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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 JUNE 30, 2001

COMMISSION FILE NUMBER 000-28317

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

Delaware(State or Other Jurisdiction of
Incorporation or Organization)

94-3342784(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.

16,809,455
shares of Common Stock, $0.001 par value, as of July 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 June 30, 2001 and December 31, 2000                                  |  | 3       
|           |  | Condensed Statements of Operations for the three months and six months ended June 30, 2001 and 2000 |  | 4       
|           |  | Condensed Statements of Cash Flows for the six months ended June 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               |  | 8       
|Item 3.    |  | Quantitative and Qualitative Disclosures about Market Risk                                          |  | 20      
|PART II.   |  | OTHER INFORMATION                                                                                   |  |         
|Item 1.    |  | Legal Proceedings                                                                                   |  | 21      
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                 |  | 21      
|Item 6.    |  | Exhibits and Reports on Form 8-K                                                                    |  | 21      
|Signatures |  | 23                                                                                                 

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

DIGIMARC CORPORATION

CONDENSED BALANCE SHEETS

(IN THOUSANDS)

(UNAUDITED)

|                                     |                                   | June 30,
2001                              |       | December 31,
2000 (1) |        
|------------------------------------ | --------------------------------- | ------------------------------------------ | ----- | --------------------- | -------
|ASSETS                               |                                   |                                            |       |                       |        
|Current assets:                      |                                   |                                            |       |                       |        
|                                     | Cash and cash equivalents         |                                            | $     | 103,520               |        
|                                     | Short-term investments            |                                            |       | 26,262                |        
|                                     | Trade accounts receivable, net    |                                            |       | 3,037                 |        
|                                     | Other current assets              |                                            |       | 1,370                 |        
|                                     |                                   |                                            |       |                       |        
|                                     |                                   | Total current assets                       |       |                       | 134,189
|Property and equipment, net          |                                   |                                            | 3,061 |                       |        
|Other assets, net                    |                                   |                                            | 23    |                       |        
|                                     |                                   |                                            |       |                       |        
|                                     |                                   | Total assets                               |       | $                     | 137,273
|                                     |                                   |                                            |       |                       |        
|LIABILITIES AND STOCKHOLDERS' EQUITY |                                   |                                            |       |                      
|Current liabilities:                 |                                   |                                            |       |                       |        
|                                     | Accounts payable                  |                                            | $     | 2,048                 |        
|                                     | Accrued payroll and related costs |                                            |       | 861                   |        
|                                     | Deferred revenue                  |                                            |       | 920                   |        
|                                     | Other current liabilities         |                                            |       | 219                   |        
|                                     |                                   |                                            |       |                       |        
|                                     |                                   | Total current liabilities                  |       |                       | 4,048  
|Other long-term liabilities          |                                   |                                            | 32    |                       |        
|                                     |                                   |                                            |       |                       |        
|                                     |                                   | Total liabilities                          |       |                       | 4,080  
|Stockholders' equity:                |                                   |                                            |       |                       |        
|                                     | Common stock                      |                                            |       | 17                    |        
|                                     | Additional paid-in capital        |                                            |       | 172,702               |        
|                                     | Deferred stock compensation       |                                            |       | (4,349                | )      
|                                     | Warrant                           |                                            |       | 633                   |        
|                                     | Accumulated deficit               |                                            |       | (35,810               | )      
|                                     |                                   |                                            |       |                       |        
|                                     |                                   | Total stockholders' equity                 |       |                       | 133,193
|                                     |                                   |                                            |       |                       |        
|                                     |                                   | Total liabilities and stockholders' equity |       | $                     | 137,273
|                                     |                                   |                                            |       |                       |        

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See
Notes to Condensed Financial Statements.

3

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DIGIMARC CORPORATION

CONDENSED STATEMENTS OF OPERATIONS (Continued)

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)

|                                       |                                                       | Three Months Ended       |        | Six Months Ended |       
|-------------------------------------- | ----------------------------------------------------- | ------------------------ | ------ | ---------------- | ------
|
|Revenue:                               |                                                       |                          |        |                  |       
|                                       | License and subscription                              |                          | $      | 841              |       
|                                       | Service                                               |                          |        | 3,366            |       
|                                       |                                                       |                          |        |                  |       
|                                       |                                                       | Total revenue            |        |                  | 4,207 
|Cost of revenue:                       |                                                       |                          |        |                  |       
|                                       | License and subscription                              |                          |        | 36               |       
|                                       | Service                                               |                          |        | 2,061            |       
|                                       |                                                       |                          |        |                  |       
|                                       |                                                       | Total cost of revenue    |        |                  | 2,097 
|Gross profit                           |                                                       |                          | 2,110  |                  |       
|Operating expenses:                    |                                                       |                          |        |                  |       
|                                       | Sales and marketing                                   |                          |        | 2,549            |       
|                                       | Research, development and engineering                 |                          |        | 1,539            |       
|                                       | General and administrative                            |                          |        | 3,283            |       
|                                       |                                                       |                          |        |                  |       
|                                       |                                                       | Total operating expenses |        |                  | 7,371 
|                                       |                                                       | Operating loss           |        |                  | (5,261
|Other income (expense):                |                                                       |                          |        |                  |       
|                                       | Interest income                                       |                          |        | 1,544            |       
|                                       | Interest expense                                      |                          |        | (3               | )     
|                                       | Other                                                 |                          |        | (6               | )     
|                                       |                                                       |                          |        |                  |       
|                                       |                                                       | Total other income, net  |        |                  | 1,535 
|                                       |                                                       |                          |        |                  |       
|Loss before provision for income taxes |                                                       |                          | (3,726 | )                |       
|Provision for income taxes             |                                                       |                          |       |                  |       
|                                       |                                                       |                          |        |                  |       
|                                       |                                                       | Net loss                 |        | $                | (3,726
|                                       |                                                       |                          |        |                  |       
|Net loss per sharebasic and diluted   |                                                       | $                        | (0.22  | )                | $     
|                                       |                                                       |                          |        |                  |       
|                                       | Weighted average shares outstandingbasic and diluted |                          |        | 16,643           |       

See
Notes to Condensed Financial Statements.

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DIGIMARC CORPORATION

CONDENSED STATEMENTS OF CASH FLOWS (Continued)

(IN THOUSANDS)

(UNAUDITED)

|                                                        |                                                                             | Six 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                                          |                                    |                                          
|                                                        | Purchase of tradename                                                       |                                    |                                          
|                                                        | Maturities of investments                                                   |                                    |                                          
|                                                        | Purchase of investments                                                     |                                    |                                          
|                                                        |                                                                             |                                    |                                          
|                                                        |                                                                             |                                    |                                          
|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    |                                                                             |                                    | 31,066                                   
|Cash and cash equivalents at beginning of period        |                                                                             |                                    | 72,454                                   
|                                                        |                                                                             |                                    |                                          
|Cash and cash equivalents at end of period              |                                                                             | $                                  | 103,520                                  
|                                                        |                                                                             |                                    |                                          
|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 (the 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 |   | Six Months Ended |  
|---------- |  | ------------------ | - | ---------------- | -
|
|Customer A |  | 61                 | % | 87               | %
|Customer B |  | 20                 | % | *                |  
|Customer C |  | 12                 | % | *                |  



Accounts
receivable concentration information is as follows:

|           |  | June 30,
2001 |   | December 31,
2000 |  
|---------- |  | ------------- | - | ----------------- | -
|Customer A |  | 65            | % | 63                | %
|Customer B |  | 15            | % | *                 |  



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

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grant, and is being recognized over the vesting periods of the related options, usually four years. Stock-based compensation expense of $477,000 and $1.0 million was recorded for the three and
six months ended June 30, 2001, respectively, and is included in the respective statement of operations expense categories for the employees to which it applies. At current estimates,
additional stock-based compensation expense related to stock option grants will be approximately $1.0 million 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 cash flows.

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 six
months ended June 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 142), Business Combinations and GoodwillandOther Intangible Assets, respectively.
FAS 141 replaces Accounting Principles Board Opinion (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. Under FAS 142, goodwill will be tested annually and whenever events or circumstances occur
indicating that goodwill might be impaired. FAS 141 and 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 be required to perform a transitional goodwill impairment assessment. The Company has determined that the impact of these standards will not have a
material affect on its results of operations and financial position when implemented.

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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
June 30, |    | Six Months Ended
June 30, |    
|--------------------------- | -------------------------------------- | --------------------------- | -- | ------------------------- | ---
|
|Revenue:                    |                                        |                             |    |                           |    
|                            | License and subscription               |                             | 20 | %                         | 2  
|                            | Service                                |                             | 80 |                           | 98 
|                            |                                        |                             |    |                           |    
|                            |                                        | Total revenue               |    | 100                       |    
|Cost of revenue:            |                                        |                             |    |                           |    
|                            | License and subscription               |                             | 1  |                           | 1  
|                            | Service                                |                             | 49 |                           | 66 
|                            |                                        |                             |    |                           |    
|                            |                                        | Total cost of revenue       |    | 50                        |    
|                            | Gross profit                           |                             | 50 |                           | 33 
|Operating expenses:         |                                        |                             |    |                           |    
|                            | Sales and marketing                    |                             | 60 |                           | 147
|                            | Research, development, and engineering |                             | 37 |                           | 38 
|                            | General and administrative             |                             | 78 |                           | 125
|                            |                                        |                             |    |                           |    
|                            |                                        | Total operating expenses    |    | 175                       |    
|                            |                                        |                             |    |                           |    
|                            |                                        | Operating loss              |    | (125                      | )  
|Other income (expense), net |                                        | 36                          |    | 48                        |    
|                            |                                        |                             |    |                           |    
|                            |                                        | Net loss                    |    | (89                       | )% 
|                            |                                        |                             |    |                           |    

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Revenue

Total revenue was $4.2 million and $7.9 million for the three and six months ended June 30, 2001, respectively, compared to total revenue
of $2.7 million and $5.3 million for the three and six months ended June 30, 2000. The $1.5 million or 56% and $2.7 million or 51% increase for the three and six
months ended June 30, 2001, respectively, was primarily the result of increased service and royalty revenue related to our Media Commerce and Digimarc MediaBridge product lines. The consortium
of banks accounted for approximately 61% and 59% of our total revenue for the three and six months ended June 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 $0.8 million and $1.6 million for the
three and six months ended June 30, 2001, respectively, compared to license and subscription revenue of $66,000 and $95,000 for the three and six months ended June 30, 2000. The
$0.8 million or 1174% and $1.5 million or 1585% increase for the three and six months ended June 30, 2001, respectively, was the direct result of increased license and royalty
revenue due to increased activity in the Media Commerce and Digimarc MediaBridge product lines.

Service.Service revenue was $3.4 million and $6.3 million for the three and six months ended
June 30, 2001, respectively, compared to service revenue of $2.6 million and $5.2 million for the three and six months ended June 30, 2000. The $0.7 million or 28%
and $1.2 million or 22% increase for the three and six months ended June 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 $36,000 and
$73,000 for the three and six months ended June 30, 2001, respectively, compared to $34,000 and $65,000 for the three and six months ended June 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 $2.1 million
and $3.6 million for the three and six months ended June 30, 2001, respectively, compared to $1.8 million and $3.3 million for the three and six months ended
June 30, 2000, respectively. The $0.3 million or 15% and $0.4 million or 11% increase for the three and six months ended June 30, 2001, respectively, was the result of the
increased services activity for both Media Commerce and Digimarc MediaBridge customers.

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

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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 $2.5 million
and $5.6 million for the three and six months ended June 30, 2001, respectively, compared to $4.0 million and $5.5 million for the three and six months ended
June 30, 2000, respectively. The $1.4 million or 36% decrease for the three months ended June 30, 2001 resulted from decreased promotional activity of approximately
$1.0 million, a decrease of approximately $0.4 million related to decreased use of outside consulting services, partially offset by approximately $0.1 million of increased use of
sales and marketing personnel to provide services for our revenue generating contracts that are included in cost of service revenue, partially offset by an increase of approximately
$0.1 million related to administrative costs associated with sales and marketing. The second quarter of 2000 had unusually high promotional costs due to the pending launch of our Digimarc
MediaBridge product. Going forward, we expect promotional costs to be consistent with levels in the second quarter of 2001. The $0.2 million or 3% increase for the six months ended
June 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 $0.8 million related to promotional activities, including advertising, decreased costs of approximately
$0.1 million related to decreased use of outside consulting services, and approximately $0.1 million of increased 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 73 and 62 as of June 30, 2001 and 2000, respectively. We anticipate that we will
continue to invest significantly in sales and marketing for the foreseeable future.

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
$1.5 million and $3.3 million for the three and six months ended June 30, 2001, respectively, compared to $1.0 million and $2.0 million for the three and six months
ended June 30, 2000, respectively. The $0.5 million or 51% increase for the three months ended June 30, 2001 resulted from increased costs of $0.3 million related to
salaries and other employee related costs, including travel expenses, increased costs of $0.1 million related to outside consultants, and increased administrative costs of $0.2 million
associated with research, development and engineering activities. These increases were offset by increased use of research, development and engineering personnel to provide services for our revenue
generating contracts, which resulted in an additional $0.1 million of these expenses being allocated to cost of service revenue. The $1.4 million or 69% increase for the six months ended
June 30, 2001 resulted from increased costs of $1.0 million related to salaries and other employee related costs, including travel expenses, increased costs of $0.1 million
related to outside consultants, and increased costs of $0.4 million in administrative costs associated with research, development and engineering. These increases were offset by increased use
of research, development and engineering personnel to provide services to our anti-counterfeiting system customer, which resulted in an additional $0.2 million of these expenses
being allocated to cost of service revenue. Research, development and engineering personnel totaled 80 and 64 as of June 30, 2001 and 2000, respectively. We anticipate that we will continue to
invest significantly in product research, development and engineering for the foreseeable 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 $3.3 million and
$6.4 million for the three and six months ended June 30, 2001, respectively, compared to $3.4 million and $5.6 million for the three and six months ended June 30,
2000, respectively. The $0.1 million or 3% decrease for the three months ended June 30, 2001 resulted from decreased costs of $0.2 million related to professional fees, including
litigation costs, partially offset by an increase of $0.1 million related to employee costs. The $0.8 million or 14% increase for the six

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months ended June 30, 2001 resulted from increased costs of $0.2 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 $0.4 million related to professional
fees, including litigation costs. General and administrative employees totaled 30 and 24 as of June 30, 2001 and 2000, respectively.

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 $477,000 and $1.0 million was recorded for the three and
six months ended June 30, 2001 and 2000, and is included in the respective statements of operations expense categories for the employees to which it applies. At June 30, 2001,
$4.3 million of stock-based compensation remains deferred and we expect approximately $1.0 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 $1.5 million and $3.6 million for the three
and six months ended June 30, 2001, respectively, and was $1.3 million and $2.5 million for the three and six months ended June 30, 2000, respectively. The
$0.2 million or 17% and $1.0 million or 41% increase for the three and six months ended June 30, 2001, respectively, came as a result of a 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.

Liquidity and Capital Resources

As of June 30, 2001, we had cash and cash equivalents and short-term investments of $129.8 million, representing a decrease of
$6.1 million from $135.9 million at December 31, 2000. Working capital at June 30, 2001 was $130.1 million, compared to working capital of $135.2 million at
December 31, 2000. The decrease in working capital is attributable primarily to the cash needs for our current operations.

The
$6.4 million of cash used in operating activities for the six months ended June 30, 2001 primarily consisted of $7.6 million in net loss and an increase in
accounts receivable of $1.4 million, partially offset by $1.1 million related to depreciation and amortization and $1.0 million related to stock-based compensation. Operating
activities used cash of $5.7 million for the six months ended June 30, 2000.

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The $36.5 million of cash provided by investing activities for the six months ended June 30, 2001 related primarily to the sale or maturity of $69.8 million in
investments, offset by the purchase of $32.7 million in investments. Investing activities used cash of $2.5 million for the six months ended June 30, 2000.

The
$1.0 million of cash provided by financing activities related primarily to proceeds from the issuance of stock for $1.0 million. Financing activities provided cash
of $42,000 for the six months ended June 30, 2000.

We
have computers and office equipment financed under long-term capital leases that expire over the next 38 months. As of June 30, 2001, we had an
outstanding balance of $0.1 million of capital lease
obligations. Other significant commitments consist of obligations under non-cancelable operating leases, which totaled $3.5 million as of June 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. 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.

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 $7.6 million for the six months ended June 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 June 30, 2001 was approximately $35.8 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 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 in recent periods, increasingly 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,

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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 59% 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 59% of our total revenue for the six months ended June 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 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

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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.

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

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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 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.

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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.

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

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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 June 30, 2001 we had 183 employees. In addition, we expect that we will need to hire additional employees in 2001. To manage this expected growth,
our management must continue to improve our operational and financial systems and expand, train, retain and manage our growing 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 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. 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.

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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. In addition, we expect
that we will need to hire additional employees in 2001. Competition for experienced personnel in our market segments is intense. We may 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 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.

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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.

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:



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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 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.

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Part II. Other Information

Item 1. Legal Proceedings

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 cash flows.

Item 4. Submission of Matters to a Vote of Security Holders

The Company held its Annual Meeting of Stockholders on May 10, 2001. The following proposals were voted on by the Company stockholders and results
obtained thereon:

Proposal 1:Election of Directors

The
election of Class II directors was approved as follows:

In Favor

Against

Abstentions

Non-votesPhilip J. Monego, Sr.

13,909,835

200,882

0

2,386,800Geoffrey Rhoads

12,519,330

1,591,387

0

2,386,800Peter Smith

13,908,524

202,193

0

2,386,800


Continuing
as Class I directors after the meeting were William A. Krepick, Alty van Luijt, and John Taysom. Continuing as Class III directors after the meeting were
Bruce Davis and Brian J. Grossi.

Proposal 2:Ratification of Appointment of Independent Auditors

KPMG
LLP was ratified as the Company's independent auditors for fiscal 2001 with 14,076,498 votes in favor, 31,629 votes against, 2,590 abstentions, and 2,386,800
non-votes.

Item 6. Exhibits and Reports On Form 8-K





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Items 2, 3 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.

|Date: |  | August 10, 2001 |  | Digimarc Corporation
|----- |  | --------------- |  | --------------------
|      |  |                 |  | By:                 

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