Digimarc CORP (Form: 10-Q, Received: 07/30/2010 12:01:27)

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2010

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

For the transition period from to

Commission File Number: 001-34108

DIGIMARC CORPORATION

(Exact name of registrant as specified in its charter)

Oregon

26-2828185

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

9405 SW Gemini Drive, Beaverton, Oregon 97008

(Address of principal executive offices) (Zip Code)

(503) 469-4800

(Registrant’s telephone number, including area code)

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 by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

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

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

As of July 26, 2010, there were 7,302,499 shares of the registrant’s common stock, par value $0.001 per share, outstanding.

Table of Contents


PART I FINANCIAL INFORMATION
Item 1.	Financial Statements:	3
	Balance Sheets as of June 30, 2010 and December 31, 2009 (Unaudited)	3
	Statements of Operations for the three- and six-months ended June 30, 2010 and 2009 (Unaudited)	4
	Statements of Stockholders’ Equity as of June 30, 2010 and December 31, 2009 (Unaudited)	5
	Statements of Cash Flows for the six-months ended June 30, 2010 and 2009 (Unaudited)	6
	Notes to Financial Statements (Unaudited)	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	32
Item 4.	Controls and Procedures	32
PART II OTHER INFORMATION
Item 1.	Legal Proceedings	32
Item 1A.	Risk Factors	32
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33
Item 5.	Other Information	33
Item 6.	Exhibits	34
SIGNATURES		35

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements.

DIGIMARC CORPORATION

BALANCE SHEETS

(In thousands, except share data)

(UNAUDITED)


	June 30, 2010		December 31, 2009(1)
ASSETS
Current assets:
Cash and cash equivalents	$	7,825	$	8,884
Marketable securities		38,757		33,902
Trade accounts receivable, net		2,393		3,570
Other current assets		1,018		872

Total current assets		49,993		47,228
Property and equipment, net		948		1,114
Intangibles, net		1,826		1,302
Investments in joint ventures		791		409
Other assets, net		450		430

Total assets	$	54,008	$	50,483

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and other accrued liabilities	$	819	$	1,407
Deferred revenue		1,972		2,318

Total current liabilities		2,791		3,725
Long-term liabilities		168		99

Total liabilities		2,959		3,824
Commitments and contingencies (Note 11)
Stockholders’ equity:
Preferred stock (10,000 shares issued and outstanding at June 30, 2010 and December 31, 2009)		50		50
Common stock (7,302,499 and 7,205,701 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively)		7		7
Additional paid-in capital		50,793		49,283
Retained earnings (accumulated deficit)		199		(2,681	)

Total stockholders’ equity		51,049		46,659

Total liabilities and stockholders’ equity	$	54,008	$	50,483

(1)	Derived from the Company’s December 31, 2009 audited financial statements

See Notes to Unaudited Financial Statements.

DIGIMARC CORPORATION

STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(UNAUDITED)


	Three Months Ended June 30, 2010			Three Months Ended June 30, 2009			Six Months Ended June 30, 2010			Six Months Ended June 30, 2009
Revenue:
Service	$	2,918		$	2,585		$	6,432		$	5,055
License and subscription		2,330			1,739			9,008			3,698

Total revenue		5,248			4,324			15,440			8,753
Cost of revenue:
Service		1,483			1,480			3,283			2,897
License and subscription		57			48			114			116

Total cost of revenue		1,540			1,528			3,397			3,013
Gross profit		3,708			2,796			12,043			5,740
Operating expenses:
Sales and marketing		759			728			1,500			1,473
Research, development and engineering		1,321			1,217			2,580			2,488
General and administrative		1,687			1,448			3,572			3,076
Intellectual property		319			217			576			494

Total operating expenses		4,086			3,610			8,228			7,531

Operating income (loss)		(378	)		(814	)		3,815			(1,791	)
Other income (expenses)
Net loss from joint ventures		(561	)		—			(1,018	)		—
Other		61			140			122			313

Other income (expenses), net		(500	)		140			(896	)		313

Income (loss) before provision for income taxes		(878	)		(674	)		2,919			(1,478	)
Provision for income taxes		(18	)		(4	)		(39	)		(9	)

Net income (loss)	$	(896	)	$	(678	)	$	2,880		$	(1,487	)

Earnings (loss) per share:
Net income (loss) per share—basic	$	(0.13	)	$	(0.09	)	$	0.41		$	(0.21	)
Net income (loss) per share—diluted	$	(0.13	)	$	(0.09	)	$	0.39		$	(0.21	)
Weighted average shares outstanding—basic		7,097			7,158			7,097			7,158
Weighted average shares outstanding—diluted		7,097			7,158			7,403			7,158

See Notes to Unaudited Financial Statements.

DIGIMARC CORPORATION

STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands, except share data)

(UNAUDITED)


								Additional paid-in capital			Retained Earnings (Accumulated Deficit)			Total stockholders’ equity
	Preferred stock			Common stock
	Shares	Amount		Shares		Amount
BALANCE AT DECEMBER 31, 2008	10,000	$	50	7,279,442		$	7	$	48,268		$	76		$	48,401
Exercise of stock options	—		—	28,343			—		273			—			273
Issuance of restricted common stock	—		—	22,200			—		—			—			—
Purchase and retirement of common stock	—		—	(124,284	)		—		(1,737	)		—			(1,737	)
Stock-based compensation	—		—	—			—		2,479			—			2,479
Net loss	—		—	—			—		—			(2,757	)		(2,757	)

BALANCE AT DECEMBER 31, 2009	10,000	$	50	7,205,701		$	7	$	49,283		$	(2,681	)	$	46,659
Exercise of stock options	—		—	833			—		8			—			8
Issuance of restricted common stock	—		—	99,060			—		—			—			—
Purchase and retirement of common stock	—		—	(3,095	)		—		(25	)		—			(25	)
Stock-based compensation	—		—	—			—		1,527			—			1,527
Net income	—		—	—			—		—			2,880			2,880

BALANCE AT JUNE 30, 2010	10,000	$	50	7,302,499		$	7	$	50,793		$	199		$	51,049

See Notes to Unaudited Financial Statements.

DIGIMARC CORPORATION

STATEMENTS OF CASH FLOWS

(In thousands)

(UNAUDITED)


	Six Months Ended June 30, 2010			Six Months Ended June 30, 2009
Cash flows from operating activities:
Net income (loss)	$	2,880		$	(1,487	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		327			276
Stock-based compensation		1,505			1,160
Net loss from joint ventures		1,018			—
Changes in operating assets and liabilities:
Trade accounts receivable, net		1,177			1,130
Other current assets		(146	)		(45	)
Other assets, net		(20	)		(225	)
Accounts payable and other accrued liabilities		(519	)		(70	)
Deferred revenue		(346	)		(513	)

Net cash provided by operating activities		5,876			226
Cash flows from investing activities:
Purchase of property and equipment		(129	)		(214	)
Capitalized patent costs		(534	)		(428	)
Investments in joint ventures		(1,400	)		—
Sale or maturity of marketable securities		44,714			15,685
Purchase of marketable securities		(49,569	)		(22,603	)

Net cash used in investing activities		(6,918	)		(7,560	)
Cash flows from financing activities:
Issuance of common stock		8			—
Purchase of common stock		(25	)		—
Principal payments under capital lease obligations		—			(8	)

Net cash used in financing activities		(17	)		(8	)

Net increase (decrease) in cash and cash equivalents		(1,059	)		(7,342	)
Cash and cash equivalents at beginning of period		8,884			18,928

Cash and cash equivalents at end of period	$	7,825		$	11,586

Supplemental disclosure of cash flow information:
Cash paid for interest	$	—		$	2
Cash paid for income taxes	$	39		$	9
Supplemental schedule of non-cash investing activities:
Stock-based compensation capitalized to patent costs	$	22		$	19

See Notes to Unaudited Financial Statements.

DIGIMARC CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Dollar amounts in thousands, except per share data)

(UNAUDITED)

1. Description of Business and Summary of Significant Accounting Policies

Description of Business

Digimarc Corporation (“Digimarc” or the “Company”) enables governments and enterprises around the world to give digital identities to media and objects that computers can sense and recognize and to which they can react. The Company’s technology provides the means to infuse persistent digital information, perceptible only to computers and digital devices, into all forms of media content. The unique digital identifier placed in media generally persists with it regardless of the distribution path and whether it is copied, manipulated or converted to a different format, and does not affect the quality of the content or the enjoyment or other traditional uses of it. The Company’s technology permits computers and digital devices to quickly identify relevant data from vast amounts of media content.

Joint Venture and Patent License Agreements with The Nielsen Company

On June 11, 2009 the Company entered into two joint venture agreements with The Nielsen Company (“Nielsen”) to launch two new companies. The two joint venture agreements and a revised patent license agreement expand and replace the previous license and services agreement between the Company and Nielsen that had been in operation since late 2007. Under the new agreements, the Company and Nielsen plan to work together to develop new products and services, including the expansion and deployment of those products and services that were in development under the prior agreement.

Under the terms of the patent license agreement, Nielsen agreed to pay Digimarc $18,750 during the period from July 2009 through January 2014, and Digimarc granted to Nielsen a non-exclusive license to Digimarc’s patents for use within Nielsen’s business. Unless earlier terminated in accordance with the agreement, the license will continue until the expiration of the last to expire of the licensed patents.

Joint venture I, TVaura LLC, engages in the development of copyright filtering solutions, royalty/audit solutions for online video and audio rights organizations, guilds or other organizations involved in the reconciliation of royalties, residuals and other payments, and other related products. Each of the Company and Nielsen will make initial cash contributions aggregating $3,900 payable quarterly from July 2009 through October 2011. The Company will provide technical and development services to TVaura LLC’s business for the following periods for the following minimum service fees, subject to adjustment for any development service fees paid to the Company by TVaura Mobile LLC: $1,130 paid in 2009; and $2,800 and $2,740 to be paid in 2010 and 2011, respectively.

Joint venture II, TVaura Mobile LLC, engages in the development of certain enhanced television offerings, and other related products. Each of the Company and Nielsen will make initial cash contributions aggregating $2,800 payable quarterly from July 2009 through October 2011.

Pursuant to the terms of the agreements and Accounting Standards Codification (“ASC”) 810 “ Consolidation, ” the joint ventures will not be consolidated with the Company.

Interim Financial Statements

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

These financial statements should be read in conjunction with the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, which was filed with the SEC on February 24, 2010. The results of operations for the interim periods presented in these financial statements are not necessarily indicative of the results for the full year.

Use of Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. requires Digimarc to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Certain of the Company’s accounting policies require higher degrees of judgment than others in their application. Examples of these include revenue recognition on long-term service contracts, impairments and estimation of useful lives of long-lived assets and patent costs, contingencies and litigation, stock-based compensation and allowance for doubtful accounts. Digimarc bases its estimates on historical experience and on various other assumptions that are believed to be reasonable in the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Reclassifications

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

Specifically, on the balance sheet, “accrued payroll and related costs” and “accrued merger related liabilities” line items have been reclassed with “accounts payable and other accrued liabilities.” On the statement of operations, “transitional services” line item has been reclassed with “general and administrative.”

Marketable Securities

The Company considers all investments with original maturities over 90 days that mature in less than one year to be short-term marketable securities. Both short- and long-term marketable securities include federal agency notes, company notes, and commercial paper. The Company’s marketable securities are generally classified as held-to-maturity as of the balance sheet date and are reported at amortized cost, which approximates market. The book value of these investments approximates fair market value and, accordingly, no amounts have been recorded to other comprehensive income.

A decline in the market value of any security below cost that is deemed to be other-than-temporary results in a reduction in carrying amount of fair value. The impairment is charged to earnings and a new cost basis for the security is established. To determine whether an impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating that the cost of the investment is recoverable outweighs evidence to the contrary. There have been no other-than-temporary impairments identified or recorded by the Company.

Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using a method that approximates the effective interest method. Under this method, dividend and interest income are recognized when earned.

Fair Value of Financial Instruments

ASC 820 “ Fair Value Measurements and Disclosures ” defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and enhances disclosures about fair value measurements. ASC 820 describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value, which are the following:

•

Level 1—Pricing inputs are quoted prices available in active markets for identical investments as of the reporting date.

•

Level 2—Pricing inputs are quoted for similar investments, or inputs that are observable, either directly or indirectly, for substantially the full term through corroboration with observable market data. Level 2 includes investments valued at quoted prices adjusted for legal or contractual restrictions specific to these investments.

•

Level 3—Pricing inputs are unobservable for the investment, that is, inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability. Level 3 includes private portfolio investments that are supported by little or no market activity.

ASC 825 “ Financial Instruments ” allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for specified financial assets and liabilities on a contract-by-contract basis. The Company did not elect the fair value option under this statement as to specific assets or liabilities. Therefore, through June 30, 2010, the Company has not recognized the net change in fair value of its financial assets and liabilities.

The estimated fair values of the Company’s financial instruments, which include cash and cash equivalents, short- and long-term marketable securities, accounts receivable, accounts payable and accrued payroll approximate their carrying values due to the short-term nature of these instruments. These items are valued using either Level 1 or Level 2 inputs.

The Company recorded marketable securities at amortized cost of $43,756, of which $4,999 is included in cash and cash equivalents, which approximates fair value. The fair value is based on quoted market prices in active markets for identical assets, a Level 1 input. As of June 30, 2010, the cost and fair value of the Company’s money market funds were each equal to $2,807.

Concentrations of Business and Credit Risk

A significant portion of the Company’s business depends on a limited number of large contracts. The loss of any large contract may result in loss of revenue and margin on a prospective basis.

Financial instruments that potentially subject Digimarc to concentrations of credit risk consist primarily of cash and cash equivalents, marketable securities, and trade accounts receivable. Digimarc places its cash and cash equivalents with major banks and financial institutions and at times deposits may exceed insured limits. Other than cash used for operating needs, which may include short-term marketable securities with its principal banks, Digimarc’s investment policy limits its credit exposure to any one financial institution or type of financial instrument by limiting the maximum of 5% of its cash and cash equivalents or $1,000, whichever is greater, to be invested in any one issuer except for the U.S. Government and U. S. federal agencies, which have no limits, at the time of purchase. The investment policy also limits Digimarc’s credit exposure by limiting the maximum of 40%, or $15,000, whichever is greater, to be invested in any one industry category, e.g., financial or energyindustries. As a result, Digimarc’s credit risk associated with cash and investments is believed to be minimal.

Impairment of Long-Lived Assets

The Company accounts for long-lived assets in accordance with the provisions of ASC 360 “ Property, Plant and Equipment ”. This statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Fair value is determined based on discounted cash flows or appraised values, depending on the nature of the asset. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

Software Development Costs

Under ASC 985 “ Software, ” software development costs are to be capitalized beginning when a product’s technological feasibility has been established and ending when a product is made available for general release to customers. To date, the establishment of technological feasibility of the Company’s products has occurred shortly before general release and, therefore, software development costs qualifying for capitalization have been immaterial. Accordingly, the Company has not capitalized any software development costs and has charged all such costs to research and development expense.

Research and Development

Research and development costs are expensed as incurred as defined in ASC 730 “ Research and Development ”. Digimarc accounts for amounts received under its funded research and development arrangements in accordance with the provisions of ASC 730. Under the terms of the arrangements, Digimarc is not obligated to repay any of the amounts provided by the funding parties. As a result, Digimarc recognizes revenue as the services are performed.

Patent Costs

Costs associated with the application and award of patents in the U.S. and various other countries are capitalized and amortized on a straight-line basis over the term of the patents as determined at award date, which varies depending on the pendency period of the application, generally approximating seventeen years. Capitalized patent costs include internal legal labor, professional legal fees, government filing fees and translation fees related to obtaining the Company’s patent portfolio.

Costs associated with the maintenance and annuity fees of patents are accounted for as prepaid assets at the time of payment and amortized over the respective periods, generally from one to four years.

Revenue Recognition

The Company’s revenue consists of subscription revenue, which includes hardware and software sales, royalties and revenues from the licensing of digital watermarking products and related authentication services. The Company’s revenue recognition policy follows ASC 605 “ Revenue Recognition, ” ASC 985, and SEC Staff Accounting Bulletin (“SAB”) No. 104 Revenue Recognition .

Other Income (Expenses), Net

The Company’s other income (expense), net consists primarily of the net losses from the Company’s joint ventures with The Nielsen Company, TVaura LLC and TVaura Mobile LLC, and interest income from the Company’s short- and long-term marketable securities.

Stock-Based Compensation

ASC 718 “ Compensation – Stock Compensation ” requires the measurement and recognition of compensation for all stock-based awards made to employees and directors, including stock options and restricted stock based on estimated fair values.

The Company uses the Black-Scholes option pricing model as its method of valuation for stock-based awards. The Company’s determination of the fair value of stock-based awards on the date of grant using an option pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the expected life of the award, expected stock price volatility over the term of the award and actual and projected exercise behaviors. Although the fair value of stock-based awards is determined in accordance with ASC 718 and SAB No. 107 Shared-Based Payment , the Black-Scholes option pricing model requires the input of highly subjective assumptions, and other reasonable assumptions could provide differing results.

Income Taxes

The Company accounts for income taxes under the asset and liability method. Under the asset and liability method, deferred income taxes reflect the future tax consequences of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce tax assets to the amount expected to be realized.

2. Recent Accounting Standards Update

In April 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-17, Revenue Recognition – Milestone Method (Topic 605): Milestone Method of Revenue Recognition, a consensus of the FASB Emerging Issues Task Force , which provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. ASU No. 2010-17 is effective for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. The Company is currently assessing the potential impact that adoption of this standard will have on its financial statements.

In October 2009, the FASB issued ASU No. 2009-14, Software: Certain Revenue Arrangements That Include Software Elements—a consensus of the FASB Emerging Issues Task Force , which will significantly improve the reporting of certain transactions to more closely reflect the underlying economics of the transactions. By excluding from its scope certain software-enabled devices, multiple-element arrangements that include such software-enabled devices will now be evaluated for separation and allocation using the guidance in ASU No. 2009-13 (described below). ASU No. 2009-14 is effective for revenue arrangements entered or materially modified in fiscal years beginning on or after June 15, 2010. The Company is currently assessing the potential impact of this standard, but does not expect the adoption of the standard will have a material impact on the financial condition or results of operations of the Company.

In October 2009, the FASB issued ASU No. 2009-13, Revenue Recognition: Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force , which eliminates the use of the residual method for allocating consideration, as well as the criteria that requires objective and reliable evidence of fair value of undelivered elements in order to separate the elements in a multiple-element arrangement. By removing the criterion requiring the use of objective and reliable evidence of fair value in separately accounting for deliverables, the recognition of revenue will more closely align with certain revenue arrangements. The standard also will replace the term “fair value” in the revenue allocation guidance with “selling price” to clarify that the allocation of revenue is based on entity-specific assumptions rather than assumptions of a marketplace participant. ASU No. 2009-13 is effective for revenue arrangements entered or materially modified in fiscal years beginning on or after June 15, 2010. The Company is currently assessing the potential impact of this standard, but does not expect the adoption of the standard will have a material impact on the financial condition or results of operations of the Company.

3. Revenue Recognition

Revenue is recognized in accordance with ASC 985 and SAB 104 when the following four criteria are met:

(i)

persuasive evidence of an arrangement exists;

(ii)

delivery has occurred;

(iii)

the fee is fixed or determinable; and

(iv)

collection is probable.

Some customer arrangements encompass multiple deliverables, such as software, maintenance, and software development. If the deliverables meet the criteria in ASC 605, the deliverables are divided into separate units of accounting and revenue is allocated to the deliverables based on their relative fair values. The criteria specified in ASC 605 are as follows:

(i)

the delivered item has value to the customer on a stand-alone basis;

(ii)

there is objective and reliable evidence of the fair value of the undelivered item; and

(iii)

if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item is considered probable and substantially in the control of the vendor.

For the Company’s purposes, fair value is generally defined as the price at which a customer could purchase each of the elements independently from other vendors or as the price that the Company has sold the element separately to another customer. Management applies judgment to ensure appropriate application of ASC 605, including value allocation among multiple deliverables, determination of whether undelivered elements are essential to the functionality of delivered elements and timing of revenue recognition, among others.

ASC 985 requires that revenue be recognized using the “residual method” in circumstances when vendor specific objective evidence (“VSOE”) exists only for undelivered elements. Under the residual method, revenue is recognized as follows: (1) the total fair value of undelivered elements, as indicated by VSOE, is deferred and subsequently recognized in accordance with the relevant sections of ASC 985, and (2) the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to the delivered elements.

Applicable revenue recognition criteria is considered separately for each separate unit of accounting as follows:

•

Revenue from professional service arrangements is generally determined based on time and materials. Revenue for professional services is recognized as the services are performed. Billing for services rendered generally occurs within one month after the services are provided.

•

Royalty revenue is recognized when the royalty amounts owed to the Company have been earned, are determinable, and collection is probable. Subscriptions are paid in advance and revenue is recognized ratably over the term of the subscription. These revenues include the licensing of digital watermarking products and services for use in authenticating documents, detecting fraudulent documents and deterring unauthorized duplication or alteration of high-value documents, for use in communicating copyright, asset management and business-to-business image commerce solutions, and for use in connecting analog media to a digital environment.

•

Software revenue is recognized in accordance with ASC 985. Revenue for licenses of the Company’s software products is recognized upon the Company meeting the following criteria: persuasive evidence of an arrangement exists; delivery has occurred; the vendor’s fee is fixed or determinable; and collectibility is probable. Software revenue is recognized over the term of the license or upon delivery and acceptance if the Company grants a perpetual license with no further obligations.

•

Maintenance revenue is recognized when the maintenance amounts owed to the Company have been earned, are determinable, and collection is probable. Maintenance contracts are, at times, paid in advance and revenue is recognized ratably on a straight-line basis over the term of the service period.

•

The Company records revenue from some customers upon cash receipt as a result of collectibility not being reasonably assured.

•

Revenue earned which has not been invoiced at the last day of the period, but which is generally billed within one to two weeks of the last day of the period, is included in trade accounts receivables, net in the balance sheets.

•

Deferred revenue consists of billings in advance for professional services, licenses, subscriptions and hardware for which revenue has not been earned.

4. Segment Information

Geographic Information

The Company derives its revenue from a single reporting segment: media management solutions. Revenue is generated in this segment through licensing of intellectual property, subscriptions to various products and services, and the delivery of services pursuant to contracts with various customers. The Company markets its products in the U.S. and in non-U.S. countries through its sales personnel.

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


	Three Months Ended June 30, 2010		Three Months Ended June 30, 2009		Six Months Ended June 30, 2010		Six Months Ended June 30, 2009
Domestic	$	2,103	$	1,777	$	9,343	$	3,553
International		3,145		2,547		6,097		5,200

Total	$	5,248	$	4,324	$	15,440	$	8,753

Major Customers

Customers who accounted for more than 10% of the Company’s revenues are as follows:


	Three Months Ended June 30, 2010		Three Months Ended June 30, 2009		Six Months Ended June 30, 2010		Six Months Ended June 30, 2009
Central Banks	47	%	54	%	32	%	52	%
Arbitron	—		—		29	%	—
The Nielsen Company	17	%	31	%	12	%	30	%
TVaura LLC	13	%	—		*		—
Civolution	11	%	*		*		*

* Less than 10%

5. Stock-Based Compensation

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

Determining Fair Value

Preferred Stock

The Board of Directors authorized 10,000 shares of Series A Redeemable Nonvoting Preferred stock to be issued to the executive officers. The Series A Redeemable Nonvoting Preferred stock has no voting rights, except as required by law, and may be redeemed by the Board of Directors at any time on or after June 18, 2013.

The fair value of Series A Redeemable Nonvoting Preferred stock is based on the stated fair value of $5.00 per share, and the related stock compensation expense is recognized over the non-redeemable period of 5 years, or 60 months, through June 2013 using the straight-line method.

Stock Options

Valuation and Amortization Method. The Company estimates the fair value of stock-based awards granted using the Black-Scholes option valuation model. The Company amortizes the fair value of all awards on a straight-line basis over the requisite service periods, which are generally the vesting periods. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model.

Expected Term (Life). The expected life of awards granted represents the period of time that the awards are expected to be outstanding. The Company determined the initial expected life based on a simplified method in accordance with ASC 718, giving consideration to the contractual terms, vesting schedules and pre-vesting and post-vesting forfeitures. Stock options granted generally vest over four years for employee grants and two years for director grants, and have contractual terms of ten years.

Expected Volatility. The Company estimates the initial volatility of its common stock at the date of grant based on a 50/50 blend of the Company’s own historical volatility and an independent analysis of a peer group’s historical volatility of its common stock using the Black-Scholes option valuation model based on historical stock prices over the most recent period commensurate with the estimated expected life of the award.

Risk-Free Interest Rate. The Company bases the risk-free interest rate used in the Black-Scholes option valuation model on an interest rate on a Treasury bond with a maturity commensurate with each expected term estimate.

Expected Dividend Yield. The Company has never paid any cash dividends on its common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of zero in the Black-Scholes option valuation model.

Expected Forfeitures. The Company uses a zero forfeiture for both the stock options granted to employees, which vest monthly, and the stock options granted to the Company’s directors. Initial option grants, made to new directors, vest 50% on the first anniversary of the date of grant and then monthly thereafter and which the annual option grants, made to continuing directors, vest monthly. The Company records stock-based compensation expense only for those awards that are expected to vest, including awards made to directors who are expected to continue with the Company through the year following the date of grant. Forfeitures that occur during the month are not expensed.

A summary of the weighted average assumptions and results for options granted as follows:


	2010		2009
Expected life (in years)	5.2 - 6.0		5.64
Expected volatility	52% - 55	%	70.45	%
Risk-free interest rate	2.5% - 3.0	%	2.17	%
Expected dividend yield	0	%	0	%
Expected forfeiture rate	0	%	0	%

Restricted Stock

The Compensation Committee of the Board of Directors awards restricted stock shares under the Company’s 2008 Stock Incentive Plan to certain employees. The shares subject to the restricted stock awards vest over a certain period, usually four years, following the date of the grant. Specific terms of the restricted stock awards are governed by restricted stock agreements between the Company and the award recipients.

The fair value of restricted stock awards granted is based on the fair market value of the Company’s common stock on the date of the grant (measurement date), and is recognized over the vesting period of the related restricted stock using the straight-line method.

Stock-based Compensation


	Three Months Ended June 30, 2010		Three Months Ended June 30, 2009		Six Months Ended June 30, 2010		Six Months Ended June 30, 2009
Stock-based compensation:
Cost of revenue	$	91	$	50	$	188	$	99
Sales and marketing		49		50		91		102
Research, development and engineering		76		49		146		93
General and administrative		527		429		1,034		833
Intellectual property		22		16		46		33

Stock-based compensation expense		765		594		1,505		1,160
Capitalized to patent costs		11		11		22		19

Total stock-based compensation	$	776	$	605	$	1,527	$	1,179

At June 30, 2010, the Company had 10,000 shares of Series A redeemable nonvoting preferred stock, 763,384 non-vested stock options and 205,160 shares of restricted common stock outstanding. As of June 30, 2010, the Company had $7,213 of total unrecognized compensation cost related to non-vested stock-based awards granted under all equity compensation plans, including preferred stock, stock options and restricted stock. Total unrecognized compensation cost will be adjusted for any future changes in estimated forfeitures. The Company expects to recognize this compensation cost for stock options and restricted stock over a weighted average period of 1.33 years and 1.88 years, respectively, through May 2014.

Stock Option Activity

As of June 30, 2010, under all of the Company’s stock-based compensation plans, options to purchase an aggregate of 1.3 million shares were outstanding, and options to purchase an additional 0.9 million shares were authorized for future grants under the plans. The Company issues new shares upon option exercises.

Options granted, exercised, canceled and expired under the Company’s stock option plans are summarized as follows:


Three-months ended June 30, 2010:	Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life
Outstanding at March 31, 2010	1,276,490		$	10.11
Options granted	30,000		$	18.01
Options exercised	—			—
Options canceled or expired	—			—

Outstanding at June 30, 2010	1,306,490		$	10.29	8.48 years

Exercisable at June 30, 2010	543,106		$	9.85	8.40 years


Six-months ended June 30, 2010:	Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life
Outstanding at December 31, 2009	1,167,323		$	9.65
Options granted	140,000		$	15.64
Options exercised	(833	)	$	9.64
Options canceled or expired	—			—

Outstanding at June 30, 2010	1,306,490		$	10.29	8.48 years

Exercisable at June 30, 2010	543,106		$	9.85	8.40 years

The following table summarizes information about stock options outstanding at June 30, 2010:


	Options Outstanding				Options Exercisable
Range of Exercise Prices	Number Outstanding	Remaining Contractual Life (Years)	Weighted Average Price		Number Exercisable	Weighted Average Price
$9.64	1,136,490	8.33	$	9.64	496,649	$	9.64
$9.91	30,000	8.84	$	9.91	30,000	$	9.91
$14.99	110,000	9.51	$	14.99	11,457	$	14.99
$18.01	30,000	9.84	$	18.01	5,000	$	18.01

$9.64 - $14.99	1,306,490	8.48	$	10.29	543,106	$	9.85

At June 30, 2010, the aggregate intrinsic value of outstanding and exercisable stock options was $11,054 and $4,836, respectively. The aggregate intrinsic value is based on the closing price of $18.75 per share of Digimarc common stock on June 30, 2010, which would have been received by the optionees had all of the options with exercise prices less than $18.75 per share been exercised on that date.

The estimated average fair value of outstanding stock options was $6.48 per share at June 30, 2010.

Restricted Stock Activity

The following table reconciles the unvested balance of restricted stock:


Three-months ended June 30, 2010:	Number of Shares
Unvested balance, March 31, 2010	207,190
Granted	120
Vested	(350	)
Canceled	(1,800	)

Unvested balance, June 30, 2010	205,160


Six-months ended June 30, 2010:	Number of Shares
Unvested balance, December 31, 2009	111,000
Granted	99,060
Vested	(3,100	)
Canceled	(1,800	)

Unvested balance, June 30, 2010	205,160

6. Trade Accounts Receivable

Trade Accounts Receivable

Trade accounts receivable are recorded at the invoiced amount and do not bear interest.


	June 30, 2010		December 31, 2009
Trade accounts receivable	$	2,393	$	3,570
Allowance for doubtful accounts		—		—

Trade accounts receivable, net	$	2,393	$	3,570

Unpaid deferred revenues included in accounts receivable	$	969	$	1,926

Allowance for doubtful accounts

The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company determines the allowance based on historical write-off experience and current information. The Company reviews its allowance for doubtful accounts monthly. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

Unpaid deferred revenues

The unpaid deferred revenues that are included in accounts receivable are billed in accordance with the provisions of the contracts with the Company’s customers. Unpaid deferred revenues from cash-basis revenue recognition customers are not included in accounts receivable nor deferred revenue accounts.

Major customers

Customers who accounted for more than 10% of accounts receivable, net, are as follows:


	June 30, 2010		December 31, 2009
Central Banks	29	%	38	%
The Nielsen Company	38	%	25	%
Civolution	20	%	*

* Less than 10%

7. Property and Equipment

Property and equipment are stated at cost. Property and equipment under capital lease obligations are stated at the lower of the present value of minimum lease payments at the beginning of the lease term or fair value of the leased assets at the inception of the lease. Repairs and maintenance are charged to expense when incurred.

Depreciation on property and equipment is calculated by the straight-line method over the estimated useful lives of the assets, generally two to seven years. Property and equipment held under capital leases are amortized by the straight-line method over the shorter of the lease term or the estimated useful life. Amortization of property and equipment under capital lease is included in depreciation expense.

Leasehold improvements are amortized by the straight-line method over the shorter of the estimated useful life or the lease term.


	June 30, 2010			December 31, 2009
Office furniture fixtures	$	294		$	291
Equipment		1,276			1,150
Leasehold improvements		423			423

		1,993			1,864
Less accumulated depreciation and amortization		(1,045	)		(750	)

	$	948		$	1,114

8. Intangible Assets—Purchase and Capitalized Patent Costs

Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.


	June 30, 2010			December 31, 2009
Gross intangible assets	$	1,895		$	1,339
Accumulated amortization		(69	)		(37	)

Intangible assets, net	$	1,826		$	1,302

9. Other Income (Expenses), Net

Other income (expenses), net consists primarily of the net losses from the Company’s joint ventures with The Nielsen Company, TVaura LLC and TVaura Mobile LLC, and interest income from the Company’s cash and short- and long-term marketable securities.


	Three Months Ended June 30, 2010			Three Months Ended June 30, 2009		Six Months Ended June 30, 2010			Six Months Ended June 30, 2009
Net loss from joint ventures	$	(561	)	$	—	$	(1,018	)	$	—
Interest income, net		64			137		127			312
Other		(3	)		3		(5	)		1

Total	$	(500	)	$	140	$	(896	)	$	313

10. Income Taxes

The provision for income taxes reflects withholding tax expense in various foreign jurisdictions. These withholding taxes are computed by the Company’s customers and paid to foreign jurisdictions on its behalf. Other than foreign withholding tax expense, there was no provision for current income taxes related to net income because the computation of taxable income is fully offset by available net operating loss carry-forwards previously offset by a full valuation allowance for the period.

11. Commitments and Contingencies

Certain of the Company’s product license and services agreements include an indemnification provision for claims from third parties relating to the Company’s intellectual property. Such indemnification provisions are accounted for in accordance with ASC 450 “ Contingencies. ” To date, there have been no claims made under such indemnification provisions.

The Company is subject from time to time to legal proceedings and claims arising in the ordinary course of business. Although the ultimate outcome of these matters cannot be determined, management believes that, as of June 30, 2010, the final disposition of these proceedings will not have a material adverse effect on the financial position, results of operations, or liquidity of the Company. In accordance with ASC 450, no accrual has been recorded because the amounts are not probable or reasonably estimatable.

12. Stock Repurchases

In April 2009, the Board of Directors approved a stock repurchase program authorizing the purchase, at the discretion of management, of up to $5,000 of Digimarc’s common stock through either periodic open-market or private transactions at then prevailing market prices through April 30, 2010. In April 2010, the Board of Directors approved an extension of the stock repurchase program through April 30, 2011. For the three- and six-month period ended June 30, 2010, the Company made no purchases under this program. The Company has paid $1,560 to repurchase 111,667 shares of outstanding common stock under this program since the program’s inception.

As part of the Company’s 2008 Stock Incentive Plan, restricted stock shares are awarded to certain employees. Pursuant to the terms of the restricted stock award agreement, the Company withheld (purchased) from fully vested shares of common stock otherwise deliverable to any employee, a number of whole shares of common stock having a fair market value (as determined by the Company as of the date of vesting) equal to the amount of tax required to be withheld by law, in order to satisfy the tax withholding obligations of the Company in connection with the vesting of such shares. A total of 350 shares and 3,100 shares of restricted stock vested in the three- and six-month periods ended June 30, 2010, and 146 and 1,295 shares of common stock were withheld (purchased) by the Company, in satisfaction of $3 and $25 in required withholding tax liability, respectively.

13. Related Party Transactions


	Three Months Ended June 30, 2010		Three Months Ended June 30, 2009		Six Months Ended June 30, 2010		Six Months Ended June 30, 2009
TVaura LLC:
Capital contributions	$	400	$	—	$	800	$	—
Revenue ⁽¹⁾	$	682	$	—	$	1,374	$	—
Net loss	$	372	$	—	$	749	$	—

TVaura Mobile LLC:
Capital contributions	$	300	$	—	$	600	$	—
Revenue	$	—	$	—	$	—	$	—
Net loss	$	189	$	—	$	269	$	—

(1)	Technical and development services


	June 30, 2010		December 31, 2009
TVaura LLC:
Accounts Receivable	$	234	$	190
Accounts Payable	$	—	$	—

TVaura Mobile LLC:
Accounts Receivable	$	—	$	2
Accounts Payable	$	—	$	—

Summarized financial data for TVaura LLC:


	Three Months Ended June 30, 2010			Three Months Ended June 30, 2009		Six Months Ended June 30, 2010			Six Months Ended June 30, 2009
Revenue	$	—		$	—	$	—		$	—
Gross profit		—			—		—			—
Sales and marketing		92			—		133			—
Research and development		625			—		1,304			—
General and administrative		13			—		33			—
Operating Income (loss)		(730	)		—		(1,470	)		—
Net income (loss)		(730	)		—		(1,469	)		—

14. Subsequent Events

In accordance with ASC 855 “ Subsequent Events, ” the Company is required to evaluate subsequent events through the date on which financial statements are issued. Subsequent events were evaluated through the date the Company’s quarterly report on Form 10-Q for the quarter ended June 30, 2010 was filed with the Securities and Exchange Commission.

15. Quarterly Financial Information—Unaudited


Quarter ended:	March 31			June 30
*2010*
Service revenue	$	3,514		$	2,918
License and subscription revenue		6,678			2,330

Total revenue		10,192			5,248
Total cost of revenue		1,857			1,540
Gross profit		8,335			3,708
Gross profit percent, service revenue		49	%		49	%
Gross profit percent, license and subscription revenue		99	%		98	%
Gross profit percent, total		82	%		71	%
Sales and marketing		741			759
Research, development and engineering		1,259			1,321
General and administrative		1,885			1,687
Intellectual property		257			319
Operating income (loss)		4,193			(378	)
Net income (loss)		3,776			(896	)
Earnings (loss) per share:
Net income per share—basic	$	0.53		$	(0.13	)
Net income per share—diluted	$	0.51		$	(0.13	)
Weighted average shares outstanding—basic		7,096			7,097
Weighted average shares outstanding—diluted		7,387			7,097


Quarter ended:	March 31			June 30			September 30			December 31
*2009*
Service revenue	$	2,470		$	2,585		$	2,827		$	2,963
License and subscription revenue		1,959			1,739			1,942			2,586

Total revenue		4,429			4,324			4,769			5,549
Total cost of revenue		1,485			1,528			1,541			1,747
Gross profit		2,944			2,796			3,228			3,802
Gross profit percent, service revenue		43	%		43	%		47	%		43	%
Gross profit percent, license and subscription revenue		97	%		97	%		98	%		98	%
Gross profit percent, total		66	%		65	%		68	%		69	%
Sales and marketing		745			728			753			808
Research, development and engineering		1,271			1,217			1,191			1,310
General and administrative		1,628			1,448			1,521			1,702
Intellectual property		277			217			262			257
Operating loss		(977	)		(814	)		(499	)		(275	)
Net loss		(809	)		(678	)		(687	)		(583	)
Loss per share:
Net loss per share—basic & diluted	$	(0.11	)	$	(0.09	)	$	(0.10	)	$	(0.08	)
Weighted average shares outstanding—basic and diluted		7,158			7,158			7,134			7,103

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, that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements. Please see the discussion regarding forward-looking statements included in this Quarterly Report on Form 10-Q under the caption “Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995.”

The following discussion should be read in conjunction with our financial statements and the related notes and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q. Readers are also urged to carefully review and consider the disclosures made in Part II, Item 1A (Risk Factors) of this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2009 (the “2009 Annual Report”) and in the audited financial statements and related notes included in our 2009 Annual Report, and other reports and filings made with the Securities and Exchange Commission (“SEC”).

Unless the context otherwise requires, references in this Quarterly Report on Form 10-Q to “Digimarc,” “we,” “our” and “us” refer to Digimarc Corporation.

All dollar amounts are in thousands, unless otherwise noted.

Overview

Digimarc Corporation enables governments and enterprises around the world to give digital identities to media and objects that computers can sense and recognize and to which they can react. Our technology provides the means to infuse persistent digital information, perceptible only to computers and digital devices, into all forms of media content. The unique digital identifier placed in media generally persists with it regardless of the distribution path and whether it is copied, manipulated or converted to a different format, and does not affect the quality of the content or the enjoyment or other traditional uses of it. Our technology permits computers and digital devices to quickly identify relevant data from vast amounts of media content. Our technology, and those of our licensees, span a range of media content, enabling our customers and those of our partners to:

•

Quickly identify and effectively manage music, movies, television programming, digital images, documents and other printed materials, especially in light of new non-linear distribution over the internet;

•

Deter counterfeiting of money, media and goods, and piracy of movies and music;

•

Support new digital media distribution models and methods to monetize media content;

•

Leverage the power of ubiquitous computing to instantly link consumers to a wealth of information and/or interactive experiences related to the media and objects they encounter each day;

•

Provide consumers with more choice and access to media content when, where and how they want it;

•

Enhance imagery and video by associating metadata or authenticating media content for government and commercial uses; and

•

Better secure identity documents to enhance national security and combat identity theft and fraud.

At the core of our intellectual property is a signal processing technology innovation known as “digital watermarking” which allows imperceptible digital information to be embedded in all forms of digitally designed, produced or distributed media content and some physical objects, including photographs, movies, music, television, personal identification documents, financial instruments, industrial parts and product packages. The digital information can be detected and read by a wide range of computers, mobile phones, and other digital devices.

We provide technology-based solutions directly and through our licensees. Our proprietary technology has proven to be a powerful element of document security, giving rise to our long-term relationship with a consortium of central banks, which we refer to as the Central Banks, and many leading companies in the information technology industry. We and our licensees have successfully propagated digital watermarking in music, movies, television broadcasts, images and printed materials. Digital watermarks have been used in these applications to improve media rights and asset management, reduce piracy and counterfeiting losses, improve marketing programs, permit more efficient and effective distribution of valuable media content and enhance consumer entertainment and commercial experiences.

Our growth strategy continues to focus on both our government and commercial businesses. We plan additional investment in research and development of a commercial mobile platform that boosts device specific capabilities.

To protect our significant efforts in creating our technology, we have implemented an extensive intellectual property protection program that relies on a combination of patent, copyright, trademark and trade secret laws, and nondisclosure agreements and other

contracts. We believe we have one of the world’s most extensive patent portfolios in the field of digital watermarking and related media enhancement innovations, with over 600 U.S. and foreign patents and more than 420 U.S. and foreign patent applications on file as of June 30, 2010.

As part of our intellectual property marketing initiative and patent evaluation process, significant consideration is given to the identification of potential infringers, the longevity of the patented technology and a variety of other factors that directly impact the magnitude and potential success of our licensing program. Our intellectual property department and outside patent attorneys are experienced in evaluating potentially infringing technologies and in presenting the claims of our patents and demonstrating how they apply to companies we believe are using our technology in their products or services. These presentations can take place in a non-adversarial business setting, or can occur in litigation. We prefer to execute patent licensing arrangements with users of our patented technology without filing patent infringement litigation, but will do so through the negotiation of settlement arrangements in connection with the filing of patent infringement litigation.

We believe recent intellectual property licensing initiatives we have commenced represent substantial opportunities for us to grow our license and subscription revenues and, to a lesser extent, our service revenues. These initiatives, however, may require additional investment in our intellectual property enforcement program.

Critical Accounting Policies and Estimates

Detailed information on our critical accounting policies and estimates are set forth in our 2009 Annual Report in Part II, Item 7 thereof (“Management’s Discussion and Analysis of Financial Condition and Results of Operations”), under the caption “Critical Accounting Policies and Estimates,” which is incorporated by reference into this Quarterly Report on Form 10-Q.

Results of Operations

The following table presents statements of operations data for the periods indicated as a percentage of total revenue. Unless otherwise indicated, all references in this Management’s Discussion and Analysis of Financial Condition and Results of Operations to the three- and six-month periods relate to the three- and six-month periods ended June 30, 2010 and all changes discussed with respect to such periods reflect changes compared to the three- and six-month periods ended June 30, 2009.


	Three Months Ended June 30, 2010		Three Months Ended June 30, 2009		Six Months Ended June 30, 2010		Six Months Ended June 30, 2009
Revenue:
Service	56	%	60	%	42	%	58	%
License and subscription	44		40		58		42

Total revenue	100		100		100		100
Cost of revenue:
Service	28		34		21		33
License and subscription	1		1		1		1

Total cost of revenue	29		35		22		34
Gross profit	71		65		78		66
Operating expenses:
Sales and marketing	15		17		10		17
Research, development and engineering	25		28		16		28
General and administrative	32		34		23		35
Intellectual property	6		5		4		6

Total operating expenses	78		84		53		86

Operating income (loss)	(7	)	(19	)	25		(20	)

Other income (expense), net	(10	)	3		(6	)	3

Income (loss) before provision for income taxes	(17	)	(16	)	19		(17	)
Provision for income taxes	—		—		—		—

Net income (loss)	(17	)%	(16	)%	19	%	(17	)%

Our revenue for the three- and six-month periods ended June 30, 2010 increased 21% to $5.2 million from $4.3 million and 76% to $15.4 million from $8.8 million, respectively, for the prior periods. The increases were primarily the result of royalty revenues from Civolution that exceeded expectations, the receipt of $4.5 million in connection with the licensing arrangement with Arbitron, completion of government contracts that are non-linear in nature and increased program work from the Central Banks.

Revenue


	Three Months Ended June 30, 2010			Three Months Ended June 30, 2009			Dollar Increase		Percent Increase		Six Months Ended June 30, 2010			Six Months Ended June 30, 2009			Dollar Increase		Percent Increase
Revenue:
Service	$	2,918		$	2,585		$	333	13	%	$	6,432		$	5,055		$	1,377	27	%
License and subscription		2,330			1,739			591	34	%		9,008			3,698			5,310	144	%

Total	$	5,248		$	4,324		$	924	21	%	$	15,440		$	8,753		$	6,687	76	%

Revenue (as % of total revenue):
Service		56	%		60	%						42	%		58	%
License and subscription		44	%		40	%						58	%		42	%

Total		100	%		100	%						100	%		100	%

We derive our revenue primarily from:

the provision of development services to the Central Banks, TVaura LLC, a joint venture between Digimarc and The Nielsen Company (“Nielsen”), from July 2009, Nielsen between October 2007 and June 2009 and other government and commercial customers and

licensing our patents.

Service. Service revenue consists primarily of software development and consulting services. The majority of service revenue arrangements are structured as time and materials or fixed price consulting agreements. The majority of our services revenue is derived from contracts with the Central Banks, Nielsen, the TVaura LLC joint venture and other government agencies. The agreements range from several months to several years in length, and our longer term contracts are subject to work plans that are reviewed and agreed upon at least annually. These contracts generally provide for billing hours worked at predetermined rates and, to a lesser extent, for cost reimbursement for third party costs and services. Increases or decreases in the services provided under these contracts are generally subject to both volume and price changes. The volume of work is generally negotiated at least annually and can be modified as the customer’s needs change. We also have provisions in our longer term contracts that allow for specific hourly rate increases on an annual basis to account for cost of living variables. Contracts with other government agencies are generally shorter term in nature, are less linear in billings and less predictable than our longer terms contracts because the contracts with other government agencies are subject to government budgets and funding.

The increase in service revenue for the three-month period ended June 30, 2010, compared to the corresponding three-month period ended June 30, 2009, was due primarily to increased services under our joint venture agreement with Nielsen and increased program work from the Central Banks.

The increase in service revenue for the six-month period ended June 30, 2010, compared to the corresponding six-month period ended June 30, 2009, was due primarily to the completion of government contracts that are non-linear in nature, increased program work from the Central Banks and increased services under our joint venture agreement with Nielsen.

License and subscription. License revenue originates primarily from licensing our technology and patents where we receive royalties as our income stream. Subscription revenue consists primarily of royalty revenue from the sale of our web-based subscriptions related to various software products, which are more recurring in nature. Revenues from our licensed products have minimal associated direct costs, and thus provide very high gross margins.

The increase in license and subscription revenue for the three-month period ended June 30, 2010, compared to the corresponding three-month period ended June 30, 2009, was due primarily to increased royalties from licensees.

The increase in service revenue for the six-month period ended June 30, 2010, compared to the corresponding six-month period ended June 30, 2009, was due primarily to the licensing arrangement with Arbitron and increased royalties from other licensees.

Revenue by Geography


	Three Months Ended June 30, 2010			Three Months Ended June 30, 2009			Dollar Increase		Percent Increase		Six Months Ended June 30, 2010			Six Months Ended June 30, 2009			Dollar Increase		Percent Increase
Revenue by geography:
Domestic	$	2,103		$	1,777		$	326	18	%	$	9,343		$	3,553		$	5,790	163	%
International		3,145			2,547			598	23	%		6,097			5,200			897	17	%

Total	$	5,248		$	4,324		$	924	21	%	$	15,440		$	8,753		$	6,687	76	%

Revenue (as % of total revenue):
Domestic		40	%		41	%						61	%		41	%
International		60	%		59	%						39	%		59	%

Total		100	%		100	%						100	%		100	%

Domestic revenue increased for the three-month period ended June 30, 2010, compared to the corresponding three-month period ended June 30, 2009, primarily due to the licensing agreement and the services under our joint venture agreement with Nielsen.

The increase in domestic revenue for the six-month period ended June 30, 2010, compared to the corresponding six-month period ended June 30, 2009, was due primarily to the licensing arrangement with Arbitron, the completion of government contracts and revenues received under the licensing and joint venture agreements with Nielsen.

International revenue increased for the three- and six-month periods ended June 30, 2010, compared to the corresponding three-and six-month periods ended June 30, 2009, primarily due to increased royalties from licensees and increased revenue from the Central Banks. We anticipate revenue growth for the remainder of 2010, compared to the same period in 2009 from our existing customers and from new customers as we expand the marketing and monetization of our intellectual property portfolio.

Cost of Revenue and Gross Profit

Service. Cost of service revenue primarily includes costs that are allocated from research, development, engineering and sales and marketing that relate directly to producing revenue under our customer contracts, and, to a lesser extent, direct costs of program delivery for both personnel and operating expenses. Allocated costs include:

•

salaries, a payroll tax and benefit factor, incentive compensation and related costs of our software developers, quality assurance personnel, product managers, business development managers and other personnel where we bill our customers for time and materials costs;

•

payments to outside contractors that are billed to customers;

•

charges for equipment directly used by the customer;

•

depreciation charges for machinery, equipment and software; and

•

travel costs directly attributable to service and development contracts.

License and subscription. Cost of license and subscription revenue primarily includes:

•

patent or software license costs for any patents licensed from third parties where the party receives a portion of royalties or license revenue paid to by Digimarc;

•

internet service provider connectivity charges and image search data fees to support the services offered to our subscription customers; and, to a lesser extent,

•

amortization of capitalized patent costs.

Gross Profit


	Three Months Ended June 30, 2010			Three Months Ended June 30, 2009			Dollar Increase		Percent Increase		Six Months Ended June 30, 2010			Six Months Ended June 30, 2009			Dollar Increase		Percent Increase
Gross Profit:
Service	$	1,435		$	1,105		$	330	30	%	$	3,149		$	2,158		$	991	46	%
License and subscription		2,273			1,691			582	34	%		8,894			3,582			5,312	148	%

Total	$	3,708		$	2,796		$	912	33	%	$	12,043		$	5,740		$	6,303	110	%

Gross Profit (as % of related revenue components):
Service		49	%		43	%						49	%		43	%
License and subscription		98	%		97	%						99	%		97	%
Total		71	%		65	%						78	%		66	%

The increase in gross profit for the three-month period ended June 30, 2010, compared to the corresponding three—month period ended June 30, 2009, was primarily due to increased service revenue under our joint venture agreement with Nielsen and our agreement with the Central Banks and increased royalty revenues from Civolution.

The increase in gross profit for the six-month period ended June 30, 2010, compared to the corresponding six-month period ended June 30, 2009, primarily reflected the impact of the licensing arrangement with Arbitron and other licensees, and the completion of government contracts.

The increase in gross profit as a percentage of revenue for the three-month period ended June 30, 2010, compared to the corresponding three-month period ended June 30, 2009, were due primarily to favorable margins from our government (including the Central Banks) and Nielsen joint venture contracts due primarily to improved labor utilization from the variable component of our costs of services and from financial leverage arising from higher revenues without corresponding increases in the fixed portion of our costs of services.

The increase in gross profit as a percentage of revenue for the six-month period ended June 30, 2010, compared to the corresponding six-month period ended June 30, 2009, were due primarily to favorable margins from our government contracts, improved labor utilization and from financial leverage noted above, and increased revenues attributed to the licensing arrangement with Arbitron and other licensees.

Operating Expenses

Sales and marketing


	Three Months Ended June 30, 2010			Three Months Ended June 30, 2009			Dollar Increase		Percent Increase		Six Months Ended June 30, 2010			Six Months Ended June 30, 2009			Dollar Increase		Percent Increase
Sales and marketing	$	759		$	728		$	31	4	%	$	1,500		$	1,473		$	27	2	%
Sales and marketing (as % of total revenue)		15	%		17	%						10	%		17	%

Sales and marketing expenses consist primarily of:

•

compensation, benefits and related costs of sales and marketing employees and product managers;

•

travel and market research costs, and costs associated with marketing programs, such as trade shows, public relations and new product launches;

•

incentive compensation in the form of stock-based compensation; and

•

charges for infrastructure and centralized costs of facilities and information technology.

We allocate certain costs of sales and marketing to cost of service revenue when they relate directly to our service contracts. For direct billable labor hours, we allocate to cost of service revenue:

•

salaries;

•

a payroll tax and benefits factor; and

•

incentive compensation related to our stock compensation plan.

We record all remaining, or “residual,” costs as sales and marketing costs.

Sales and marketing expense for the three- and six-month periods ended June 30, 2010, compared to the corresponding three-and six-month periods ended June 30, 2009, remained relatively constant.

We anticipate that we will continue to incur sales and marketing costs at existing or higher levels to support ongoing sales initiatives.

Research, development and engineering


	Three Months Ended June 30, 2010			Three Months Ended June 30, 2009			Dollar Increase		Percent Increase		Six Months Ended June 30, 2010			Six Months Ended June 30, 2009			Dollar Increase		Percent Increase
Research, development and engineering	$	1,321		$	1,217		$	104	9	%	$	2,580		$	2,488		$	92	4	%
Research, development and engineering (as % of total revenue)		25	%		28	%						16	%		28	%

Research, development and engineering expenses arise primarily from three areas that support our business model:

•

Fundamental Research:

•

Investigation of new watermarking algorithms to increase robustness and/or computational efficiency;

•

Mobile device usage models and imaging sub-systems in camera-phones;

•

Industry conference participation and authorship of papers for industry journals;

•

Survey and study of human and computer interaction models with a focus on mobile devices and modeling of intent;

•

Development of new intellectual property, including documentation of claims and production of supporting diagrams and materials; and

•

Research in fingerprinting and other content identification technologies.

•

Platform Development:

•

Tuning and optimization of implementation models to improve resistance to non-malicious attacks and routine transformations, such as JPEG, cropping and printing; and

•

Mobile platform creation to leverage device specific capabilities (e.g. instruction sets and GPUs).

•

Product Development:

•

Migration of applications to new platforms, specifically linking Digimarc for Images (formerly known as ImageBridge) to DGSDK and Digimarc Mobile;

•

Updating Digimarc for Images Plug-Ins for Photoshop CS5, including new interfaces and translation into 27 languages; and

•

Development of the Digimarc Mobile reader prototype in support of publishing applications.

Research, development and engineering expenses consist primarily of:

•

compensation, benefits and related costs of software developers and quality assurance personnel;

•

payments to outside contractors;

•

the purchase of materials and services for product development;

•

incentive compensation in the form of stock-based compensation; and

•

charges for infrastructure and centralized costs of facilities and information technology.

We allocate certain costs of research, development and engineering to cost of service revenue when they relate directly to our service contracts. For direct billable labor hours, we allocate to cost of service revenue:

•

salaries;

•

a payroll tax and benefits factor; and

•

incentive compensation related to our stock compensation plan.

We record all remaining, or “residual,” costs as research, development and engineering costs.

Research, development and engineering expense for the three- and six-month periods ended June 30, 2010, compared to the corresponding three- and six-month periods ended June 30, 2009, resulted primarily from increased headcount and employee compensation-related expenses from hiring additional engineers and scientists to facilitate expected growth in service revenue, and to increase our investment in research and development.

We anticipate that we will continue to invest in research, development and engineering expenses at existing or higher levels in the near term to support certain ongoing product initiatives and service contracts.

General and administrative


	Three Months Ended June 30, 2010			Three Months Ended June 30, 2009			Dollar Increase		Percent Increase		Six Months Ended June 30, 2010			Six Months Ended June 30, 2009			Dollar Increase		Percent Increase
General and administrative	$	1,687		$	1,448		$	239	17	%	$	3,572		$	3,076		$	496	16	%
General and administrative (as % of total revenue)		32	%		34	%						23	%		35	%

We incur general and administrative costs in the functional areas of finance, legal, human resources, executive and board of directors. Costs for facilities and information technology are also managed as part of the general and administrative processes and are allocated to this line item as well as to costs of services, sales and marketing, and research development and engineering.

General and administrative expenses consist primarily of:

•

compensation, benefits and related costs;

•

third party and professional fees associated with legal, accounting, human resources and costs associated with being a public company;

•

incentive compensation in the form of stock-based compensation; and

•

charges for infrastructure and centralized costs of facilities and information technology.

The increases in general and administrative expenses for the three-month period ended June 30, 2010, compared to the corresponding three-month period ended June 30, 2009, resulted primarily from:

•

increased stock-based compensation of $0.1 million related to a additional layers of stock-based award grants, and

•

increased expenses of $0.1 million related primarily to litigation activity associated with our intellectual property marketing efforts, and to a lesser extent costs related to our proxy and investor initiatives.

The increases in general and administrative expenses for the six-month period ended June 30, 2010, compared to the corresponding six-month period ended June 30, 2009, resulted primarily from:

•

increased stock-based compensation of $0.2 million related to a additional layers of stock-based award grants, and

•

increased legal fees of $0.2 million related primarily to litigation activity associated with our intellectual property marketing efforts.

We anticipate that we will continue to incur general and administrative expenses at least at existing levels, while continuing to examine means to reduce general and administrative expenses as a percentage of revenue in the longer term.

Intellectual property


	Three Months Ended June 30, 2010			Three Months Ended June 30, 2009			Dollar Increase		Percent Increase		Six Months Ended June 30, 2010			Six Months Ended June 30, 2009			Dollar Increase		Percent Increase
Intellectual property	$	319		$	217		$	102	47	%	$	576		$	494		$	82	17	%
Intellectual property (as % of total revenue)		6	%		5	%						4	%		6	%

We incur intellectual property expenses that arise primarily from costs associated with documenting, applying for, and maintaining domestic and international patents and trademarks.

Gross expenditures for intellectual property costs, before reflecting the effect of capitalized patent costs, primarily consist of:

•

compensation, benefits and related costs of attorneys and legal assistants;

•

third party costs, including filing and governmental regulatory fees and fees for outside legal counsel, and translation costs, each incurred in the patent process;

•

incentive compensation in the form of stock-based compensation; and

•

charges for infrastructure and centralized costs of facilities and information technology.

Intellectual property expenses for the three- and six-month periods ended June 30, 2010, compared to the corresponding three- and six-month periods ended June 30, 2009, resulted primarily from legal and maintenance related costs associated with our patent registration activity.

Intellectual property expenses can vary from period to period based on the level of capitalized patent activity.

We anticipate that we will continue to incur intellectual property expenses at existing or higher levels.

Stock-based compensation


	Three Months Ended June 30, 2010		Three Months Ended June 30, 2009		Dollar Increase (Decrease)			Percent Increase (Decrease)		Six Months Ended June 30, 2010		Six Months Ended June 30, 2009		Dollar Increase (Decrease)			Percent Increase (Decrease)
Cost of revenue	$	91	$	50	$	41		82	%	$	188	$	99	$	89		90	%
Sales and marketing		49		50		(1	)	(2	)%		91		102		(11	)	(11	)%
Research, development and engineering		76		49		27		55	%		146		93		53		57	%
General and administrative		527		429		98		23	%		1,034		833		201		24	%
Intellectual property		22		16		6		38	%		46		33		13		39	%

Total	$	765	$	594	$	171		29	%	$	1,505	$	1,160	$	345		30	%

The increase in stock-based compensation expense for the three- and six-month periods ended June 30, 2010, compared to the corresponding three- and six-month periods ended June 30, 2009, was primarily due to an additional layer of stock-based awards being expensed pursuant to Accounting Standards Codification (“ASC”) 718 “ Compensation—Stock Compensation. ” We anticipate incurring an additional $7.2 million in stock-based compensation expense through June 2014 for awards outstanding as of June 30, 2010. The future effect of stock-based compensation on our financial position and results of operations will be determined by stock-based awards granted in future periods and the assumptions on which the value of those stock-based awards are based. Our tax accounting may also be affected by actual exercise behavior and the relative market prices at exercise of the awards.

Other income (expenses), net


	Three Months Ended June 30, 2010			Three Months Ended June 30, 2009		Dollar Decrease			Percent Decrease		Six Months Ended June 30, 2010			Six Months Ended June 30, 2009		Dollar Decrease			Percent Decrease
Net loss from joint ventures	$	(561	)	$	—	$	(561	)	—		$	(1,018	)	$	—	$	(1,018	)	—	%
Interest income, net		64			137		(73	)	(53	)%		127			312		(185	)	(59	)%
Other		(3	)		3		(6	)	(200	)%		(5	)		1		(6	)	(600	)%

Total	$	(500	)	$	140	$	(640	)	(457	)%	$	(896	)	$	313	$	(1,209	)	386	%

Other income (expenses), net consists primarily of the net losses from the joint ventures with The Nielsen Company, TVaura LLC and TVaura Mobile LLC, and interest income from our cash and short- and long-term marketable securities.

The decrease in other income (expense), net for the three- and six-month periods ended June 30, 2010, compared to the corresponding three- and six-month periods ended June 30, 2009, resulted primarily from the net losses of $372 and $749 from TVaura LLC and $189 and $269 from TVaura Mobile LLC, respectively, and lower interest earned on cash and investment balances, reflecting lower interest rates paid on these balances.

Provision for Income Taxes

There was no provision for income taxes of Digimarc, other than foreign withholding taxes, for the three- and six-month periods ended June 30, 2010 since the estimated effective tax rate for the period ending December 31, 2010 is expected to be zero, with the exception of foreign withholding tax.

Liquidity and Capital Resources


	June 30, 2010		December 31, 2009
	(in thousands)
Working capital	$	47,202	$	43,503
Current (liquidity) ratio(1)		17.9:1		12.7:1
Cash, cash equivalents and short-term marketable securities	$	46,582	$	42,786

(1)	The current (liquidity) ratio is calculated by dividing total current assets by total current liabilities.

The $3.7 million increase in working capital at June 30, 2010 compared to December 31, 2009 resulted primarily from increased revenues, the majority associated with the revenue and related profit contribution from the Arbitron licensing arrangement, offset by investments in our business for both capital and intellectual property initiatives and cash contributions to the joint ventures with The Nielsen Company.

Operating Cash Flow. The components of operating cash flows were:


	Six Months Ended June 30, 2010		Six Months Ended June 30, 2009			Dollar Increase (Decrease)			Percent Increase (Decrease)
Net income (loss)	$	2,880	$	(1,487	)	$	4,367		294	%
Non-cash items		2,850		1,436			1,414		98	%
Changes in operating assets and liabilities		146		277			(131	)	(47	)%

Net cash provided by operating activities	$	5,876	$	226		$	5,650		2,500	%

Net income (loss).

The increase in operating results for the six-month period ended June 30, 2010, compared to the corresponding six-month period ended June 30, 2009, reflects higher revenues, primarily attributable to revenue received under the licensing arrangement with Arbitron.

Non-cash items.

The increase in non-cash items for the six-month period ended June 30, 2010, compared to the corresponding six-month period ended June 30, 2009, was primarily the result of the net losses from the joint ventures and an additional layer of stock-based awards.

Operating assets and liabilities.

The primary changes in the operating assets and liabilities for the six-month period ended June 30, 2010, compared to the corresponding six-month period ended June 30, 2009, related to:

•

collection of advanced billings, as provided in our contracts with customers; offset by

•

a reduction in compensation related liabilities related to accrued bonuses at year-end that were paid compared with no bonus accrual at June 30, 2010, as a result of the elimination of the bonus program.

The primary changes in the operating assets and liabilities for the prior year period relate to:

•

collection of advanced billings, as provided in our contracts with customers; offset by

•

the recognition of deferred revenues.

Cash flows from investing activities.

The primary changes in the investing activities for the six-month period ended June 30, 2010, compared to the corresponding six-month period ended June 30, 2009, related to:

•

investments made in property and equipment, primarily in our information technology area for computer systems and related equipment used to operate our business;

•

investments made in the patent application and granting process;

•

investments made in joint ventures; and

•

net activity from investing our cash and cash equivalents and short- and long-term marketable securities.

Cash flows from financing activities.

The primary changes in the financing activities for the six-month period ended June 30, 2010, compared to the corresponding six-month period ended June 30, 2009, related to purchases of common stock as part of the restricted stock award agreements to satisfy tax withholding obligations, partially offset by the exercise of stock options.

Future Cash Expectations.

We believe that our current cash, cash equivalents, and short-term investment balances will satisfy our projected working capital and capital expenditure requirements for at least the next 12 months. Thereafter, we anticipate continuing to use cash, cash equivalents and short-term investment balances to satisfy our projected working capital and capital expenditure requirements.

We may utilize cash resources to fund acquisitions or investments in complementary businesses, technologies or product lines. In order to take advantage of opportunities, we may find it necessary to obtain additional equity financing, debt financing, or credit facilities. We do not believe at this time, however, that our long-term working capital and capital expenditures would require us to take steps to remedy any such potential deficiencies. If it were necessary to obtain additional financings or credit facilities, we may not be able to do so, or if these funds are available, they may not be available on satisfactory terms.

Contractual Obligations

Pursuant to the terms of the joint venture agreements with Nielsen, we are obligated to contribute $6.7 million to the joint ventures payable in quarterly installments from July 2009 through October 2011, of which $4.2 million was outstanding as of June 30, 2010.

In May 2010 we entered into an amendment with the landlord of our corporate offices to extend the length of our facilities lease through August 2016 with rent payments totaling $5.3 million.

Our significant commitments consist of obligations under non-cancelable operating leases for our facilities, rent and various equipment leases, which totaled $5.2 million as of June 30, 2010 and are payable in monthly installments through August 2016. Other than as described above, as of June 30, 2010 there have been no material changes in the contractual obligations disclosed in our 2009 Annual Report.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our business.

Recent Accounting Standards Update

See the disclosure related to Accounting Standards Update (“ASU”) set forth in Part 1, Item 1, under Note 2 Recent Accounting Standards Update” of this Quarterly Report on Form 10-Q.

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

This Quarterly Report on Form 10-Q includes “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. Words such as “may,” “plan,” “should,” “could,” “expect,” “anticipate,” “intend,” “believe,” “project,” “forecast,” “estimate,” “continue,” variations of such terms or similar expressions are intended to identify such forward- looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements, or other statements made by us, are made based on our expectations and beliefs concerning future events impacting us, and are subject to uncertainties and factors (including those specified below), which are difficult to predict and, in many instances, are beyond our control. As a result, our actual results could differ materially from those expressed in or implied by any such forward-looking statements, and investors are cautioned not to place undue reliance on such statements. Forward- looking statements include but are not limited to statements relating to:

•

concentration of revenues with few customers comprising a large majority of the revenues;

•

trends and expectations in revenue growth;

•

our future level of investment in our business and the joint ventures in which we have invested, including investment in research, development and engineering of products and technology, development of our intellectual property, the acquisition of new customers and development of new market opportunities;

•

our ability to improve margins;

•

anticipated expenses, costs, margins and investment activities in the foreseeable future;

•

anticipated revenue to be generated from current contracts and as a result of new programs;

•

our profitability in future periods;

•

business opportunities that could require us to seek additional financing;

•

the size and growth of our markets;

•

the existence of international growth opportunities and our future investment in such opportunities;

•

the sources of our future revenue;

•

our expected short-term and long-term liquidity positions;

•

our ability to fund our working capital needs through cash flow from operations;

•

our use of cash in upcoming quarters;

•

capital market conditions, including the recent economic crisis, interest rate volatility and other limitations on the availability of capital, which could have an impact on our cost of capital and our ability to access the capital markets;

•

anticipated levels of backlog and bid activity in future periods;

•

protection of our intellectual property portfolio; and

•

other risks detailed in our filings with the Securities and Exchange Commission, including the risk factors set forth in Part I, Item1A (“Risk Factors”) of our 2009 Annual Report.

We believe that the risk factors contained in Part I, Item 1A of our 2009 Annual Report, among others, could affect our future performance and the liquidity and value of our securities and cause our actual results to differ materially from those expressed or implied by forward-looking statements made by us or on our behalf. Investors should understand that it is not possible to predict or identify all risk factors and that there may be other factors that may cause our actual results to differ materially from the forward-looking statements. All forward-looking statements made by us or by persons acting on our behalf apply only as of the date of this Quarterly Report on Form 10-Q. We do not undertake any obligation to publicly update or revise any forward-looking statements to reflect future events, information or circumstances that arise after the date of the filing of this Quarterly Report on Form 10-Q.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

The market risk disclosures as set forth in Part 1, Item 7A of our 2009 Annual Report have not changed materially.

Item 4.

Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

We conducted an evaluation (pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”)), under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of the end of the period covered by this Form 10-Q. These disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that this information is accumulated and communicated to management, including the principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Based on the evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures were effective as of the end of the period covered by this Form 10-Q.

Changes in Controls

There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the fiscal quarter ended June 30, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION.

Item 1.

Legal Proceedings.

From time to time in our normal course of business we are a party to various legal claims, actions and complaints. On November 16, 2009, Digimarc filed suit in the U.S. District Court for the District of Oregon (Civil Action No. 3:09-cv-1355-KI), alleging patent infringement against Shazam Entertainment Ltd., asserting that Shazam’s music identification technology infringes three Digimarc patents. We served the complaint in March 2010. Digimarc filed an amended complaint on April 7, 2010, asserting that Shazam is infringing six Digimarc patents. Digimarc dismissed its suit without prejudice on June 16, 2010.

Item 1A.

Risk Factors.

Detailed information about risks that may affect our business, financial condition, results of operations, or cash flows are set forth in Part I, Item 1A thereof (“Risk Factors”) of our 2009 Annual Report.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

The following table sets forth information regarding purchases of our equity securities during the three-month period ended June 30, 2010:


Period	(a) Total number of shares (or units) purchased		(b) Average price paid per share (or unit)			(c) Total number of shares (or units) purchased as part of publicly announced plans or programs	(d) Maximum number (or approximate dollar value) of shares (or units) that may yet be purchased under the plans or programs
Month 1
April 1, 2010 to April 30, 2010	—			—		—	$	3.4 million	⁽²⁾
Month 2
May 1, 2010 to May 31, 2010	146	⁽¹⁾	$	18.20	⁽¹⁾	—	$	3.4 million	⁽²⁾
Month 3
June 1, 2010 to June 30, 2010	—			—		—	$	3.4 million	⁽²⁾

Total	146	⁽¹⁾	$	18.20	⁽¹⁾	—

(1)	Fully vested restricted stock shares of common stock withheld (purchased) by us in satisfaction of required withholding tax liability.

(2)

In April 2009, the Board of Directors approved a stock repurchase program authorizing the purchase, at the discretion of management, of up to $5 million in shares of our common stock through either periodic open-market or private transactions at then-prevailing market prices through April 30, 2010. In April 2010, the Board of Directors approved an extension of the stock repurchase program through April 30, 2011. For the three- and six-month periods ended June 30, 2010, we made no purchases under this program. We have paid $1.6 million to repurchase 111,667 shares of outstanding common stock under this program since the program’s inception, and $3.4 million remains available to repurchase common stock under the stock repurchase program.

Item 5.

Other Information.

In May 2010, the Company entered into an amendment to the lease for its corporate offices located in Beaverton, Oregon. The original lease term was to expire in August 2011. The amendment extended the lease term through August 2016, with rent payments totaling $5.3 million, and provided an additional lessee improvement allowance of $0.4 million. The lease, as amended, is attached as Exhibit 10.1

Item 6.

Exhibits.


Exhibit Number		Exhibit Description
2.1		Agreement and Plan of Merger dated April 30, 2010 between Digimarc Corporation, a Delaware corporation, and Digimarc Oregon Corporation, an Oregon corporation (incorporated by reference to the Company’s Current Report on Form 8-K, filed with the Commission on May 4, 2010 (File No. 001-34108)).

3.1		Articles of Incorporation of Digimarc Corporation, an Oregon corporation (incorporated by reference to the Company’s Current Report on Form 8-K, filed with the Commission on May 4, 2010 (File No. 001-34108)).

3.2		Bylaws of Digimarc Corporation, an Oregon corporation (incorporated by reference to the Company’s Current Report on Form 8-K, filed with the Commission on May 4, 2010 (File No. 001-34108)).

10.1		Lease Agreement, dated March 22, 2004, between Digimarc Corporation and PS Business Parks, L.P., as amended on May 13, 2010.

31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer

31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer

32.1		Section 1350 Certification of Chief Executive Officer

32.2		Section 1350 Certification of Chief Financial Officer

SIGNATURES

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


Date: July 30, 2010	D IGIMARC C ORPORATION

	By:	/s/ M ICHAEL M C C ONNELL
		Michael McConnell Chief Financial Officer and Treasurer (Duly Authorized Officer and Principal Financial Officer)

Exhibit 10.1

FULL SERVICE LEASE

Date: March 22, 2004

Lessor: PS Business Parks, L.P., a California Limited Partnership

Lessee: Digimarc Corporation, a Delaware Corporation

1.	Lease Terms

1.01 The Premises is the Building whose address is 9405 SW Gemini Drive, Beaverton, OR 97008 . The Premises contains approximately 46,083 rentable square feet and is shown on Exhibit “A-1.” The Building contains approximately 46,083 rentable square feet and is shown on Exhibit “A-2”. The Project is depicted on Exhibit “A-3” and contains approximately 117,870 rentable square feet. The Property is depicted on Exhibit “A-4” and is commonly referred to as Creekside Corporate Park and contains approximately 584,493 rentable square feet.

1.02 Lessee’s Notice Address: Lessee’s Notice Address is the address of the Premises as stated in Paragraph 1.01 above.

1.03 Lessor’s Notice Address: 15455 NW Greenbrier Parkway, Suite 245, Beaverton, OR 97006 .

1.04 Lessee’s Permitted Use: Lessee shall use the Premises only for the following purpose(s) and for no other purpose whatsoever: General office uses .

1.05 Lease Term: The Lease Term commences on September 1, 2004 or such other date as is determined by the provisions of this Lease (the “Commencement Date”) and ends on the final day of the 84th full calendar month thereafter.

1.06 Base Rent: Base Rent shall be paid monthly in the amounts specified below:


$	0.00	Beginning September 1, 2004	Ending February 28, 2005
$	46,667	Beginning March 1, 2005	Ending August 31, 2005
$	63,287	Beginning September 1, 2005	Ending August 31, 2006
$	65,169	Beginning September 1, 2006	Ending August 31, 2007
$	67,128	Beginning September 1, 2007	Ending August 31, 2008
$	69,125	Beginning September 1, 2008	Ending August 31, 2009
$	71,237	Beginning September 1, 2009	Ending August 31, 2010
$	73,349	Beginning September 1, 2010	Ending August 31, 2011

1.07 Security Deposit: $ 75,000.00

1.08 Initial Monthly Rent Charges: Base Rent $46,667.00 .

1.09 Proportionate Share: Lessee’s Proportionate Share of the Property, which represents the approximate Proportionate Share of the Premises to the Property, is 7.8842 %. Lessee’s Proportionate Share of the Project, which represents the approximate Proportionate Share of the Premises to the Project, is 39.0964%. Lessee’s Proportionate Share of the Building within which the Premises is located, which represents the approximate Proportionate Share of the Premises to the Building, is 100 %. Proportionate Share may be adjusted by Lessor during the Lease Term if the size of the Project, Premises or Building changes.

1.10 Expense Base Year: 2005 .

1.11 Broker(s): Hume Myers Tenant Counsel L.L.C. for Lessee; Grubb & Ellis for Lessor .

1.12 Automatic Payments: Unless Lessor otherwise directs in writing, all payments of Base Rent and the monthly estimated payments of Lessee’s Proportionate Share of Operating Expenses shall be made by electronic payment. Lessee shall execute such necessary and reasonable documents, provide

such necessary and reasonable information, and follow such necessary and reasonable procedures as are requested by Lessor from time to time to facilitate such payments. If, by reason of insufficient funds or other reason, any such payment is not fully made and received, such event shall be deemed a failure of Lessee to make the required payment. Payment shall be deemed made by Lessee on the date funds are actually received by Lessor; provided, if Lessee is then in default, Lessor shall have the right to return all or a part of any payment received within ten (10) business days of receipt, in which event the returned amount shall be deemed to have not been paid by Lessee or received by Lessor. Receipt of any funds pursuant to this Paragraph shall not constitute a waiver by Lessor of any Default by Lessee whether or not such Default is known to Lessor.

2.	Lease of Premises

2.01 Lessor leases to Lessee, and Lessee leases from Lessor, the Premises, upon the terms of this Lease. The Premises are leased “AS IS” except only for the improvements, if any, which are to be constructed by Lessor pursuant to Exhibit “B.” Any such improvements to be constructed by Lessor pursuant to Exhibit “B” are herein referred to as “Lessor’s Work.” Except as provided herein, Lessee acknowledges that neither Lessor nor any agent of Lessor has made any representation or warranty regarding the Premises. The square footages set forth in this Lease are approximate and agreed. Use of the terms “rentable” and “usable” is for convenience only and represents Lessor’s interpretation of such terms. Lessor will deliver the Premises to Lessee with existing plumbing, electrical, fire sprinkler, lighting, air conditioning, heating and mechanical systems located in the Premises, if any, in good working condition.

2.02 Lessor’s Work, if any, shall be installed by Lessor in compliance with all then applicable codes. Lessee, at its sole expense, agrees to comply with all laws, codes, ordinances and other legal requirements (including covenants and restrictions) applicable to the Premises (herein “Laws”); provided, however, that Lessor, in conjunction with the Lessor’s work, shall affect any repairs and improvements required under any Laws as of the Commencement Date. Lessee agrees to cause the Premises to comply with all Laws, including by making any changes to the Premises necessitated by any Lessee activity, including but not limited to changes required by (a) any Lessee Improvements or Lessee Alterations (as defined below), or (b) any use of the Premises or Property by Lessee; provided, Lessor reserves the right to accomplish such changes itself at the expense of Lessee. If any activity of Lessee necessitates changes to the Project other than the Premises, then Lessor shall elect that Lessor accomplish the same at the expense of Lessee or that Lessee accomplish the same at its own expense. Notwithstanding anything to the contrary herein, Lessee shall not be responsible for making any structural modifications to the Premises except to the extent Lessee’s space plan requires structural modifications.

2.03 If for any reason Lessor cannot deliver possession of the Premises three (3) weeks prior to the estimated Commencement Date of the Lease Term, Lessor will not be subject to any liability nor will the validity of this Lease be affected in any manner. Rather, the Commencement Date shall be delayed until three (3) weeks after delivery of possession to allow Lessee to fixturize the Premises in which event the expiration date of the Lease Term shall be extended to include the same number of full calendar months as set forth in Paragraph 1 above (plus any partial first month); provided, in the event delivery of possession is delayed by any act, omission or request of Lessee, then the Premises shall be deemed to have been delivered (and the Commencement Date shall occur) on the earlier of the actual date of delivery or the date delivery would have occurred absent the number of days of such delay attributable to Lessee and the term shall then be for such number of full calendar months (plus any partial first month). If for any reason possession of the Premises is not delivered on the scheduled Commencement Date set forth in Paragraph 1 above, Lessee may a) receive two (2) days free rent for each day of delay beyond the scheduled commencement date, and b) terminate this Lease by written notice given after a forty-five (45) day period beyond the scheduled commencement date but prior to delivery of possession; provided, such forty-five (45) day period shall be extended by (a) the number of days of delays attributable to Lessee (including but not limited to delays in approvals of plans or cost estimates, delays related to changes in plans requested by Lessee whether or not approved by Lessor, delays caused by Lessee installing any “Lessee Improvements,” delays caused by other early entry or early occupancy by Lessee, and/or other delays attributable to Lessee), plus (b) the number of days of delays caused by events beyond the reasonable control of Lessor (including but not limited to fire, earthquake, other casualty, inclement weather, acts of God, shortages of labor or material, lead times on ordered items, strike, acts or omissions of government, and/or delays in governmental permits, inspections or approvals). Any such termination shall be without liability of Lessor to Lessee. Any such termination by Lessee shall be Lessee’s sole remedy for delay in delivery of possession.

2.04 Upon expiration or termination of this Lease, Lessee agrees to return the Premises to Lessor in the same condition as received by Lessee, normal wear and tear excepted, with all removal, repair, and restoration duties of Lessee being fully performed.

2.05 Upon request made by Lessor following the Commencement Date, Lessee shall execute and deliver an agreement setting forth the Commencement Date, the date upon which the Lease Term shall expire, and such other matters regarding the commencement of this Lease as Lessor shall request. If Lessee, with Lessor’s prior written consent, occupies the Premises prior to the Commencement Date, Lessee’s occupancy of the Premises shall be subject to all the provisions of the Lease. Early occupancy of the Premises shall not advance the expiration date of the Lease.

3.	Base Rent

On or before the first day of each calendar month of the Lease Term, Lessee will pay to Lessor the Base Rent for such month. Base Rent for any first partial month and for the first full calendar month of the Lease Term, is due and payable upon due date called for in this Lease. Security deposit is due and payable upon Lease execution. Monthly rent for any partial calendar month will be prorated. All sums payable by Lessee to Lessor hereunder shall be deemed rent. Base Rent and all other amounts required to be paid by Lessee hereunder shall be paid without deduction or offset and without prior notice or demand. All such amounts shall be paid in lawful money of the United States of America and shall be paid to Lessor at the address stated herein or to such other persons or to such other places as Lessor may designate in writing from time to time. Amounts payable hereunder shall be deemed paid when actually received by Lessor.

4.	Additional Rent

4.01 Unless otherwise specifically stated in this Lease, any charge payable by Lessee under this Lease other than Base Rent is called “Additional Rent.” The term “rent” whenever used in this Lease means Base Rent, Additional Rent and/or any other monies payable by Lessee under the terms of this Lease.

4.02 “Operating Expenses” as used herein shall include all costs and expenses related to the ownership, management, operation, maintenance, replacement, improvement and repair of the Premises, Building, Project and/or Property, or any part thereof, incurred by Lessor including but not limited to: (1) Property supplies, materials, labor, equipment, and tools; (2) Lessor-incurred Utility and Service Costs (as further described in Paragraph 4.03B below), security, janitorial, trash removal, and all applicable service and maintenance agreements; (3) Property related legal, accounting, and consulting fees, costs and expenses, including but not limited to the cost of contests of Real Property Taxes; (4) Insurance Premiums for all policies deemed reasonably necessary by Lessor and/or its lenders, and all deductible amounts under such policies (as further described in Paragraph 4.03C below); (5) costs and expenses of operating, maintaining, and repairing the Property, including but not limited to all interior areas and also driving, parking, loading, and other paved or unpaved areas (including but not limited to, resurfacing and striping and any snow and ice removal Lessor elects to conduct), landscaped areas (including but not limited to, tree trimming), building exteriors (including but not limited to, painting and roof work), signs and directories, and lighting; (6) capital improvements and replacements (including but not limited to, all financing costs and interest charges); (7) compensation (including but not limited to, any payroll taxes, worker’s compensation for employees, and customary employee benefits) of all persons, including independent contractors, who perform duties, or render services on behalf of, or in connection with the Property, or any part thereof, including but not limited to, Property operations, maintenance, repair, and rehabilitation; (8) Property management fees not exceeding 5% of Annual Base Rent and the reasonable cost of providing space used by the Property manager; and (9) Real Property Taxes (as further described in Paragraph 4.03A, below). All Operating Expenses other than Real Property Taxes, Utility and Service Costs, and Insurance Premiums, are herein referred to as Common Area Expenses (CAM). Any increases in CAM expenses shall be limited to a non-cumulative 5% per year. In addition, in the event Lessor effects any capital improvements or replacements, the cost of the same shall be amortized over the number of years equal to the useful life of any such capital improvements or replacements.

4.03A “Real Property Taxes” shall include any fee, license fee, tax, levy, charge, or assessment (hereinafter individually and/or collectively referred to as “Tax”) imposed by any authority having the direct or indirect power to tax and where such Tax is imposed against the Property, or any part thereof, or Lessor in connection with its ownership or operation of the Property, including but not limited to: (1) any Tax on rent or Tax against Lessor’s business of leasing the Property; (2) any Tax by any authority for services or maintenance provided to the Property, or any part thereof, including but not limited to, fire protection, streets, sidewalks, and utilities; (3) any Tax on real estate or personal property levied with respect to the Property, or any part thereof, and any fixtures and equipment and other property used in connection with the Property; (4) any Tax based upon a reassessment of the Property due to a change in ownership or transfer of all or part of Lessor’s interest in the Property; and, (5) any Tax replacing, substituting for, or in addition to any Tax previously included in this definition. Real Property Taxes do not include Lessor’s federal or state net income taxes.

4.03B “Utility and Service Costs” shall include all Lessor incurred utility and service costs and expenses including but not limited to costs related to water and plumbing, electricity, gas, lighting, steam, sewer, waste disposal, and HVAC, and all costs related to plumbing, mechanical, electrical, elevator, HVAC, and other systems.

4.03C “Insurance Premiums” shall include all insurance premiums for all insurance policies maintained by Lessor from time to time related to the Property.

4.04 Throughout the Lease Term following the Base Year, Lessee will pay as Additional Rent its Proportionate Share (of the Project and/or Building, as designated from time to time by Lessor) of the amount by which total Operating Expenses in each calendar year exceed total Operating Expenses for the Base Year, subject to the limitation set forth in Section 4.02 above. Estimated payments shall be made monthly on or before the first day of each calendar month each in the amount of Lessor’s then current estimate as outlined below. Lessee’s Proportionate Share will be prorated for partial months. All Operating Expenses will be adjusted, at the election of Lessor, to reflect 100% occupancy during any calendar year in which the Project is not fully occupied (in which event Operating Expenses for the Base Year shall also be so adjusted).

4.05 Lessee’s Proportionate Share of Operating Expenses shall be determined and paid as follows:

4.05A. Lessee’s Operating Expense estimates: On or about April 1 ^st of each calendar year, Lessor will provide Lessee with a statement of: (1) Lessee’s annual share of estimated Operating Expenses in excess of Base Year Operating Expenses for the then current calendar year; (2) Lessee’s monthly Operating Expense estimate for the then current year; and, (3) Lessee’s retroactive estimate correction billing (for the period of January 1 ^st through the date immediately prior to the commencement date of Lessee’s new monthly Operating Expense estimate) for the difference between Lessee’s new and previously billed monthly Operating Expense estimates for the then current year.

4.05B. Lessee’s Proportionate Share of actual annual Operating Expenses: Each year, Lessor will provide Lessee with a statement reflecting the total Operating Expenses for the previous calendar year. If the total of Lessee’s Operating Expense estimates billed for the previous calendar year are less than Lessee’s Proportionate Share of the actual Operating Expenses in excess of Base Year Operating Expenses, the statement will indicate the payment amount and date due. If Lessee has paid more than its Proportionate Share of excess Operating Expenses for the preceding calendar year, Lessor will credit the overpayment toward Lessee’s future Operating Expense obligations. Monthly Operating Expense estimates are due on the 1 ^st of each month and shall commence in the month specified by Lessor. Lessee’s retroactive estimate correction, and actual annual Operating Expense charges, if any, shall be due, in full, on the date(s) specified by Lessor.

4.06 Unless Lessor otherwise elects, Lessee shall pay each Operating Expense in accordance with Lessee’s Proportionate Share of the Building or Lessee’s Proportionate Share of the Project, whichever is designated by Lessor. Lessor shall have the right to make allocations (“Allocations”) to Lessee of any one or more Operating Expenses on a different basis. Lessor shall have the right to make any such Allocations in any manner which Lessor deems reasonable (including use of estimates). For example, if Lessor deems it reasonable to do so, Lessor shall have the right to elect at any time and from time to time (a) to make any Allocation of one or more Operating Expenses based upon Lessee’s Proportionate Share of the Building and to make other Allocations on Lessee’s Proportionate Share of the Project, (b) to make Allocations of certain Operating Expense items among less than all lessees and/or other than based upon the respective square footages of the lessees, (c) to make different Allocations for different Operating Expenses, and/or (d) to alter an Allocation or the method of determining an Allocation from time to time. In no event shall Lessor be liable to Lessee based upon any incorrect or disputed Allocation nor shall Lessee have any right to terminate this Lease by reason of any such Allocation.

4.07 In the event Lessee wishes to audit any Operating Expense charge, such an audit shall be limited to an audit of the annual statement delivered under Paragraph 4.05B above. Such audit shall be performed only if, at the time of the audit request and at all times thereafter to and during the course of the audit, Lessee has paid in full all Operating Expenses billed and is not in Default (as defined in Section 20.02 below). Any audit shall be conducted at a time and location designated by Lessor. Lessor and Lessee agree that any Lessee audit must be requested by Lessee by written notice given within six (6) months of the date that Lessor provides the applicable annual statement under Paragraph 4.05B above, and must be completed by Lessee within thirty (30) days of its written notice requesting the audit; if Lessee does not give such written notice within the period of time allowed, or fails to complete the audit within the time allowed, Lessee’s right to audit is waived, and the Operating Expenses, as billed, including all calculations used as the basis for Lessor’s charges (including any “Allocations” and any applicable Expense Base Year or expense stop calculations), shall be deemed conclusive and final for all purposes under this Lease. All calculations by Lessor of Operating Expenses for the Expense Base Year shall be conclusive and final, and Lessee shall have no right to audit the same, except only Lessee may audit the same as part of an audit of Operating Expenses for the first Expense Comparison Year. Any audit shall be conducted only by Lessee and the CPA then used by Lessee for the preparation of its tax returns and financial statements; no agent of Lessee employed in connection with the audit shall be employed on any contingent payment basis. Lessee shall maintain as strictly confidential, and shall cause its auditor to execute in favor of Lessor a confidentiality agreement (in form prepared by Lessor)

regarding, all financial information audited, the results of any such audit, and the resolution of any disputed issues arising in connection with such audit. Lessor shall not be bound by the result of any such audit. If the parties do not agree upon the inclusion or amount of any Operating Expense charged by Lessor, the sole remedy of Lessee shall be to conduct an audit within the time specified in this Lease and, if still in disagreement with Lessor, to submit the matter to arbitration pursuant to Section 27.17 below within thirty (30) days after completion of the audit to request an adjustment to any disputed Operating Expense item to cause the same to not exceed the amount that Lessor has the right to collect hereunder for such item. In no event will this Lease be terminable nor shall Lessor be liable for damages based upon any disagreement regarding or adjustment of Operating Expenses.

5.	Late Charges

If any sum payable by Lessee to Lessor is not received by Lessor within five (5) days after it becomes due, Lessee shall pay a late charge equal to fifty dollars ($50.00) or five (5%) of the then delinquent amount, whichever is greater. A fifty dollar ($50.00) handling fee will be paid to Lessor by Lessee for each bank returned check, and Lessee will be required to make all future payments to Lessor by wire or electronic transfer or by cashier’s check. The acceptance of late charges and returned check charges by Lessor will not constitute a waiver of Lessee’s Default nor any other rights or remedies of Lessor. Lessee shall not be in default of this Lease the first time in a twelve (12) consecutive month period that Lessee fails to pay rent when due so long as Lessee pays such overdue rent within five (5) days of written notice from Lessor that such overdue amount is due.

6.	Security Deposit and Financial Reporting

6.01 Upon Lessee’s execution of this Lease, Lessee will deposit with Lessor an initial Security Deposit in the amount specified in Paragraph 1 as security for Lessee’s full and faithful performance of every provision under this Lease. Lessor will not be required to keep the Security Deposit separate from its general funds and has no obligation or liability for payment of interest thereon (except when required by law). Lessee hereby grants to Lessor a security interest in the Security Deposit. Lessee will not have the right to apply any part of the Security Deposit to any amounts payable under the terms of this Lease nor is it a measure or limitation of Lessor’s damages in event of a Default by Lessee. If Lessee fails to pay any rent due herein, or otherwise is in Default of any provision of this Lease, Lessor may, without waiver of the Default or of any other right or remedy, use, apply or retain all or any portion of the Security Deposit for the payment of any amount due Lessor or to compensate Lessor for any loss or damage suffered by Lessee’s Default. Within five (5) days after written notification by Lessor, Lessee will restore the Security Deposit to the full amount required under this Lease.

6.02 Within ten (10) days after written request from Lessor but not more often than annually, Lessee shall deliver to Lessor such financial statements as Lessor reasonably requests regarding Lessee or any assignee, subtenant, or guarantor of Lessee. Lessee represents and warrants to Lessor that each financial statement is a true and accurate statement. Lessor shall use such statements only for valid business purposes. Lessor shall have the right to make such financial statements and the other contents of its files available to law enforcement or other governmental agencies upon request.

7.	Use of Premises

7.01 The Premises will be used and occupied only for Lessee’s Permitted Use. Lessee will, at its sole expense, comply with all conditions and covenants of this Lease, and all Laws. Lessee will not use or permit the use of the Premises, the Property or any part thereof, in a manner that is unlawful, diminishes the appearance or aesthetic quality of any part of the Property, creates waste or a nuisance, or causes damage to the Property. Lessee shall not permit any objectionable or unpleasant odors, smoke, dust, gas, noise or vibrations to emanate from the Premises nor take or permit any other action in the Premises that would endanger, annoy, or interfere with the operations of, Lessor or any other tenant of the Project. Lessee shall obtain, at its sole expense, any permit or other governmental authorization required to operate its business from the Premises. Any animals, excepting guide dogs, on or about the Property or any part thereof are expressly prohibited.

7.02 In the event of any excessive trash in or outside the Premises, as determined by Lessor in its sole discretion, Lessor will have the right to remove such excess trash, charge all costs and expenses attributable to its removal to Lessee. Lessee will not cause, maintain or permit any outside storage on or about the Property without prior written consent by Lessor. In the event of any unauthorized outside storage by Lessee, Lessor will have the right, without notice, in addition to such other rights and remedies it may have, to remove any such storage at the expense of Lessee.

8.	Parking

All parking will comply with the terms and conditions of this Lease and the parking rules and regulations included in Exhibit “D.” Lessee will have a non-exclusive privilege to use of one-hundred eighty (180) parking spaces designated by Lessor for public parking and four (4) designated visitor parking spaces at the entry to the Premises. Vehicles parked in public parking areas will be no larger than full-sized passenger automobiles or standard pick-up trucks. Lessor reserves the right, without notice to Lessee, to tow away at Lessee’s sole cost and expense any vehicles parked in any parking area for any continuous period of 24 hours or more, or earlier if Lessor, in its sole discretion, determines such parking to be a hazard or inconvenience to other lessees or Lessor, or violates any rules or regulations or posted notices related to parking. Lessor shall not be responsible for enforcing Lessee’s parking rights against third parties. From time to time, Lessor reserves the right, upon written notice to Lessee, to change the location, the availability and nature of parking spaces, establish reasonable time limits on parking, and, on an equitable basis, to assign specific spaces with or without charge to Lessee as Additional Rent. The parking privileges granted to Lessee are personal to Lessee; Lessee shall not assign or sublet parking privileges.

9.	Utilities and Services

9.01 Subject to the other provisions of this Lease, the following services are provided.

Electricity, water, and elevator service (if elevators presently serve the Premises) are provided.

Heating and air conditioning are provided 7:00 a.m. to 6:00 p.m. Monday through Saturday, except holidays. If Lessee desires such service during other hours, Lessee must prearrange the same with Lessor and pay an additional charge for such service.

Five days per week janitorial service, periodic window cleaning, supplies for Building operation, and other customary services.

If Lessee uses any utility or service in excess of normal usage levels, as determined by Lessor in its sole discretion, Lessor shall have the right to charge Lessee for such excess use and to charge Lessee the cost to separately meter such use.

9.02 Lessor will not be liable or deemed in Lessor Default, nor will there be any abatement of rent or right to terminate this Lease, for (a) any interruption or reduction of utilities, utility services or telecommunication services not caused by Lessor, (b) any telecommunications or other company (whether selected by Lessor or Lessee) failing to provide such utilities or services or providing the same defectively, and/or (c) any utility interruption in the nature of blackouts, brownouts, or rolling interruptions. Lessee agrees to comply with any energy conservation programs required by law or implemented by Lessor. Lessee acknowledges that utility and service costs and availability may fluctuate significantly, due to power shortages or other events and factors, and Lessee accepts the risks of such fluctuations. Lessor reserves the right, in its reasonable discretion, to designate, at any time, the utility and service providers for Lessee’s use within the Property; no such designation shall impose liability upon Lessor.

9.03 Lessee has satisfied itself as to the adequacy of any Lessor owned utility equipment and the quantity of telephone lines and other service connections to the Building available for Lessee’s use.

10.	Lessee Improvements; Lessee Alterations and Mechanic’s Liens

10.01 Any improvements to be constructed in the Premises by Lessee prior to Lessee initially commencing use of the Premises are referred to throughout this Lease as “Lessee Improvements.” All Lessee Improvements will be performed in accordance with the terms and conditions outlined in Exhibit “B” and also in accordance with the provisions set forth in this Paragraph 10 regarding Lessee Alterations.

10.02 The following provisions apply to “Lessee Alterations” which means and includes (a) any alterations or improvements to the Premises undertaken by Lessee (other than nonstructural installation of equipment or trade fixtures), (b) any utility installations at the Premises undertaken by Lessee, and (c) any repair, restoration, replacement, or maintenance work at the Premises undertaken by Lessee whether or not Lessee is required to undertake such work pursuant to this Lease. Lessee shall not commence any Lessee Alteration without first obtaining the prior written consent of Lessor in each instance which consent may be withheld or conditioned in Lessor’s reasonable discretion. Lessee shall submit such information regarding the intended Lessee Alteration as Lessor may reasonably require, and no request for consent shall be deemed complete until such information is delivered. The following provisions apply to all Lessee Alterations.

(a)

Lessee shall hire a licensed general contractor who, in turn, shall hire only licensed subcontractors. All work shall be conducted expeditiously and be completed within a reasonable time.

(b)

Lessee shall obtain all required permits and deliver a copy of the same to Lessor. Lessee shall install all Lessee Alterations in strict compliance with all permits, any plans approved by Lessor, and all conditions to Lessor’s approval.

(c)

Unless Lessor elects otherwise in its applicable prior written consent, Lessee shall remove each Lessee Alteration at the end of this Lease or Lessee’s right of possession and restore the Premises to its prior condition, all at Lessee’s expense.

(d)

Lessee shall deliver to Lessor, within ten (10) days following installation of each Lessee Alteration, (w) accurate, reproducible as-built plans, (x) proof of final inspection and approval by all governmental authorities, (y) complete lien waivers for all costs of the Lessee Alteration, and (z) a copy of a recorded notice of completion.

10.03 Lessor shall have the right to inspect all Lessee Alterations. Lessee shall pay to Lessor a fee equal to 5% of total project cost up to $50,000 and 2.5% thereafter, to compensate Lessor for review of plans, inspection of work, and other activities regarding any Lessee Alterations. Approval of any plans or inspection of any work is for the sole benefit of Lessor and is not a representation by Lessor that any work is suitable or complies with applicable requirements. Lessor’s approval of any Lessee Improvements and Lessee Alterations and/or Lessor’s approval or designation of any general contractor, subcontractor, supplier or other project participant will not create any liability whatsoever on the part of Lessor.

10.04 Lessee shall pay all costs of Lessee Alterations as and when due. Lessee shall not allow any lien to be filed. Lessee shall obtain advance lien waivers and third-party beneficiary agreements from all contractors, subcontractors, suppliers, and others providing equipment, labor, materials, or services, in the form required by Lessor. If any lien is filed, then, without waiver of any other right or remedy, Lessor shall have the right to cause such lien to be removed by any means allowed by law, including bond, deposit, and/or payment of the underlying claim. All sums expended by Lessor in connection with such lien and/or its removal, including attorney fees, shall be immediately due from Lessee to Lessor, together with interest at the rate of 12%.

10.05 All Lessee Improvements and Lessee Alterations are part of the realty and belong to Lessor. Lessee shall be solely responsible to insure all Lessee Alterations and to restore the same following any casualty. As a condition of Lessor consenting to any Lessee Improvements or Lessee Alterations, Lessor reserves the right, at any time to elect to make Lessee the owner of all or any specified part of the Lessee Improvements or Lessee Alterations and/or to require Lessee, upon termination of this Lease, to remove none, all, or part of the same at its sole cost and expense. The provisions of this Paragraph shall survive the termination of this Lease.

10.06 Notwithstanding any other provision of this Lease, Lessee shall remove, at or prior to the expiration or termination of this Lease, at its expense, all wiring and cabling installed at the Premises which shall have been installed by Lessee or which Lessor shall have installed pursuant to this Lease or at the request of Lessee. Such wiring and cabling shall include but not be limited to (a) wiring and cabling above the ceiling panels, behind or within walls, and under or within floors, (b) wiring and cabling for voice, data, security or other purposes, (c) wiring and cabling installed pursuant to this Paragraph 10, pursuant to Exhibit B, or otherwise, and (d) all related installations, equipment and items whatsoever.

11.	Repairs

11.01 Subject to Paragraph 11.02 below , Lessee shall, at all times and at its sole cost and expense, keep all parts of the Premises (including Lessee Improvements and Lessee Alterations) in good order, and in a neat, clean and safe condition. If Lessee does not perform required maintenance, Lessor shall have the right, without waiver of Default nor of any other right or remedy, to perform such obligations of Lessee on Lessee’s behalf, and Lessee will reimburse Lessor for any costs incurred immediately upon demand.

11.02 Lessor shall perform all repairs required in the Premises. All costs incurred by Lessor in making such repairs shall be Operating Expenses; provided, Lessee shall reimburse Lessor for 100% of any such costs incurred by Lessor (a) due to the act or omission of Lessee (including but not limited to clogging of plumbing, stain removal, and repair of damage to the Premises), or (b) for repairs or maintenance in excess of or other than routine Building standard repairs and maintenance as determined by Lessor in its reasonable discretion (for example, maintenance of any above standard dedicated HVAC unit, repair of built-in appliances, or periodic replacing of above standard light bulbs).

12.	Insurance

12.01 Lessee will not do or permit anything to be done within or about the Premises or the Property which will increase the existing rate of any insurance on any portion of the Property or cause the cancellation of any insurance policy covering any portion of the Property. Lessee will, at its sole cost and expense, comply with any requirements of any insurer of Lessor.

12.02 Lessee agrees to maintain policies of insurance described in this Paragraph. Lessor reserves the right, from time to time, to require additional coverage’s (including, for example, flood insurance, if the Premises is located in a flood hazard zone), and/or to require higher amounts of coverage’s. Any additional and/or higher must conform to reasonable industry standards. No insurance policy of Lessee shall have a deductible greater than $50,000.


(a)	Workers’ Compensation	Statutory Requirements
	Employer’s Liability	Not less than $1,000,000.00

(b)	Commercial General Liability	Not less than $1,000,000.00

	Combined single limit per occurrence this location	Not less than $2,000,000.00 aggregate

The Commercial General Liability policies shall insure on an occurrence and not a claims-made basis and cover the Premises, Project and Property. Such policies shall cover liability arising from premises, operations, independent contractors, products-completed operations, personal injury, advertising injury and liability assumed under an insured contract (specifically insuring performance of the indemnity obligations of Lessee hereunder); such policies shall not be excess.

(c)

Automobile Liability

single limit including property damage

Not less than $300,000.00 combined

(d)

“Causes of Loss — Special Form” coverage including endorsements for flood coverage, earthquake sprinkler leak coverage, and such endorsements and supplemental as Lessor may require from time to time. This insurance coverage must be upon the Premises and all property owned by Lessee, for which Lessee is legally liable, which Lessee is obligated to repair and restore hereunder, and/or which was installed at the expense of or at the request of Lessee, including but not limited to, any Lessee Improvements, Lessee Alterations, furniture, fixtures, equipment, installations and any other personal property of Lessee, in an amount not less than their full replacement value. All proceeds of this insurance shall only be used for the repair and replacement of property so insured; Lessee hereby assigns to Lessor all its rights to receive any proceeds of such insurance policies attributable to any Lessee Improvements and Lessee Alterations if this Lease is terminated due to damage or destruction.

The limits of the insurance coverage required under this Lease will not limit the liability of Lessee nor relieve Lessee of any obligation hereunder. All insurance to be carried by Lessee will be primary to, and non-contributory with, Lessor’s insurance, and contain cross-liability endorsements and will in addition to the above coverage specifically insure Lessor against any damage or loss that may result either directly or indirectly from any default of Lessee under Paragraph 14 (Hazardous Materials) herein. Any similar insurance carried by Lessor will be considered excess insurance only.

12.03 Lessee will name Lessor (and, at Lessor’s request, any mortgagee) and Lessor’s agents as additional insured’s on all insurance policies required of Lessee under this Lease, other than Worker’s Compensation, Employer’s Liability, Automobile Liability, and Fire and Extended coverage (except on Lessee Improvements or Lessee Alterations to the Premises for which Lessor shall be named an additional insured) insuring Lessor and such other additional insured’s regardless of any defenses the insurer may have against Lessee and regardless of whether the subject claim is also made against Lessee. All insurance policies carried by Lessee will permit the insured, prior to any loss, to agree with a third party to waive any claim it might have against said third party without invalidating the coverage under the insurance policy, and will release Lessor (and Lessor’s affiliates and subsidiaries, and all officers, partners, directors, and employees of Lessor and/or of any such subsidiary or affiliate), from any claims for damage to any person, to the Property of which the Premises are a part, any existing improvements, Lessee Improvements and Lessee Alterations to the Premises, and to any furniture, fixtures, equipment, installations and any other personal property of Lessee caused by or resulting from, risks which are to be insured against by Lessee under this Lease, regardless of cause.

12.04 Lessee will deliver to Lessor (and, at Lessor’s request, to any mortgagee or to any other third party), simultaneously with its execution of this Lease and thereafter at least thirty (30) days prior to expiration, cancellation or change in insurance, certificates of insurance evidencing, at a minimum, the

coverage specified in Paragraph 12.02. All such certificates shall be in form and substance satisfactory to Lessor, shall affirmatively demonstrate all and requirements set forth in this Lease, shall contain no disclaimers of coverage, and shall include a firm and unconditional obligation to give to Lessor at least 10 days’ prior written notice prior to cancellation or change in any coverage. All insurance required hereunder will be with companies licensed and authorized to do business in the state in which the Property is located and holding a “General Policyholders Rating” of “A VIII” or better, as set forth in the most current Best’s Insurance Guide .

12.05 Lessor will secure and maintain insurance coverage in such limits as Lessor may deem reasonable in its reasonable judgment to afford Lessor adequate protection. The premiums for such coverage are “Insurance Premiums” under Paragraph 4.03C above. Any proceeds of such insurance shall be the sole property of Lessor to use as Lessor determines. Lessor makes no representation that the insurance policies and coverage amounts specified to be carried by Lessee or Lessor under the terms of this Lease are adequate to protect Lessee. Lessee will provide, at its own expense, all insurance as Lessee deems adequate to protect its interests.

12.06 Without limiting the effect of any other waiver of or limitation on the liability of Lessor set forth herein, and except as provided in Paragraph 13 and/or Paragraph 14 below, neither Lessor nor Lessee shall be liable to the other party or to any insurance company (by way of subrogation or otherwise) for any loss of or damage to tangible property due to casualty regardless of negligence. For purposes of this Paragraph 12.06, “Lessor” shall include Lessor’s affiliates and subsidiaries, and all officers, partners, directors, and employees of Lessor or of any such subsidiary or affiliate.

13.	Waiver of Claims and Indemnification

Lessee waives all claims against Lessor for any damage to any property in or about the Property, for any loss of business or income, and for injury to or death of any persons, regardless of the cause of any such loss or event or time of occurrence, except loss, injury or death caused by Lessor’s gross negligence or willful misconduct. Lessee will indemnify, protect, defend and hold harmless Lessor from and against all claims, losses, damages, causes of action, costs, expenses and liabilities, including legal fees, arising out of Lessee’s occupancy of the Premises or presence on the Property, the conduct of Lessee’s business, any Default by Lessee, and/or any act, omission or neglect of Lessee, its agents, contractors, employees, suppliers, licensees or invitees. For purposes of this Paragraph 13, “Lessor” shall include also Lessor’s affiliates and subsidiaries, and all officers, partners, directors, and employees of Lessor or of any such subsidiary or affiliate.

14.	Hazardous Materials

14.01 “Hazardous Materials” will mean any substance commonly referred to, or defined in any Law, as a hazardous material or hazardous substance (or other similar term), including but not be limited to, chemicals, solvents, petroleum products, flammable materials, explosives, asbestos, urea formaldehyde, PCB’s, chlorofluorocarbons, Freon or radioactive materials. Lessee will not cause or permit any Hazardous Materials to be brought upon, kept, stored, discharged, released or used in, under or about any portion of the Property by Lessee, or its agents without the prior written consent of Lessor, which consent may be withheld or conditioned in Lessor’s sole discretion; provided, Lessee may bring into the Premises small amounts of Hazardous Materials (such as cleaning products and copy toner) which are readily available to Lessee by unregulated retail purchase if the same are necessary in Lessee’s normal business operations. If Lessee brings any Hazardous Materials to the Premises or Property, with or without the prior written consent of Lessor (without waiver of the requirement of prior written consent), Lessee shall: (1) use such Hazardous Material only as is reasonably necessary to Lessee’s business, in small, properly labeled quantities; (2) handle, use, keep, store, and dispose of such Hazardous Material using the highest accepted industry standards and in compliance with all applicable Laws; (3) maintain at all times with Lessor a copy of the most current MSDS sheet for each such Hazardous Material; and (4) comply with such other rules and requirements Lessor may from time to time impose. Upon expiration or earlier termination of this Lease, Lessee will, at Lessee’s sole cost and expense, cause all Hazardous Materials brought to the Premises or the Property by Lessee, its agents, contractors, employees, suppliers, licensees or invitees, to be removed from the Property in compliance with any and all applicable Laws.

14.02 If Lessee or its agents violate the provisions of this Paragraph 14, or performs any act or omission which contaminates or expands the scope of contamination of the Premises, the Property, or any part thereof, the underlying groundwater, or any property adjacent to the Property, then Lessee will promptly, at Lessee’s expense, take all investigatory and/or remedial action (collectively called “Remediation”) that is necessary to fully clean up, remove and dispose of such Hazardous Materials and any contamination so caused and shall do so in compliance with any applicable Laws. Lessee will also repair any damage to the Premises and any other affected portion(s) of the Property caused by such contamination and Remediation.

14.03 Lessee shall immediately provide to Lessor written notice of any investigation or claim arising out of the use by Lessee of Hazardous Materials at the Property or the violation of any provision of this Paragraph 14 and shall keep Lessor fully advised regarding the same. Lessee shall provide to Lessor all reports regarding the use of Hazardous Materials by Lessee at the Property and any incidents regarding the same, regardless of whether any such documentation is considered by Lessee to be confidential. Lessor retains the right to participate in any legal actions affecting the Property involving Hazardous Materials.

14.04 Lessee will indemnify, protect, defend and forever hold Lessor, its lenders and ground lessor, if any, and the Premises, the Property, or any portion thereof, harmless from any and all damages, causes of action, fines, losses, liabilities, judgments, penalties, claims, and other costs arising out of any failure of Lessee to observe any covenants of this Paragraph 14 of this Lease. All provisions of this Paragraph 14 shall survive the expiration of this Lease and any termination of this Lease or of Lessee’s right of possession. For purposes of this Paragraph 14.04, “Lessor” shall include also Lessor’s affiliates and subsidiaries, and all officers, partners, directors, and employees of Lessor or of any such subsidiary or affiliate.

15.	Lessor’s Access

Lessor, its agents, contractors, consultants, servants and employees, will have the right to enter the Premises at any time in the case of an emergency, and otherwise at reasonable times upon reasonable notice to examine the Premises, perform work in the Premises, show the Premises, exercise any right or remedy, or for any other purpose. For each of these purposes, Lessor will at all times have and retain any necessary keys. Lessee will not alter any lock or install new or additional locks or bolts on any door in or about the Premises without obtaining Lessor’s prior written approval and will, in each event, furnish Lessor with a new key. Access by Lessor will not give Lessee the right to terminate this Lease, and will be without abatement of rent or liability on the part of Lessor.

16.	Damage or Destruction

16.01 If the Premises is damaged or destroyed by fire or other casualty, Lessee will immediately give written notice to Lessor of the casualty. Lessor will have the right to terminate this Lease following a casualty if any of the following occur by giving notice to Lessee within sixty (60) days of the casualty: (i) insurance proceeds actually paid to Lessor and available for use are not sufficient to pay the full cost to fully repair the damage; (ii) Lessor determines that the Premises or the Building cannot be fully repaired within 180 days; (iii) the Premises are damaged or destroyed within the last twelve (12) months of the Lease Term; (iv) Lessee is in Default of this Lease at the time of the casualty; (v) Lessor would be required under this Lease to abate or reduce Lessee’s rent for a period in excess of six (6) months if the repairs were undertaken; or (vi) the Project, or the Building in which the Premises is located, is damaged such that the cost of repair of the same would exceed 10% of the replacement cost of the same. If Lessor elects to terminate this Lease, Lessor will be entitled to retain all applicable Lessee insurance proceeds excepting those attributable to Lessee’s furniture, fixtures, equipment, and any other personal property.

16.02 If this Lease is not terminated pursuant to Paragraph 16.01, Lessor will repair the Premises and this Lease shall continue. The repair obligation of Lessor shall be limited to repair of the Premises excluding any Lessee Improvements, Lessee Alterations, and any personal property and trade fixtures of Lessee. During the period of repair, rent will be abated or reduced in proportion to the degree to which Lessee’s use of the Premises is impaired, as determined by Lessor, not to exceed the total amount of rent loss insurance proceeds, directly attributable to Lessee’s Premises, Lessor has received. However, rent will not be abated if Lessee or any of its agents is the cause of the casualty.

17.	Transfer (Assignment/Subletting)

17.01 Lessee will not, voluntarily or by operation of law, assign, sell, convey, sublet or otherwise transfer all or any part of Lessee’s right or interest in this Lease, or allow any other person or entity to occupy or use all or any part of the Premises (collectively called “Transfer”) without first obtaining the written consent of Lessor which may be withheld or conditioned by Lessor in its reasonable discretion. Any Transfer without the prior written consent of Lessor shall be void. Without limiting the generality of the definition of “Transfer,” it is agreed that each of the following shall be deemed a “Transfer” for purposes of this Paragraph: (a) an entity other than Lessee becoming the tenant hereunder by merger, consolidation, or other reorganization; and (b) a transfer of any ownership interest in Lessee (unless Lessee is an entity whose stock is publicly traded). Lessee shall provide to Lessor all information requested by Lessor concerning a Transfer. If Lessor has not granted consent in writing to a Transfer within thirty (30) days of Lessee’s request hereunder and delivery of all such information, Lessor will be deemed to have rejected Lessee’s request. In no event shall Lessee mortgage, encumber, pledge or assign for security purposes all or any part of its interest in this Lease. Notwithstanding the foregoing, Lessee may assign this Lease or sublease the Premises, in whole or in part, without the express written consent of

Lessor to: (i) any corporation into which or with which Lessee has merged or consolidated; (ii) any parent, subsidiary, successor, or affiliated corporation of Lessee; (iii) any corporation which acquires all or substantially all of the assets or issued and outstanding shares of capital stock of Lessee; (iv) any partnership, the majority interest of which shall be owned by the parent of Lessee; provided the resulting entity from such merger or consolidation or the transferee, other than a parent, subsidiary or affiliated corporation of Lessee, from any such acquisition, shall have a net worth not less than Lessee’s prior to the merger, consolidation, or acquisition; and provided further any such assignee or successor shall agree in writing to assume and perform all of the terms and conditions of this Lease on Lessee’s part to be performed from and after the effective date of such assignment or subletting, so long as the resulting entity’s use of the Premises does not violate any provision of this Lease or any applicable governmental law, rule or regulation.

17.02 In the event Lessor consents to a Transfer, the Transfer will not be effective until Lessor receives a fully executed agreement regarding the Transfer, in a form and of substance acceptable to Lessor, any documents or information required by such agreement (including any estoppel certificate and any subordination agreement required by any lender of Lessor), an amount equal to all attorneys fees and other expenses of Lessor incurred in connection with the Transfer, and a Transfer fee in an amount determined by Lessor (a minimum fee of $250 is payable). Lessee agrees to pay to Lessor an amount equal to all attorneys’ fees and other expenses incurred by Lessor related to a request for consent to Transfer regardless of whether such consent is granted and regardless of whether the Transfer is consummated.

17.03 Fifty percent (50%) of any consideration paid to Lessee solely for assignment of this Lease, less any reasonable brokerage commission and reasonable tenant improvements paid by Lessee with respect to such assignment, shall be immediately paid to Lessor. In the event of a sublease of all or a portion of the Premises, fifty percent (50%) of all rents payable by the subtenant in excess of rents payable hereunder (allocated on a per square foot basis in the event of a partial sublease) shall be immediately due and payable to Lessor; provided, excess rental shall be calculated taking into account straight-line amortization, without interest, of any reasonable brokerage commission less any reasonable tenant improvements paid by Lessee in connection with the subject sublease transaction.

17.04 Lessor may, within thirty (30) days after submission of Lessee’s written request for Lessor’s consent to a Transfer, terminate this Lease (or, as to a partial subletting, terminate this Lease as to the portion of the Premises proposed to be sublet) as of the date the proposed Transfer was to be effective. If Lessor terminates this Lease as to only a portion of the Premises, then (a) this Lease shall cease as to such portion of the Premises, (b) Lessee shall pay to Lessor all Base Rent and other amounts accrued through the termination date relating to the portion of the Premises covered by the proposed Transfer (allocated on an equitable basis determined by Lessor), and (c) Lessee shall execute, upon request of Lessor, an amendment hereto setting forth matters related to such partial termination. Lessor may physically separate the recaptured portion of the Premises and lease such portion of the Premises to the prospective transferee (or to any other person) without liability to Lessee.

17.05 Regardless of whether consent by Lessor is granted in connection with any Transfer, no Transfer shall release Lessee from any obligation or liability hereunder; Lessee shall remain primarily liable to pay all rent and other sums due hereunder to Lessor and to perform all other obligations hereunder. Similarly, no Transfer, with or without the consent of Lessor, shall release any guarantor from its obligations under its guaranty. Upon any assignment or sublease, any rights, options or opportunities granted to Lessee hereunder to extend or renew the Lease Term, to shorten the Lease Term, or to lease additional space shall be null and void.

18.	Default

Time is of the essence in the performance of all covenants of Lessee. Lessee will be in Default if any of the following events occurs:

18.01 Lessee fails to make within five (5) days of when due, any payment of Base Rent, Additional Rent, or any other monetary payment required to be made by Lessee herein and Lessee does not cure such failure within three (3) days after Lessor gives written notice of such failure to Lessee; provided, if Lessor has given such a written notice with respect to two (2) payments due in any calendar year, then the failure by Lessee to pay any other payment due in such calendar year, on or before the date when first due, shall be a Default hereunder without any written notice from Lessor and without any grace or cure period. Notwithstanding the foregoing, Lessee shall not be in default of this Lease the first time in a twelve (12) month period that Lessee fails to pay rent when due so long as Lessee pays such overdue rent within five (5) days of written notice from Lessor that such overdue amount is due.

18.02 Lessor discovers that any representation or warranty made by Lessee or any guarantor was materially false when made or that any financial statement of Lessee or of any guarantor of this Lease given to Lessor was materially false.

18.03 Lessee makes any general arrangement or assignment for the benefit of creditors, becomes a “debtor” in a bankruptcy proceeding, is unable to pay its debts or obligations as they occur, or has an attachment, execution or other seizure of substantially all of its assets located at the Property or its interest in this Lease.

18.04 Lessee fails to observe, perform or comply with any of the non-monetary terms, covenants, conditions, provisions or rules and regulations applicable to Lessee under this Lease other than as specified above in this Paragraph 18; provided, if such failure is a curable failure, then such failure shall not be a “Default” unless Lessee does not cure such failure as soon as practicable possible but in no event later than thirty (30) days following written notice of such failure from Lessor; provided, however, that if said default cannot be cured within said thirty (30) day period using reasonable diligence, no Default shall be deemed to have occurred if Lessee commences action to cure the Default within said thirty (30) day period and diligently pursues a cure thereafter.

18.05 Any guarantor becomes insolvent, becomes a “debtor” in a bankruptcy proceeding, fails to perform any obligation under its guaranty, or attempts to revoke its guaranty.

19.	Remedies of Lessor

19.01 If Lessee fails to perform any duty or obligation of Lessee under this Lease, Lessor may at its option, without waiver of Default nor any other right or remedy, perform any such duty or obligation on Lessee’s behalf. The costs and expenses of any such performance by Lessor will be immediately due and payable by Lessee upon receipt from Lessor of the reimbursement amount required.

19.02 Upon a Default, with or without notice or demand, and without limiting any other of Lessor’s rights or remedies, Lessor may:

(a)

Terminate this Lease and/or terminate Lessee’s right to possession of the Premises. Upon any such termination, Lessee will immediately surrender possession of the Premises to Lessor. On termination of this Lease or Lessee’s right of possession, Lessor will be entitled to recover from Lessee: (i) the worth at the time of the award of the unpaid rent which had been earned at the time of the termination; (ii) the worth at the time of the award of the amount by which the unpaid rents which would have been earned after termination until the time of award exceeds the amount of such rental loss that Lessee proves could have been avoided; (iii) the worth at the time of the award of the amount by which the unpaid rents for the balance of the Lease Term after the time of award exceeds the amount of such rental loss for such period that Lessee proves could be reasonably avoided; and (iv) the worth at the time of the award of any other amount necessary to compensate Lessor for all the damage proximately caused by Lessee’s failure to perform its obligations under this Lease, including specifically the unamortized portion of all brokerage commissions paid in connection with this Lease and all costs of Lessor’s Work (amortized without interest on a straight line basis over the initial Lease Term), and reimbursement of any free rent, deferred rent or other Lease execution inducement. The expiration or termination of this Lease, and/or the termination of Lessee’s right to possession, will not release Lessee from any liability under this Lease.

(b)

Continue the Lease and Lessee’s right to possession and recover rent as it becomes due. Acts of maintenance or preservation, efforts to relet the Premises, removal or storage of Lessee’s personal property or the appointment of a receiver to protect Lessor’s interest under this Lease, will not constitute a termination of Lessee’s right to possession.

(c)

Pursue any other remedy now or hereafter available to Lessor under the laws or judicial decisions of the state wherein the Premises are located.

19.03 The “worth at the time of award” referred to in Paragraph 19.02(a)(i), 19.02(a)(ii), and 19.02(a)(iv) will additionally include interest computed by allowing interest at the rate of 12% per annum (or, if lower, at the maximum rate allowed by law). The “worth at the time of award” referred to in Paragraph 19.02(a)(iii) will be computed by discounting the amount at the discount rate of the Federal Reserve Bank of San Francisco in effect at the time of award, plus one percent (1%).

19.04 No right or remedy conferred upon or reserved to Lessor in this Lease is intended to be exclusive of any right or remedy granted to Lessor by statute or common law, and each and every such right and remedy will be cumulative.

20.	Condemnation

If any portion of the Premises or any portion of the Building in which the Premises is located, or any portion of the Property which would substantially interfere with Lessor’s ownership, or Lessor’s or Lessee’s ability to conduct business is taken for any public or quasi-public purpose by any governmental authority, including but not limited to, by exercise of the right of appropriation, inverse condemnation, condemnation or eminent domain, or sold in lieu of such taking, Lessor, at its option, may terminate this Lease without recourse by Lessee. If this Lease is not terminated, Lessor will promptly proceed to restore the Premises and/or any portion of the Property used in common by all lessees to substantially the same condition as prior to such taking allowing for any reasonable effects of such taking. Should a portion of the Premises be taken in a case where Lessor does not exercise its right to terminate this Lease, Lessor will abate the rent corresponding to the term during which, and to the part of the Premises which, Lessee is deprived on account of such taking. Any award for any taking or payment made in lieu of exercise of such power will be the property of Lessor, whether such award be made as compensation for diminution of value of the leasehold or for the taking of the fee, or as severance damages; however, Lessee will be entitled to any compensation, separately awarded to Lessee for Lessee’s relocation expenses.

21.	Estoppel Certificate

Lessee will execute and deliver to Lessor, within ten (10) days after written request from Lessor, a written Estoppel Certificate in form prepared by Lessor certifying: (i) that this Lease is unmodified and in full force and effect (or, if modified, specifying each such modification); (ii) the Commencement Date and expiration of the Lease Term; (iii) the absence or status of any rights of Lessee to renew, extend, or otherwise alter the Lease Term or to lease additional space or alter the definition of the Premises; (iv) the date to which rent and any other charges are paid in advance, if any; (v) that there are not, to Lessee’s knowledge, any uncured Defaults on the part of Lessor, or stating the nature of any uncured Defaults; (vi) the current Base Rent amount and the amount and form of the Security Deposit on deposit with Lessor; (vii) that Lessor has completed any promised improvements to the Premises and paid any promised improvement allowance (or detailing any work to be performed or allowance to be paid); and (viii) any other information requested, including but not limited to, any requested information regarding Hazardous Materials. Any such Estoppel Certificate may be relied upon by Lessor, and also by any actual or prospective buyer or lender of the Property and any other third party designated by Lessor (the “Beneficiaries”). If Lessee fails to execute and deliver such Estoppel Certificate within such ten (10) day period, then without waiver of Default or of any other right or remedy of Lessor, Lessor shall have the right to deliver to the Beneficiaries a completed Substitute Estoppel Certificate regarding this Lease certifying the matters which Lessee was requested to certify in the Estoppel Certificate. A notice enclosing a copy of the Substitute Estoppel Certificate shall be simultaneously sent to Lessee. Each statement in the Substitute Estoppel Certificate shall be deemed true, and shall be binding upon Lessee, unless Lessee provides, within five (5) days of the receipt of Lessor’s notice, written notice addressed to Lessor and the Beneficiaries disagreeing with such statement on specific grounds. Lessee shall defend and indemnify Lessor regarding any claim that a statement in the Substitute Estoppel Certificate to which Lessee did not so disagree is inaccurate.

22.	Notices

All communications and notices required under this Lease shall be in writing and shall be addressed to the respective address of the receiving party set forth in Paragraph 1 above. All notices to Lessee shall be given by reputable overnight courier, U. S. mail (First Class, postage prepaid), or hand delivery, and shall be deemed received (i) if mailed, on the earlier of actual receipt or three (3) days after such mailing, (ii) one business day following delivery by Lessor to such an overnight courier, or (iii) upon hand delivery. Any notice to Lessee may also be given by posting at the Premises and shall be effective upon such posting. Notices to Lessor shall be sent to Lessor by U. S. mail, postage prepaid, registered or certified mail with return receipt requested to the address indicated in Paragraph 1 and shall be deemed received five (5) days after such mailing. At any time during the Lease Term, Lessor or Lessee may specify a different Notice Address by providing written notification to the other.

23.	Holdover

If Lessee remains in possession of all or any part of the Premises with Lessor’s prior written consent after the expiration or termination of this Lease or of Lessee’s right to possession, such possession will constitute a month-to-month tenancy which may be terminated by either Lessor or Lessee upon thirty (30) days written notice and will not constitute a renewal or extension of the Lease Term. If Lessee remains in possession after such expiration or termination without Lessor’s prior written permission, such possession will constitute a tenancy-at-will terminable upon forty-eight (48) hours’ notice by Lessor and will not constitute a month-to-month tenancy nor a renewal or extension of the Lease Term. In the event of a month-to-month tenancy or tenancy-at-will under this Paragraph, Lessee’s Base Rent will be two hundred percent (200%) of the Base Rent payable during the last month of the Lease Term, any other sums due under this Lease will be payable in the amounts and at the times specified in this Lease, and all options, rights of refusal, expansions and/or renewals shall be null and void. Any tenancy under this Paragraph will be subject to every other term, condition and covenant contained in this Lease. Lessee agrees to defend, indemnify and hold Lessor harmless from any claim or cause of action arising out of related to the failure of Lessee to surrender possession of the Premises to

Lessor upon the expiration of this Lease or upon any such termination. Notwithstanding the foregoing, Lessee shall have the option to holdover for a period of up to three (3) months following the expiration of the lease term at 115% of the last rent due under the terms of the lease. Lessee shall be required to provide Lessor one-hundred eighty (180) days notice prior to lease the lease expiration date.

24.	Default by Lessor; Limitation of Liability; Real Estate Investment Trust

24.01 In the event Lessor fails to perform any obligation required to be performed under this Lease, Lessee will notify Lessor in writing of such failure. Lessor shall not be deemed in Lessor Default hereunder unless and until such notice is actually received by Lessor and Lessor fails within thirty (30) days of receipt of such notice to commence to make a good faith effort to cure the failure or thereafter ceases to pursue such cure to completion.

24.02 The obligations of Lessor under this Lease shall be binding only on the undersigned Lessor and not upon any of its subsidiaries or affiliates nor upon any partners, investors, trustees, directors, officers, employees, agents, shareholders, advisors or managers of Lessor in their individual capacities. With respect to any obligations of Lessor to Lessee under this Lease and with respect to any liabilities arising at the Property, Lessee’s sole and exclusive remedy shall be a claim against the undersigned Lessor.

24.03 In consideration of the benefits accruing hereunder, Lessee on behalf of itself and all of its Transferees covenants and agrees that, in the event of any actual or alleged Lessor Default of this Lease or in the event of any other claim or cause of action by Lessee, Lessee’s recourse against Lessor for any monetary damages (over and above damages actually paid by available insurance, if any) will be limited to Lessor’s interest in the amount of equity Lessor would have in the Property if the Property were encumbered by debt in an amount equal to fifty percent (50%) of the value of the Property; calculations of equity shall be made as of the initial date Lessee notifies Lessor of the actual or alleged Default or other claim the Property. Any judgment against Lessor shall be satisfied only out of an offset against Rents and out of the Property; no other assets of Lessor shall be subject to levy, execution or other enforcement procedure for the satisfaction of any judgment by Lessee against Lessor. Any claims by Lessee against Lessor will be limited to actual damages only and will not, under any circumstances, include lost profits or consequential damages.

24.04 If Lessor is a real estate investment trust, and if Lessor in good faith determines that its status as a real estate investment trust under the applicable provisions of the Internal Revenue Code of 1986, as heretofore or hereafter amended, will be jeopardized because of any provision of this Lease, Lessor may require reasonable amendments to this Lease and Lessee shall not unreasonably withhold or delay its consent thereto, provided that such modifications do not in any way, (i) increase the obligations of Lessee under this Lease or (ii) adversely affect any rights or benefits to Lessee under this Lease. Lessor shall pay all reasonable costs incurred by Lessee, including without limitation, legal fees incurred for reviewing any such proposed modifications.

24.05 Lessee represents that, to its knowledge, no person or entity who is a significant indirect owner of Lessor, owns actually or constructively a 10% or more interest in Lessee. Lessee will promptly notify Lessor if it learns that any such ownership interest exists. Significant owners of Lessor at this time include Public Storage, Inc. and New York Common Retirement Fund.

24.06 Lessor and any successor Lessor have the right to sell the Property or any portion of it, or to assign its interest in this Lease, at any time and from time to time. Upon the sale or any other conveyance by Lessor of the Property, or a portion thereof which includes the Premises, Lessor will be released from all obligations and liability under this Lease arising out of any act, event, occurrence or omission occurring or existing after the date of such conveyance.

25.	Subordination

Without the necessity of any additional document being executed by Lessee for the purposes of effecting a subordination, and at the election of Lessor or any mortgagee or any ground lessor with respect to the land of which the Premises are a part, this Lease will be subject and subordinate at all times to: (i) all ground leases or underlying leases which may now exist or hereafter be executed affecting the Property, and (ii) the lien of any mortgage or deed of trust which may now exist or hereafter be executed in any amount for which the Property, ground leases or underlying leases, or Lessor’s interest or estate in any of said items is specified as security. Lessor or any mortgagee or ground lessor will have the right, at its election, to subordinate or cause to be subordinated any ground lessee or underlying leases or any such liens to this Lease. If Lessor’s interest in the Premises is acquired by any ground lessor or mortgagee, or in the event any proceedings are brought for the foreclosure of, or in the event of exercise of power of sale under, any mortgage or deed of trust made by Lessor covering the Premises, or in the event a conveyance in lieu of foreclosure is made for any reason, Lessee will, notwithstanding any subordination and upon the request of such successor in interest to Lessor, attorn to and become the Lessee of the

successor in interest to Lessor and recognize such successor in interest as the Lessor under this Lease, provided Lessee’s interests hereunder shall not be disturbed so long as Lessee is not in Default hereunder. Lessee acknowledges that although this Paragraph is self-executing, Lessee covenants and agrees to execute and deliver, upon demand by Lessor and in the form requested by Lessor, or any other mortgagee or ground lessor, any additional documents evidencing the priority or subordination of this Lease with respect to any such ground leases or underlying leases or the lien of any such mortgage or deed of trust, provided Lessee’s interests hereunder shall not be disturbed so long as Lessee is not in Default hereunder. Lessee agrees that any person or entity who acquires title to the Premises pursuant to a foreclosure of a deed of trust or mortgage, or deed in lieu thereof, or the termination of an underlying ground lease or master lease (a “Foreclosing Party”), even if such Foreclosing Party elects to have Lessee attorn to the Foreclosing Party under this Lease, shall not be (i) liable for any act or omission of any prior lessor or with respect to events occurring prior to its acquisition of ownership, (ii) subject to any offsets or defenses which Lessee might have against any prior lessor, (iii) bound by prepayment of more than one month’s rent, (iv) liable for any security deposit not actually received by such person or entity, (v) bound by any amendment or modification to this Lease not consented to in writing by the holder of the mortgage, deed of trust, ground lease or master lease or the Foreclosing Party, or (vi) liable for any obligation or liability accruing under this Lease after the Foreclosing Party assigns its interest under this Lease to a third party. Any such Foreclosing Party is expressly made a third party beneficiary of the foregoing provisions, and all other provisions of this Lease which are for the benefit of a Foreclosing Party, which rights shall survive a foreclosure of the deed of trust or mortgage.

26.	Force Majeure

Lessor will not be deemed in Lessor Default or have liability to Lessee, nor will Lessee have any right to terminate this Lease or abate rent or assert a claim of partial or constructive eviction, because of Lessor’s failure to perform any of its obligations under this Lease if the failure is due in part or in full to reasons beyond Lessor’s reasonable control. If this Lease specifies a time period for performance of an obligation by Lessor, that time period will be extended by the period of any delay in Lessor’s performance caused by such events as described herein.

27.	Miscellaneous Provisions

27.01 Whenever the context of this Lease requires, the word “person” shall include any entity, and the singular shall include the plural and the plural shall include the singular. If more than one person or entity is Lessee, the obligations of each such person or entity under this Lease will be joint and several. Without diminishing the provisions of Paragraph 17, the terms, conditions and provisions of this Lease will apply to and bind the heirs, successors, executors, administrators and assigns of Lessor and Lessee.

27.02 The captions and headings of this Lease are used for the purpose of convenience only and shall not be construed to interpret, limit or extend the meaning of any part of this Lease. This Lease contains all of the agreements and conditions made between Lessor and Lessee and may not be modified in any manner other than by a written agreement signed by both Lessor and Lessee. Any statements, promises, agreements, warranties or representations, whether oral or written, not expressly contained herein will in no way bind Lessor and Lessee expressly waives all claims for damages by reason of any statements, promises, agreements, warranties or representations, if any, not contained in this Lease. No provision of this Lease shall be deemed to have been waived by Lessor unless such waiver is in writing signed by a regional vice president or higher of Lessor or of Lessor’s management company, and no custom or practice which may develop between the parties during the Lease Term shall waive or diminish the Lessor’s right to enforce strict performance by Lessee of any terms of the Lease. No waiver by Lessor of a Default by Lessee of any term, covenant or condition of this Lease will be deemed a waiver of any other term, covenant or condition of this Lease, or of any subsequent Default by Lessee of the same or any other term, covenant or condition of this Lease. No delay or omission by Lessor to seek a remedy for any Lessee Default of this Lease shall be deemed a waiver by Lessor of its remedies or rights with respect to such Default. Additionally, regardless of Lessor’s knowledge of a Default at the time of such acceptance, the acceptance of rent or any other payment by Lessor will not constitute a waiver by Lessor of any Default by Lessee. The duties and warranties of Lessor are limited to those expressly stated in this Lease and do not and shall not include any implied duties or implied warranties, now or in the future. No representations or warranties have been made by Lessor other than those contained in this Lease. This Lease is governed and construed in accordance with the laws of the state in which the Premises are located, and venue of any legal action will be in the county where the Premises are located.

27.03 Time is of the essence for the performance of each term, condition and covenant of this Lease.

27.04 This Lease has been fully reviewed by both parties and shall not be strictly or adversely construed against the drafter. If any provision contained herein is determined to be invalid, illegal or unenforceable in any respect, then (a) such provision shall be enforced to the fullest extent allowed, and (b) such invalidity, illegality, or unenforceability will not affect any other provision of this Lease.

27.05 Lessee hereby agrees not to disclose any terms of this Lease without the prior written consent of Lessor. Lessee shall not record this Lease or any short form memorandum hereof.

27.06 The rights and obligations of the parties under this Lease shall survive the expiration of this Lease and the termination of this Lease and/or of Lessee’s right of possession.

27.07 Lessor and Lessee each warrant to the other that it has not dealt with any broker or agent in connection with this Lease, other than the person(s) listed in Paragraph 1 above. Lessor and Lessee each agree to indemnify the other against all costs, expenses, legal fees and other liability for commissions or other compensation claimed by any other broker or agent by reason of the act or agreement of the indemnifying party.

27.08 Lessee shall not permit or allow any activity in the Premises which will have an adverse effect on indoor air quality, including smoking and any remodeling activity or introduction of materials which would have such an effect. Lessor shall have the right, but not the obligation, to monitor indoor air quality within the Project. Lessee shall take such steps to protect and to improve indoor air quality as Lessor may request from time to time.

27.09 Lessor has no duty to provide security for any portion of the Project. To the extent Lessor elects to provide any security, Lessor is not warranting the effectiveness of any security personnel, services, procedures or equipment and Lessee shall not rely on any such personnel, services, procedures or equipment. Lessor shall not be liable for failure of any such security personnel, services, procedures or equipment to prevent or control, or to apprehend anyone suspected of, personal injury or property damage in, on or around the Project.

27.10 The grant of any consent or approval required from Lessor under this Lease shall be proved only by proof of a written document signed and delivered by Lessor expressly setting forth such consent or approval. Unless otherwise specified herein, any such consent or approval may be withheld in Lessor’s sole discretion. Any consent may be issued subject to conditions determined by Lessor, in its sole discretion. Notwithstanding any other provision of this Lease, the sole and exclusive remedy of Lessee for any alleged or actual improper withholding, delaying or conditioning of any consent or approval by Lessor shall be the right to specifically enforce any right of Lessee to require issuance of such consent or approval on conditions allowed by this Lease; in no event shall Lessee have the right to terminate this Lease, to collect monetary damages, or to pursue any other remedy for any actual or alleged improper withholding, delaying or conditioning of any consent or approval, regardless of whether this Lease requires that such consent or approval not be unreasonably withheld, conditioned or delayed.

27.11 Lessee agrees to abide by, keep and observe all Rules and Regulations set forth in Exhibit “D” and all additions and amendments to the same of which Lessor provides written notice to Lessee. Lessor will not be responsible to Lessee for any nonperformance by any other lessee, occupant or invitee of the Property of any said Rules and Regulations.

27.12 Lessee will not place any signage on or about the Property, or on any part thereof, without the prior written consent of Lessor which Lessor may withhold or condition in its sole discretion. All Lessee signage will comply with the terms and conditions of this Lease, the sign criteria set forth in Exhibit “C” and Exhibit “D,” or other criteria which Lessor may establish from time to time.

27.13 Lessee will not vacate or abandon the Premises, or permit the Premises to remain unoccupied for any period longer than fifteen (15) consecutive days any time during the Lease Term. If Lessee abandons, vacates, or surrenders the Premises, or is dispossessed by process of law, or otherwise, any personal property belonging to Lessee left in or about the Premises will, at the option of Lessor, be deemed abandoned and may be disposed of by Lessor at the expense and risk of Lessee.

27.14 In the event any party to this Lease initiates litigation to enforce the terms of this Lease or to declare rights under this Lease, the prevailing party will be entitled to collect its reasonable attorneys fees shall include all attorneys fees incurred at and in preparation for discovery, arbitration, trial, appeal and review, including deposition attorney’s fees. This attorney’s fee provision shall also apply to all litigation and other proceedings in Bankruptcy Court.

27.15 Submission of this document for examination and signature by Lessee is not an offer to lease and does not create a reservation or option to lease. This document will become effective and binding only upon full execution and delivery by both Lessee and Lessor.

27.16 OPTION TO RENEW LEASE

Provided Lessee is not in Default of the Lease at the time it exercises this option and has not been in Default during any other period of the Lease Term that has not been cured, Lessee is hereby granted one option to renew this Lease for an additional five (5) years at the Base Rent rate then in effect for

comparable space in the market at the effective date of the commencement of such renewal term, but not less than the last monthly rental amount payable by Lessee prior to commencement of such renewal term. Such leasing for the renewal term shall be, at the election of Lessor, on the same terms and conditions as set forth in this Lease or on the terms and conditions of the standard lease form then used by Lessor with respect to the Project. The within option shall be exercised by Lessee, if at all, by written notice given no sooner than twelve (12) full calendar months and no later than eight (8) full calendar months prior to the expiration of the Lease Term; Lessee shall include with such notice a complete set of current financial statements of Lessee and all guarantors.

In the event Lessor and Lessee are unable to agree as to the Base Rent rate applicable to such renewed term within thirty (30) days of Lessee’s exercise of its option to renew, both parties agree to mediate their disagreement. If mediation does not resolve the disagreement in fair market value, Lessee shall have the option to refer the matter to an MAI certified appraisal procedure to determine the Base Rent rate. Lessor and Lessee shall appoint an MAI certified appraiser, such appraiser shall determine the current market rent (to be not less than the minimum rent set forth above in this Section) and such determination shall be binding upon Lessor and Lessee. Lessor and Lessee shall each pay one-half of the fees and costs of such appraiser.

Upon determination of the Base Rent rate, Lessor shall deliver to Lessee either an amendment to this Lease renewing the Lease Term, or a new lease for the renewal term based upon the form of the standard lease then used by Lessor with respect to the Project. Lessee shall execute and deliver the submitted document to Lessor within ten (10) days accompanied by payment of the amount of money which, when added to any existing Security Deposit, shall increase the Security Deposit amount to a sum which bears the same relationship to the renewal Base Rent as the original Security Deposit bears to the Base Rent with respect to the initial Lease Term.

Notwithstanding any provision hereof, during the thirty (30) day period allowed for the parties to agree upon the renewal Base Rent rate, Lessor shall have the right to rescind the exercise of the renewal option by written notice in the event Lessor determines, in its reasonable discretion, that the financial statements delivered by Lessee with the renewal notice are not satisfactory to Lessor.

The rights of Lessee under this Paragraph are not assignable separately from this Lease. Such rights of Lessee shall terminate upon: (a) any assignment, sublease, or other Transfer, and/or (b) any monetary default and/or (c) any termination of this Lease or of Lessee’s right of possession hereunder; provided, however, in the event Lessee shall have exercised this renewal option and Lessor subsequently terminates this Lease or Lessee’s right of possession hereunder for Default, the damages to which Lessor shall be entitled shall include damages with respect to the renewal term.

27.17 Mediation First

Any disputes under the Lease, after first attempting to be resolved through mediation, including with respect to the determination of Additional Rent and/or Fair Market Rent, shall be resolved by binding arbitration under the rules of the Arbitration Service of Portland, or such other procedures as shall be mutually agreed upon between Lessor and Lessee, as set for the in the lease. Pending the final determination of any dispute, Lessee shall pay the last Base Rent amount due under the Initial Term and make up any shortfall immediately after final determination of Fair Market Rent.

27.18 The following Exhibits are attached to this Lease and by this reference made a part hereof: “A-1”, “A-2”, “A-3”, “A-4”, “B”, “C”, and “D”.

IN WITNESS WHEREOF, Lessor and Lessee have executed this Lease as of the Lease Execution Date.

THIS LEASE, WHETHER OR NOT EXECUTED BY LESSEE, IS SUBJECT TO ACCEPTANCE BY LESSOR, ACTING BY ITSELF OR BY ITS AGENT BY THE SIGNATURE ON THIS LEASE OF ITS SENIOR VICE PRESIDENT, VICE PRESIDENT, REGIONAL MANAGER OR DIRECTOR OF LEASING.


LESSOR:				LESSEE:

PS Business Parks, L.P. A California Limited Partnership By PS Business Parks, Inc. Its General Partner				Digimarc Corporation A Delaware Corporation

/s/ Coby A. Holley				/s/ Paul R. Gifford
By: Coby A. Holley, Vice President				By: Paul R. Gifford, President & COO

Date: 3-24-04				Date: March 22, 2004

Lease Execution Date

Lessor Fed. ID #: 95-4609260

PREMISES “A-1” FIRST FLOOR