<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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 JULY 3, 1999.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13(d) OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______.
COMMISSION FILE NUMBER: 0-18690
DIGITAL ORIGIN, INC.
(FORMERLY RADIUS INC.)
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 68-0101300
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
460 E. MIDDLEFIELD ROAD
MOUNTAIN VIEW, CA 94043
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE)
(650) 404-6000
(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
--- ---
THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT'S COMMON STOCK ON
AUGUST 11, 1999 WAS 5,554,498.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
DIGITAL ORIGIN, INC.
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at June 30, 1999 (unaudited) and
September 30, 1998 3
Consolidated Statements of Operations for the Three and Nine Months Ended
June 30, 1999 and 1998 (unaudited) 4
Consolidated Statements of Cash Flows for the Nine Months Ended
June 30, 1999 and 1998 (unaudited) 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES 18
</TABLE>
-2-
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIGITAL ORIGIN, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
JUNE 30, SEPTEMBER 30,
1999 1998 (1)
--------- -------------
(unaudited)
<S> <C> <C>
ASSETS:
Current assets:
Cash $ 3,121 $ 600
Accounts receivable, net 1,446 364
Note receivable from Korea Data Systems America, Inc. 350 4,500
Inventories 264 803
Prepaid expenses and other current assets 86 156
--------- ---------
Total current assets 5,267 6,423
Property and equipment, net 48 133
Other assets 188 -
--------- ---------
$ 5,503 $ 6,556
--------- ---------
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY (Net capital deficiency):
Current liabilities:
Accounts payable $ 1,864 $ 1,971
Accrued payroll and related expenses 404 324
Other accrued liabilities 1,097 2,069
Deferred income 350 4,833
Accrued income taxes 301 1,102
Short-term borrowings - 1,340
--------- ---------
Total current liabilities 4,016 11,639
Accrued income taxes 800 -
Shareholders' equity (Net capital deficiency):
Common stock 169,183 169,102
Accumulated deficit (168,496) (174,185)
--------- ---------
Total shareholders' equity (Net capital deficiency) 687 (5,083)
--------- ---------
$ 5,503 $ 6,556
--------- ---------
--------- ---------
</TABLE>
(1) The balance sheet at September 30, 1998 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
See accompanying notes.
-3-
<PAGE>
DIGITAL ORIGIN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data; unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales $3,660 $3,823 $ 9,077 $13,514
Commissions and royalties 122 47 172 911
------ ------ ------- -------
Total net sales 3,782 3,870 9,249 14,425
Cost of sales 1,257 2,223 3,367 9,283
------ ------ ------- -------
Gross profit 2,525 1,647 5,882 5,142
------ ------ ------- -------
Operating expenses:
Research and development 677 737 1,966 2,051
Selling, general and administrative 1,828 1,661 5,220 5,474
------ ------ ------- -------
Total operating expenses 2,505 2,398 7,186 7,525
------ ------ ------- -------
Income (loss) from operations 20 (751) (1,304) (2,383)
Other income, net 1,794 4,715 7,048 10,211
Interest expense - (78) (55) (416)
------ ------ ------- -------
Income before income taxes 1,814 3,886 5,689 7,412
Provision for income taxes - - - -
------ ------ ------- -------
Net income $1,814 $3,886 $ 5,689 $ 7,412
------ ------ ------- -------
------ ------ ------- -------
Net income per share:
Basic net income per share $ 0.33 $ 0.70 $ 1.03 $ 1.34
------ ------ ------- -------
------ ------ ------- -------
Diluted net income per share $ 0.32 $ 0.70 $ 1.00 $ 1.33
------ ------ ------- -------
------ ------ ------- -------
Shares used in per share computations:
Shares used in computing basic net
income per share 5,527 5,529 5,525 5,519
------ ------ ------- -------
------ ------ ------- -------
Shares used in computing diluted net
income per share 5,723 5,546 5,669 5,566
------ ------ ------- -------
------ ------ ------- -------
</TABLE>
See accompanying notes.
-4-
<PAGE>
DIGITAL ORIGIN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(in thousands, unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
JUNE 30,
--------------------
1999 1998
----- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 5,689 $ 7,412
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization 94 115
Gain on the sale of Splash Common Stock - (9,016)
Gain on the sale of the Color Server Group and other assets to Splash (2,485) -
Gain on the monitor license and sale of other assets to KDS (4,152) -
Loss on disposal of fixed assets - 25
(Increase) decrease in assets:
Accounts receivable (1,082) 165
Note receivable 4,150 -
Inventories 539 (276)
Prepaid expenses and other current assets 70 (16)
Increase (decrease) in liabilities:
Accounts payable (107) (107)
Accrued payroll and related expenses 80 (880)
Other accrued liabilities (972) (1,063)
Deferred income (4,483) -
Accrued restructuring costs - (1,536)
Accrued income taxes (1) 11
------- --------
Total adjustments (8,349) (12,578)
------- --------
Net cash used in operating activities (2,660) (5,166)
Cash flows from investing activities:
Capital expenditures (9) (1)
Other assets (188) -
Net proceeds from the sale of Splash and UCC Common Stock - 8,288
Net proceeds on the sale of the Color Server Group and other assets to Splash 2,485 -
Net proceeds from the monitor license and sale of other assets to KDS 4,152 500
------- --------
Net cash provided by investing activities 6,440 8,787
Cash flows from financing activities:
Short-term borrowings, net (1,340) (3,041)
Principal payments of long-term debt and capital leases - (273)
Issuance of common stock 81 108
------- --------
Net cash used in financing activities (1,259) (3,206)
------- --------
Net increase (decrease) in cash and cash equivalents 2,521 415
Cash and cash equivalents, beginning of period 600 773
------- --------
Cash and cash equivalents, end of period $ 3,121 $ 1,188
------- --------
------- --------
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ - $ 427
------- --------
------- --------
Income taxes $ 1 $ 8
------- --------
------- --------
Non-cash investing activity:
Receivable from sale of shares of Splash Technology Holdings, Inc. $ - $ 728
------- --------
------- --------
</TABLE>
See accompanying notes.
-5-
<PAGE>
DIGITAL ORIGIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The consolidated financial statements of Digital Origin, Inc.
("Digital Origin" or the "Company") as of June 30, 1999 and for the three
and nine months ended June 30, 1999 and 1998 are unaudited. In the opinion
of management, the consolidated financial statements reflect all
adjustments (consisting only of normal recurring items) necessary for a
fair presentation in conformity with generally accepted accounting
principles. Preparing financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses. Examples include provisions for returns
and bad debts and the length of product life cycles. Actual results may
differ from management's estimates. Results for the three and nine months
ended June 30, 1999 will not necessarily indicate the results to be
expected for the fiscal year ending September 30, 1999 or any other future
period. The information included in this Form 10-Q should be read in
conjunction with the Consolidated Financial Statements and notes thereto
included in the Company's Annual Report on Form 10-K for the fiscal year
ended September 30, 1998.
For clarity of presentation, all fiscal periods are reported as
ending on a calendar month end.
NOTE 2. INVENTORIES
Inventories, stated at the lower of cost or market, consist of (in
thousands):
<TABLE>
<CAPTION>
JUNE 30, SEPTEMBER 30,
1999 1998
--------- -------------
(unaudited)
<S> <C> <C>
Raw materials $ 2 $ 20
Work in process 68 238
Finished goods 194 545
---- ----
$264 $803
---- ----
---- ----
</TABLE>
NOTE 3. COMMITMENTS AND CONTINGENCIES
(a) On January 13, 1999 and January 28, 1999, the Company and one
of its former directors, Charles Berger, were named as defendants in two
shareholder class action lawsuits against Splash Technology Holdings, Inc.
("Splash"), various directors and executives of Splash and certain selling
shareholders of Splash. The suits were filed in the United States District
Court in Northern District of California and have been consolidated and
captioned IN RE SPLASH TECHNOLOGY HOLDINGS INC. SECURITIES LITIGATION
(Master File No. C99-0109 SBA). The law firm of Milberg Weiss Bershad Hynes
& Lerach LLP has been designated lead counsel for the eight lead
plaintiffs.
The lawsuit alleges, among other things, that the defendants made
or were responsible for material misstatements, and failed to disclose
information concerning Splash's business, finances and future business
prospects in order to artificially inflate the price of Splash Common
Stock. The complaint does not identify any statements alleged to have been
made by either Digital Origin or Charles Berger. The complaint further
alleges that Digital Origin (then Radius Inc.) engaged in a scheme to
artificially inflate the price of Splash Common Stock to reap a large
return on the sale of the Common Stock in order to pay off the Company's
substantial debt. Digital Origin and Charles Berger vigorously deny all
allegations of wrongdoing and intend to aggressively defend themselves in
these matters. Defendants filed a motion to dismiss the action on June 11,
1999 that is scheduled for hearing on October 19, 1999.
(b) On July 18, 1997, Intelligent Electronics, Inc. and its
affiliates filed a suit in the United States District Court for the
District of Colorado alleging a breach of contract and related claims in
the approximate amount of $800,000, maintaining that the Company failed to
comply with various return, price protection, inventory balancing and
marketing development funding undertakings. In 1997, the Company filed an
answer to the complaint and cross-claimed against the plaintiffs and in
October 1997 additionally cross claimed against Deutsche Financial, Inc., a
factor in the account relationship between the Company and the plaintiffs,
seeking the recovery of approximately $2 million.
-6-
<PAGE>
The Company continues to investigate these claims as well as cross
claims and expects to vigorously defend and prosecute them as
applicable. This case is scheduled for trial on November 8, 1999. The
Company has provided reserves for the full amount of accounts receivable
due from Intelligent Electronics, Inc. and Deutsche Financial, Inc.
(c) The Company is involved in a number of other judicial and
administrative proceedings incidental to its business. The Company intends
to defend such lawsuits vigorously and although adverse decisions (or
settlements) may occur in one or more of such cases, the final resolution
of these lawsuits, individually or in the aggregate, is not expected to
have a material adverse effect on the financial position of the Company.
However, depending on the amount and timing of an unfavorable resolution of
these lawsuits, it is possible that the Company's future results of
operations or cash flows could be materially adversely affected in a
particular period. In addition, the costs of defense, regardless of the
outcome, could have a material adverse effect on the results of operations
and financial condition of the Company.
NOTE 4. LICENSING OF ASSETS TO KOREA DATA SYSTEMS AMERICA, INC.
In June 1998, the Company licensed certain technology and assets
necessary to conduct its monitor and color publishing business to Korea
Data Systems America, Inc. ("KDS"), leaving the Company free to focus on
its digital video software business. The brand name and trademark RADIUS
was one of the assets so licensed because of its primary association with
monitors. In August 1998, the Company amended and restated this license and
agreed to sell the licensed assets to KDS pursuant to an asset transfer
agreement, subject to certain contingencies at the discretion of KDS. The
monitor business has accounted for substantially all of the revenues of the
color publishing product line and 55.3% of the Company's revenues during
fiscal 1998. Under the license and asset transfer agreement, the Company
transferred its Radius, Supermac, PressView and certain other trademarks to
KDS and licensed certain intellectual property pertaining to PressView and
PrecisionView monitors. The expected value of the transaction is $6.2
million to be paid in installments. As of June, 1999, $5.9 million was paid
under the license and asset transfer agreement.
On May 17, 1999, the Company completed the sale of its monitor and
color publishing business to Korea Data Systems America, Inc. In connection
with this transaction, the Company received the sum of $1.0 million which
represents three installment payments on the note related to the license
agreement. As of June 30, 1999, the remaining balance receivable under the
agreement was $0.3 payable through July 1999, which is included as note
receivable and deferred revenue in the accompanying Consolidated Balance
Sheets. The Company will recognize other income under the license agreement
as cash is received on the note. In July 1999, the Company received the
final installment on the note.
On December 4, 1998, the Company and KDS supplementally agreed to
the sale of certain tangible personal property and the transfer of rights
in the Radius Emachines and Colormatch trademarks for $100,000 and other
consideration.
-7-
<PAGE>
NOTE 5. TECHNOLOGY PURCHASE FROM POST DIGITAL SOFTWARE, INC.
On November 23, 1998, the Company acquired certain software and
other intangible property from Post Digital Software, Inc. for (i) an
initial payment of $50,000, (ii) earnout payments equal to at least $50,000
but not exceeding $700,000 based on subsequent sales of the Company's
digital video products incorporating such software and (iii) a warrant to
purchase up to 50,000 shares of the Company's Common Stock at an exercise
price of $1.50 per share. The warrant is non-forfeitable and exercisable
over a four year period through November 23, 2002. The warrant can be
exercised for up to 12,000 shares as of May 1, 1999, plus an additional
2,000 shares for each full month that transpires thereafter, up to a total
of 50,000 shares. The value of this agreement, as noted below, is included
as other assets in the accompanying Consolidated Balance Sheet. The
technology is being amortized over a three year period and future royalties
based on digital video products sold will be expensed as they are incurred.
As of June 30, 1999, the Company has accrued approximately $14,000 in
royalties.
<TABLE>
<S> <C>
Initial purchase price $ 50,000
Guaranteed earnout 50,000
Value assigned to warrant 50,000
--------
Purchased technology 150,000
Less amortization (4,167)
--------
Net purchased technology $145,833
--------
--------
</TABLE>
NOTE 6. TRANSACTIONS WITH SPLASH TECHNOLOGY HOLDINGS, INC.
ESCROW FUND RELEASE
In connection with the Company's sale of its Color Server Group to
Splash Technology Holdings, Inc. in January 1996, an escrow fund was
established to secure certain indemnification obligations. On December 31,
1998, the balance of the escrow fund of approximately $2.2 million was
released to the Company as a result of the Federal Circuit Court affirming
the summary judgment in favor of the Company in the EFI litigation. The
Company used approximately $1.0 million of the proceeds to repay all
outstanding indebtedness to Silicon Valley Bank under the working capital
line of credit.
SALE OF CERTAIN COLOR PUBLISHING TECHNOLOGY
On December 4, 1998, the Company agreed to sell certain software
and other intangible property associated with its monitor and color
publishing business to Splash Technology Holdings, Inc. for $275,000 and
other consideration.
NOTE 7. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, FASB issued SFAS 131, "Disclosures about Segments of
an Enterprise and related Information." This statement establishes
standards for the way companies report information about operating segments
in financial statements. It also establishes standards for related
disclosures about products and services, geographic areas and major
customers. The disclosures prescribed by SFAS 131 will be adopted for the
fiscal year ending September 30, 1999.
In December 1998, the American Institute of Certified Public
Accountants issued SOP 98-9, "Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions." SOP 98-9 amends SOP
97-2 and SOP 98-4 extending the deferral of the application of certain
provisions of SOP 97-2, amended by SOP 98-4, through fiscal years beginning
on or before March 15, 1999. All other provisions of SOP 98-9 are effective
for transactions entered into in fiscal years beginning after March 15,
1999. The Company has not yet determined the effect of the final adoption
of SOP 98-9 on its financial condition or results of operations.
-8-
<PAGE>
NOTE 8. EARNINGS PER SHARE
Basic earnings per share is computed using the weighted average
number of common shares outstanding during the period. Diluted earnings per
share is computed using the weighted average number of common and dilutive
common equivalent shares outstanding during the period. Dilutive common
equivalent shares consist of employee stock options and warrants using the
treasury stock method.
The following table shows the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
------------------ -----------------
1999 1998 1999 1998
------ ------ ------ ------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
NUMERATOR:
Numerator for basic and diluted earnings per share
Net income $1,814 $3,886 $5,689 $7,412
------ ------ ------ ------
------ ------ ------ ------
DENOMINATOR:
Denominator for basic earnings per share - weighted-average
shares outstanding 5,527 5,529 5,525 5,519
Effect of dilutive securities:
Employee stock options 146 17 111 47
Warrants 50 - 33 -
------ ------ ------ ------
Dilutive potential common shares 196 17 144 47
Denominator for diluted earnings per share - adjusted
weighted-average shares outstanding 5,723 5,546 5,669 5,566
------ ------ ------ ------
------ ------ ------ ------
Basic earnings per share $ 0.33 $ 0.70 $ 1.03 $ 1.34
------ ------ ------ ------
------ ------ ------ ------
Diluted earnings per share $ 0.32 $ 0.70 $ 1.00 $ 1.33
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
-9-
<PAGE>
NOTE 9. COMPREHENSIVE NET INCOME
As of October 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive
Income." SFAS 130 requires foreign currency translation adjustments and
changes in the fair value of available-for-sale-securities to be included
in comprehensive income. However, it has no impact on the net income or
stockholders' equity as presented in the financial statements.
The components of comprehensive net income, net of tax, are as
follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
------------------ -------------------
1999 1998 1999 1998
------ ------ ------ --------
<S> <C> <C> <C> <C>
Net income $1,814 $3,886 $5,689 $ 7,412
Unrealized loss on available-for-sale-securities - (758) - (12,078)
------ ------ ------ --------
Comprehensive net income (loss) $1,814 $3,128 $5,689 $ (4,666)
------ ------ ------ --------
------ ------ ------ --------
</TABLE>
NOTE 10. OPERATING LEASE
The Company has signed an operating lease for its headquarters in
Mountain View, California, for a period of three years beginning April 15,
1999, with an option to extend the lease for an additional two years. The
base rent will be $25,000 per month the first year, $27,500 the second year
and $30,000 for years three through five, if extended.
NOTE 11. 1999 EMPLOYEE STOCK PURCHASE PLAN
The Company's Employee Stock Purchase Plan allows eligible
employee participants to purchase shares of the Company's Common Stock at a
discount through payroll deductions. Employees purchase shares at 85% of
the market value at either the beginning of the offering period or the end
of the purchase period, whichever price is lower. The plan consists of one
year offering periods with two six-month purchase periods in each offering
period. The Company has reserved 137,500 shares of its Common Stock for
issuance under the plan, in addition to 15,900 shares reserved under the
previous plan.
-10-
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS: The following
discussion contains forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934 that are subject to risks and
uncertainties. Statements indicating that the Company or management
"intends", "plans", "expects," "estimates" or "believes" are forward-looking,
as are all other statements concerning future financial results, product
offerings or other events that have not yet occurred. There are several
important factors that could cause actual results or events to differ
materially from those anticipated by the forward-looking statements contained
in this discussion and other sections of this Form 10-Q. Such factors
include, but are not limited to: the Company's ability to sustain
profitability; the Company's ability to successfully conclude its litigation
with Intelligent Electronics, Inc. and Splash shareholders; the success of
the Company's digital video software products; the success of the Apple
Macintosh computer line and operating system, the success of Apple, as well
as the Company's ability to compete successfully with Apple in its markets,
including the non linear digital video editing software market; the success
of Apple's Quicktime technology for Windows; favorable licensing terms for
Quicktime from Apple; the Company's reliance on Adobe Systems for products
which are bundled with the Company's products; the Company's ability to
successfully develop, introduce and market new software products, including
products for the Windows operating system, to keep pace with technological
innovation, particularly in light of its limited financial resources; the
Company's ability to compete in the digital video software market, including
with Apple; the ability of the Company's manufacturers and suppliers to
deliver components and manufacture the Company's products; the Company's
ability to achieve Year 2000 readiness in its business operations and its
dealings with significant third parties; the Company's reliance on
international sales and its new distributor arrangements with respect to
Europe and Japan and with Canon; and the Company's ability to attract and
retain its key personnel.
Each forward-looking statement should be read in conjunction with the entire
consolidated interim financial statements and the notes thereto in Part I,
Item 1 of this Quarterly Report, with the information contained in Item 2,
including, but not limited to, "Certain Factors That May Affect Future
Results," and with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contained in the Company's Annual Report
on Form 10-K for the fiscal year ended September 30, 1998, including, but not
limited to, "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Certain Factors That May Affect the Company's Future
Results of Operations."
OVERVIEW
The Company designs, develops, assembles, markets and supports digital
video computer products for creative professionals and consumers who use
digital camcorders. The Company's current product line includes: multimedia
authoring and editing video systems and software that can acquire and
manipulate video and audio information.
The primary target markets for the Company's products are video editors,
video producers, and creators of multimedia. These markets encompass creative
professionals involved in such areas as multimedia authoring, video editing,
video and multimedia production and corporate training.
Historically, substantially all of the Company's products have been
designed for and sold to users of Macintosh computer products (the
"Macintosh") manufactured by Apple Computer, Inc. ("Apple") as Apple products
have been the preferred platform in the Company's target markets. During
fiscal 1998, the Company added cross platform (Windows and Macintosh)
capabilities to many of the Company's products in order to market these
products to users of the Windows operating system. Sales made to
cross-platform users were 19% of digital video net sales in the fourth
quarter of fiscal 1998. This compares to 31%, 31% and 56% of digital video
net sales to cross-platform users in the first, second and third quarter of
fiscal 1999, respectively.
For the quarter ended June 30, 1999, the Company had an operating profit
of $20,000. However, as shown in the accompanying consolidated financial
statements, the Company had incurred substantial operating losses in prior
quarters. During fiscal 1997 and 1998, management implemented a number of
actions to address its cash flow and operating issues including: refocusing
its efforts on providing solutions for digital video customers; discontinuing
sales of mass market and other low value added products; divesting a number
of businesses and product lines, including most recently the agreement for
the sale and related license of significant assets of its monitor business to
Korea Data Systems America, Inc. ("KDS"); significantly reducing expenses and
headcount; and reducing its lease obligations given its reduced occupancy
requirements.
-11-
<PAGE>
There can be no assurance that these measures will be sufficient to allow the
Company continued success in achieving profitability. As of June 30, 1999,
the Company had working capital of $1.3 million. The Company intends to
finance its existing working capital needs through cash, and cash
equivalents, and cash generated by operations. The Company may need to
further reduce its operating expenses or seek additional sources of working
capital or additional equity if software product sales do not increase at the
rate assumed in the Company's current operating plans or if the Company
increases its working capital needs.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain
operational data as a percentage of net sales (may not add due to rounding).
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JUNE 30, JUNE 30,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 33.2 57.4 36.4 64.4
----- ----- ----- -----
Gross profit 66.8 42.6 63.6 35.6
----- ----- ----- -----
Operating expenses:
Research and development 17.9 19.1 21.3 14.2
Selling, general and administrative 48.3 42.9 56.4 37.9
----- ----- ----- -----
Total operating expenses 66.2 62.0 77.7 52.1
----- ----- ----- -----
Income (loss) from operations 0.6 (19.4) (14.1) (16.5)
Other income, net 47.4 121.8 76.2 70.8
Interest Expense 0.0 (2.0) (0.6) (2.9)
----- ----- ----- -----
Income before income taxes 48.0 100.4 61.5 51.4
Provision for income taxes 0.0 0.0 0.0 0.0
----- ----- ----- -----
Net income 48.0% 100.4% 61.5% 51.4%
----- ----- ----- -----
----- ----- ----- -----
</TABLE>
NET SALES
The Company's total net sales decreased 2.3% to $3.8 million in the
third quarter of fiscal 1999 from $3.9 million for the same quarter in fiscal
1998. Net sales for the first nine months of fiscal 1999 decreased 35.9% to
$9.2 million from $14.4 in the same period of fiscal 1998. During fiscal
1998, the Company decided to focus its efforts on its digital video software
product lines. Accordingly, during the latter part of fiscal 1998 the Company
divested itself of its various hardware product lines, including the sale of
its monitor business to KDS. Consequently, revenues for the current periods
declined from comparable periods a year ago as current period revenues are
almost entirely video software.
Future sales will be predominately attributable to sales of software
products since the Company's digital video product line is primarily
software. Shipments of digital video products in the three month period ended
June 30, 1999 were $3.7 million, an increase of 29% from the second quarter
of fiscal 1999 and represented approximately 96.8% of net revenue. There can
be no assurance that sales of these software products will continue to
increase or that they will increase at the same growth rate experienced in
fiscal 1999. The Company also experienced continued growth in direct and
on-line sales, which represented 18% of net revenue in the third quarter of
fiscal 1999 as compared with 15% of net revenue in the previous quarter.
Revenue recognition related to software product sales is as follows: revenue
from the sale of software, net of estimated returns, is recognized upon
either shipment of the physical product or delivery of electronic product, at
which time collectibility is probable and the Company has no remaining
obligations.
Sales to Ingram Micro, Canon U.S.A., Inc., Broadfield Distributing, and
SGI Japan accounted for 16.5%, 20.5%, 10.5% and 10.3% of net sales for the
third quarter of fiscal 1999, respectively. For the corresponding period of
fiscal 1998, the same customers accounted for 57.2%, 0.0%, 1.8% and 0.0% of
the Company's net sales. For the nine month period of
-12-
<PAGE>
fiscal 1999, Ingram Micro and Canon U.S.A., Inc. accounted for 21.7% and
18.1%, respectively, as compared to 55.8% and 0.0% for the corresponding
period of fiscal 1998.
GROSS PROFIT
The Company's gross profit margin was 66.8% and 63.6% for the three and
nine month periods ended June 30, 1999, respectively, compared with 42.6% and
35.6% for the same periods in fiscal 1998. The increase in gross profit
margin in fiscal 1999 was due primarily to increased sales of higher gross
margin digital video software products. Also contributing to the increase in
gross profit margin were overall efficiencies in the Company's distribution
system. The gross profit margin for the three and nine month periods ended
June, 1998 reflects the sales of discontinued monitors, color publishing,
accelerated graphics and DOS on Mac products at very low profit margins.
The Company anticipates the gross profit margins will be higher in
fiscal 1999 as compared to the gross profit margins in fiscal 1998 due to the
Company's decision to refocus its business on higher margin digital video
software products. Additionally, the Company is taking further steps to
reduce product costs and control expenses. However, there can be no assurance
that the Company's gross margins will improve or remain at current levels.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses were $0.7 million or 17.9% of net
sales in the third quarter of fiscal 1999 compared to $0.7 million or 19.1%
of net sales in the same quarter of fiscal 1998. Research and development
expenses were $2.0 million or 21.3% of net sales for the first nine months of
fiscal 1999 and $2.1 million or 14.2% of net sales for the corresponding
period of fiscal 1998. The increase in research and development expenses
expressed as a percentage of net sales for the nine month period ended June
30, 1999 were primarily attributed to the decrease in net sales. The Company
expects that decreases in its research and development expenses due to the
divestiture of the monitor and color publishing business will be offset by
increases in the expenses for the digital video product line and, therefore,
expects to devote approximately $3.0 million to research and development
during the entire fiscal 1999. The Company expects to continue to invest in
research and development activities to support its goal of continued growth
through the development of new and competitive digital software products.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were $1.8 million or 48.3%
of net sales and $5.2 million or 56.4% of net sales for the three and nine
month periods ended June 30, 1999, respectively, compared to $1.7 million or
42.9% and $5.5 million or 37.9% of net sales for the same periods of the
prior year. The Company increased its selling, general and administrative
expenses in the three month period ended June 30, 1999 primarily due to sales
and marketing efforts in Japan and Europe. The decrease in selling, general
and administrative expenses year to date is primarily due to the reduction in
personnel expenses resulting from the Company's efforts to refocus its
business.
OTHER INCOME, NET
Other income was $1.8 million and $7.0 million for the three and nine
month periods ended June 30, 1999, respectively, compared to $4.7 million and
$10.2 million for the same periods in fiscal 1998. In the nine month period
ended June 30, 1999, other income resulted primarily from $4.1 million in
income from KDS, a reversal of approximately $0.6 million of previously
accrued sales taxes as a result of settlement of various sales tax exposures
in certain jurisdictions, and the release of approximately $2.2 million from
escrow related to the 1996 divestiture of the Color Server Group. In the
first nine months of fiscal 1998, other income resulted from the sale of
approximately 537,000 shares of Splash Common Stock.
INTEREST EXPENSE
Interest expense was minimal in the third quarter of fiscal 1999 and
$55,000 for the nine months ended June 30, 1999, compared with $78,000 and
$416,000 for the same periods in the prior year. This decrease was due to the
repayment of the working capital line of credit to IBM Credit in July 1998
and Silicon Valley Bank working capital line of credit in January 1999.
-13-
<PAGE>
INCOME TAXES
The Company did not record a provision for income taxes for the three
and nine month periods ended June 30, 1999 and June 30, 1998 due to the
availability of net operating loss carryforwards.
FAS 109 provides for the recognition of deferred tax assets if
realization of such assets is more likely than not. Based on the weight of
available evidence, the Company has provided a full valuation allowance
against its deferred tax assets. The company will continue to evaluate the
realization of the deferred tax assets on a quarterly basis.
NET PROFIT
As a result of the above factors, the Company had a net income of $1.8
million and $5.7 for the three and nine months ended June 30, 1999,
respectively, compared to a net income of $3.9 million and $7.4 for the three
and nine months ended June 30, 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents increased to $3.1 million at
June 30, 1999, a $2.5 million increase from September 30, 1998. The increase
in the Company's cash and cash equivalents was primarily attributable to
funds received from the Splash escrow and income from the license agreement
with KDS which was offset by funding of operating losses of the Company. The
Company had working capital of $1.3 million at June 30, 1999.
During the third quarter ended June 30, 1999, the Company invested $1.8
million in highly liquid investments with maturities of three months or less
at date of acquisition to primarily minimize principal risk and maintain
liquidity. Approximately $0.1 million of the $3.1 million of cash and cash
equivalents available at June 30, 1999 was restricted under a letter of
credit.
Under the license and asset transfer agreement with KDS, the Company
transferred its Radius, Supermac, PressView and certain other trademarks to
KDS and licensed certain intellectual property pertaining to PressView and
PrecisionView monitors. The value of the transaction was $6.2 million. On May
17, 1999, the Company completed the sale of its monitor and color publishing
business to KDS. In connection with this transaction, the Company received
the sum of $1.0 million, which represents the prepayment of three installment
payments on the promissory note related to the license agreement. In July
1999, the Company received the final installment on the note.
The Company believes that its cash and cash equivalents, cash flow from
operations, and other sources of financing, will be sufficient to fund
operations for at least the remainder of this fiscal year. However, there can
be no assurances that the sale of software products will continue to increase
to a sufficient extent to offset the loss of revenues and gross margin from
the monitor business. The Company may need to further reduce its operating
expenses or seek additional sources of working capital if software product
sales do not increase at the rate assumed in the Company's current operating
plans. The Company and its management believe that other sources of financing
will be available and that it can further reduce such operating expenses, if
necessary.
The Company anticipates that it will have cash available for its
ordinary course of business operating expenses. Although the Company has
achieved favorable trade terms with its critical vendors, certain suppliers
may put the Company on a cash or prepay basis and/or require the Company to
provide security for their risk in procuring components or reserving
manufacturing time. In the event the Company were unable to generate
sufficient net sales or if the Company incurs unforeseen operating expenses,
it may not be able to meet its operating expenses without additional
financing.
CERTAIN FACTORS THAT MAY AFFECT THE COMPANY'S FUTURE RESULTS OF OPERATIONS
A number of uncertainties exist that could affect the Company's future
operating results, including, without limitation, the following factors: the
Company's ability to sustain profitability; the Company's ability to
successfully conclude its litigation with
-14-
<PAGE>
Intelligent Electronics, Inc. and Splash shareholders; the success of the
Company's digital video software products; the success of the Apple Macintosh
computer line and operating system, the success of Apple, as well as the
Company's ability to compete successfully with Apple in its markets,
including the non linear digital video editing software market; the success
of Apple's Quicktime technology for Windows; favorable licensing terms for
Quicktime from Apple; the Company's reliance on Adobe Systems for products
which are bundled with the Company's products; the Company's ability to
successfully develop, introduce and market new software products, including
products for the Windows operating system, to keep pace with technological
innovation, particularly in light of its limited financial resources; the
Company's ability to compete in the digital video software market, including
with Apple; the ability of the Company's manufacturers and suppliers to
deliver components and manufacture the Company's products; the Company's
ability to achieve Year 2000 readiness in its business operations and its
dealings with significant third parties; the Company's reliance on
international sales and its new distributor arrangements with respect to
Europe and Japan and with Canon; the Company's ability to attract and retain
its key personnel; and the risk factors identified from the Company's Annual
Report on Form 10-K for the fiscal year ended September 30, 1998.
IMPACT OF YEAR 2000
The year 2000 Issue ("Y2K Issue") is the result of computer programs
being written using two digits rather than four to define the applicable
year. Any of the Company's computer programs or hardware that have
time-sensitive software may recognize a date using "00" as the year 1900
rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices,
distribute via Internet, or engage in similar normal business activities. The
Company's plan to resolve the Y2K Issue involves the following four phases:
assessment, remediation, testing, and implementation. To date, the Company
has fully completed its assessment of all internal systems and products that
could be significantly affected. The assessment of risks associated with
suppliers and distributors is not yet complete.
Based on recent assessments of its information management and accounting
systems, the Company has determined that it will be required to modify or
replace significant portions of its software and certain hardware so that
those systems will properly utilize dates beyond December 31, 1999. The
Company presently believes that with such modifications and replacements, the
Y2K Issue can be mitigated without a material adverse impact on the Company.
However, if such modifications and replacements are not timely made, the Y2K
Issue could have a material impact on the operations of the Company. None of
these systems interoperate directly with the systems of suppliers or
distributors.
Based on a review of its product line, the Company has determined that
primarily all of the products it has sold and will continue to sell do not
require remediation to be Year 2000 compliant, as primarily all operate in
conjunction with the MacOS. Accordingly, the Company does not believe that
the Y2K Issue presents a material risk with respect to the Company's products.
The Company is approximately 75% through the remediation phase with
respect to its information management and accounting systems and expects to
complete software and hardware replacement no later than September 30, 1999.
Once the software and hardware is replaced for a system, the Company begins
testing and implementation. These phases run concurrently for different
systems. Completion of the testing phase for all significant existing
software systems was completed as of January 31, 1999, with all remediated
systems to be fully tested and implemented by December 31, 1999.
None of the Company systems interface directly with significant third
party suppliers. The Company is in the process of working with third
party suppliers and distributors to ensure that any Company systems that
could interface directly with third parties are Year 2000 compliant by
December 31, 1999. Remediation and testing of all significant systems is
expected no later than December 31, 1999. The Company believes that its key
suppliers, two of whom are sole sources, are in the process of making their
billing systems Year 2000 compliant. The Company is not aware of any supplier
or distributor with a Y2K Issue that would materially impact the Company's
results of operations, liquidity, or capital resources. However, the Company
has no means of ensuring that such suppliers and distributors will be Year
2000 ready. The inability of suppliers and distributors to complete their
Year 2000 resolution process in a timely fashion could materially impact the
Company. There are no vendors that could not be replaced in a reasonable
period of time, except for transport vendors. The failure of Fedex, UPS,
Airborne and the U.S. Mail would impact direct sales. The effect of this
occurrence is not determinable.
-15-
<PAGE>
The Company will utilize both internal and external resources to
reprogram, or replace, test, and implement the software and operating
equipment for Year 2000 compliance. The total future cost of the Year 2000
compliance is estimated at approximately $500,000 to $600,000 and is being
funded through net cash flows or capital leases. Some of these expenditures
were likely to have been made in the ordinary course of upgrading and
replacing obsolete systems without regard to the Y2K Issue. Through the third
quarter of fiscal 1999, the Company has incurred less than $100,000 related
to all phases of the Year 2000 project and assumes that most of the new
system cost will be funded via leasing.
Management of the Company believes it has an effective program in place
to resolve those aspects of the Y2K Issue within its control in a timely
manner. As noted above, the Company has not completed all necessary phases of
the Year 2000 program. In the event that the Company does not complete these
phases, the Company would be unable in some degree to take customer orders,
manufacture and ship products, invoice customers and collect payments. In
addition, disruptions in the economy generally resulting from Year 2000
issues could also materially adversely affect the Company. The Company could
be subject to litigation for computer systems product failure, for example,
equipment shutdown or failure to properly date business records. Furthermore,
although management is not aware of any Y2K Issue with products sold, there
can be no assurance that the use of such products alone or in conjunction
with other products will not malfunction and expose the Company to liability.
The amount of potential liability and lost revenue associated with these
risks cannot be reasonably estimated at this time.
The Company has contingency plans for certain critical applications and
is working on such plans for others. These contingency plans involve, among
other actions, manual workarounds, increasing inventories, and adjusting
staffing strategies. All of the Company's production, shipping, purchasing,
billing and inventory functions could be accomplished via outsource vendors
that are currently readily available, although there can be no assurance that
such vendors will be available on reasonable terms as the millennium
approaches.
The above discussion regarding costs, risks and estimated completion
dates for the Year 2000 is based on the Company's good faith estimates based
on information that is currently available, and is subject to change. As the
Company continues to progress with this initiative, it may discover that
actual results will differ materially from these estimates.
-16-
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 3 to Consolidated Financial Statements - Commitments and Contingencies.
ITEM 5. OTHER INFORMATION
Possible Delisting from Nasdaq SmallCap Market: As of June 30, 1999, the
Company had assets of $5.5 million and total liabilities of $4.8 million and
therefore had net tangible assets of $0.7 million. In order for the Company's
Common Stock to continue to be listed on the Nasdaq SmallCap Market, the
Company will be required to maintain net tangible assets of at least $2.0
million, or must have net income in its most recently completed fiscal year
or in two of the three prior fiscal years. The Company had net income in
fiscal years 1997 and 1998. However, in the event that the Company does not
increase its net tangible assets to greater than $2.0 million, the Company's
Common Stock would be subject to delisting if it also failed to achieve net
income for its next two fiscal years.
On June 1, 1999, Charles Berger resigned as a director and the Board of
Directors appointed Carl Rosendahl to the newly vacant Board seat. Mr.
Rosendahl is Chairman of Pacific Data Images, Inc. "PDI", a privately held
Palo Alto company employing about 300 employees founded in 1980 by Mr.
Rosendahl to combine interests in filmmaking and computer graphics. PDI is an
award winning producer of high-end animation and visual effects for the
feature film, commercial and entertainment industries. PDI has a
co-production pact with DreamWorks SKG to create original, computer animated
feature films, including the movie ANTZ for which Mr. Rosendahl was executive
producer. The Academy of Motion Picture Arts and Sciences recognized PDI and
its founders in 1998 with a Technical Achievement Award for the concept and
architecture of PDI's proprietary animation system. Mr. Rosendahl holds a
BSEE from Stanford University (1979), has taught a graduate level course
entitled "Computer Animation and Visual Effects for Film and Television" at
USC Film School in 1993 and 1994 and is a member of ACM SIGGRAPH and the
governing board of directors of the Visual Effects Society.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
The following exhibits are filed with this Quarterly Report:
27.01 Financial Data Schedule (EDGAR version only).
(b) REPORTS ON FORM 8-K
On May 28, 1999, a report pursuant to Items 2 and 7 of Form 8-K was filed
by the Company relating to the sale of the its monitor and color publishing
business. Such sale was previously reported in the Company's Annual Report on
Form 10-K for the fiscal year ended September 30, 1998 and the Company's
Quarterly Reports on Form 10-Q for the quarters ended December 31, 1998 and
March 31, 1999. Pro forma financial information relating to the sale of the
monitor and color publishing business was included therewith.
-17-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: August 13, 1999 DIGITAL ORIGIN, INC.
By: /s/ MARY F. BOBEL
------------------------
Mary F. Bobel
Chief Financial Officer
-18-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-END> JUN-30-1999
<CASH> 3,121
<SECURITIES> 0
<RECEIVABLES> 5,203
<ALLOWANCES> (3,757)
<INVENTORY> 264
<CURRENT-ASSETS> 5,267
<PP&E> 6,892
<DEPRECIATION> (6,844)
<TOTAL-ASSETS> 5,503
<CURRENT-LIABILITIES> 4,016
<BONDS> 0
0
0
<COMMON> 169,183
<OTHER-SE> (168,496)
<TOTAL-LIABILITY-AND-EQUITY> 5,503
<SALES> 9,249
<TOTAL-REVENUES> 9,249
<CGS> 3,367
<TOTAL-COSTS> 3,367
<OTHER-EXPENSES> 7,186
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 55
<INCOME-PRETAX> 5,689
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,689
<EPS-BASIC> 1.03
<EPS-DILUTED> 1.00
</TABLE>
