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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

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FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001

COMMISSION FILE NUMBER 000-28317

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DIGIMARC CORPORATION(Exact Name of Registrant as Specified in Its Charter)

Delaware

94-3342784(State or Other Jurisdiction of
Incorporation or Organization)

(I.R.S. Employer
Identification Number)


19801 SW 72nd Ave, Ste 100, Tualatin, Oregon 97062(Address of Principal Executive Offices)

Telephone: (503) 885-9699(Registrant's Telephone Number, Including Area Code)

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Indicate
by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  /x/    No  / /

Indicate
the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

16,887,196
shares of Common Stock, $0.001 par value, as of October 31, 2001.

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DIGIMARC CORPORATION  TABLE OF CONTENTS

|           |  |                                                                                                           |  | Page No.
|---------- |  | --------------------------------------------------------------------------------------------------------- |  | --------
|PART I.    |  | FINANCIAL INFORMATION                                                                                     |  |         
|Item 1.    |  | Financial Statements:                                                                                     |  |         
|           |  | Condensed Balance Sheets as of September 30, 2001 and December 31, 2000                                   |  | 3       
|           |  | Condensed Statements of Operations for the three months and nine months ended September 30, 2001 and 2000 |  | 4       
|           |  | Condensed Statements of Cash Flows for the nine months ended September 30, 2001 and 2000                  |  | 5       
|           |  | Notes to Condensed Financial Statements                                                                   |  | 6       
|Item 2.    |  | Management's Discussion and Analysis of Financial Condition and Results of Operations                     |  | 9       
|Item 3.    |  | Quantitative and Qualitative Disclosures about Market Risk                                                |  | 22      
|PART II.   |  | OTHER INFORMATION                                                                                         |  |         
|Item 1.    |  | Legal Proceedings                                                                                         |  | 22      
|Item 6.    |  | Exhibits and Reports on Form 8-K                                                                          |  | 22      
|Signatures |  | 23                                                                                                       

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

DIGIMARC CORPORATION  CONDENSED BALANCE SHEETS  (IN THOUSANDS)  (UNAUDITED)

|                                     |                                   | September 30,
2001                         |       | December 31,
2000 (1) |        
|------------------------------------ | --------------------------------- | ------------------------------------------ | ----- | --------------------- | -------
|ASSETS                               |                                   |                                            |       |                       |        
|Current assets:                      |                                   |                                            |       |                       |        
|                                     | Cash and cash equivalents         |                                            | $     | 92,854                |        
|                                     | Short-term investments            |                                            |       | 32,793                |        
|                                     | Trade accounts receivable, net    |                                            |       | 2,421                 |        
|                                     | Other current assets              |                                            |       | 1,487                 |        
|                                     |                                   |                                            |       |                       |        
|                                     |                                   | Total current assets                       |       |                       | 129,555
|Property and equipment, net          |                                   |                                            | 2,672 |                       |        
|Other assets, net                    |                                   |                                            | 19    |                       |        
|                                     |                                   |                                            |       |                       |        
|                                     |                                   | Total assets                               |       | $                     | 132,246
|                                     |                                   |                                            |       |                       |        
|LIABILITIES AND STOCKHOLDERS' EQUITY |                                   |                                            |       |                       |        
|Current liabilities:                 |                                   |                                            |       |                       |        
|                                     | Accounts payable                  |                                            | $     | 1,580                 |        
|                                     | Accrued payroll and related costs |                                            |       | 879                   |        
|                                     | Deferred revenue                  |                                            |       | 459                   |        
|                                     | Other current liabilities         |                                            |       | 104                   |        
|                                     |                                   |                                            |       |                       |        
|                                     |                                   | Total current liabilities                  |       |                       | 3,022  
|Other long-term liabilities          |                                   |                                            | 19    |                       |        
|                                     |                                   |                                            |       |                       |        
|                                     |                                   | Total liabilities                          |       |                       | 3,041  
|Stockholders' equity:                |                                   |                                            |       |                       |        
|                                     | Common stock                      |                                            |       | 17                    |        
|                                     | Additional paid-in capital        |                                            |       | 172,818               |        
|                                     | Deferred stock compensation       |                                            |       | (3,866                | )      
|                                     | Warrant                           |                                            |       | 657                   |        
|                                     | Accumulated deficit               |                                            |       | (40,421               | )      
|                                     |                                   |                                            |       |                       |        
|                                     |                                   | Total stockholders' equity                 |       |                       | 129,205
|                                     |                                   |                                            |       |                       |        
|                                     |                                   | Total liabilities and stockholders' equity |       | $                     | 132,246
|                                     |                                   |                                            |       |                       |        

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See
Notes to Condensed Financial Statements.

3

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DIGIMARC CORPORATION  CONDENSED STATEMENTS OF OPERATIONS  (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)  (UNAUDITED)

|                                       |                                                         | Three Months Ended       |        | Nine Months Ended |       
|-------------------------------------- | ------------------------------------------------------- | ------------------------ | ------ | ----------------- | ------
|
|
|Revenue:                               |                                                         |                          |        |                   |       
|                                       | License and subscription                                |                          | $      | 386               |       
|                                       | Service                                                 |                          |        | 2,681             |       
|                                       |                                                         |                          |        |                   |       
|                                       |                                                         | Total revenue            |        |                   | 3,067 
|Cost of revenue:                       |                                                         |                          |        |                   |       
|                                       | License and subscription                                |                          |        | 21                |       
|                                       | Service                                                 |                          |        | 1,552             |       
|                                       |                                                         |                          |        |                   |       
|                                       |                                                         | Total cost of revenue    |        |                   | 1,573 
|Gross profit                           |                                                         |                          | 1,494  |                   |       
|Operating expenses:                    |                                                         |                          |        |                   |       
|                                       | Sales and marketing                                     |                          |        | 2,592             |       
|                                       | Research, development and engineering                   |                          |        | 1,581             |       
|                                       | General and administrative                              |                          |        | 3,159             |       
|                                       |                                                         |                          |        |                   |       
|                                       |                                                         | Total operating expenses |        |                   | 7,332 
|                                       |                                                         | Operating loss           |        |                   | (5,838
|Other income (expense):                |                                                         |                          |        |                   |       
|                                       | Interest income                                         |                          |        | 1,237             |       
|                                       | Interest expense                                        |                          |        | (4                | )     
|                                       | Other                                                   |                          |        | (6                | )     
|                                       |                                                         |                          |        |                   |       
|                                       |                                                         | Total other income, net  |        |                   | 1,227 
|                                       |                                                         |                          |        |                   |       
|Loss before provision for income taxes |                                                         |                          | (4,611 | )                 |       
|Provision for income taxes             |                                                         |                          |       |                   |       
|                                       |                                                         |                          |        |                   |       
|                                       | Net loss                                                |                          | $      | (4,611            | )     
|                                       |                                                         |                          |        |                   |       
|Net loss per share  basic and diluted |                                                         | $                        | (0.27  | )                 | $     
|                                       |                                                         |                          |        |                   |       
|                                       | Weighted average shares outstanding  basic and diluted |                          |        | 16,831            |       

See
Notes to Condensed Financial Statements.

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DIGIMARC CORPORATION  CONDENSED STATEMENTS OF CASH FLOWS  (IN THOUSANDS)  (UNAUDITED)

|                                      |                                                                             | Nine Months Ended                                               |                                          
|------------------------------------- | --------------------------------------------------------------------------- | --------------------------------------------------------------- | -----------------------------------------
|
|Cash flows from operating activities: |                                                                             |                                                                 |                                          
|                                      | Net loss                                                                    |                                                                 | $                                        
|                                      | Adjustments to reconcile net loss to net cash used in operating activities: |                                                                 |                                          
|                                      |                                                                             | Depreciation and amortization                                   |                                          
|                                      |                                                                             | Stock-based compensation expense                                |                                          
|                                      |                                                                             | Changes in assets and liabilities:                              |                                          
|                                      |                                                                             |                                                                 | Trade accounts receivable                
|                                      |                                                                             |                                                                 | Prepaid expenses and other current assets
|                                      |                                                                             |                                                                 | Accounts payable                         
|                                      |                                                                             |                                                                 | Accrued payroll and related costs        
|                                      |                                                                             |                                                                 | Other short term liabilities             
|                                      |                                                                             |                                                                 | Deferred revenue                         
|                                      |                                                                             |                                                                 |                                          
|                                      |                                                                             |                                                                 |                                          
|Cash flows from investing activities: |                                                                             |                                                                 |                                          
|Purchase of property and equipment    |                                                                             |                                                                 | (854                                     
|Purchase of tradename                 |                                                                             |                                                                 |                                         
|Sales and maturities of investments   |                                                                             |                                                                 | 74,837                                   
|Purchase of investments               |                                                                             |                                                                 | (44,212                                  
|                                      |                                                                             |                                                                 |                                          
|                                      |                                                                             |                                                                 |                                          
|Cash flows from financing activities: |                                                                             |                                                                 |                                          
|                                      | Net proceeds from issuance of common stock                                  |                                                                 |                                          
|                                      | Principal payments on notes payable                                         |                                                                 |                                          
|                                      | Principal payments under capital lease obligations                          |                                                                 |                                          
|                                      |                                                                             |                                                                 |                                          
|                                      |                                                                             |                                                                 |                                          
|                                      |                                                                             |                                                                 |                                          
|                                      | Net increase (decrease) in cash and cash equivalents                        |                                                                 |                                          
|                                      | Cash and cash equivalents at beginning of period                            |                                                                 |                                          
|                                      |                                                                             |                                                                 |                                          
|                                      | Cash and cash equivalents at end of period                                  |                                                                 | $                                        
|                                      |                                                                             |                                                                 |                                          
|                                      | Supplemental disclosure of cash flow information:                           |                                                                 |                                          
|                                      |                                                                             | Cash paid for interest                                          |                                          
|                                      | Summary of non-cash investing and financing activities:                     |                                                                 |                                          
|                                      |                                                                             | Equipment acquired or exchanged under capital lease obligations |                                          

See
Notes to Condensed Financial Statements.

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DIGIMARC CORPORATION  NOTES TO CONDENSED FINANCIAL STATEMENTS

1.  The Company, Basis of Presentation

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. However,
certain information or footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been
condensed, or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). In the opinion of management, the statements include all adjustments necessary (which are
of a normal and recurring nature) for the fair presentation of the results of the interim periods presented. The results of operations for such periods are not necessarily indicative of the results
expected for a full year or for any future period.

These
financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2000 included in the Company's 2000 Annual Report
on Form 10-K filed with the SEC on March 22, 2001.

2.  Loss Per Share Computation

Basic and diluted net loss per share is computed using the weighted average number of shares of common stock outstanding for the period. The effect of
outstanding stock options and outstanding warrants are excluded from the calculation of diluted net loss per share for the periods presented as their inclusion would be antidilutive.

3.  Segment Information

The Company derives its revenue from a single operating segment, digital watermarking applications. Revenue concentration information is as follows:

|           |  | Three Months Ended |   | Nine Months Ended |  
|---------- |  | ------------------ | - | ----------------- | -
|
|Customer A |  | 70                 | % | 76                | %
|Customer B |  | 11                 | % | *                 |  



Accounts
receivable concentration information is as follows:

|           |  | September 30,
2001 |   | December 31,
2000 |  
|---------- |  | ------------------ | - | ----------------- | -
|Customer A |  | 61                 | % | 63                | %
|Customer B |  | 25                 | % | *                 |  



4.  Stock-based Compensation Allocation

Stock-based compensation expense includes costs relating to stock-based employee compensation arrangements. Stock-based 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-based compensation expense of $484,000 and $1.5 million was recorded for the three and nine months

6

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ended September 30, 2001, respectively, and is included in the respective statement of operations expense categories for the employees to which it relates. At current estimates, additional
stock-based compensation expense related to stock option grants will be approximately $484,000 for the remainder of 2001, approximately $1.9 million for 2002, and approximately
$1.4 million for 2003.

5.  Commitments and Contingencies

Between May 3, 2001 and June 20, 2001, several class action complaints were filed in the Southern District of New York against the Company and
the underwriters of its initial public offering. The complaint alleges violations of the securities laws in connection with certain alleged compensation arrangements entered into by the underwriters
subsequent to the offering. The Company is reviewing the action and believes that the allegations are without merit. Although no assurance can be given that this matter will be resolved in the
Company's favor, the Company believes that the resolution of these lawsuits will not have a material adverse effect on the Company's financial position, results of operations or liquidity.

6.  Comprehensive Income (Loss)

The Company has adopted Statement of Financial Accounting Standards (SFAS) No. 130,Reporting Comprehensive
Income, which establishes standards of reporting and display of comprehensive income (loss) and its components of net income (loss) and other comprehensive income (loss). Other
comprehensive income (loss) refers to revenues, expenses, gains and losses that are not included in net income (loss) but rather are recorded directly in stockholders' equity. For the three and nine
months ended September 30, 2001 and 2000, there is no difference between net income (loss) and comprehensive income (loss).

7.  Recent Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board ("FASB") issued FASB Statements Nos. 141 and 142 ("FAS 141" and "FAS 142"),
"Business Combinations" and "Goodwill and Other Intangible Assets." FAS 141 replaces APB 16 and eliminates pooling-of-interests accounting prospectively. It also
provides guidance on purchase accounting related to the recognition of intangible assets and accounting for negative goodwill. FAS 142 changes the accounting for goodwill from an amortization
method to an impairment-only approach. Under FAS 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired.
FAS 141 and FAS 142 are effective for all business combinations initiated after June 30, 2001.

Upon
adoption of FAS 142, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 will cease, and intangible assets acquired prior
to July 1, 2001 that do not meet the criteria for recognition under FAS 141 will be reclassified to goodwill. Companies are required to adopt FAS 142 for fiscal years beginning
after December 15, 2001. The Company will adopt FAS 142 on January 1, 2002. In connection with the adoption of FAS 142, the Company will be required to perform a
transitional goodwill impairment assessment. The Company has not yet determined the impact, if any, these standards will have on its results of operations and financial position.

In
August 2001, the FASB issued FASB Statement No. 143 ("FAS 143"), "Accounting for Asset Retirement Obligations", which addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. FAS 143 is required to be adopted for fiscal years
beginning after June 15, 2002. The Company has not yet determined what effect this statement will have on its financial statements.

In
August 2001, the FASB issued FASB Statement No. 144 ("FAS 144"), Accounting for the Impairment or Disposal of Long-lived Assets", which supercedes
FASB Statement No. 121, "Accounting

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for the Impairment of Long-lived Assets and for Long-lived to be Disposed of". This new statement also supersedes certain aspects of APB 30, "Reporting the Results of
OperationsReporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", with regard to reporting the
effects of a disposal of a segment of a business and will require expected future operating losses from discontinued operations to be reported in discontinued operations in the period incurred (rather
than as of the measurement date as presently required by APB30). In addition, more dispositions may qualify for discontinued operations treatment. The provisions of this statement are required to be
applied for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The Company has not yet determined what effect this statement will have on its
financial statements.

8.  Subsequent Events

On October 17, 2001, the Company implemented a reduction in workforce of approximately 20% and restructured its operations to place more emphasis on
security applications and licensing.

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements
relating to future events or the future financial performance of Digimarc, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these
forward-looking statements as a result of certain factors, including those set forth under "Risks Related to our Business" and "Risks Related to our Industry," and those risks described in our Annual
Report on Form 10-K filed with the Securities and Exchange Commission on March 22, 2001. This discussion and analysis should also be read in conjunction with our interim
unaudited Condensed Financial Statements and Related Notes included herein.

Overview

Digimarc is a leading provider of digital watermarking technologies that allow imperceptible digital code to be embedded in the printed or digital versions of
media content, such as commercial and consumer photographs, movies, music, magazine advertisements, catalogs, product packages and valuable documents like financial instruments, passports and event
tickets. In addition to a code that can be embedded within various types of media content, our technologies include reader software that, as a resident application on PCs and other devices, enables
the recognition of these embedded codes. We believe our technologies have many potential applications. We are developing products and services to address what we believe are our three largest
near-term market opportunities: the deterrence of digital counterfeiting and piracy; the enhancement of Internet access and navigation; and the enhancement and protection of audio and
video digital files.

Results of Operations

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

|                    |                                        | Three Months
Ended       |     | Nine Months
Ended |   
|------------------- | -------------------------------------- | ------------------------ | --- | ----------------- | --
|
|
|Revenue:            |                                        |                          |     |                   |   
|                    | License and subscription               |                          | 13  | %                 | 19
|                    | Service                                |                          | 87  |                   | 81
|                    |                                        |                          |     |                   |   
|                    |                                        | Total revenue            |     | 100               |   
|Cost of revenue:    |                                        |                          |     |                   |   
|                    | License and subscription               |                          | 1   |                   | 1 
|                    | Service                                |                          | 51  |                   | 55
|                    |                                        |                          |     |                   |   
|                    |                                        | Total cost of revenue    |     | 52                |   
|                    | Gross profit                           |                          | 48  |                   | 44
|Operating expenses: |                                        |                          |     |                   |   
|                    | Sales and marketing                    |                          | 84  |                   | 89
|                    | Research, development, and engineering |                          | 51  |                   | 39
|                    | General and administrative             |                          | 103 |                   | 92
|                    |                                        |                          |     |                   |   
|                    |                                        | Total operating expenses |     | 238               |   
|                    |                                        |                          |     |                   |   
|                    |                                        | Operating loss           |     | (190              | ) 
|                    | Other income (expense), net            |                          | 40  |                   | 40
|                    |                                        |                          |     |                   |   
|                    |                                        | Net loss                 |     | (150              | )%
|                    |                                        |                          |     |                   |   

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Revenue

Total revenue was $3.1 million and $11.0 million for the three and nine months ended September 30, 2001, respectively, compared to total
revenue of $3.1 million and $8.4 million for the three and nine months ended September 30, 2000. The slight decrease for the three months ended September 30, 2001 was
primarily related to decreased royalty and consulting revenues within the quarter. The $2.6 million or 31% increase for the nine months ended September 30, 2001 was primarily related to
overall increased royalty and consulting revenues. The consortium of banks accounted for approximately 70% and 62% of our total revenue for the three and nine months ended September 30, 2001,
respectively. This customer has a discretionary right of early termination with respect to the agreement. Unless the customer exercises this right, we expect to earn revenue under the agreement for
the remainder of 2001. We intend 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 other
related institutions. We also 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, commercial printers, and other producers of print and digital media. Successful
introduction and implementation of these new products and services, if achieved, would significantly change the mix and concentration of our future revenue.

License and subscription.License and subscription revenue was $0.4 million and $2.0 million for the
three and nine months ended September 30, 2001, respectively, compared to license and subscription revenue of $0.6 million and $0.7 million for the three and nine months ended
September 30, 2000. The $0.2 million or 36% decrease for the three months ended September 30, 2001 was primarily related to decreased royalty revenues within the quarter. The
$1.3 million or 185% increase for the nine months ended September 30, 2001 was primarily related to overall increased royalty revenues.

Service.Service revenue was $2.7 million and $9.0 million for the three and nine months ended
September 30, 2001, respectively, compared to service revenue of $2.5 million and $7.7 million for the three and nine months ended September 30, 2000. The
$0.2 million or 6% and $1.3 million or 17% increase for the three and nine months ended September 30, 2001, respectively, was primarily the result of increased activity in
providing services for both Media Commerce and Digimarc MediaBridge customers.

Cost of Revenue

License and subscription.Cost of license and subscription revenue includes compensation for operations personnel,
Internet service provider connectivity charges and image search data fees to support the services offered to our subscription customers. Cost of license and subscription revenue was $21,000 and
$94,000 for the three and nine months ended September 30, 2001, respectively, compared to $19,000 and $84,000 for the three and nine months ended September 30, 2000, 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 service and development contracts. Cost of service revenue was $1.6 million
and $5.2 million for the three and nine months ended September 30, 2001, respectively, compared to $1.7 million and $5.0 million for the three and nine months ended
September 30, 2000, respectively. The $0.1 million or 10% decrease and $0.2 million or 3% increase for the three and nine months ended September 30, 2001, respectively, was
the result of increased services activity for both Media Commerce and Digimarc MediaBridge customers.

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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 $2.6 million and $8.2 million for the three and nine months ended September 30, 2001, respectively, compared to
$2.8 million and $8.3 million for the three and nine months ended September 30, 2000, respectively. The $0.2 million or 8% decrease for the three months ended
September 30, 2001 resulted from decreased promotional activity of approximately $0.2 million, a decrease of approximately $0.2 million related to decreased use of outside
consulting services, partially offset by approximately $0.2 million increase in S&M due to the decreased use of sales and marketing personnel to provide services for our revenue generating
contracts that would have been included in cost of service revenue. The $0.1 million or 1% decrease for the nine months ended September 30, 2001 resulted from increased costs of
$0.9 million related to salaries and other employee related costs, including travel expenses, and increased administrative costs of $0.3 million associated with sales and marketing,
offset by decreased costs of $0.9 million related to promotional activities, including advertising, decreased costs of approximately $0.4 million related to decreased use of outside
consulting services, and approximately $0.1 million of decreased use of sales and marketing personnel to provide services for our revenue generating contracts that are included in cost of
service revenue. Sales and marketing employees totaled 71 and 65 as of September 30, 2001 and 2000, respectively.

Research, development and engineering.Research, development and engineering expenses consist primarily of
compensation, benefits and related costs of software developers and quality assurance personnel and payments to outside contractors. Research, development and engineering expenses were
$1.6 million and $4.9 million for the three and nine months ended September 30, 2001, respectively, compared to $1.2 million and $3.2 million for the three and nine
months ended September 30, 2000, respectively. The $0.4 million or 29% increase for the three months ended September 30, 2001 resulted from increased costs of $0.1 million
related to outside consultants, increased administrative costs of $0.2 million associated with research, development and engineering activities, and $0.2 million related to decreased use
of research, development and engineering personnel to provide services for our revenue generating contracts, partially offset by a decrease of $0.1 million related to salaries and other
employee related costs, including travel expenses. The $1.7 million or 53% increase for the nine months ended September 30, 2001 resulted from increased costs of $0.8 million
related to salaries and other employee related costs, including travel expenses, increased costs of approximately $0.3 million related to increased use of outside consultants, and increased
costs of $0.6 million in administrative costs associated with research, development and engineering. Research, development and engineering personnel totaled 83 and 75 as of September 30,
2001 and 2000, respectively.

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 $3.2 million and
$9.6 million for the three and nine months ended September 30, 2001, respectively, compared to $2.9 million and $8.5 million for the three and nine months ended
September 30, 2000, respectively. The $0.3 million or 9% increase for the three months ended September 30, 2001 resulted from increased costs of $0.3 million related to
salaries and other employee related costs, including travel expenses. The $1.1 million or 12% increase for the nine months ended September 30, 2001 resulted from increased costs of
$0.5 million related to employee costs, including executive compensation, travel expenses, and executive recruiting fees; increased costs of $0.1 million related to administrative costs,
including facilities, office expenses, and depreciation; and increased costs of approximately $0.5 million related to professional fees, including litigation costs. General and administrative
employees totaled 31 and 25 as of September 30, 2001 and 2000, respectively.

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Stock-based compensation.Stock-based compensation expense includes costs relating to stock-based employee compensation
arrangements. Stock-based 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-based compensation expense of $484,000 and $1.5 million was recorded for the three and
nine months ended September 30, 2001 and 2000, and is included in the respective statements of operations expense categories for the employees to which it applies. At September 30, 2001,
$3.8 million of stock-based compensation remains deferred and we expect approximately $0.5 million for the remainder of 2001, $1.9 million for 2002, and $1.4 million for
2003 to be recognized as expense.

Other Income (Expense).Other income (expense) consists primarily of interest received and paid. Other income (expense)
was $1.2 million and $4.8 million for the three and nine months ended September 30, 2001, respectively, and was $1.3 million and $3.8 million for the three and nine
months ended September 30, 2000, respectively. The $0.1 million or 4% decrease and $1.0 million or 26% increase for the three and nine months ended September 30, 2001,
respectively, came as a result of significantly higher cash and cash equivalent balance earning interest due to the funds received from our private placement offering in October 2000, offset in
part by declining interest rates in 2001.

Provision for Income Taxes.We have recognized operating losses since inception and as such have not incurred income
tax expense. As of December 31, 2000, we had operating loss carryovers for federal and state income tax reporting purposes of approximately $32.4 million and research and development tax
credit carryforwards of approximately $130,000, the last of which will expire in 2020 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, July 1996, and July 1999 and in connection with the initial public offering of our common stock in December 1999. Accordingly, we estimate that approximately
$9.0 million of net operating loss carryforwards are subject to the utilization limitation.

Recent Accounting Pronouncements.In July 2001, the Financial Accounting Standards Board ("FASB") issued FASB
Statements Nos. 141 and 142 ("FAS 141" and "FAS 142"), "Business Combinations" and "Goodwill and Other Intangible Assets." FAS 141 replaces APB 16 and eliminates
pooling-of-interests accounting prospectively. It also provides guidance on purchase accounting related to the recognition of intangible assets and accounting for negative
goodwill. FAS 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Under FAS 142, goodwill will be tested annually and whenever
events or circumstances occur indicating that goodwill might be impaired. FAS 141 and FAS 142 are effective for all business combinations initiated after June 30, 2001.

Upon
adoption of FAS 142, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 will cease, and intangible assets acquired prior
to July 1, 2001 that do not meet the criteria for recognition under FAS 141 will be reclassified to goodwill. Companies are required to adopt FAS 142 for fiscal years beginning
after December 15, 2001. The Company will adopt FAS 142 on January 1, 2002. In connection with the adoption of FAS 142, the Company will be required to perform a
transitional goodwill impairment assessment. The Company has not yet determined the impact, if any, these standards will have on its results of operations and financial position.

In
August 2001, the FASB issued FASB Statement No. 143 ("FAS 143"), "Accounting for Asset Retirement Obligations", which addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. FAS 143 is required to be adopted for fiscal years
beginning after June 15, 2002. The Company has not yet determined what effect this statement will have on its financial statements.

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In August 2001, the FASB issued FASB Statement No. 144 ("FAS 144"), Accounting for the Impairment or Disposal of Long-lived Assets", which supercedes
FASB Statement No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived to be Disposed of". This new statement also supersedes certain aspects of
APB 30, "Reporting the Results of OperationsReporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions",
with regard to reporting the effects of a disposal of a segment of a business and will require expected future operating losses from discontinued operations to be reported in discontinued operations
in the period incurred (rather than as of the measurement date as presently required by APB30). In addition, more dispositions may qualify for discontinued operations treatment. The provisions of this
statement are required to be applied for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The Company has not yet determined what effect this
statement will have on its financial statements.

Liquidity and Capital Resources

As of September 30, 2001, we had cash and cash equivalents and short-term investments of $125.6 million, representing a decrease of
$10.3 million from $135.9 million at December 31, 2000. Working capital at September 30, 2001 was $126.5 million, compared to working capital of
$135.2 million at December 31, 2000. The decrease in working capital is attributable primarily to the cash used for our current operations.

The
$10.5 million of cash used in operating activities for the nine months ended September 30, 2001 primarily consisted of $12.2 million in net loss and an
increase in accounts receivable of $0.8 million, partially offset by $1.7 million related to depreciation and amortization and $1.5 million related to stock-based compensation.
Operating activities used cash of $8.8 million for the nine months ended September 30, 2000.

The
$29.8 million of cash provided by investing activities for the nine months ended September 30, 2001 related primarily to the sale or maturity of $74.8 million
in investments, offset by the purchase of $44.2 million in investments. Investing activities used cash of $3.3 million for the nine months ended September 30, 2000 related
primarily to the purchase of equipment.

The
$1.1 million of cash provided by financing activities related primarily to proceeds from the issuance of stock for $1.2 million related to the Employee Stock
Purchase plan and Employee Stock Option plans. Financing activities provided cash of $0.1 million for the nine months ended September 30, 2000.

We
have computers and office equipment financed under long-term capital leases that expire over the next 35 months. As of September 30, 2001, we had an
outstanding balance of approximately $0.1 million of capital lease obligations. Other significant commitments consist of obligations under non-cancelable operating leases, which
totaled $3.4 million as of September 30, 2001, and are payable in monthly installments through 2005.

We
expect to experience significant operating expenses for the foreseeable future in order to execute our business plan, including the effect of our recent reduction in workforce. As
a result, we anticipate that such operating expenses, as well as planned capital expenditures, will constitute a material use of our cash resources. In addition, we may utilize cash resources to fund
acquisitions or investments in complementary businesses, technologies or product lines.

We
believe that our current cash, cash equivalent, and short-term investment balances will satisfy our projected working capital and capital expenditure requirements for
at least the next 12 months. Thereafter, we may find it necessary to obtain additional equity financing, debt financing, or credit facilities. We may not be able to obtain additional financings
or credit facilities, or if these funds are available, they may not be available on satisfactory terms.

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Risks Related to Our Business

We have a history of losses and expect future losses; we cannot assure you that we will achieve profitability

We have incurred significant net losses since inception and we expect to incur a loss for the 2001 fiscal year in light of our planned operating expenditures.
We incurred net losses of $12.2 million for the nine months ended September 30, 2001. 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, 2001 was approximately $40.4 million. In order to achieve profitability, we will need to generate significantly higher revenue
than we have in prior years. Even if we ultimately achieve profitability, we may not be able to sustain or increase our profitability. We anticipate that we will continue to invest significantly in
research and development, sales and marketing, product development and general and administrative expenses for the foreseeable future. If our revenue grows more slowly than we anticipate, or if our
operating expenses exceed our expectations, our operating results will be harmed and we may not be profitable.

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 and products include media 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, from Secure Document applications and from Media Commerce applications. In the future, we anticipate that an increasing share of our revenue
will be from sales of our Digimarc MediaBridge system, which was released in the second half of 2000, and sales of other applications of our digital watermarking technologies. We have not fully
developed a revenue model for the Digimarc MediaBridge system, or for our other future applications. In addition, because these products are not yet fully established 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 are developed and are currently developing for these products
will be accepted. If we do not successfully develop, market and support the Digimarc MediaBridge system, it is likely that our future revenue will fall below our targeted objectives. Any shortfall in
revenue from the Digimarc MediaBridge system 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 applications 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 business, operating results and financial condition may seriously be harmed.

Because we currently receive 62% 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 which we have a development and license agreement related
to banknote counterfeit deterrence. Revenue from products and services provided to this significant customer accounted for 62% of our total revenue for the nine months ended September 30, 2001.
We anticipate that this relationship will account for a majority of our revenue until we are able to generate additional revenue from the introduction of other new products and services that we are
developing. The customer has a

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discretionary right of early termination with respect to the agreement. Unless the customer exercises this right, we expect to earn revenue under the agreement through the remainder of the year, which
concludes our initial agreement with the consortium of banks. While we are optimistic that the agreement will be renewed for future periods, we cannot guarantee that this will happen.

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.

Our future growth will depend on the successful implementation of our product solutions by third-party partners

The Digimarc MediaBridge system and other applications and services that we intend to provide 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 agreements with 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 their 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.

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:



We
cannot assure you that our business strategy will be successful or that we will successfully address these risks and the risks described below.

Our future quarterly operating results may not meet analysts' expectations and may fluctuate significantly in the future, which could adversely affect our stock price

Our quarterly operating results have fluctuated significantly in the past, and we expect that our quarterly operating results will fluctuate significantly in
the future. Our operating results are difficult to forecast because of our limited operating history and the nature of our business. Accordingly, you should not rely on
quarter-to-quarter comparisons of our historical results as an indication of future
performance or any trend in our performance. In addition, if our quarterly operating results do not meet the expectations of analysts or investors, the market price of our common stock will likely
decline.

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Our quarterly results may fluctuate in the future as a result of many factors, some of which are outside our control, including:



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.

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 media 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. 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

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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 seriously 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 that we have taken to prevent misappropriation of our solutions or technologies may not prevent their misappropriation,
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 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" "MARCSPIDER" "MARCCENTRE" "PICTUREMARC" and the "D" logo as trademarks in the United States and other countries, and are pursuing registration of the
"DIGIMARC" trademark in additional countries. We also have trademark rights with respect to "MediaBridge" and are pursuing registration of this mark in the United States and other countries. However,
our tradenames or trademarks may be registered by third parties in other countries, impairing our ability to enter and compete in these markets. In the United States, the trademarks "Digimark" and
"Mediabridge" and the domain names "Digimark.com" and "Mediabridge.com" have been registered by unrelated companies. While we have successfully co-existed with these other companies, we
cannot assure you that this state of affairs will continue. If we were forced to change our name or were prevented from using our other brand names, including MediaBridge, we would lose a significant
amount of our brand equity, and our business would suffer.

As
more companies enter the digital watermarking 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.

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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 digital code in media 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 media commerce, anti-counterfeiting and piracy systems and self-authentication solutions
including Grand Central linking servers. 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, services and reputation 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 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 inability 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 September 30, 2001 we had 185 employees. In October 2001 we implemented a reduction in workforce decreasing our headcount by approximately
20%. To manage our operations, management must continue to improve our operational and financial systems and expand, train, retain and manage our employee base. Additional growth of our product lines
or business could significantly strain our managerial and financial resources. If we cannot manage our growth effectively, we may not be able to

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coordinate the activities of our technical, accounting and marketing staffs, and our business could be harmed.

We may acquire other businesses or technologies; if we do, we may be unable to integrate them with our own business, or we may impair our financial performance

From time to time we have discussions with third parties about potential acquisitions. If appropriate opportunities present themselves, we may attempt to
acquire other businesses or technologies. We may not be able to identify, negotiate or finance any future acquisition successfully. Even if we do succeed in acquiring a business, technology, service
or product, we have limited experience in integrating an acquisition into our business. The process of integration may produce operating difficulties and expenditures and may require significant
attention of our management that otherwise would be available for the ongoing development of our business. Moreover, if we make acquisitions, we may issue shares of stock that dilute our stockholders,
incur debt, assume contingent liabilities or create additional expenses related to amortizing goodwill and other intangible assets, any of which might negatively affect our financial results and cause
our stock price to decline. Any financing that we might need for future acquisitions may also place restrictions on our business. We may never achieve any of the benefits that we might anticipate from
a future acquisition.

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. Most of our senior management do not have 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 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

Our ability to successfully develop, market and sell our applications and products depends to a significant degree upon the continued contributions of our key
personnel in engineering, sales, marketing and operations, many of whom would be difficult to replace. We believe our future success will also depend in large part upon our ability to retain our
current key employees or our ability to attract, integrate and retain other highly skilled managerial, engineering, sales, marketing and operations personnel in the future. 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. Competition for experienced personnel in our market segments is intense. If we do not succeed in attracting new personnel or in integrating, retaining and motivating our current personnel,
our business could be harmed. In October 2001, we implemented a reduction of force decreasing our headcount by approximately 20%. We do not believe these reductions in workforce have had a
material adverse affect on our operations. However, these reductions in workforce may make it difficult for us to recruit necessary personnel in the future. If we are unable to attract or retain
qualified personnel in the future, or if we experience delays in hiring required personnel, particularly qualified engineers and sales personnel, our ability to develop, introduce and sell our
products could be harmed.

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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 our 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. 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 seriously harmed.

Future sales of our common stock could cause our stock price to decline

We currently have 100,000,000 shares of common stock authorized for issuance. We may sell additional shares of common stock to third parties in the future.
Sales of a substantial number of shares of our common stock 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.

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 the following anti-takeover provisions in our charter documents:



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.

Risks Related to Our Industry

If we are unable to respond to regulatory or industry standards effectively, our business 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 audio, video, and image content, and for other uses of metadata with such content, in a timely and cost-effective manner. If we are
unable to influence or respond to these standards effectively, our business could be harmed.

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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:



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 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 applications. Because our business models are 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:



In
addition, as we more broadly apply our technologies to the Internet through the Digimarc MediaBridge system and other new image commerce 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

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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.

Item 3: Quantitative and Qualitative Disclosures about Market Risk

The Company's market risk disclosures set forth in Item 7A of its Annual Report on Form 10-K for the year ended December 31, 2000
have not changed significantly.

Part II. Other Information

Item 1. Legal Proceedings

Beginning in May 2001, a number of substantially identical class action complaints alleging violations of the federal securities laws were filed in the United
States District Court for the Southern District of New York naming the Company, certain of its officers and directors, and certain underwriters of the Company's initial public offering as defendants.
The complaints have since been consolidated into a single action. The complaints allege, among other things, that the underwriters of the Company's initial public offering violated the securities laws
by failing to disclose certain alleged compensation arrangements (such as undisclosed commissions or stock stabilization practices) in the offering's registration statement. Similar complaints have
been filed against over 180 other issuers that have had initial public offerings since 1998. The Company intends to defend these actions vigorously. Although no assurance can be given that this matter
will be resolved in the Company's favor, the Company believes that the resolution of these lawsuits will not have a material adverse effect on the Company's financial position, results of operations
or cash flows.

Item 6. Exhibits and Reports On Form 8-K





Items 2, 3, 4 and 5 have been omitted as they are not applicable.

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SIGNATURES

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

|                        |  | Digimarc Corporation
|----------------------- |  | --------------------
|Date: November 14, 2001 |  | By:                 

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