our vice president and general manager of secure
documents since June 1999. Prior to that, he served as our vice president of
marketing and business development from January 1998 to May 1999, and director
of business development from May 1996 to December 1997. Prior to joining us,
Mr. Carr served as vice president of marketing at nCUBE Corporation, a
manufacturer of video servers, from July 1995 to May 1996. Prior to that, Mr.
Carr worked as a staff architect at Sequent Computer Systems, Inc., a computer
equipment manufacturer, from August 1992 to July 1995. Mr. Carr received his
B.S. in computer science from Oregon State University.
Indraneel Paul has served as our vice president and general manager of
Paper-as-Portal since November 1999. From January 1995 through October 1999,
Mr. Paul held various positions with TV Guide Networks, a provider of
electronic television program guides for the cable television industry. His
most recent position at TV Guide Networks was executive vice president of
operations. Prior to that, he served as vice president of engineering and
operations at Vyvx, a provider of fiber optic transmission services for the
broadcast television industry. Mr. Paul received a B.Tech. in electrical
engineering from the Indian Institute of Technology and an M.S. in electrical
engineering from Rensselaer Polytechnic Institute.
Corporate Officers
Burt W. Perry has served as our vice president of engineering since July 1996
and served as interim co-president from August through December 1997. Prior to
that, Mr. Perry worked as an engineering manager at Intel, designing and
managing technology and software development, from June 1993 to July 1996. Mr.
Perry received a B.S. in computer science from the University of Delaware.
Kathy S. Brogdon has served as our vice president of finance and operations
since October 1996 and served as interim co-president from August through
December 1997. Prior to joining us, Ms. Brogdon served as vice president of
finance and operations at Active Arts, Inc., a multimedia company, from
December 1995 to October 1996. Ms. Brogdon worked as the controller and a
partner at Nova Northwest, Inc., a lending, leasing and financial advisory
company, from September 1990 to December 1995. Ms. Brogdon received a B.A. in
accounting and quantitative methods from the University of Oregon and became a
Certified Public Accountant in Oregon in 1978.
William Y. Conwell has served as our vice president of intellectual property
since July 1999. Prior to joining us, Mr. Conwell was a patent attorney at
Klarquist Sparkman Campbell Leigh & Whinston, LLP since 1984, and became a
partner in January 1990. Mr. Conwell received a bachelor's degree in Electrical
Engineering from Georgia Institute of Technology and a J.D. from Emory
University School of Law.
Directors
Philip J. Monego, Sr. has been chairman of our board of directors since 1996.
Mr. Monego has served as chief executive officer and chairman of the board of
directors of Voquette, Inc., an Internet media portal company, since May 1999.
Prior to that, Mr. Monego was co-founder, president and chief executive officer
of NetChannel, Inc., an Internet information delivery service, from May 1996 to
June 1998. Prior to that, Mr. Monego was interim president and chief executive
officer of Yahoo! Corporation from April 1995 to September 1995. He is an early
investor in several new media startups and also currently a venture partner in
the Media Technology Venture fund. Mr. Monego received a B.A. in management
from LaSalle University.
49
<PAGE>
Brian J. Grossi has served as one of our directors since July 1996. Mr.
Grossi co-founded AVI Capital, a venture capital firm specializing in high-
technology companies, in 1994. Prior to that, Mr. Grossi was a general partner
with Alpha Partners, a venture capital firm, from 1982 to 1992. Prior to that,
he worked at the Stanford Research Institute as a research engineer and project
leader from 1976 to 1982. Currently, Mr. Grossi serves as a director of
Apptitude, Inc., Aptia, Inc., Intraspect Software, Inc., InVisio, Inc.,
nCommand, Inc., Vivant! Corporation and Pointbase, Inc. Mr. Grossi received a
B.S. and an M.S. in mechanical engineering from Stanford University.
John Taysom has served as one of our directors since December 1997. Mr.
Taysom has been employed by Reuters, a worldwide television and news agency,
since 1982 and is currently the Managing Director of the Reuters Greenhouse
Fund. Mr. Taysom also serves on the board of directors of TIBCO Software Inc.
and Fantastic Corporation, a Swiss company. Mr. Taysom received a B.Sc. in
economics from Bath University.
Our board of directors is divided into three classes. Beginning in 2000, one
class of directors will be elected each year for a three-year term and until
their successors are selected and qualified or until their earlier resignation
or removal. Mr. Taysom will serve until our 2000 annual meeting of
shareholders; Messrs. Monego and Rhoads will serve until our 2001 annual
meeting of shareholders; and Messrs. Davis and Grossi will serve until our 2002
annual meeting of shareholders. Executive officers are elected by and serve at
the discretion of the board of directors.
Board Committees
The board of directors has established a compensation committee and an audit
committee. The compensation committee, consisting of Messrs. Monego and Grossi,
exercises the authority of the board of directors on all compensation matters,
including both cash and equity incentive compensation, and administers our
employee benefit plans.
The audit committee, consisting of Messrs. Monego and Grossi, recommends the
selection of independent public accountants to the board of directors, reviews
the scope and results of the audit and other services provided by our
independent accountants and reviews our accounting practices and systems of
internal accounting controls.
Director Compensation
Directors who are also employees of Digimarc receive no additional
compensation for their services as directors. Directors who are not employees
of Digimarc do not receive a fee for attendance in person at meetings of the
board of directors or committees of the board of directors, but they are
reimbursed for travel expenses and other out-of-pocket costs incurred in
connection with their attendance of meetings. Non-employee directors have also
been granted stock options in the past. After the closing of this offering, we
will adopt an option program for our non-employee directors. See "Management--
Employee Benefit Plans--1999 Non-Employee Director Option Program."
Compensation Committee Interlocks and Insider Participation
No member of our compensation committee was at any time during the fiscal
year ended December 31, 1998 an officer or employee of Digimarc. No member of
our compensation committee serves as a member of the board of directors or
compensation committee of any entity that has any executive officer serving as
a member of our board of directors or compensation committee.
50
<PAGE>
Summary Compensation Table
The following table contains information in summary form concerning the
compensation paid to our chief executive officer and each of our most highly
compensated executive officers, which we refer to in this prospectus as the
named executive officers, whose total salary, bonus and other compensation
exceeded $100,000 during the years ended December 31, 1996, 1997 and 1998.
The salary information shown for Messrs. Davis and Carr reflects compensation
paid to each in his principal position commencing on December 1997 and May
1996, respectively.
<TABLE>
<CAPTION>
Long-Term
Annual Compensation Compensation
-------------------- ------------
Securities
Name and Principal Underlying All Other
Position Year Salary ($) Bonus ($) Options (#) Compensation ($)
- ------------------ ---- ---------- --------- ------------ ----------------
<S> <C> <C> <C> <C> <C>
Bruce Davis(1) ........ 1998 208,124 75,000 -- 65,529
President and Chief
Executive Officer 1997 2,596 -- 400,000 --
1996 -- -- -- --
Geoffrey Rhoads(2) .... 1998 123,542 75,000 -- --
Chief Technology
Officer 1997 90,101 -- -- --
1996 78,700 -- -- 302,505
J. Scott Carr ......... 1998 109,167 45,000 -- --
Vice President and
General Manager-- 1997 90,000 -- 50,000 --
Secure Documents 1996 55,625 -- 60,000 --
</TABLE>
- --------
(1) The $65,529 of other compensation represents reimbursement for relocation
expenses.
(2) In July 1996, Geoffrey Rhoads and his spouse granted us, for a one-time
cash payment of $217,505.30, an option to purchase a maximum of 701,630
shares of our common stock owned by them at an exercise price of $0.01 per
share. The number of shares subject to the option lapsed on a monthly
basis, and the option could only be exercised by us upon Mr. Rhoads'
voluntary departure or his termination for cause. As of July 30, 1999, our
rights under this option lapsed. In July 1996, we repurchased 170,000
shares of our common stock from Mr. Rhoads for an aggregate purchase price
of $85,000.
Aggregate Option Exercises in Last Fiscal Year and
Fiscal Year-End Values
The following table provides summary information, as to the named executive
officers, concerning stock options exercised during 1998 and the number of
shares subject to both exercisable and unexercisable stock options as of
December 31, 1998. The value of unexercised options at year-end is based on an
assumed fair market value of our common stock at December 31, 1998 of $0.50 per
share less the exercise price.
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Options at In-the-Money Options at
Shares Fiscal Year-End (#) Fiscal Year-End ($)(1)
Acquired on Value ------------------------- -------------------------
Name Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- ------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Bruce Davis............. -- -- 100,000 300,000 0 0
Geoffrey Rhoads......... -- -- -- -- -- --
J. Scott Carr........... -- -- 66,664 43,336 17,500 3,500
</TABLE>
- --------
(1) Fair market value as of December 31, 1998 was determined by the board of
directors, and is based upon its assessment of our overall business,
business prospects and financial condition at that time. The board
considered, among other things, the illiquid nature of Digimarc's common
stock, the price paid for shares of preferred stock in arm's-length
transactions and Digimarc's financial performance and operating results at
that time.
51
<PAGE>
Employment Arrangements
In July 1999, we adopted a policy regarding the vesting of stock options for
all our officers, including prior grants. All shares subject to their options
that have not vested will immediately vest if the following two conditions are
met:
. we merge with another company and there is a change of control of our
company or we sell substantially all of our assets to another company;
and
. any officer's employment is terminated, or constructively terminated,
within twelve months thereafter.
Employee Benefit Plans
1995 Stock Incentive Plan
The 1995 plan was approved by our board of directors in October 1995 and by
our shareholders in March 1996. Initially, a total of 500,000 shares of common
stock were reserved for issuance under the 1995 plan. This reserve was amended
several times to reserve a total of 2,800,000 shares of common stock for
issuance under the plan. As of November 30, 1999, options to purchase
426,932 shares of common stock granted had been exercised, options to purchase
2,373,068 shares of common stock were outstanding and zero options to purchase
shares of common stock remained available for grant. The outstanding options
were exercisable at a weighted average exercise price of approximately $1.24
per share. Outstanding options to purchase an aggregate of 663,068 shares were
held by employees and consultants who are not officers or directors of our
company.
After the closing of this offering, all options granted under the 1995 plan
that expire without having been exercised or are cancelled will become
available for grant under the 1999 plan. The 1995 plan will terminate in 2005,
unless terminated earlier by our board of directors. Awards under the 1995 plan
may consist of restricted stock, incentive stock options, which are stock
options that qualify under Section 422 of the Internal Revenue Code, or non-
qualified stock options, which are stock options that do not qualify under that
provision.
The board may grant incentive stock options to employees, including officers
and directors who are employees. Non-qualified stock options and restricted
stock may be granted to employees, including officers and directors who are
employees, or consultants. The compensation committee may set the terms of such
grants, subject to the restrictions in the 1995 plan.
During an optionee's lifetime, only the optionee can exercise an option. The
optionee cannot transfer their options other than by will or the laws of
descent and distribution. If an optionee's status as an employee or consultant
terminates for any reason other than death or disability, the optionee may
exercise their exercisable options within the three-month period following the
termination. In the event the optionee becomes disabled or dies while the
optionee is an employee or consultant of our company, the options vested as of
the date of disability or death may be exercised prior to the earlier of their
expiration date or 12 months from the date of the optionee's disability or
death. In November 1997, we amended the plan to adjust certain exercise
periods, which affects all grants made after that time. Under this amendment,
the time to exercise after termination was reduced from three months to one
month and the time to exercise after death or disability was reduced from 12
months to four months.
In the event of a proposed sale of all or substantially all of our assets or
a merger by us with or into another company, every option outstanding under the
1995 plan may be assumed or substituted
52
<PAGE>
with an equivalent option by the successor company, or its parent or
subsidiary. However, our board of directors may determine, in lieu of
assumption or substitution, that an optionee is entitled to exercise their
options, including options which would not otherwise be exercisable within
thirty days of this determination by the board. Our officers' stock option
grant agreements provide for accelerated vesting of their options in the event
of a change of control. If we liquidate or dissolve, the options will terminate
immediately prior to the completion of the dissolution or liquidation. However,
our board may in its sole discretion declare that any option terminates on a
date fixed by the board and give the optionees the right to exercise their
options, including options which would not otherwise be exercisable.
The 1995 plan will terminate automatically in 2005 unless terminated earlier
by our board of directors. The board of directors has the authority to amend or
terminate the 1995 plan, subject to stockholder approval of certain amendments.
However, no action may be taken which will affect any shares of common stock
previously issued and sold or any option previously granted under the
1995 plan, without the optionee's consent. We do not anticipate granting
options under this plan after closing of this offering.
1999 Stock Incentive Plan
Our 1999 Stock Incentive Plan was approved by our board of directors on
October 6, 1999 and by our stockholders on November 22, 1999. After the
completion of this offering, we anticipate all further option grants will be
made solely under the 1999 Stock Incentive Plan. Initially, we reserved
1,500,000 shares of our common stock for issuance under the 1999 Stock
Incentive Plan. The number of shares initially reserved will be increased by
the number of shares reserved under our 1995 Stock Incentive Plan and available
for grant as of the date of the closing of this offering, and represented by
awards under the 1995 Stock Incentive Plan that are forfeited, expire or are
cancelled following the adoption of the 1999 Stock Incentive Plan. Commencing
on the first day of our fiscal year beginning in 2001, the number of shares of
stock reserved for issuance under the 1999 Stock Incentive Plan will be
increased annually by a number equal to the lesser of 3% of the fully-diluted
number of shares outstanding as of that date or a lesser number of shares
determined by the board. However, the maximum number of shares available for
issuance as incentive stock options shall be increased by the lesser of
625,000 shares, 3% of the number of fully-diluted shares outstanding as of that
date or a lesser number of shares determined by the board.
Zero options to purchase shares of our common stock under the 1999 Stock
Incentive Plan have been exercised, 157,643 options to purchase shares of
common stock are outstanding, and options to purchase 1,342,357 shares of
common stock remained available for grant prior to this offering. The
outstanding options were exercisable at a weighted average exercise price of
$2.50 per share. Outstanding options to purchase an aggregate of 157,643 shares
were held by employees and consultants who are not officers or directors of our
company.
The purpose of the 1999 Stock Incentive Plan is to attract and retain the
best available personnel, to provide additional incentive to our employees,
directors and consultants and our related entities and to promote the success
of our business. The 1999 Stock Incentive Plan provides for the granting to
employees of incentive stock options, and the granting to our employees,
directors and consultants and our related entities of non-statutory stock
options, stock appreciation rights, dividend equivalent rights, restricted
stock, performance units, performance shares and other equity-based rights.
53
<PAGE>
Under the 1999 Stock Incentive Plan, our board of directors, or a committee
designated by the board made up of two or more non-employee directors,
administers the granting of stock and options to directors and officers in a
way that allows these grants of stock to be exempt from Section 16(b) of the
Securities Exchange Act and determines the provisions, terms and conditions of
each award. When stock or options are granted to other participants in the 1999
Stock Incentive Plan, our board, or a committee designated by our board
administers these awards and determines the provisions, terms and conditions of
each award.
During their lifetime, those who hold the incentive stock options granted
under this plan cannot transfer these options. The options may be distributed
by a will or the laws of descent upon the death of the option holder. No one is
allowed to exercise the incentive stock options except the person to whom the
options were first issued while that person is alive. Stock or options other
than incentive stock options which are issued under the 1999 Stock Incentive
Plan can be transferred to the extent agreed upon at the time of the award.
The term of 1999 Stock Incentive Plan awards will be determined by the board.
The exercise price or purchase price, if any, of 1999 Stock Incentive Plan
awards that are not incentive stock options will be determined by the board,
but will not be less than 50% of the fair market value of the stock. The form
of payment for the shares of common stock when options are exercised or stock
is purchased under a 1999 Stock Incentive Plan award will be determined by the
board and may include cash, check, shares of common stock or the assignment of
part of the proceeds from the sale of shares acquired upon exercise or purchase
of the award.
Where the award agreement permits the exercise or purchase of an award for a
period of time following the recipient's termination of service with us,
disability or death, that award will terminate to the extent not exercised or
purchased on the last day of the specified period or the last day of the
original term of the award, whichever occurs first.
If a third party acquires us through the purchase of all or substantially all
of our assets, a merger or other business combination, all unexercised options
will terminate unless assumed by the successor corporation. Unless terminated
sooner, the 1999 Stock Incentive Plan will terminate automatically in 2009. The
board has the authority to amend, suspend or terminate the 1999 Stock Incentive
Plan, subject to stockholder approval of certain amendments. However, no action
may be taken which will affect awards previously granted under the 1999 Stock
Incentive Plan unless agreed to by the affected grantees.
1999 Non-Employee Director Option Program
Our 1999 Non-Employee Director Option Program was adopted as part of to the
1999 Stock Incentive Plan and is subject to the terms and conditions of the
1999 Stock Incentive Plan. Our 1999 Non-Employee Director Stock Option Program
was approved by our board of directors on October 6, 1999. The 1999 Non-
Employee Director Stock Option Program is effective as of the effective date of
this prospectus, and no awards will be made under this program until that time.
The purpose of the 1999 Non-Employee Director Stock Option Program is to
enhance our ability to attract and retain the best available non-employee
directors, to provide them additional incentives and, therefore, to promote the
success of our business.
The 1999 Non-Employee Director Stock Option Program establishes an automatic
option grant program for the grant of awards to non-employee directors. Under
this program, each then-existing
54
<PAGE>
non-employee director upon the effective date of this prospectus and each non-
employee director first elected to our board of directors following the closing
of this offering will automatically be granted an option to acquire 10,000
shares of our common stock at an exercise price per share equal to the fair
market value of our common stock at the date of grant. These options will vest
and become exercisable in four equal installments on each anniversary of the
grant date. Upon the date of each annual stockholders' meeting, each non-
employee director who has been a member of our board of directors for at least
six months prior to the date of the stockholders' meeting will receive an
automatic grant of options to acquire 2,500 shares of our common stock at an
exercise price equal to the fair market value of our common stock at the date
of grant. These options will vest and become fully exercisable on the first
anniversary of the grant date.
The term of each automatic option grant and the extent to which it will be
transferable will be provided in the agreement evidencing the option. The
consideration for the option may consist of cash, check, shares of our common
stock, the assignment of part of the proceeds from the sale of shares acquired
upon exercise of the option or any combination.
The 1999 Non-Employee Director Stock Option Program is administered by the
board or a committee designated by the board made up of two or more non-
employee directors so that such awards would be exempt from Section 16(b) of
the Exchange Act. The program administrator shall determine the terms and
conditions of awards, and construe and interpret the terms of the program and
awards granted under the program. Non-employee directors may also be granted
additional incentives, subject to the discretion of the board or the committee.
Unless terminated sooner, the 1999 Non-Employee Director Stock Option Program
will terminate automatically in 2009 when the 1999 Stock Incentive Plan
terminates. Our board of directors has the authority to amend, suspend or
terminate the 1999 Non-Employee Director Stock Option Program provided that no
such action may affect awards to non-employee directors previously granted
under the program unless agreed to by the affected non-employee directors.
1999 Employee Stock Purchase Plan
Our 1999 Employee Stock Purchase Plan was approved by our board of directors
on October 6, 1999 and by our stockholders on November 22, 1999. The
1999 Employee Stock Purchase Plan is intended to qualify as an "employee stock
purchase plan" under Section 423 of the Internal Revenue Code in order to
provide our employees with an opportunity to purchase common stock through
payroll deductions. The 1999 Employee Stock Purchase Plan will be administered
by our board of directors or a committee designated by our board, which will
have the authority to terminate or amend the 1999 Employee Stock Purchase Plan,
subject to specified restrictions, and otherwise to administer the
1999 Employee Stock Purchase Plan and to resolve all questions relating to its
administration.
Initially, we reserved 625,000 shares of our common stock for issuance and
made them available for purchase under the 1999 Employee Stock Purchase Plan,
subject to adjustment in the event of a stock split, stock dividend or other
similar change in our common stock or our capital structure. Commencing on the
first day of our fiscal year beginning in 2001, the number of shares of stock
reserved for issuance under this plan will be increased annually by a number
equal to the lesser of 1% of the fully-diluted number of shares outstanding as
of that date, 250,000 shares or a lesser number of shares determined by the
board.
All employees of our company and of our subsidiaries whose customary
employment is for more than five months in any calendar year and 20 hours or
more per week are eligible to participate
55
<PAGE>
in our 1999 Employee Stock Purchase Plan. Employees hired after the closing of
this offering are eligible to participate in our 1999 Employee Stock Purchase
Plan, subject to a ten-day waiting period after hiring. Non-employee directors,
consultants and employees subject to the rules or laws of a foreign
jurisdiction that prohibit or make impractical their participation in the
1999 Employee Stock Purchase Plan are not eligible to participate in our 1999
Employee Stock Purchase Plan.
The 1999 Employee Stock Purchase Plan designates the periods when the stock
is offered, when it can be purchased, and the exercise dates for options. Offer
periods are generally overlapping periods of 24 months. The initial offer
period begins on the effective date of this prospectus, and ends on January 31,
2002. Additional offer periods will commence each December 1 and June 1.
Purchase periods are generally six-month periods, with the initial purchase
period commencing on the effective date of this prospectus and ending on May
31, 2000. After the effective date of this prospectus, purchase periods will
commence each December 1 and June 1. Exercise dates are the last day of each
purchase period. If we merge with or into another corporation, sell all or
substantially all of our assets or enter into other transactions in which our
shareholders before the transaction own less than 50% of the total combined
voting power of our outstanding securities following the transaction, the board
may elect to shorten the offer period then in progress.
On the first day of each offer period, a participating employee is granted a
purchase right. A purchase right is a form of option to be exercised
automatically on the forthcoming exercise dates within the offer period. During
the offer period, authorized deductions from the pay of participants are
credited to their accounts under the 1999 Employee Stock Purchase Plan. When
the purchase right is exercised, the participant's withheld salary is used to
purchase shares of common stock. The price per share at which shares of common
stock are to be purchased under the 1999 Employee Stock Purchase Plan during
any purchase period is the lesser of 85% of the fair market value of the common
stock on the date of the grant of the option, which is the beginning of the
offer period, or 85% of the fair market value of the common stock on the
exercise date. The participant's purchase right is exercised in this manner on
each exercise date arising in the offer period unless, on the first day of any
purchase period, the fair market value of the common stock is lower than the
fair market value of the common stock on the first day of the offer period. If
it is, the participant's participation in the original offer period is
terminated, and the participant is automatically enrolled in the new offer
period effective the same date with an exercise price equal to the fair market
value of the stock on the first day of the new offer period.
Payroll deductions may range from 1% to 15% in whole percentage increments of
a participant's regular base pay, including cash payments for commissions,
overtime, bonuses, annual awards and other cash incentive payments.
Participants may not make direct cash payments to their accounts. The maximum
number of shares of common stock that any employee may purchase under the 1999
Employee Stock Purchase Plan during a purchase period is 750 shares. The
Internal Revenue Code imposes additional limitations on the amount of common
stock that may be purchased during any calendar year.
401(k) Plan
In 1997, we implemented a 401(k) Plan covering certain of our employees who
are at least 21 years old and have been employed at least four months. Pursuant
to the 401(k) Plan, eligible employees may elect to reduce their current
compensation by up to the lesser of 15% of their compensation or the prescribed
annual limit ($10,000 in 1999) and contribute these amounts to the 401(k) Plan.
We may make contributions to the 401(k) Plan on behalf of eligible employees.
56
<PAGE>
Employees become 25% vested in these contributions after one year of service,
and increase their vested percentages by an additional 25% for each year of
additional service. The 401(k) Plan is intended to qualify under Section 401 of
the Internal Revenue Code so that contributions by employees or by us to the
401(k) Plan, and income earned on the 401(k) Plan contributions, are not
taxable to employees until withdrawn from the 401(k) Plan, and so that
contributions by us, if any, will be deductible by us when made. The trustee
under the 401(k) Plan, at the direction of each participant, invests the 401(k)
Plan employee salary deferrals in selected investment options. We made no
contributions to the 401(k) Plan in 1995, 1996, 1997 or 1998. We do not
presently expect to make any contributions to the 401(k) Plan during fiscal
1999.
Limitation of Liability and Indemnification Matters
We reincorporated in the State of Delaware on December 1, 1999. Our
certificate of incorporation and bylaws provide that we will indemnify all
directors and officers of Digimarc to the fullest extent permitted by Delaware
law. Our certificate of incorporation and bylaws also authorize us to indemnify
our employees and other agents, at our option, to the fullest extent permitted
by Delaware law. We intend to enter into agreements to indemnify our directors
and officers, in addition to indemnification provided for in our charter
documents. These agreements, among other things, will provide for the
indemnification of our directors and officers for certain expenses (including
attorneys' fees), judgments, fines and settlement amounts incurred by any such
person in any action or proceeding, including any action by or in the right of
Digimarc, arising out of such person's services as a director or officer of
Digimarc or any other company or enterprise to which such person provides
services at the request of Digimarc to the fullest extent permitted by
applicable law. We believe that these provisions and agreements will assist us
in attracting and retaining qualified persons to serve as directors and
officers.
Delaware law permits a corporation to provide in its certificate of
incorporation that a director of the corporation shall not be personally liable
to the corporation or its stockholders for monetary damages for breach of
fiduciary duty as a director, except for liability for any breach of the
director's duty of loyalty to the corporation or its stockholders, for acts or
omissions not in good faith or which involve intentional misconduct or a
knowing violation of law for liability arising under Section 174 of the General
Corporation Law of the State of Delaware, or for any transaction from which the
director derived an improper personal benefit. Our certificate of incorporation
provides for the elimination of personal liability of a director for breach of
fiduciary duty, as permitted by Delaware law.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of Digimarc in
accordance with the provisions contained in our charter documents, Delaware law
or otherwise, we have been advised that in the opinion of the Securities and
Exchange Commission this indemnification is against public policy as expressed
in the Securities Act and is, therefore, unenforceable. If a claim for
indemnification against such liabilities (other than the payment by Digimarc of
expenses incurred or paid by a director, officer or controlling person of
Digimarc in the successful defense of any action, suit, or proceeding) is
asserted by such director, officer or controlling person, we will, unless in
the opinion of our counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by us is against public policy as expressed in the
Securities Act and we will follow the court's determination.
We purchased and maintain insurance on behalf of our officers and directors,
insuring them against liabilities that they may incur in such capacities or
arising out of such status.
57
<PAGE>
RELATED PARTY TRANSACTIONS
Reincorporation
We reincorporated in Delaware on December 1, 1999 and our existing
stockholders received shares of common stock and preferred stock of the
Delaware corporation in exchange for their shares of common stock and preferred
stock of the Oregon corporation. In connection with the closing of this
offering, each share of Series A and Series B preferred stock will
automatically convert into two shares of common stock and each share of Series
C, Series D and Series D-X preferred stock will automatically convert into one
share of common stock.
Private Placement Transactions
Since our inception, we have issued in private placement transactions shares
of preferred stock as follows:
. an aggregate of 151,411 shares of Series A-1 preferred stock at $2.50 per
share in June 1996 to eight investors;
. an aggregate of 11,089 shares of Series A-1 preferred stock at $4.50 per
share in June 1996 to two investors;
. an aggregate of 902,000 shares of Series B-1 preferred stock at $5.00 per
share in July 1996 to seven investors, including Adobe Ventures L.P., AVI
Capital L.P. and affiliates whose general partner, Brian Grossi, is a
member of our board of directors, Justsystem, Inc. and Softbank Ventures,
Inc.;
. an aggregate of 2,029,786 shares of Series C-1 preferred stock at $2.86
per share in December 1997 to 16 investors, including Philip Monego, Sr.,
chairman of our board of directors, Adobe Ventures L.P., AVI Capital L.P.
and affiliates, Macrovision Corporation, Reuters, Ltd., a general manager
of which is John Taysom, a member of our board of directors, and
Justsystem, Inc.;
. an aggregate of 1,266,000 shares of Series D preferred stock at $5.00 per
share in June 1999 to 14 investors, including Philip Monego, Sr., Adobe
Ventures L.P., AVI Capital L.P. and affiliates, Macrovision Corporation
and Reuters Holdings Switzerland, S.A.; and
. an aggregate of 160,000 shares of Series D-X preferred stock at $5.00 per
share in August 1999 to three investors, including Philip Monego, Sr.
The following table sets forth the number of shares of Series A-1, Series B-
1, Series C-1, Series D and Series D-X preferred stock purchased by our
directors, five percent stockholders and their respective affiliates.
<TABLE>
<CAPTION>
Series A-1* Series B-1* Series C-1 Series D Series D-X
Holders Preferred Preferred Preferred Preferred Preferred
- ------- ----------- ----------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C>
Macrovision
Corporation............ -- -- 524,475 400,000 --
Reuters Group........... -- -- 699,300 200,000 --
AVI Capital L.P. and
affiliates............. -- 252,000 233,549 150,000 --
Adobe Ventures L.P...... -- 250,000 231,692 115,000 --
Philip Monego, Sr....... 16,000 -- 34,965 50,000 40,000
Justsystem, Inc......... -- 200,000 87,412 -- --
Softbank Ventures,
Inc.................... -- 200,000 -- -- --
</TABLE>
- --------
* Each share of Series A-1 and Series B-1 Preferred converts into two shares of
common stock.
58
<PAGE>
Investors' Rights Agreement
Certain holders of common stock and preferred stock have registration rights
with respect to their shares of common stock, including common stock issuable
upon conversion of their preferred stock. See "Description of Capital Stock--
Registration Rights of Certain Holders."
Transactions with Directors and Executive Officers
In July 1996, we repurchased 170,000 shares of our common stock from Mr.
Rhoads for an aggregate purchase price of $85,000, which was the same price as
the exercise price of stock options granted to other purchasers at
approximately the same time.
See "Management--Executive Compensation" for a description of stock
transactions entered into with our directors and executive officers.
Transactions with Affiliates
In September 1996, we entered into a software development and distribution
agreement with Adobe Systems Incorporated. Under that agreement, we granted a
non-exclusive license to Adobe for the use of our licensed software to be
bundled with Adobe products in exchange for a one-time engineering fee of
$100,000 for the development and license of the software.
We believe that all of the transactions set forth above were made on terms no
less favorable to us than could have been obtained from unaffiliated third
parties. We intend that all future transactions, including loans, between us
and our officers, directors, principal shareholders and their affiliates will
be approved by the board of directors, including a majority of the
disinterested outside directors on the board of directors, and will be on terms
no less favorable to us than could be obtained from unaffiliated third parties.
59
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth the beneficial ownership of our common stock
as of November 30, 1999 and as adjusted to reflect the sale of the shares of
common stock in this offering by:
. each person or entity known by us to own beneficially more than five
percent of our common stock;
. our chief executive officer, each of the other named executive officers
and each of our directors; and
. all of our executive officers and directors as a group.
The beneficial ownership is calculated based on 8,013,255 shares of our
common stock outstanding as of November 30, 1999 and 12,013,255 shares
immediately following the closing of this offering. Beneficial ownership is
determined in accordance with the rules of the Securities and Exchange
Commission and generally includes voting or investment power with respect to
securities. Unless otherwise indicated, each person or entity named in the
table has sole voting power and investment power, or shares voting and
investment power with his or her spouse, with respect to all shares of capital
stock listed as owned by that person. Shares issuable upon the exercise of
options that are currently exercisable or become exercisable within sixty days
of November 30, 1999 are considered outstanding for the purpose of calculating
the percentage of outstanding shares of our common stock held by the
individual, but not for the purpose of calculating the percentage of
outstanding shares of our common stock held by any other individual.
The address of each of the executive officers and directors is c/o Digimarc
Corporation, 19801 S.W. 72nd Avenue, Tualatin, Oregon 97062.
<TABLE>
<CAPTION>
Percentage of Shares
Beneficially Owned
Number of -------------------------
Shares Beneficially Prior to After
Name and Address Owned the Offering the Offering
- ---------------- ------------------- ------------ ------------
<S> <C> <C> <C>
5% Stockholders
Macrovision Corporation .... 924,475 11.5% 7.7%
1341 Orleans Drive
Sunnyvale, California 94089
Reuters Group PLC(1)........ 899,300 11.2% 7.5%
c/o Reuters Ltd.
85 Fleet Street
London, EC4P 4AJ
England
AVI Capital Management L.P.
and affiliates(2).......... 887,549 11.1% 7.4%
One First Street
Los Altos, California 94022
Adobe Systems
Incorporated(3) ........... 507,189 6.3% 4.2%
c/o Adobe Incentive
Partners
345 Park Avenue
San Jose, California 95110
Justsystem Corporation(4)... 487,412 6.1% 4.1%
c/o Justsystem, Inc.
2460 Sand Hill Road,
Suite 201
Menlo Park, California
94025
Softbank Corp.(5)........... 400,000 5.0% 3.3%
c/o Softbank Ventures, Inc.
333 West San Carlos Avenue,
Suite 1225
San Jose, California 95110
</TABLE>
60
<PAGE>
<TABLE>
<CAPTION>
Percentage of Shares
Beneficially Owned
Number of -------------------------
Shares Beneficially Prior to After
Name and Address Owned the Offering the Offering
- ---------------- ------------------- ------------ ------------
<S> <C> <C> <C>
Named Executive Officers
and Directors
Philip J. Monego, Sr.(6)... 246,965 3.0% 2.0%
Bruce Davis(7)............. 200,000 2.4% 1.6%
Geoffrey Rhoads(8)......... 749,780 9.4% 6.2%
J. Scott Carr(9)........... 90,203 1.1% 0.7%
Brian J. Grossi(10)........ 887,549 11.1% 7.4%
John Taysom(11)............ 899,300 11.2% 7.5%
All executive officers and
directors as a group (6
persons)(12).............. 3,073,797 36.8% 24.9%
</TABLE>
- --------
* Less than 1%.
(1) Represents 699,300 shares held by Reuters, Ltd. and 200,000 shares held by
Reuters Holdings Switzerland, S.A., affiliates of Reuters Group PLC.
(2) Brian Grossi is a partner of AVI Capital Management, L.P. and of AVI
Management Partners III, L.P. The shares listed represent 754,531 shares
held by AVI Capital, L.P., 104,325 shares held by Associated Venture
Investors III, L.P., 21,452 shares held by AVI Partners Growth Fund II,
L.P. and 7,241 shares held by AVI Silicon Valley Partners, L.P. AVI
Capital Management, L.P. is the general partner of AVI Capital, L.P., and
AVI Management Partners III, L.P. is the general partner of Associated
Ventures Investors III, L.P., AVI Partners Growth Fund II, L.P. and AVI
Silicon Valley Partners, L.P. In such capacity, AVI Capital Management.
L.P. and AVI Management Partners III, L.P., through a committee comprised
of all of their partners, exercises sole voting and investment power with
respect to all shares held of record by the respective named investment
partnerships; individually, no partner of AVI Capital Management, L.P. or
of AVI Management Partners III, L.P., is deemed to have or share such
voting or investment power.
(3) Represents 507,189 shares held by Adobe Incentive Partners. Adobe Systems
Incorporated is the general partner of Adobe Incentive Partners.
(4) Represents 487,412 shares held by Justsystem, Inc., a subsidiary of
Justsystem Corporation.
(5) Represents 400,000 shares held by Softbank Ventures, Inc., a subsidiary of
Softbank Corp.
(6) Includes options for 90,000 shares of common stock exercisable within 60
days of November 30, 1999.
(7) Includes options for 160,000 shares exercisable within 60 days of November
30, 1999 and 5,000 shares owned by Gary and Kimberly Davis, 5,000 shares
owned by Joseph and Barbara Davis, 5,000 shares owned by Thomas and Donna
Davis, 5,000 shares owned by George and Candace Richard, 5,000 shares
owned by John and Halene Richard, 5,000 shares owned by Robert Bradford,
Jr. and Grace Richard, 5,000 shares owned by Robert Bradford III and Darcy
Richard and 5,000 shares owned by Gary and Karen Gorney, all of whom are
relatives of Bruce Davis. Mr. Davis disclaims beneficial ownership of
these shares owned by his relatives.
(8) Includes 13,000 shares owned by Amanda Rhoads Trust, 13,000 shares owned
by Hudson Rhoads Trust, 1,050 shares owned by Craig and Laura Mikkelson,
10,210 shares owned by Barbara K. Rhoads, 850 shares owned by Bryan Gurrie
Rhoads, 950 shares owned by Cynthia Brooke Rhoads, 44,740 shares owned by
Gurrie and Alice Rhoads, 100 shares owned by Nicole Rhoads--Trustee for
the Children of Geoffrey and Nicole Rhoads, 13,000 shares owned by Trevor
Rhoads Trust, 750 shares owned by Mittie Hellmich, 750 shares owned by
Taylor James Pierce and 750 shares owned by Dirk Pierce, all of whom are
relatives of Geoffrey Rhoads or trusts established for their benefit. Mr.
Rhoads disclaims beneficial ownership of these shares owned by his
relatives.
(9) Represents options for 90,203 shares of common stock exercisable within 60
days of November 30, 1999.
(10) Represents shares held by AVI Capital L.P. and affiliates of which Mr.
Grossi is a general partner. Mr. Grossi disclaims beneficial ownership of
these shares except to the extent of his pecuniary interest as a general
partner.
(11) Represents shares held by Reuters Group. Mr. Taysom disclaims beneficial
ownership of these shares.
(12) Includes options for 340,203 shares of common stock exercisable within 60
days of November 30, 1999.
61
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Following the closing of this offering, our authorized capital stock will
consist of 30,000,000 shares of common stock and 5,000,000 shares of
undesignated preferred stock. The following description of our capital stock is
subject to, and qualified in its entirety by, the provisions of our certificate
of incorporation and bylaws, which are included as exhibits to the registration
statement of which this prospectus is a part, and by the provisions of
applicable law.
Common Stock
As of November 30, 1999, there were 2,428,469 shares of common stock
outstanding that were held of record by approximately 96 shareholders. Based on
the shares outstanding as of November 30, 1999, there will be 12,013,255 shares
of common stock outstanding, assuming no exercise of the underwriters' over-
allotment option and no exercise of outstanding options, after giving effect to
the sale of the common stock we are offering.
The holders of our common stock are entitled to one vote for each share held
of record on all matters submitted to a vote of the stockholders, including the
election of directors. Subject to preferences that may be granted to any then
outstanding preferred stock, holders of common stock are entitled to receive
ratably those dividends as may be declared by the board of directors out of
funds legally available for such purpose, as well as any distributions to the
stockholders. In the event of our liquidation, dissolution or winding up,
holders of common stock are entitled to share ratably in all of our assets
remaining after payment of liabilities and the liquidation preference of any
then outstanding preferred stock. Holders of common stock have no preemptive or
other subscription or conversion rights. There are no redemption or sinking
fund provisions applicable to the common stock. All outstanding shares of
common stock are fully paid and non-assessable.
Preferred Stock
As of November 30, 1999, there were 4,520,286 shares of preferred stock
outstanding and held of record by 26 stockholders. In connection with the
closing of this offering, all outstanding shares of Series A and Series B
preferred stock will automatically be converted into common stock on a two-for-
one basis, and all outstanding shares of Series C, Series D and Series D-X
preferred stock will automatically be converted into common stock on a one-for-
one basis, and all these shares of preferred stock will be cancelled. As of
December 1, 1999, we are authorized to issue 5,000,000 shares of preferred
stock that will not be designated as a particular class. Our board of directors
has the authority to issue the undesignated preferred stock in one or more
series and to determine the powers, preferences and rights and the
qualifications, limitations or restrictions granted to or imposed upon any
wholly unissued series of undesignated preferred 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 stockholders. The issuance of preferred stock may
have the effect of delaying, deferring or preventing a change of control of our
company without further action by the stockholders and may adversely affect the
voting and other rights of the holders of common stock. At present, we have no
plans to issue any shares of preferred stock.
Registration Rights of Certain Holders
After the closing of this offering, and assuming we comply with other
requirements, the holders of approximately 5,584,786 shares of common stock
will have the right to cause us to register their
62
<PAGE>
shares under the Securities Act. These rights are held under the terms of an
investors' rights agreement between us and the holders of these registrable
securities. Under the terms of this agreement, if we propose to register any of
our securities under the Securities Act, we must give the holders of these
registrable securities 30 days' prior notice of registration and include a
portion of their shares of common stock in the registration. Additionally, upon
written demand of holders of more than 50% of the then-outstanding registrable
securities, we will use our best efforts to promptly register the securities
that the holders request to be registered, provided, among other limitations,
that the aggregate offering price to the public exceeds $10 million. We are not
required to register securities more than twice under the holders' rights to
demand these registrations. We will be required to file a registration
statement on form S-3 or any similar short-form registration statement if
requested to do so by any of these holders, provided that the aggregate
offering price for the securities to be sold is more than $1,000,000.
Furthermore, we are only required to effect one demand registration on form S-3
within any 12-month period. The holders cannot demand that we file a
registration statement prior to the date 180 days following the effective date
of any registration statement filed by us.
All expenses in effecting these registrations will be borne by us, excluding
underwriting discounts, selling commissions and stock transfer taxes, which
shall be borne proportionately by the holders of the securities that have been
registered. These registration rights are subject to conditions and
limitations, among them the right of the underwriters of an offering to limit
the number of shares included in the registration. We have agreed to indemnify
the holders of these registration rights, and each selling holder has agreed to
indemnify us, against liabilities under the Securities Act, the Securities
Exchange Act or other applicable federal or state law.
Anti-Takeover Provisions
Delaware Takeover Statute
We are subject to the provisions of Section 203 of the Delaware General
Corporation Law, as amended from time to time. Section 203 provides, with
certain exceptions, that a publicly-held corporation is prohibited from
engaging in a "business combination" with an "interested stockholder" for a
period of three years after the date of the transaction in which the person
became an interested stockholder, unless:
. prior to such date, the board of directors of the corporation approved
either the business combination or the transaction that resulted in the
stockholder becoming an interested stockholder; or
. upon consummation of the transaction that resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the time
the transaction commenced, excluding for purposes of determining the
number of shares outstanding those shares owned by persons who are
directors and also officers, and by employee stock plans in which
employee participants do not have the right to determine confidentially
whether shares held subject to the plan will be tendered in a tender or
exchange offer; or
. at or subsequent to such date, the business combination is approved by
the board of directors and authorized at an annual or special meeting of
stockholder, and not by written consent, by the affirmative vote of at
least 66 2/3% of the outstanding voting stock that is not owned by the
interested stockholder.
63
<PAGE>
A "business combination" includes the following:
. any merger or consolidation involving the corporation and the interested
stockholder;
. any sale, transfer, pledge or other disposition of 10% or more of the
assets of the corporation involving the interested stockholder;
. subject to certain exceptions, any transaction that results in the
issuance or transfer by the corporation of any stock of the corporation
to the interested stockholder;
. any transaction involving the corporation that has the effect of
increasing the proportionate share of the stock of any class or series of
the corporation beneficially owned by the interested stockholder; or
. the receipt by the interested stockholder of the benefit of any loans,
advances, guarantees, pledges or other financial benefits provided by or
through the corporation.
Subject to certain exceptions, an "interested stockholder" is a person who,
together with affiliates and associates, owns, or within three years did own,
15% or more of the corporation's voting stock. The Delaware takeover statute
may render the removal of directors and management more difficult.
Certificate of Incorporation and Bylaws
Our certificate of incorporation and bylaws contain provisions that could
have the effect of discouraging potential acquisition proposals or making a
tender offer or delaying or preventing a change in control of Digimarc. In
particular, our certificate of incorporation and bylaws, as applicable, among
other things:
. Provide that our board of directors will be divided into three classes of
directors (disregarding the effect of any voting rights of holders of
convertible preferred stock), as nearly equal in number as is reasonably
possible, serving staggered terms so that directors' initial terms will
expire at the first, second and third succeeding annual meeting of the
stockholders following our initial public offering, respectively. At each
succeeding annual meeting, directors elected to succeed those directors
whose terms are expiring at that meeting shall be elected for a three-
year term of office. A vote of at least 80% of our capital stock is
required to amend this provision.
. Provide that special meetings of the stockholders may be called only by
our president, by our secretary or at the direction of the board. Advance
written notice is required, which generally must be received by the
secretary not less than 30 days nor more than 60 days prior to the
meeting, by a stockholder of a proposal or director nomination which that
stockholder desires to present at a meeting of stockholders. Any
amendment of this provision requires a vote of at least 80% of our
capital stock.
. Do not include a provision for cumulative voting in the election of
directors. Under cumulative voting, a minority stockholder holding a
sufficient number of shares may be able to ensure the election of one or
more directors. The absence of cumulative voting may have the effect of
limiting the ability of minority stockholders to effect changes in the
board and, as a result, may have the effect of deterring a hostile
takeover or delaying or preventing changes in control or management of
Digimarc.
. Provide that vacancies on our board may be filled by a majority of
directors in office, although less than a quorum, and not by the
stockholders.
64
<PAGE>
. Allow us to issue up to 5,000,000 shares of undesignated preferred stock
with rights senior to those of the common stock and that otherwise could
adversely affect the rights and powers, including voting rights, of the
holders of common stock. In certain circumstances, this issuance could
have the effect of decreasing the market price of the common stock, as
well as having the anti-takeover effect discussed above.
These provisions are intended to enhance the likelihood of continuity and
stability in the composition of our board and in the policies formulated by
them, and to discourage certain types of transactions that may involve an
actual or threatened change in control of Digimarc. These provisions are
designed to reduce our vulnerability to an unsolicited acquisition proposal and
to discourage certain tactics that may be used in proxy fights. However, these
provisions could have the effect of discouraging others from making tender
offers for our shares that could result from actual or rumored takeover
attempts. These provisions also may have the effect of preventing changes in
our management.
Transfer Agent and Registrar
The transfer agent and registrar for our common stock is EquiServe. Its
address is: 150 Royale Street, Canton, Massachusetts 02021, its telephone
number is (781) 575-3400, and its website is www.equiserve.com.
65
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Excluding the 4,000,000 shares of common stock offered hereby (which will be
freely tradable except if held by our "affiliates" as defined in Rule 144 of
the Securities Act) and assuming no exercise of the underwriters' over-
allotment option, as of the effective date of the registration statement, there
will be 8,013,255 shares of common stock outstanding, all of which are
"restricted" shares under the Securities Act. 7,430,856 of the restricted
shares are subject to lock-up agreements with the underwriters where the
holders of the restricted shares have agreed not to sell, pledge or otherwise
dispose of such shares for a period of 180 days after the date of this
prospectus. BancBoston Robertson Stephens Inc. may release the shares subject
to the lock-up agreements in whole or in part at any time with or without
notice. However, BancBoston Robertson Stephens Inc. has no current plans to do
so.
The following table indicates approximately when the 8,013,255 shares of our
common stock that are not being sold in the offering but that will be
outstanding at the time the offering is complete will be eligible for sale in
the public market:
<TABLE>
<CAPTION>
Eligibility of Restricted Shares for Sale in Public Market
----------------------------------------------------------
<S> <C>
At effective date................................................. 480,427
90 days after effective date...................................... 59,920
180 days after effective date..................................... 7,430,856
More than 181 days after effective date upon expiration of the
one-year holding periods applicable to those shares.............. 42,054
</TABLE>
Approximately 2,679,184 of the restricted shares that will become available
for sale in the public market beginning 180 days after the effective date will
be subject to the volume and other resale restrictions of Rule 144 because the
holders are affiliates of Digimarc. In general, a person who has beneficially
owned restricted shares for at least one year, will be entitled to sell in any
three-month period a number of shares that does not exceed the greater of
. 1% of the then outstanding shares of the common stock, approximately
120,133 shares immediately after this offering, or
. the average weekly trading volume during the four calendar weeks
preceding the date on which notice of the sale is filed with the SEC.
Sales made in accordance with Rule 144 are subject to requirements relating
to manner of sale, notice and availability of current public information about
Digimarc. A person who is not deemed to have been an affiliate of Digimarc at
any time during the 90 days immediately preceding the sale and who has
beneficially owned his or her shares for at least two years is entitled to sell
such shares in accordance with Rule 144(k) without regard to the limitations
described above.
Any employee, officer or director of or consultant to Digimarc who purchased
his or her shares prior to the Effective Date or who holds vested options as of
that date under a written compensatory plan or contract is entitled to rely on
the resale provisions of Rule 701, which permits non-affiliates to sell their
Rule 701 shares without having to comply with the public-information, holding-
period, volume-limitation or notice provisions of Rule 144 and permits
affiliates to sell their Rule 701 shares without having to comply with Rule
144's holding-period restrictions, in each case commencing 90 days after the
Effective Date. However, we and our officers, directors and a majority of our
other stockholders have agreed not to sell or otherwise dispose of any shares
of our common stock for the
66
<PAGE>
180-day period after the date of this prospectus without the prior written
consent of the underwriters. See "Underwriting."
As soon as practicable after the effective date of this prospectus, we intend
to file a registration statement on Form S-8 under the Securities Act to
register the 4,925,000 shares of common stock reserved for issuance under the
1995 stock incentive plan, the 1999 stock incentive plan and the 1999 employee
stock purchase plan, thus permitting the resale of such shares by non-
affiliates in the public market without restriction under the Securities Act.
As of September 30, 1999, options to purchase 2,255,961 shares of common stock
were outstanding. However, holders of approximately 99% of the shares that will
be registered and that are exercisable within 180 days of the effective date
have agreed with BancBoston Robertson Stephens Inc. not to sell their shares
into the public market during the 180-day period after the effective date of
the registration statement.
Lock-Up Agreements
All officers and directors and a majority of holders of common stock and
options to purchase common stock have agreed that they will not offer, sell,
contract to sell, pledge, grant any option to sell, or otherwise dispose of any
shares of common stock or securities convertible into common stock, or warrants
or other rights to purchase common stock, for a period of 180 days after the
date of this prospectus without the prior written consent of BancBoston
Robertson Stephens Inc.
67
<PAGE>
UNDERWRITING
The underwriters named below, acting through their representatives,
BancBoston Robertson Stephens Inc., Hambrecht & Quist LLC and U.S. Bancorp
Piper Jaffray Inc., have severally agreed with us, subject to the terms and
conditions of the underwriting agreement, to purchase from us the number of
shares of common stock indicated opposite their names below. The underwriters
are committed to purchase and pay for all of the shares if any are purchased.
<TABLE>
<CAPTION>
Number Of
Underwriters Shares
------------ ---------
<S> <C>
BancBoston Robertson Stephens Inc................................ 2,000,000
Hambrecht & Quist LLC............................................ 1,200,000
U.S. Bancorp Piper Jaffray Inc. ................................. 800,000
---------
Total.......................................................... 4,000,000
=========
</TABLE>
We have been advised that the underwriters propose to offer the shares of
common stock to the public at the public offering price located on the cover
page of this prospectus and to dealers at that price less a concession of not
in excess of $0.84 per share, of which $0.10 may be reallowed to their dealers.
After the initial public offering, the public offering price, concession and
reallowance to dealers may be reduced by the representatives. No reduction in
this price will change the amount of proceeds to be received by us as indicated
on the cover page of this prospectus.
The underwriters do not intend to confirm sales to any accounts over which
they exercise discretionary authority.
Over-Allotment Option. We have granted to the underwriters an option,
exercisable during the 30-day period after the date of this prospectus, to
purchase up to 600,000 additional shares of common stock at the same price per
share as we will receive for the 4,000,000 shares that the underwriters have
agreed to purchase. To the extent that the underwriters exercise this option,
each of the underwriters will have a firm commitment to purchase approximately
the same percentage of these additional shares that the number of shares of
common stock to be purchased by it shown in the above table represents as a
percentage of the 4,000,000 shares offered by this prospectus. If purchased,
such additional shares will be sold by the underwriters on the same terms as
those on which the 4,000,000 shares are being sold. We will be obligated, under
this option, to sell shares to the extent the option is exercised. The
underwriters may exercise the option only to cover over-allotments made in
connection with the sale of the shares of common stock offered by this
prospectus.
The following table shows the per share and total underwriting discounts and
commissions to be paid by us to the underwriters. This information is presented
assuming either no exercise or full exercise by the underwriters of their over-
allotment option.
<TABLE>
<CAPTION>
Without
Per Share Option With Option
--------- ----------- -----------
<S> <C> <C> <C>
Public offering price.................. $20.00 $80,000,000 $92,000,000
Underwriting discounts and
commissions........................... $ 1.40 $ 5,600,000 $ 6,440,000
Proceeds, before expenses, to us....... $18.60 $74,400,000 $85,560,000
</TABLE>
The other expenses of the offering are estimated at $1,326,000 and are
payable entirely by us. BancBoston Robertson Stephens Inc. expects to deliver
the shares of common stock to purchasers on December 7, 1999.
68
<PAGE>
Indemnity. The underwriting agreement contains covenants of indemnity among
the underwriters and us against certain civil liabilities, including
liabilities under the Securities Act and liabilities arising from breaches of
representations and warranties contained in the underwriting agreement.
Lock-Up Agreements. All of our executive officers and directors, and a
majority of our stockholders, optionholders and warrantholders have agreed, for
a period of 180 days after the date of this prospectus, not to offer to sell,
contract to sell or otherwise sell, dispose of, loan, pledge or grant any
rights to, any shares of common stock, any options or warrants to purchase any
shares of common stock or any securities convertible into or exchangeable for
shares of common stock owned as of the date of this prospectus or subsequently
acquired directly by the holders or to which they have or subsequently acquire
the power of disposition, without the prior written consent of BancBoston
Robertson Stephens Inc. However, BancBoston Robertson Stephens Inc., in some
instances may, in its sole discretion and at any time without notice, release
all or any portion of the securities subject to lock-up agreements. There are
no agreements between the representatives and any of our stockholders providing
consent by the representatives to the sale of shares prior to the expiration of
the period of 180 days after the date of this prospectus.
Future Sales. In addition, we have agreed that during the period of 180 days
after this prospectus, we will not, subject to certain exceptions, without the
prior written consent of BancBoston Robertson Stephens Inc.:
. Consent to the disposition of any shares held by stockholders prior to
the expiration of the period of 180 days after this prospectus; or
. Issue, sell, contract to sell or otherwise dispose of any shares of
common stock, any options or warrants to purchase any shares of common
stock or any securities convertible into, exercisable for or exchangeable
for shares of common stock other than (1) the sale of shares in this
offering, (2) the issuance of common stock upon the exercise or
conversion of outstanding options, warrants or convertible securities,
(3) our issuance of stock options under existing stock option plans and
(4) our issuance of common stock under the Employee Stock Purchase Plan.
See "Shares Eligible for Future Sale."
Listing. Our common stock has been approved for quotation on the Nasdaq
National Market under the symbol DMRC.
No Prior Public Market. Prior to this offering, there has been no public
market for our common stock. Consequently, the initial public offering price
for the common stock offered hereby was determined through negotiations between
us and the representatives. Among the factors considered in such negotiations
were prevailing market conditions, certain of our financial information, market
valuations of other companies that we and the representatives believed to be
comparable to us, estimates of our business potential, the present state of our
development and other factors deemed relevant.
Stabilization. The representatives have advised us that, in accordance with
Regulation M under the Securities Act, some participants in the offering may
engage in transactions, including stabilizing bids, syndicate covering
transactions or the imposition of penalty bids, that may have the effect of
stabilizing or maintaining the market price of the common stock at a level
above that which might otherwise prevail in the open market. A "stabilizing
bid" is a bid for or the purchase of the common
69
<PAGE>
stock on behalf of the underwriters for the purpose of fixing or maintaining
the price of the common stock. A "syndicate covering transaction" is a bid for
or the purchase of the common stock on behalf of the underwriters to reduce a
short position incurred by the underwriters in connection with this offering. A
"penalty bid" is an arrangement permitting the representatives to reclaim the
selling concession otherwise accruing to an underwriter or syndicate member in
connection with this offering if the common stock originally sold by such
underwriter or syndicate member is purchased by the representatives in a
syndicate covering transaction and has therefore not been effectively placed by
these underwriter or syndicate member. The representatives have advised us that
these transactions may be effected on the Nasdaq National Market or otherwise
and, if commenced, may be discontinued at any time.
Directed Share Program. We have requested that the underwriters reserve up to
400,000 shares of common stock to be issued by us and offered hereby for sale,
at the initial public offering price, to directors, officers, employees,
business associates and related persons of Digimarc. The number of shares of
common stock available for sale to the general public will be reduced to the
extent such individuals purchase such reserved shares. Any reserved shares
which are not so purchased will be offered by the underwriters to the general
public on the same basis as the other shares offered hereby.
In August 1999, Bayview Investors, Ltd., an affiliate of BancBoston Robertson
Stephens Inc., purchased 60,000 shares of our Series D-X preferred stock for
$5.00 per share on the same terms and conditions as the other purchasers of
Series D-X preferred stock. The National Association of Securities Dealers,
Inc. has deemed these shares to be underwriting compensation in connection with
this offering. As a result, Bayview Investors, Ltd. has generally agreed that
it will not sell, transfer, assign or hypothecate these shares until the first
anniversary of the date of this prospectus. All of these shares will
automatically convert into common stock upon the closing of this offering.
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for us by
Morrison & Foerster LLP, San Francisco, California. Certain legal matters in
connection with the offering will be passed upon for the underwriters by Wilson
Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California.
Attorneys employed by Morrison & Foerster LLP or investment partnerships of
which they are the beneficial owners hold approximately 60,000 shares of common
stock. Attorneys employed by Morrison & Foerster LLP will also purchase shares
in our directed share program.
EXPERTS
The financial statements of Digimarc as of December 31, 1997 and 1998, and
for each of the years in the three-year period ended December 31, 1998 have
been included herein and in the registration statement in reliance upon the
report of KPMG LLP, independent certified public accountants, and upon the
authority of the firm as experts in accounting and auditing.
70
<PAGE>
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with the SEC a registration statement on Form S-1 under the
Securities Act with respect to the common stock offered in this prospectus.
This prospectus does not contain all of the information in the registration
statement and its exhibits and schedules, portions of which have been omitted
as permitted by the rules and regulations of the SEC. For further information
about us and the common stock, we refer you to the registration statement and
to its exhibits and schedules. Statements in this prospectus about the contents
of any contract, agreement or other document are not necessarily complete and,
in each instance, we refer you to the copy of such contract, agreement or
document filed as an exhibit to the registration statement. Each such statement
is qualified in all respects by reference to the document to which it refers.
Anyone may inspect the registration statement and its exhibits and schedules
without charge at the public reference facilities the SEC maintains at 450
Fifth Street, N.W., Washington, D.C. 20549, and at the regional offices of the
SEC located at 7 World Trade Center, Suite 1300, New York, New York 10048, and
500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You may obtain
copies of all or any part of these materials from the SEC upon the payment of
fees prescribed by the SEC. You may obtain information on the operation of the
Public Reference Room by calling 1-800-SEC-0300. You may also inspect these
reports and other information without charge at a Web site maintained by the
SEC. The address of this site is http://www.sec.gov.
Upon completion of this offering, we will become subject to the informational
requirements of the Exchange Act and, in accordance therewith, file reports,
proxy statements and other information with the SEC. You will be able to
inspect and copy these reports, proxy statements and other information at the
public reference facilities maintained by the SEC and at the SEC's regional
offices at the addresses noted above. You also will be able to obtain copies of
this material from the Public Reference Room of the SEC as described above, or
inspect them without charge at the SEC's Web site.
71
<PAGE>
DIGIMARC CORPORATION
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of KPMG LLP........................................................ F-2
Balance Sheets............................................................ F-3
Statements of Operations.................................................. F-4
Statements of Stockholders' Equity (Deficit).............................. F-5
Statements of Cash Flows.................................................. F-6
Notes to Financial Statements............................................. F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Digimarc Corporation:
We have audited the accompanying balance sheets of Digimarc Corporation as of
December 31, 1997 and 1998, and the related statements of operations,
stockholders' equity (deficit), and cash flows for each of the years in the
three-year period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform 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
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
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.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Digimarc Corporation as of
December 31, 1997 and 1998, and the results of its operations and its cash
flows for each of the years in the three-year period ended December 31, 1998 in
conformity with generally accepted accounting principles.
/s/ KPMG LLP
Portland, Oregon
March 9, 1999, except as to note 12(b) which is
as of December 1, 1999
F-2
<PAGE>
DIGIMARC CORPORATION
BALANCE SHEETS
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
December 31,
----------------
1997 1998 September 30, 1999
------- ------- -----------------------
(unaudited) (unaudited)
(Pro Forma)
ASSETS
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents........... $ 5,638 $ 2,137 $ 8,039
Trade accounts receivable, net...... 102 298 1,653
Prepaid expenses and other current
assets............................. 81 98 1,026
------- ------- --------
Total current assets............... 5,821 2,533 10,718
Property and equipment, net.......... 251 329 501
Other assets, net.................... 96 116 55
------- ------- --------
Total assets....................... $ 6,168 $ 2,978 $ 11,274
======= ======= ========
<CAPTION>
LIABILITIES, REDEEMABLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY
(DEFICIT)
<S> <C> <C> <C> <C>
Current liabilities:
Short-term borrowings............... $ 400 $ 250 $ --
Accounts payable.................... 335 228 723
Current portion of capital lease
obligations........................ 79 124 119
Accrued payroll and related costs... 186 390 615
Deferred revenue.................... 190 345 1,734
Current portion of notes payable to
stockholders....................... -- -- 308
------- ------- --------
Total current liabilities.......... 1,190 1,337 3,499
Capital lease obligations, less
current portion..................... 111 171 182
Notes payable to stockholders, less
current portion..................... 284 298 --
Other long-term liabilities.......... 78 82 80
------- ------- --------
Total liabilities.................. 1,663 1,888 3,761
------- ------- --------
Convertible redeemable preferred
stock; 10,874,000 shares authorized;
2,931,786 shares issued and
outstanding at December 31, 1997 and
1998 and 4,357,786 shares
outstanding at September 30, 1999;
aggregate liquidation preference
$10,315 and $17,445 at December 31,
1998 and September 30, 1999,
respectively (unaudited); pro forma
no shares issued
and outstanding..................... 10,185 10,185 17,266 $ --
------- ------- -------- --------
Commitments and contingencies
Stockholders' equity (deficit):
Convertible preferred stock; 325,000
shares authorized; aggregate
liquidation preference $429:
Series A-1, $.001 par value; issued
and outstanding 162,500 shares at
December 31, 1997 and 1998 and
September 30, 1999; pro forma no
shares issued and outstanding..... -- -- -- --
Series A-N, $.001 par value; no
shares issued and outstanding..... -- -- -- --
Common stock, $.001 par value;
authorized 12,500,000 shares;
issued and outstanding 2,252,993
and 2,313,623 and 2,398,469 shares
at December 31, 1997 and 1998 and
September 30, 1999, respectively;
pro forma 7,983,255 shares issued
and outstanding.................... 2 2 3 8
Additional paid-in capital.......... 851 878 4,509 21,770
Deferred stock compensation......... -- -- (3,466) (3,466)
Accumulated deficit................. (6,533) (9,975) (10,799) (10,799)
------- ------- -------- --------
Total stockholders' equity
(deficit)......................... (5,680) (9,095) (9,753) $ 7,513
------- ------- -------- ========
Total liabilities, convertible
redeemable preferred stock and
stockholders' equity (deficit).... $ 6,168 $ 2,978 $ 11,274
======= ======= ========
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE>
DIGIMARC CORPORATION
STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
Nine Months Ended
Years Ended December 31, September 30,
------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- ---------
(unaudited)
<S> <C> <C> <C> <C> <C>
Revenue:
License and
subscription......... $ 186 $ 161 $ 484 $ 379 $ 175
Service............... 50 25 500 312 4,010
--------- --------- --------- --------- ---------
Total revenue....... 236 186 984 691 4,185
--------- --------- --------- --------- ---------
Cost of revenue:
License and
subscription......... 7 126 114 93 62
Service............... -- -- 1,466 775 1,814
--------- --------- --------- --------- ---------
Total cost of
revenue............ 7 126 1,580 868 1,876
--------- --------- --------- --------- ---------
Operating expenses:
Sales and marketing... 376 1,330 825 742 731
Research and
development.......... 690 934 658 546 450
Impairment charge..... -- 453 -- -- --
General and
administrative....... 834 1,282 1,407 913 1,961
--------- --------- --------- --------- ---------
Total operating
expenses........... 1,900 3,999 2,890 2,201 3,142
--------- --------- --------- --------- ---------
Operating loss...... (1,671) (3,939) (3,486) (2,378) (833)
Other income (expense):
Interest income....... 68 76 189 162 88
Interest expense...... (71) (86) (119) (13) (75)
Other................. 96 (30) (26) (92) (4)
--------- --------- --------- --------- ---------
Loss before
provision for
income taxes....... (1,578) (3,979) (3,442) (2,321) (824)
Provision for income
taxes.................. -- -- -- -- --
--------- --------- --------- --------- ---------
Net loss............ $ (1,578) $ (3,979) $ (3,442) $ (2,321) $ (824)
========= ========= ========= ========= =========
Net loss per share--
basic and diluted...... $ (0.71) $ (1.88) $ (1.50) $ (1.02) $ (0.35)
========= ========= ========= ========= =========
Weighted average shares
used in computing net
loss per share--basic
and diluted............ 2,226,519 2,120,477 2,288,442 2,284,642 2,342,732
========= ========= ========= ========= =========
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE>
DIGIMARC CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
Convertible
preferred stock Common stock Additional Total
----------------- ----------------- paid-in Deferred Accumulated stockholders'
Shares Amount Shares Amount capital compensation deficit deficit
--------- ------- --------- ------ ---------- ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31,
1995................... -- $ -- 2,047,364 $ 2 $ 182 $ -- $ (874) $ (690)
Issuance of common stock
through conversion of
note payable........... -- -- 272,000 -- 41 -- -- 41
Repurchase and
cancellation of
common stock previously
issued................. -- -- (288,340) -- -- -- (102) (102)
Issuance of common stock
in exchange for
services............... -- -- 36,369 -- 5 -- -- 5
Issuance of Series A-1
preferred stock, net... 162,500 -- -- -- 439 -- -- 439
Net loss................ -- -- -- -- -- -- (1,578) (1,578)
--------- ------ --------- --- ------ ------- -------- -------
BALANCE AT DECEMBER 31,
1996................... 162,500 -- 2,067,393 2 667 -- (2,554) (1,885)
Exercise of stock
options................ -- -- 62,600 -- 13 -- -- 13
Repurchase and
cancellation of
common stock previously
issued................. -- -- (56,000) -- (8) -- -- (8)
Common stock issued for
the acquisition of
assets................. -- -- 179,000 -- 179 -- -- 179
Net loss................ -- -- -- -- -- -- (3,979) (3,979)
--------- ------ --------- --- ------ ------- -------- -------
BALANCE AT DECEMBER 31,
1997................... 162,500 -- 2,252,993 2 851 -- (6,533) (5,680)
Stock issued............ -- -- 27,144 -- 13 -- -- 13
Exercise of stock
options................ -- -- 33,486 -- 14 -- -- 14
Net loss................ -- -- -- -- -- -- (3,442) (3,442)
--------- ------ --------- --- ------ ------- -------- -------
BALANCE AT DECEMBER 31,
1998................... 162,500 -- 2,313,623 2 878 -- (9,975) (9,095)
Exercise of stock
options (unaudited).... -- -- 84,846 1 44 -- -- 45
Deferred compensation
related to
stock options
(unaudited)............ -- -- -- -- 3,587 (3,587) -- --
Stock compensation
expense (unaudited).... -- -- -- -- -- 121 -- 121
Net loss (unaudited).... -- -- -- -- -- -- (824) (824)
--------- ------ --------- --- ------ ------- -------- -------
BALANCE AT SEPTEMBER 30,
1999 (unaudited)....... 162,500 $ -- 2,398,469 $ 3 $4,509 $(3,466) $(10,799) $(9,753)
========= ====== ========= === ====== ======= ======== =======
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE>
DIGIMARC CORPORATION
STATEMENTS OF CASH FLOWS
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
Nine Months
Years Ended December Ended
31, September 30,
------------------------- ----------------
1996 1997 1998 1998 1999
------- ------- ------- ------- -------
(unaudited)
<S> <C> <C> <C> <C> <C>
Cash flows from operating
activities:
Net loss......................... $(1,578) $(3,979) $(3,442) $(2,321) $ (824)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Depreciation and amortization... 23 100 178 130 203
Amortization of discount on note
payable........................ 19 13 14 10 10
Asset impairment................ -- 453 -- -- --
Non-cash expenses............... 15 27 20 7 121
Gain on forgiveness of debt..... (96) (33) -- -- --
Changes in assets and
liabilities:
Trade accounts receivable....... -- (102) (196) 64 (1,355)
Prepaid expenses and other
assets......................... (54) (36) (33) (18) (906)
Accounts payable................ 118 43 (107) (199) 495
Accrued payroll and related
costs.......................... 32 199 204 (100) 225
Deferred revenue................ (26) 173 152 150 1,387
------- ------- ------- ------- -------
Net cash used in operating
activities.................... (1,547) (3,142) (3,210) (2,277) (644)
------- ------- ------- ------- -------
Cash flows from investing
activities:
Purchase of property and
equipment....................... (165) (23) (8) (10) (209)
Purchases of patents............. -- -- (50) (50) (10)
Sale of tradename................ -- -- -- -- 10
Acquisition of assets............ -- (417) -- -- --
------- ------- ------- ------- -------
Net cash used in investing
activities.................... (165) (440) (58) (60) (209)
------- ------- ------- ------- -------
Cash flows from financing
activities:
Proceeds (repayment) of short-
term borrowings................. -- 400 (150) (3) (250)
Net proceeds from issuance of
preferred stock................. 4,510 5,744 -- (1) 7,081
Net proceeds from issuance of
common stock.................... -- 13 14 7 45
Proceeds from issuance of notes
payable......................... 350 -- -- -- --
Principal payments of notes
payable......................... (111) -- -- -- --
Proceeds from sale-leaseback..... 142 -- -- -- --
Repurchase of common stock
previously issued............... (102) (8) -- -- --
Principal payments under capital
lease obligations............... (10) (42) (97) (70) (121)
------- ------- ------- ------- -------
Net cash provided by (used in)
financing activities.......... 4,779 6,107 (233) (67) 6,755
------- ------- ------- ------- -------
Net (decrease) increase in cash
and cash equivalents............. 3,067 2,525 (3,501) (2,404) 5,902
Cash and cash equivalents at
beginning of period.............. 46 3,113 5,638 5,638 2,137
------- ------- ------- ------- -------
Cash and cash equivalents at end
of period........................ $ 3,113 $ 5,638 $ 2,137 $ 3,234 $ 8,039
======= ======= ======= ======= =======
Supplemental disclosure of cash
flow information:
Cash paid for interest........... $ 3 $ 38 $ 125 $ 85 $ 76
======= ======= ======= ======= =======
Summary of non-cash investing and
financing activities:
Conversion of note payable to
common stock.................... $ 41 $ -- $ -- $ -- $ --
Equipment acquired or exchanged
under capital lease
obligations..................... 40 64 202 127 167
Common stock issued for the
acquisition of assets........... -- 179 -- -- --
======= ======= ======= ======= =======
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE>
DIGIMARC CORPORATION
NOTES TO FINANCIAL STATEMENTS
(In thousands, except share and per share data)
(1) Summary of Significant Accounting Policies
(a) The Company
Digimarc Corporation (the Company) was incorporated on January 3, 1995. The
Company has developed digital watermarking technology used to identify, track,
manage and enhance visual communications. Digitally watermarked images contain
hidden messages which are imperceptible during normal use but detectable by
software or other devices.
(b) Interim Financial Statements
The financial information included herein for the nine-month periods ended
September 30, 1998 and 1999 is unaudited; however, such information reflects
all adjustments (consisting only of normal recurring adjustments) which are, in
the opinion of management, necessary for a fair presentation of the financial
position, results of operations and cash flows for the interim periods. The
interim consolidated financial statements should be read in conjunction with
the financial statements and the notes included in the financial statements.
The results of operations for the interim period presented are not necessarily
indicative of the results to be expected for the full year.
(c) Accounts Receivable
Trade accounts receivable are shown net of allowance for doubtful accounts.
The amount of the allowance and the charges were as follows:
<TABLE>
<CAPTION>
December 31,
-------------- September 30,
1996 1997 1998 1999
---- ---- ---- -------------
(unaudited)
<S> <C> <C> <C> <C>
Balance--beginning of period................... $ -- $ -- $17 $ 2
Provision (recovery)........................... -- 17 (7) 4
Charge offs.................................... -- -- (8) --
---- ---- --- ---
Balance--end of period......................... $ -- $ 17 $ 2 $ 6
==== ==== === ===
</TABLE>
(d) Property and Equipment
Property and equipment are stated at cost. Property and equipment under
capital lease obligations are stated at the lower of the present value of
minimum lease payments at the beginning of the lease term or fair value of the
leased assets at the inception of the lease. Repairs and maintenance are
charged to expense when incurred.
Depreciation on property and equipment is calculated by the straight-line
method over the estimated useful lives of the assets, generally three to five
years. Property and equipment held under capital leases are amortized by the
straight-line method over the lease term. Amortization of property and
equipment under capital lease is included in depreciation expense.
(e) Software Development Costs
Under Statement of Financial Accounting Standards No. 86 (SFAS No. 86),
software development costs are to be capitalized beginning when a product's
technological feasibility has been
F-7
<PAGE>
DIGIMARC CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share data)
established and ending when a product is made available for general release to
customers. To date, the establishment of technological feasibility of the
Company's products has occurred shortly before general release and, therefore,
software development costs qualifying for capitalization have been immaterial.
Accordingly, the Company has not capitalized any software development costs and
has charged all such costs to research and development expense.
(f) Funded Research and Development
The Company accounts for amounts received under its funded research and
development arrangements in accordance with the provisions of SFAS No. 68,
Research and Development Arrangements. Under the terms of the arrangements, the
Company is not obligated to repay any of the amounts provided by the funding
parties. As a result, the Company recognizes revenue as the services are
performed.
Revenues recognized under vendor and end-user funding arrangements totaled
$500 for the year ended December 31, 1998. Direct costs allocated to the
arrangement were $1,466 for the year ended December 31, 1998. There were no
such revenues recognized or cost incurred related to a funding arrangement in
1996 or 1997.
(g) Other Assets
Other assets consist primarily of the costs of acquired patents and
trademarks, and are amortized by the straight-line method over a useful life of
three to five years. They are shown net of accumulated amortization of $16 and
$63 at December 31, 1997 and 1998, respectively.
(h) Advertising Costs
Advertising costs are expensed as incurred. Total advertising expenses were
$13, $157 and $135 for the years ended December 31, 1996, 1997 and 1998,
respectively.
(i) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
The Company accounts for long-lived assets in accordance with the provisions
of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of. This Statement requires that long-lived
assets and certain identifiable intangibles be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to future net cash
flows expected to be generated by the asset. If such assets are considered to
be impaired, the impairment to be recognized is measured by the amount by which
the carrying amount of the assets exceeds the fair value of the assets. Assets
to be disposed of are reported at the lower of the carrying amount or fair
value less costs to sell.
(j) Revenue Recognition
In October 1997, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) No. 97-2, Software Revenue
Recognition. Subsequently, in March 1998, the Financial Accounting Standards
Board (FASB) approved SOP 98-4, Deferral of the Effective Date
F-8
<PAGE>
DIGIMARC CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share data)
of a Provision of 97-2, Software Revenue Recognition. SOP 98-4 defers for one
year the application of several paragraphs and examples in SOP 97-2 that limit
the definition of vendor specific objective evidence (VSOE) of the fair value
of various elements in a multiple-element arrangement. SOP 97-2 generally
requires revenue earned on software arrangements involving multiple elements to
be allocated to each element based on VSOE of the relative fair values of each
element in the arrangement. The Company establishes VSOE based on the price
when the element is sold separately.
The provisions of SOPs 97-2 and 98-4 have been applied by the Company to
transactions entered into beginning January 1, 1998. Prior to 1997, the
Company's revenue policy was in accordance with the preceding authoritative
guidance provided by SOP No. 91-1, Software Revenue Recognition.
Software license revenue consists of fees for licenses of the Company's
software products. Revenue allocated to software licenses is recognized upon
delivery of software, assuming no significant future obligations or customer
acceptance rights exist. Software license agreements have not contained
significant obligations or customer acceptance rights to date.
Revenue allocated to subscriptions are paid in advance and revenues are
recognized ratably over the term of the subscription. Revenue allocated to
contracted professional services is recognized as the services are performed.
The Company recognizes revenues on service contracts on a method that
approximates the percentage of completion basis using budgeted amounts
established with the customer at the inception of the contract. Progress
towards completion is measured using allowable costs incurred as compared to
the budgeted amounts contained in the basic contract. Losses on contracts, if
any, are provided for in the period in which the loss becomes determinable. The
contract is considered complete upon completion of the deliverables specified
in the contract. Deferred revenue consists of payments received in advance for
consulting services and subscriptions to the Company's internet service for
service and support not yet performed.
In December 1998, the AICPA issued SOP 98-9, Modification of SOP 97-2
Software Revenue Recognition, with Respect to Certain Transactions. This SOP
amends SOP 97-2 to require recognition of revenue using the "residual method"
in circumstances outlined in the SOP. Under the residual method, revenue is
recognized as follows: (1) the total fair value of undelivered elements, as
indicated by VSOE, is deferred and subsequently recognized in accordance with
the relevant sections of SOP 97-2 and (2) the difference between the total
arrangement fee and the amount deferred for the undelivered elements is
recognized as revenue related to the delivered elements.
SOP 98-9 is effective for fiscal years beginning after March 15, 1999. Also
the provisions of SOP 97-2 that were deferred by SOP 98-4 will continue to be
deferred until the date SOP 98-9 becomes effective.
(k) Use of Estimates
Generally accepted accounting principles require management to make estimates
and assumptions that affect the reported amounts of assets, liabilities and
contingencies at the date of the financial statements and the reported amounts
of revenues and expense during the reporting periods. Actual results could
differ from those estimates.
F-9
<PAGE>
DIGIMARC CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share data)
(l) Income Taxes
The Company accounts for income taxes under the asset and liability method.
Under the asset and liability method, deferred income taxes reflect the future
tax consequences of differences between the tax bases of assets and liabilities
and their financial reporting amounts at each year-end. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. Valuation allowances are established when necessary to reduce
tax assets to the amount expected to be realized.
(m) Concentrations of Credit Risk
Financial instruments which potentially subject the Company to concentrations
of credit risk consist primarily of cash and trade receivables. The credit risk
associated with cash is minimal. The Company had accounts receivable from three
customers representing approximately 83% of trade accounts receivable at
December 31, 1998. Loss of or non-performance by these significant customers
could adversely affect the Company's financial position, liquidity or results
of operations.
(n) Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, accounts receivable,
accounts payable and accrued payroll approximate fair value due to the short-
term nature of these instruments. The carrying amounts of capital leases and
notes payable approximate fair value as the stated interest rates reflect
current market rates. Fair value estimates are made at a specific point in
time, based on relevant market information about the financial instrument when
available. These estimates are subjective in nature and involve uncertainties
and matters of significant judgment and, therefore, cannot be determined with
precision. Changes in assumptions could significantly affect the estimates.
(o) Stock-Based Employee Compensation
The Company adopted SFAS No. 123, Accounting for Stock-Based Compensation,
which permits entities to recognize expense over the vesting period based on
the fair value of all stock-based awards on the date of grant. Alternatively,
SFAS No. 123 also allows entities to continue to apply the provisions of
Accounting Principles Board (APB) Opinion No. 25 and provide pro forma net
income and pro forma earnings per share disclosures as if the fair-value-based
method defined in SFAS No. 123 had been applied. The Company has elected to
apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure
provisions of SFAS No. 123.
(p) Contingencies and Factors that Could Affect Future Results
A portion of the Company's revenues each year is generated from licensing of
technology. In the extremely competitive industry environment in which the
Company operates, such product generation, development and marketing processes
are uncertain and complex, requiring accurate prediction of demand as well as
successful management of various development risks inherent in
F-10
<PAGE>
DIGIMARC CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share data)
technology development. In light of these dependencies, it is possible that
failure to successfully manage future changes in technology with respect to the
Company's technology could have long-term impact on the Company's growth and
results of operations.
(q) Net Income (Loss) Per Share
In 1997, the Company adopted SFAS No. 128 "Earnings Per Share" which provides
that "basic net income (loss) per share" and "diluted net income (loss) per
share" for all prior periods presented are to be computed using the weighted
average number of common shares outstanding during each period, with diluted
net income per share including the effect of potentially dilutive common
shares.
Common stock equivalents related to stock options of 180,260, 640,857, and
1,327,426 are antidilutive in a net loss year and, therefore, are not included
in 1996, 1997 and 1998 diluted net loss per share, respectively.
(2) Acquisition of Assets
In July 1997, the Company acquired substantially all of the assets of
NetRights, LLC (NetRights) for approximately $417 and 179,000 shares of common
stock. NetRights was developing a software product which would provide direct
access to remote information, initiate direct connections to Web sites and
commerce services and automate communications between suppliers of digitized
creative works and consumers through the digital content pictures themselves.
Assets acquired by the Company included certain office equipment, certain
trademarks and tradenames, and all engineering drawings, designs and
documentation, including patent applications.
The allocation of the purchase price resulted in capitalization of purchased
technology of $453, capitalization of office equipment of $48, and patent and
tradename capitalizations of $95, which are being amortized over three years.
Subsequent to the acquisition a decision was made not to use the purchased
technology, and as a result the purchased technology was considered impaired
and written off.
(3) Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all
highly liquid instruments with an original maturity of three months or less to
be cash equivalents.
Cash and cash equivalents include various money market instruments and
investments in government bonds totaling $125 and $2,137 at December 31, 1997
and 1998, respectively. Cash equivalents are carried at cost, which
approximates market.
F-11
<PAGE>
DIGIMARC CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share data)
(4) Property and Equipment
<TABLE>
<CAPTION>
December
31,
-----------
1997 1998
---- -----
<S> <C> <C>
Furniture and fixtures.......................................... $ 38 $ 51
Office equipment................................................ 311 504
Leasehold improvements.......................................... -- 4
---- -----
349 559
Less accumulated depreciation and amortization.................. (98) (230)
---- -----
$251 $ 329
==== =====
</TABLE>
(5) Leases
The Company leases certain office equipment under long-term capital leases,
which expire over the next four years. At December 31, 1997 and 1998, the cost
of these assets was $245 and $447, respectively, and accumulated amortization
was $68 and $168, respectively.
Future minimum lease payments under non-cancelable operating leases and the
present value of future minimum capital lease payments are as follows:
<TABLE>
<CAPTION>
Capital Operating
Year ending December 31: leases leases
------------------------ ------- ---------
<S> <C> <C>
1999....................................................... $156 $107
2000....................................................... 114 73
2001....................................................... 65 --
2002....................................................... 9 --
---- ----
Total minimum lease payments............................. 344 $180
====
Less amount representing interest.......................... 49
----
295
Less current portion of capital lease...................... 124
----
$171
====
</TABLE>
Rent expense on the operating leases for the years ended December 31, 1996,
1997 and 1998 totaled $22, $62 and $71, respectively.
(6) Notes Payable
<TABLE>
<CAPTION>
December 31,
-------------
1997 1998
------ ------
<S> <C> <C>
Notes payable to stockholders, net of unamortized discount of
$100 and $86 at December 31, 1997 and 1998, respectively,
interest at 7% beginning in 1998, due and payable May 2005 or
earlier under certain conditions, unsecured.................. $ 284 $ 298
------ ------
284 298
Less current portion.......................................... -- --
------ ------
$ 284 $ 298
====== ======
</TABLE>
F-12
<PAGE>
DIGIMARC CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share data)
(7) Short-term Borrowings
The Company has a $400 revolving line of credit with a bank which matures on
August 20, 1999 and is secured by the assets of the Company. The line bears
interest at the prime rate plus 1%. The interest rate on short-term borrowings
during 1997 and 1998 was 11.5% and 8.75%, respectively. At December 31, 1997
and 1998, $400 and $250, respectively, was outstanding on this line. See
note 14.
(8) Defined Contribution Pension Plan
The Company has an employee savings plan (the Plan) which qualifies as a
deferred salary arrangement under Section 401(k) of the Internal Revenue Code.
Employees become eligible to participate in the Plan after four months of
service. Employees may contribute up to 15% of their pay to the Plan, subject
to the limitations of the Internal Revenue Code. The Company made no
contributions to the Plan during 1996, 1997 or 1998.
(9) Convertible Redeemable Preferred Stock
The Company has authorized several series of convertible redeemable preferred
stock. The title, carrying amount, and number of shares issued and outstanding
are as follows:
<TABLE>
<CAPTION>
December 31,
--------------- September 30,
1997 1998 1999
------- ------- -------------
(unaudited)
<S> <C> <C> <C>
Series B-1, $.001 par value; issued and
outstanding 902,000 shares at December 31,
1997 and 1998; liquidation preference
$4,510...................................... $ 4,441 $ 4,441 $ 4,441
Series B-N, $.001 par value; no shares issued
and outstanding.............................
Series C-1, $.001 par value; issued and
outstanding 2,029,786 shares at December 31,
1997 and 1998; liquidation preference
$5,805...................................... 5,744 5,744 5,744
Series C-N, $.001 par value; no shares issued
and outstanding.............................
Series D, $.001 par value; issued and
outstanding 1,266,000 shares at
September 30, 1999; liquidation preference
$6,330...................................... -- -- 6,281
Series D-X, $.001 par value; issued and
outstanding 160,000 shares at September 30,
1999; liquidation preference $800........... -- -- 800
------- ------- -------
Total convertible redeemable preferred
stock....................................... $10,185 $10,185 $17,266
======= ======= =======
</TABLE>
Preferred Series B and Series C stock is subject to certain mandatory
redemption features following the affirmative vote of at least 60% of the
outstanding shares of the Series B and Series C preferred stock, effective no
earlier than June 30, 2001. The Company shall redeem all of the then
outstanding Series B and Series C preferred stock or an amount determined by
the Company for which funds are available for redemption. The per share
redemption price for the Series B and Series C preferred stock is equal to its
per share issue price, plus any undeclared and unpaid dividends. Each Series B
and Series C preferred stockholder may, but is not obligated to, participate in
the Series B and Series C redemption up to that holder's pro rata share of the
total number of shares specified in the redemption request. See note 10 for
additional features of convertible redeemable preferred stock. See note 14.
F-13
<PAGE>
DIGIMARC CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share data)
(10) Stockholders' Equity
(a) Stockholders' Agreement
The Company and its stockholders have an agreement that includes
restrictions on the purchase and sale of the Company's common stock. Except
for expressly provided exceptions, no stockholder is allowed to transfer
ownership of common stock without the prior written consent of the Company. If
a stockholder desires to sell any shares, the stockholder must first offer to
sell those shares to the Company or its designee before offering shares to a
third party. These restrictions lapse upon the effectiveness of a registration
of common stock under the Securities Act of 1933, as amended, and the
consummation of the sale of common stock under that registration statement.
(b) Preferred Stock
The Company has issued Series A-1, Series B-1 and Series C-1 preferred
stock. In addition, the Company is also authorized to issue Series A-N, Series
B-N and Series C-N preferred stock. The terms for each series of preferred
stock are similar and are summarized below:
Dividends
Preferred stockholders are entitled to receive dividends when and if
declared by the Board of Directors at an annual rate of $.25 per share for
Series A-1 and A-N, $.50 per share for Series B-1 and B-N and $.286 per share
for Series C-1 and C-N. The right to receive dividends on preferred stock is
not cumulative and no right to receive dividends shall accrue to holders of
the preferred stock in the event the Board of Directors does not declare
dividends. No dividends may be declared or paid on common stock until equal
dividends on preferred stock have been declared and paid. After payment of all
dividends on preferred stock, the holders of preferred stock are entitled to
participate, on an as-converted basis, with the outstanding common stock as to
any dividends paid on such common stock. As of December 31, 1998, no dividends
had been declared or paid.
Liquidation Preferences
Upon dissolution, liquidation, or winding-up of the affairs of the Company
(Liquidation), either voluntary or involuntary, the preferred stockholders
receive preference over the common stockholders of the Company. The
liquidation value for each outstanding share is $2.50 for Series A-1 and A-N
(Series A), $5.00 for Series B-1 and B-N (Series B) and $2.86 for Series C-1
and C-N (Series C), adjusted for any stock dividends. If upon liquidation the
assets of the Company available for distribution are insufficient to pay the
holders of preferred stock the full preference, then the entire assets and
funds of the Company legally available for distribution to its stockholders
will be distributed ratably among all holders of preferred stock. After paying
the full preference, any assets of the Company remaining available for
distribution to stockholders upon liquidation will be distributed ratably
among all holders of common and preferred stock in proportion to the amount of
common stock each stockholder holds, treating each holder of Series B and
Series C preferred stock as if such stock were converted into common stock at
the existing conversion price. Series A preferred stock automatically converts
to common stock prior to a liquidation, if as a result of the conversion the
consideration per share to be received with respect to the preferred stock
would be
F-14
<PAGE>
DIGIMARC CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share data)
larger than the Series A preferred stock preference. The conversion price for
Series A-1, Series B-1 and Series C-1 is $1.25, $2.50 and $2.86, respectively,
at December 31, 1998.
Voting
The holder of each share of each series of preferred stock shall have the
right to the number of votes such holders would be entitled to if the shares of
preferred stock were converted to common stock.
Conversion
Each share of preferred stock is voluntarily convertible into common stock at
any time after the date of issuance at a rate that equals the original issue
price divided by the conversion price at the time in effect, subject to certain
adjustments as set forth in the purchase agreements. Automatic conversion of
the Series A preferred into common stock at the then effective conversion rate
will occur upon the closing and issuance of shares following the effectiveness
of a registration statement under the Securities Act of 1933, or upon the
approval of the conversion by holders of a majority of the originally issued
shares of Series A preferred stock, or approval of the conversion by 67% of the
originally outstanding shares of all series of preferred stock, or in the case
of a liquidation where the consideration per share to be received with respect
to the preferred stock would be larger than the Series A preferred stock
preference. Automatic conversion of the Series B preferred into common stock at
the then effective conversion rate will occur upon the closing of the issuance
shares following the effectiveness of a registration statement under the
Securities Act of 1933 in which the aggregate price to the public equals or
exceeds $10,000 and in which the public offering price per share of common
stock equals or exceeds $10, or on the approval of the conversion by holders of
67% of the outstanding shares of preferred stock. Automatic conversion of the
Series C preferred into common stock at the then effective conversion rate will
occur upon the consummation of a designated initial public offering, or on the
approval of conversion by the holders of 67% of the outstanding shares of
preferred stock.
As of December 31, 1998, the Company has reserved a total of 4,158,786 shares
of its common stock expressly for the conversion privileges of preferred stock.
(c) Stock Incentive Plan
The Company has a Stock Incentive Plan (the Plan). Under the terms of the
Plan, the Board of Directors is authorized to grant incentive stock options,
non-qualified stock options and restricted stock to employees or consultants.
Prices for all options or stock granted under the Plan are determined by the
Board of Directors. Option prices for incentive stock options are set at not
less than the fair market value of the common stock at the date of grant.
Options vest over periods determined by the Board of Directors. Options are
contingent upon continued employment with the Company and, unless otherwise
specified, expire ten years from the date of grant. The Company has reserved
1,800,000 shares of its common stock for issuance under the Plan.
F-15
<PAGE>
DIGIMARC CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share data)
SFAS No. 123 "Accounting for Stock-Based Compensation" defines a fair value
based method of accounting for an employee stock option and similar equity
instrument. As is permitted under SFAS No. 123, the Company has elected to
continue to account for its stock-based compensation plans under APB Opinion
No. 25. The Company has computed, for pro forma disclosure purposes, the value
of all options granted during 1996, 1997 and 1998 using the Black-Scholes
option pricing model as prescribed by SFAS No. 123 with the following weighted
average assumption for grants:
<TABLE>
<CAPTION>
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Risk-free interest rate........................ 6.0% 6.25% 6.0%
Expected dividend yield........................ -- -- --
Expected life (in years)....................... 4 4 4
Expected volatility............................ 100% 100% 100%
Using the Black-Scholes methodology, the total value of options granted
during 1996, 1997 and 1998 was $86, $97 and $175, respectively, which would be
amortized on a pro forma basis over the vesting period of the options. The
weighted average fair value of options granted during 1996, 1997 and 1998 was
$.055, $.077 and $.090 per share, respectively. If the Company had accounted
for its stock-based compensation plans in accordance with SFAS No. 123, the
Company's net income (loss) and net income (loss) per share would approximate
the pro forma disclosures below:
<CAPTION>
Years Ended December 31,
----------------------------
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Net loss....................................... $ (1,578) $(3,979) $(3,442)
Pro forma net loss............................. (1,613) (4,053) (3,552)
Net loss per share............................. (0.71) (1.88) (1.50)
Pro forma net loss per share................... (0.72) (1.91) (1.55)
</TABLE>
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. SFAS No. 123 does not apply to awards prior to
January 1, 1995, and additional awards are anticipated in future years.
F-16
<PAGE>
DIGIMARC CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share data)
Transactions involving the Plan are summarized as follows:
<TABLE>
<CAPTION>
Weighted
average
Number of exercise
shares price
--------- --------
<S> <C> <C>
Options outstanding,
December 31, 1995...................................... 147,000 $ .15
Granted................................................. 526,550 .32
Exercised............................................... -- --
Canceled................................................ (96,000) .15
--------- -----
Options outstanding,
December 31, 1996...................................... 577,550 .30
Granted................................................. 416,900 .50
Exercised............................................... (62,600) .22
Canceled................................................ (19,650) .50
--------- -----
Options outstanding,
December 31, 1997...................................... 912,200 .40
Granted................................................. 646,800 .50
Exercised............................................... (33,486) .50
Canceled................................................ (220,714) .50
--------- -----
Options outstanding,
December 31, 1998...................................... 1,304,800 .42
Granted (unaudited)..................................... 1,084,000 1.94
Exercised (unaudited)................................... (84,846) .50
Canceled (unaudited).................................... (47,992) .50
--------- -----
Options outstanding, September 30, 1999 (unaudited)..... 2,255,962 $1.16
========= =====
</TABLE>
At December 31, 1998, the range of exercise prices and the weighted average
remaining contractual life of outstanding options were $.15-$.50 and nine
years, respectively.
At December 31, 1997 and 1998, options to purchase 224,668 and 386,137 shares
of common stock, respectively, were exercisable. The weighted average exercise
price of those options was $.26 and $.30 at December 31, 1997 and 1998,
respectively, and 183,114 shares were available for grant at December 31, 1998.
(11) Income Taxes
The Company incurred a loss for both financial reporting and tax return
purposes and, as such, there was no current or deferred tax provision for the
years ended December 31, 1996, 1997 and 1998.
F-17
<PAGE>
DIGIMARC CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share data)
The actual income tax expense differs from the expected tax expense
(computed by applying the U.S. federal corporate income tax rate of 34% to net
income (loss) before income taxes) as follows:
<TABLE>
<CAPTION>
Years Ended
December 31,
------------------
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Computed expected income tax (benefit) expense.............. (34)% (34)% (34)%
Increase (reduction) in income tax
expense (benefit) resulting from:
State income tax (benefit) expense....................... (4) (4) (4)
Increase in valuation allowance........................... 39 39 40
Other..................................................... (1) (1) (2)
--- --- ---
Income tax expense...................................... -- % -- % -- %
=== === ===
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities as of December
31 are as follows:
<TABLE>
<CAPTION>
1997 1998
------- -------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards....................... $ 1,865 $ 3,284
Capitalized research and experimentation costs......... 326 238
Tax basis intangible assets, due to differences in
amortization.......................................... 104 82
Research and experimentation credits................... 42 113
Other.................................................. 25 22
------- -------
Total gross deferred tax assets...................... 2,362 3,739
Less valuation allowance................................. (2,314) (3,699)
------- -------
Net deferred tax assets.............................. 48 40
------- -------
Deferred tax liabilities:
Unamortized discount on notes payable.................. 10 33
Plant and equipment, due to differences in
depreciation.......................................... 38 7
------- -------
Total deferred tax liabilities....................... 48 40
------- -------
Net deferred tax liability (asset)................... $ -- $ --
======= =======
</TABLE>
The valuation allowance for deferred tax assets as of December 31, 1998 was
approximately $3.7 million. The net change in the total valuation allowance for
the years ended December 31, 1996, 1997 and 1998 was an increase (decrease) of
approximately $896, $1,418 and $1,385, respectively.
At December 31, 1998, the Company had net operating loss carryforwards of
approximately $8,562 to offset against future income for federal and state tax
purposes, and research and experimentation credits of $113. These carryforwards
expire through 2018.
A provision of the Internal Revenue Code requires that the utilization of net
operating losses and research and experimentation credits be limited when there
is a change of more than 50% in ownership of the Company. Such a change
occurred with the sale of preferred stock Series A in June 1996 and the sale of
preferred stock Series B in July 1996. Accordingly, the utilization of the
F-18
<PAGE>
DIGIMARC CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share data)
net operating loss carryforwards generated from periods prior to July of 1996
is limited; the amount subject to limitation is approximately $915.
(12) Subsequent Event
(a) Sale of a Trademark
In January 1999, the Company sold the trademark associated with NetRights,
LLC. The sales price approximated the net book value of the trademark. This
transaction is not expected to have a material effect on the financial
position, results of operations or liquidity of the Company.
(b) Stock Split
On October 21, 1999, the Board of Directors approved a one-for-two reverse
stock split of outstanding common and preferred shares which was effected on
December 1, 1999. Common and preferred share and per share data for all periods
presented in the accompanying financial statements have been adjusted to
reflect this stock split.
(13) Segment Information
(a ) Geographic Information
Digimarc derives its revenue from a single operating segment, digital
watermarking applications. Revenue is generated in this segment through
licensing and subscription of its products and the delivery of contracted and
consulting services.
The Company operates solely within the United States, and all assets are
located within the United States. Sales to identifiable foreign customers were
approximately $85, $17 and $89 for the years ended December 31, 1996, 1997 and
1998, respectively.
(b) Major Customers
Revenue from the Company's major customers was as follows:
<TABLE>
<CAPTION>
Nine Months
Ended
Years Ended September 30,
December 31, 1999
-------------- -------------
1996 1997 1998 (unaudited)
---- ---- ----
<S> <C> <C> <C> <C>
Customer A...................................... $ -- $30 $ -- $ --
Customer B...................................... -- 25 503 3,860
Customer C...................................... 100 -- -- --
---- --- ---- ------
$100 $55 $503 $3,860
==== === ==== ======
</TABLE>
No single customer accounted for more than 10% of trade accounts receivable
outstanding at December 31, 1997. The Company had accounts receivable from
three customers representing approximately 83% of trade accounts receivable at
December 31, 1998. Accounts receivable from one customer represented 98% of
trade receivables at September 30, 1999 (unaudited).
F-19
<PAGE>
DIGIMARC CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share data)
(14) Unaudited Recent Developments
(a) Issuance of Preferred Stock
On June 30, 1999, the Company authorized 1,400,000 shares of Series D-1
convertible redeemable preferred stock. The terms of the Series D-1 stock are
substantially identical to the Series B-1 and C-1 stock as described in note
10. There were 1,266,000 shares of Series D-1 stock outstanding at
September 30, 1999.
On August 26, 1999, the Company issued 160,000 shares of Series D-X
convertible redeemable preferred stock at $5.00 per share. The terms of the
Series D-X stock are substantially identical to the Series B and C stock as
described in note 10.
(b) Lease Transactions
On June 22, 1999, the Company entered into a five-year operating lease
agreement for office space. The lease requires a letter of credit in lieu of a
cash security deposit in the amount of $350 which was entered into in August
1999. The letter of credit is secured by a certificate of deposit in the amount
of $350. The letter of credit is to be released over two years in increments
upon the Company's meeting certain milestones.
(c) Short-term Borrowings
In August 1999, the Company's bank extended the maturity date on the
Company's revolving line of credit. As a result, the revolving line of credit
currently expires on November 20, 1999.
(d) Stock Incentive Plan
In April 1999, the Company increased the number of common shares reserved for
issuance under the Stock Incentive Plan to 2.8 million shares.
(e) Strategic Partnerships
In October 1999, the Company entered into a binding letter of agreement with
Wired magazine (Wired) in which the Company and Wired will jointly promote
Internet-enabled advertising. Under the agreement the Company has agreed to
provide a non-exclusive license to Wired for MediaBridge, as well as provide
Wired with all reasonable and necessary development tools, training, software
and cameras for it to comply with its obligations under the agreement. Wired
has agreed to remit to the Company a portion of the revenue it receives from
MediaBridge-enabled advertising.
In October 1999, the Company entered into a two-year agreement with Hearst
Communications, Inc. (Hearst) in which the Company and Hearst will jointly
promote Internet-enabled advertising. This agreement will commence at a date
mutually agreed by both parties. In connection with the agreement the Company
issued a warrant to purchase 150,000 shares of common stock to Hearst at an
exercise price per share equal to the initial public offering price or other
equity financing. The warrant is exercisable for a period of three years with
62,500 shares exercisable immediately after
F-20
<PAGE>
DIGIMARC CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share data)
the consummation of an initial public offering, 62,500 shares exercisable based
on the achievement of certain milestones and 25,000 shares exercisable upon the
one-year anniversary of the agreement. The Company will record non-cash charges
in their statement of operations for the fair value, as determined by the
Black-Scholes valuation model, when the vesting milestones are achieved and the
warrant becomes exercisable for these shares.
(f) Deferred Stock Compensation
Stock compensation expense is based on the difference between the estimated
fair market value of the Company's common stock and the exercise price of
options to purchase that stock on the date of grant, and is being recognized
over the vesting period of the related options, usually four years. The
estimated fair value per share used to determine unearned compensation was
derived by reference to preferred stock values reduced by a discount factor,
the execution of various contracts and letters of intent, the progress toward
completion of new products, and the estimated price range of the common stock
at the effective date. Stock compensation expense of $121 was recorded for the
nine months ended September 30, 1999. The total unearned compensation recorded
by the Company from inception to September 30, 1999 was $3.6 million.
F-21
<PAGE>
[THE DIGIMARC CORPORATION LOGO WITH IMAGES OF A BANK CARD, A DRIVER'S LICENSE,
AN ACCESS CARD AND A PASSPORT, AND INCLUDING THE FOLLOWING TEXT: "SELF-
AUTHENTICATING IDENTITY DOCUMENTS" AND "COMBAT PHOTO SWAPPING AND DEFEND
AGAINST DOCUMENT ALTERATION."]
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
[THE DIGIMARC CORPORATION LOGO AND WEB ADDRESS.]
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
[DIGIMARC LOGO]
4,000,000 Shares
Common Stock
Digimarc Corporation is offering 4,000,000 shares of its common stock. This
is our initial public offering and no public market currently exists for our
shares. We have applied to have our common stock quoted on the Nasdaq National
Market under the symbol "DMRC." The initial public offering price is $20.00.
----------------
Investing in our common stock involves risks.
See "Risk Factors" beginning on page 4.
----------------
<TABLE>
<CAPTION>
Per
Share Total
------ -----------
<S> <C> <C>
Public Offering Price....................................... $20.00 $80,000,000
Underwriting Discounts and Commissions...................... $ 1.40 $ 5,600,000
Proceeds to Digimarc........................................ $18.60 $74,400,000
</TABLE>
The Securities and Exchange Commission and state securities regulators have
not approved or disapproved these securities, or determined if this prospectus
is truthful or complete. Any representation to the contrary is a criminal
offense.
Digimarc has granted the underwriters a 30-day option to purchase up to an
additional 600,000 shares of common stock to cover any over-allotments.
----------------
Robertson Stephens International
Hambrecht & Quist
U.S. Bancorp Piper Jaffray
The date of this Prospectus is December 1, 1999.
<PAGE>
UNDERWRITING
The underwriters named below, acting through their representatives,
BancBoston Robertson Stephens Inc., Hambrecht & Quist LLC and U.S. Bancorp
Piper Jaffray Inc., have severally agreed with us, subject to the terms and
conditions of the underwriting agreement, to purchase from us the number of
shares of common stock indicated opposite their names below. The underwriters
are committed to purchase and pay for all of the shares if any are purchased.
<TABLE>
<CAPTION>
Number Of
Underwriters Shares
------------ ---------
<S> <C>
BancBoston Robertson Stephens Inc. and BancBoston Robertson
Stephens International Limited............................... 2,000,000
Hambrecht & Quist LLC......................................... 1,200,000
U.S. Bancorp Piper Jaffray Inc. .............................. 800,000
---------
Total....................................................... 4,000,000
=========
</TABLE>
We have been advised that the underwriters propose to offer the shares of
common stock to the public at the public offering price located on the cover
page of this prospectus and to dealers at that price less a concession of not
in excess of $0.84 per share, of which $0.10 may be reallowed to their dealers.
After the initial public offering, the public offering price, concession and
reallowance to dealers may be reduced by the representatives. No reduction in
this price will change the amount of proceeds to be received by us as indicated
on the cover page of this prospectus.
The underwriters do not intend to confirm sales to any accounts over which
they exercise discretionary authority.
Over-Allotment Option. We have granted to the underwriters an option,
exercisable during the 30-day period after the date of this prospectus, to
purchase up to 600,000 additional shares of common stock at the same price per
share as we will receive for the 4,000,000 shares that the underwriters have
agreed to purchase. To the extent that the underwriters exercise this option,
each of the underwriters will have a firm commitment to purchase approximately
the same percentage of these additional shares that the number of shares of
common stock to be purchased by it shown in the above table represents as a
percentage of the 4,000,000 shares offered by this prospectus. If purchased,
such additional shares will be sold by the underwriters on the same terms as
those on which the 4,000,000 shares are being sold. We will be obligated, under
this option, to sell shares to the extent the option is exercised. The
underwriters may exercise the option only to cover over-allotments made in
connection with the sale of the shares of common stock offered by this
prospectus.
The following table shows the per share and total underwriting discounts and
commissions to be paid by us to the underwriters. This information is presented
assuming either no exercise or full exercise by the underwriters of their over-
allotment option.
<TABLE>
<CAPTION>
Per Without
Share Option With Option
------ ----------- -----------
<S> <C> <C> <C>
Public offering price...................... $20.00 $80,000,000 $92,000,000
Underwriting discounts and commissions..... $ 1.40 $ 5,600,000 $ 6,440,000
Proceeds, before expenses, to us........... $18.60 $74,400,000 $85,560,000
</TABLE>
The other expenses of the offering are estimated at $1,326,000 and are
payable entirely by us. BancBoston Robertson Stephens Inc. expects to deliver
the shares of common stock to purchasers on December 7, 1999.
68
