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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
-----------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1996
OR
[ ] 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: 0-27644
DIGITAL GENERATION SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 94-3140772
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
875 BATTERY STREET
SAN FRANCISCO, CALIFORNIA 94111
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(415) 276-6600
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
NOT APPLICABLE
(FORMER NAME, FORMER ADDRESS, FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTIONS 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
--- ---
NUMBER OF SHARES OF REGISTRANT'S COMMON STOCK, WITHOUT PAR VALUE, OUTSTANDING AS
OF JULY 31, 1996: 11,538,506.
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<PAGE> 2
DIGITAL GENERATION SYSTEMS, INC.
This report contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. Actual results could differ materially from those indicated in the
forward-looking statements as a result of certain factors, including those set
forth under "Certain Business Considerations" in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and elsewhere in, or
incorporated by reference into, this report. The registrant has attempted to
identify forward-looking statements in this report by placing an asterisk(*)
following each sentence containing such statements.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page
----
<S> <C>
Item 1. Financial Statements................................................................... 3
Condensed Balance Sheets at June 30, 1996 and December 31, 1995........................ 3
Condensed Statements of Operations for the three and six months ended June 30, 1996 and
1995................................................................................... 4
Condensed Statements of Cash Flows for the three and six months ended June 30, 1996 and
1995................................................................................... 5
Notes to Condensed Financial Statements................................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................................................... 18
Item 2. Changes in Securities.................................................................. 18
Item 3. Defaults upon Senior Securities........................................................ 18
Item 4. Submission of Matters to a Vote of Security Holders.................................... 18
Item 5. Other Information...................................................................... 19
Item 6. Exhibits and Reports on Form 8-K....................................................... 19
SIGNATURES............................................................................. 21
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIGITAL GENERATION SYSTEMS, INC.
CONDENSED BALANCE SHEETS
(in thousands, except share amounts)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1996 1995
-------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 18,930 $ 6,205
Short-term investments 12,817 --
Accounts receivable, net 1,874 1,368
Prepaid expenses and other 333 624
-------- --------
Total current assets 33,954 8,197
-------- --------
PROPERTY AND EQUIPMENT, at cost:
Network equipment 10,705 7,931
Office furniture and equipment 1,738 1,373
Leasehold improvements 351 83
-------- --------
12,794 9,387
Less - Accumulated depreciation and amortization (5,388) (3,615)
-------- --------
Property and equipment, net 7,406 5,772
OTHER ASSETS, net 476 490
-------- --------
$ 41,836 $ 14,459
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,046 $ 596
Accrued liabilities 1,504 1,203
Current portion of long-term debt 2,399 1,747
-------- --------
Total current liabilities 4,949 3,546
-------- --------
LONG-TERM DEBT, net of current portion 5,466 4,540
-------- --------
SHAREHOLDERS' EQUITY:
Convertible preferred stock, no par value --
Authorized -- 5,000,000 shares at June 30, 1996
and 7,873,322 shares at December 31, 1995
Outstanding -- none outstanding at June 30, 1996 and
7,273,759 shares at December 31, 1995; aggregate
liquidation preference of $25,433 at December 31, 1995 -- 25,321
Common stock, no par value --
Authorized -- 30,000,000 shares
Outstanding -- 11,515,131 shares at June 30, 1996
and 1,112,204 shares at December 31, 1995 55,068 224
Receivable from issuance of common stock (175) (175)
Accumulated deficit (23,472) (18,997)
-------- --------
Total shareholders' equity 31,421 6,373
-------- --------
$ 41,836 $ 14,459
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
3
<PAGE> 4
DIGITAL GENERATION SYSTEMS, INC.
CONDENSED STATEMENTS OF OPERATIONS
For the Three and Six Months Ended June 30, 1996 and 1995
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- -----------------------
1996 1995 1996 1995
------- ------- -------- -------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
REVENUES $ 2,359 $ 1,289 $ 4,253 $ 2,272
------- ------- -------- -------
COSTS AND EXPENSES:
Delivery costs 703 423 1,274 735
Customer operations 977 735 1,921 1,442
Sales and marketing 970 797 1,953 1,586
Research and development 510 362 1,008 775
General and administrative 396 329 780 685
Depreciation and amortization 936 530 1,774 973
------- ------- -------- -------
Total expenses 4,492 3,176 8,710 6,196
------- ------- -------- -------
LOSS FROM OPERATIONS (2,133) (1,887) (4,457) (3,924)
------- ------- -------- -------
OTHER INCOME (EXPENSE):
Interest income 434 84 697 181
Interest expense (388) (200) (715) (373)
------- ------- -------- -------
NET LOSS $(2,087) $(2,003) $ (4,475) $(4,116)
======= ======= ======== =======
NET LOSS PER SHARE $ (0.18) $ (0.22) $ (0.39) $ (0.45)
======= ======= ======== =======
WEIGHTED AVERAGE COMMON AND
COMMON EQUIVALENT SHARES 11,482 9,133 11,579 9,129
======= ======= ======== =======
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
4
<PAGE> 5
DIGITAL GENERATION SYSTEMS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 1996 and 1995
(in thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-----------------------
1996 1995
-------- -------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (4,475) $(4,116)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 1,774 973
Provision for doubtful accounts 60 78
Changes in operating assets and liabilities --
Accounts receivable (566) (205)
Prepaid expenses and other assets 304 (35)
Accounts payable and accrued liabilities 511 358
-------- -------
Net cash used in operating activities (2,392) (2,947)
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of short-term investments (12,817) --
Acquisition of property and equipment (595) --
-------- -------
Net cash used in investing activities (13,412) --
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 29,523 10
Payments on long-term debt (994) (364)
-------- -------
Net cash provided by (used in) financing activities 28,529 (354)
-------- -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 12,725 (3,301)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 6,205 9,221
-------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 18,930 $ 5,920
======== =======
SUPPLEMENTAL CASH FLOW INFORMATION
Property and equipment financed with capitalized lease obligations $ 2,572 $ 2,252
Common stock issued for notes receivable -- 98
</TABLE>
The accompanying notes are an integral part of these condensed financial
statements.
5
<PAGE> 6
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The financial statements included herein have been prepared by the Company,
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. However, the Company believes that the disclosures are adequate to
make the information presented not misleading. These condensed financial
statements should be read in conjunction with the financial statements and the
notes thereto included in the Company's financial statements included in its
Registration Statement on Form S-1 (Registration No. 33-80203) for the year
ended December 31, 1995.
The unaudited condensed financial statements included herein reflect all
adjustments (which include only normal, recurring adjustments) which are, in the
opinion of management, necessary to state fairly the results for the three and
six month periods ended June 30, 1996. The results for the three and six month
periods ended June 30, 1996 are not necessarily indicative of the results
expected for the full fiscal year.
2. CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
In accordance with the Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities", the Company
has classified all marketable debt securities as held-to-maturity and has
accounted for these investments at amortized cost. Cash and cash equivalents
consist of liquid investments with original maturities of three months or less.
Short-term investments are marketable securities with original maturities
greater than three months and less than one year. As of December 31, 1995 and
June 30, 1996, cash and cash equivalents consist principally of U.S. Treasury
bills and various money market accounts; as a result, the amortized purchase
cost approximates the fair market value. As of June 30, 1996, short-term
investments consist principally of U.S. Treasury bills and commercial paper;
amortized cost approximates the fair market value of these instruments at the
balance sheet date.
3. NET LOSS PER SHARE
Net loss per share for the three months ended June 30, 1996 is computed using
the weighted average number of common and common equivalent shares outstanding
during the period. Common equivalent shares have been excluded from the
computation as their effect is antidilutive.
Net loss per share for the three months ended June 30, 1995 and for the six
months ended June 30, 1995 and 1996 is computed on a pro forma basis. Pro forma
net loss per share is computed using the weighted average number of common and
common equivalent shares outstanding during the period. Common equivalent shares
consist of convertible preferred stock (using the "if converted" method) and
stock options and warrants (using the treasury stock method). As the Company has
incurred losses since inception, common equivalent shares have been excluded
from the computation as their effect is antidilutive; however, pursuant to
Securities and Exchange Commission requirements, such computations include all
common and common equivalent shares issued within the 12 months preceding the
filing date as if they were outstanding for all periods presented using the
treasury stock method. Convertible preferred stock outstanding during the period
are included (using the "if converted" method) in the computation as common
equivalent shares even though the effect is antidilutive.
6
<PAGE> 7
4. CAPITAL STOCK
In January 1996, the shareholders approved a one-for-two reverse split of the
Company's preferred and common stock, which has been effected. All share and per
share amounts in the accompanying financial statements have been adjusted
retroactively to give effect to this reverse stock split.
In February 1996, the Company completed the initial public offering of its
common stock. The Company sold 3,000,000 shares for net proceeds of $30,690,000.
Concurrent with the closing of the initial public offering 7,273,759 shares of
convertible preferred stock and warrants to purchase 29,161 shares of preferred
stock were converted into an equivalent number of shares of common stock.
7
<PAGE> 8
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 that involve risks
and uncertainties. Actual results could differ materially from those indicated
in the forward-looking statements as a result of certain factors, including
those set forth under "Certain Business Considerations". The Company has
attempted to identify forward-looking statements in Management's Discussion and
Analysis of Financial Condition and Results of Operations by placing an asterisk
(*) following each sentence containing such statements.
The following table presents unaudited financial information expressed as
a percentage of total revenues and operating data for the periods indicated. The
information and operating data has been prepared by the Company on a basis
consistent with the Company's audited financial statements and includes all
adjustments, consisting only of normal recurring adjustments, that management
considers necessary for a fair presentation for the periods presented. The
operating results for any quarter should not be relied on as indicative of
results for any future period. See "Certain Business Considerations -- History
of Losses; Future Operating Results Uncertain and -- Potential Fluctuations in
Quarterly Results; Seasonality."
<TABLE>
<CAPTION>
STATEMENTS OF OPERATIONS: THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ -------------------------
1996 1995 1996 1995
------- ------ ------- -------
<S> <C> <C> <C> <C>
Revenues ......................... 100.0% 100.0% 100.0% 100.0%
Costs and Expenses:
Delivery Costs .............. 29.8 32.8 30.0 32.4
Customer operations ......... 41.4 57.0 45.2 63.5
Sales and marketing ......... 41.1 61.8 45.9 69.8
Research and development .... 21.6 28.1 23.7 34.1
General and administrative .. 16.8 25.6 18.3 30.1
Depreciation and amortization 39.7 41.1 41.7 42.8
------- ------ ------- -------
Total expenses ......... 190.4 246.4 204.8 272.7
------- ------ ------- -------
Loss from operations ............. (90.4) (146.4) (104.8) (172.7)
------- ------ ------- -------
Other income (expense):
Interest income ............. 18.4 6.5 16.4 8.0
Interest expense ............ (16.5) (15.5) (16.8) (16.5)
------- ------ ------- -------
Net loss ......................... (88.5)% (155.4)% (105.2)% (181.2)%
======= ====== ======= =======
Operating Data:
Deliveries ....................... 187,000 95,000 336,000 167,000
</TABLE>
8
<PAGE> 9
Revenues
Revenues increased 83% to $2,359,000 for the quarter ended June 30, 1996
from $1,289,000 in the quarter ended June 30, 1995. This increase is primarily
due to increased delivery volume. Deliveries increased 97% to 187,000 in the
quarter ended June 30, 1996 from 95,000 in the quarter ended June 30, 1995.
Revenues and deliveries for the six months ended June 30, 1996 increased to
$4,253,000 and 336,000, respectively, from $2,272,000 and 167,000, respectively,
for the six months ended June 30, 1995. The Company believes that the increases
in delivery volumes are the result of a number of factors, particularly
increased acceptance of the services offered by the Company and the increased
availability of an expanded network of Company equipment located in radio
stations.
Average revenue per delivery was $12.61 for the quarter ended June 30,
1996, a 7% decrease from $13.57 for the quarter ended June 30, 1995. Average
revenue per delivery for the six months ended June 30, 1996 also decreased 7% to
$12.66 from $13.60 for the six months ended June 30, 1995. The decreases in
average revenue per delivery are primarily the result of increased volume
discounts as well as an increase in the proportion of deliveries made through
the Company's dealer channel. The Company offers discounts to these marketing
partners, who consolidate and forward the deliveries of their agency customers.
Delivery Costs
Delivery costs increased 66% to $703,000, or 30% of revenues for the
quarter ended June 30, 1996, from $423,000, or 33% of revenues, for the quarter
ended June 30, 1995. Delivery costs for the six months ended June 30, 1996 were
$1,274,000, or 30% of revenues versus $735,000, or 32% of revenues in the six
months ended June 30, 1995. The increases in delivery costs are primarily due to
the increased volume of deliveries. The reductions in delivery costs as a
percentage of revenues are the result of improvements in the rate agreement
between the Company and its primary long distance telephone service provider,
increased implementation of ISDN transmission technologies by certain high
volume users, and an increase in the proportion of deliveries being performed
electronically rather than by air freight. These improvements in the long
distance telephone rate and delivery efficiency were partially offset by an
increase in the air freight rate paid by the Company under the agreement between
the Company and its primary air freight provider.
The Company expects that delivery costs will increase in absolute dollars
and may fluctuate as a percentage of revenues in future periods.* See "Certain
Business Considerations -- Potential Fluctuations in Quarterly Results;
Seasonality."
Customer Operations
Customer operations expenses increased 33% to $977,000 in the quarter
ended June 30, 1996 from $735,000 for the quarter ended June 30, 1995, and
increased 33% to $1,921,000 for the six months ended June 30, 1996 from
$1,442,000 for the six months ended June 30, 1995. These increases are the
result of adding the personnel necessary to respond to the greater volume of
orders and deliveries made by customers. Customer operations expenses as a
percentage of revenues decreased to 41% from 57% for the quarters ended June 30,
1996 and 1995, respectively, and to 45% from 64% for the six months ended June
30, 1996 and 1995, respectively, as the Company has realized the benefits of
economies of scale from the increased volume of deliveries and has also improved
the efficiency of its order processing procedures.
The Company expects that customer operations expenses will increase in
absolute dollars and may fluctuate as a percentage of sales in future periods.*
The Company believes that in order to compete effectively and manage future
growth it will be required to continue to implement changes which improve and
increase the efficiency of its customer operations.* See "Certain Business
Considerations -- Ability to Maintain and Improve Service Quality and -- Ability
to Manage Growth."
9
<PAGE> 10
Sales and Marketing
Sales and marketing expenses increased 22% to $970,000 in the quarter
ended June 30, 1996 from $797,000 for the quarter ended June 30, 1995, and
increased 23% to $1,953,000 for the six months ended June 30, 1996 from
$1,586,000 for the six months ended June 30, 1995. The increases in sales and
marketing expenses are due to the expansion of the Company's sales force
including compensation, fringes and travel, as well as increased incentive
compensation and marketing program spending.
The Company expects to continue to expand sales and marketing programs
designed to introduce the Company's services to the marketplace and to attract
new customers for its services.* See "Certain Business Considerations --
Dependence on Emerging Markets." The Company expects that sales and marketing
expenses will increase in absolute dollars in future periods and may fluctuate
as a percentage of revenue in future periods.*
Research and Development
Research and development expenses increased 41% to $510,000 in the quarter
ended June 30, 1996 from $362,000 for the quarter ended June 30, 1995, and
increased 30% to $1,008,000 for the six months ended June 30, 1996 from $775,000
for the six months ended June 30, 1995. The increase for the quarter ended June
30, 1996 over that of the prior year is due to additional compensation expense
incurred in the upgrade and retention of engineering staff and increased testing
expenditures incurred in the development of potential new services, including
satellite transmission capability and video transmission capability. The
increase in research and development expenses in the six months ended June 30,
1996 over the six months ended June 30, 1995 is due to the compensation and
testing expense increases discussed with regard to the quarter ended June 30,
1996 as well as the increased costs associated with hiring of additional staff
incurred in the first quarter of 1996, including recruiting fees and increased
compensation. These increases were partially offset by a reduction in spending
for consultants.
The Company expects that research and development expenses will increase
substantially in absolute dollars and may fluctuate as a percentage of revenue
in future periods.*
General and Administrative
General and administrative expenses increased 20% to $396,000 in the
quarter ended June 30, 1996 from $329,000 for the quarter ended June 30, 1995,
and increased 14% to $780,000 for the six months ended June 30, 1996 from
$685,000 for the six months ended June 30, 1995. The increases are primarily due
to the addition of staff to support the growth of the Company's business.
Increases in salaries, fringe benefits and overhead have been partially offset
by reduced spending for consultants and temporary labor. The Company expects
that general and administrative expenses will increase in absolute dollars and
may fluctuate as a percentage of sales in future periods.*
Depreciation and Amortization
Depreciation and amortization expenses increased 77% to $936,000 in the
quarter ended June 30, 1996 from $530,000 for the quarter ended June 30, 1995,
and increased 82% to $1,774,000 for the six months ended June 30, 1996 from
$973,000 for the six months ended June 30, 1995. These increases are due
primarily to the continued expansion of the Company's network. In particular,
the number of units located at radio stations at June 30, 1996 has increased by
approximately 55% from the number at June 30, 1995, and the capital investment
in the Company's Network Operating Center increased by $1.2 million, or
approximately 102%, between June 30, 1995 and June 30, 1996.
The Company expects to continue to invest in the expansion of its
network.* The Company also intends to develop a similar infrastructure within
the television broadcast industry that will require additional, more costly,
terminals to be built and installed in television stations.* The Company expects
depreciation and amortization to increase in absolute dollars in proportion to
this growth.* However, there can be no assurance that the Company will make such
investments or that investments will result in future revenue growth.
10
<PAGE> 11
Interest Income and Interest Expense
Interest income increased by $350,000 to $434,000 in the quarter ended
June 30, 1996 from $84,000 for the quarter ended June 30, 1995, and increased by
$516,000 to $697,000 for the six months ended June 30, 1996 from $181,000 for
the six months ended June 30, 1995. These increases are primarily due to income
derived from the short term investment of the $29.5 million of proceeds from the
Company's initial public offering, which was completed in February 1996. The
Company expects that interest income will decrease in the future based on the
levels of cash used in the Company's operations.* See "Liquidity and Capital
Resources."
Interest expense increased 94% to $388,000 in the quarter ended June 30,
1996 from $200,000 for the quarter ended June 30, 1995, and increased 92% to
$715,000 for the six months ended June 30, 1996 from $373,000 for the six months
ended June 30, 1995. These increases are due to increased debt resulting from
lease agreements used to fund the acquisition of components and equipment needed
to develop the Company's network and to provide Company personnel with the
capital resources necessary to support the Company's business growth. Debt
outstanding under these agreements has increased to $7.9 million at June 30,
1996 from $4.2 million at June 30, 1995. The Company expects that interest
expense will increase in the future based on the increased levels of borrowing.*
See "Liquidity and Capital Resources."
Liquidity and Capital Resources
Net cash used in operating activities, including the adjustment for
depreciation and amortization, decreased to $2.4 million in the six months ended
June 30, 1996 from $2.9 million in the six months ended June 30, 1995. This
change is the result of a decrease in the net loss, exclusive of depreciation
and amortization, plus changes in working capital balances.
The Company used cash of $.6 million for the purchase of property and
equipment and acquired an additional $2.6 million of property and equipment
through capital lease obligations in the six months ended June 30, 1996. In the
six months ended June 30, 1995 all of the Company's property and equipment
acquisitions, $2.3 million, had been financed with capital lease obligations.
The capital additions in the six months ended June 30, 1996 were primarily due
to the Company's continued expansion of its network. The Company also invested
$.4 million in equipment necessary to support the growth of the Company's
operating, research, sales and marketing, and administrative staffs and $.3
million of leasehold improvements were completed in conjunction with the
relocation of the Company's headquarters, which was substantially complete by
the end of February 1996. In the future, the Company expects the proportion of
equipment acquisitions financed by capital leases to fluctuate based on such
issues as the cost and availability of lease financing for particular types of
equipment and the levels of cash used or generated by the Company's operating,
investing and financing activities. *
The Company completed its initial public offering in February 1996. The
net proceeds to the Company, after underwriting discounts and offering expenses
were $29,490,000. Principal payments on long-term debt were $994,000 in the six
months ended June 30, 1996 versus $364,000 in the six months ended June 30,
1995, reflecting the increase in regularly scheduled repayment of the increased
capital lease liability incurred to finance equipment and property acquisitions.
In January 1996 the Company completed an amendment to the Master Lease Agreement
with its primary lessor which increased the balance available under the
agreement by $6.0 million.
At June 30, 1996, the Company's current sources of liquidity included
cash and cash equivalents of $18.9 million, short-term investments of $12.8
million, and $4.4 million available for capital expenditures remaining under
lease agreements which expire in December 1996. The Company currently has no
significant capital commitments other than the commitments under capital leases.
The Company believes that its existing sources of liquidity will satisfy the
Company's projected working capital, capital lease and term loan commitments and
other cash requirements at least through 1996. * See "Certain Business
Considerations -- Future Capital Needs; Uncertainty of Additional Funding."
11
<PAGE> 12
CERTAIN BUSINESS CONSIDERATIONS
The Company's business is subject to the following risks and uncertainties, in
addition to those described above.
History of Losses; Future Operating Results Uncertain. The
Company was founded in 1991 and has been unprofitable since its inception and
expects to continue to generate net losses for a minimum of the next twelve
months. As of June 30, 1996, the Company's accumulated deficit was $23.5
million. The Company has had difficulty in accurately forecasting its future
sales and operating results due to its limited operating history. Accordingly,
although the Company has recently experienced significant growth in sales, such
growth rates may not be sustainable and should not be used as an indication of
future sales growth, if any, or of future operating results. The Company's
future success will depend in part on obtaining continued reductions in delivery
and service costs, particularly continued automation of order processing and
reductions in telecommunications costs.* There can be no assurance the Company's
sales will grow or be sustained in future periods or that the Company will
achieve or sustain profitability in any future period.
Potential Fluctuations in Quarterly Results; Seasonality. The
Company's quarterly operating results have in the past and may in the future
vary significantly depending on factors such as the volume of advertising in
response to seasonal buying patterns, the timing of new product and service
introductions, increased competition, the timing of the Company's promotional
efforts, general economic factors, and other factors. For example, the Company
has historically experienced lower sales in the first quarter and higher sales
in the fourth quarter, due to increased customer advertising volumes for the
Christmas selling season. As a result, the Company believes that period to
period comparisons of its results of operations are not necessarily meaningful
and should not be relied upon as an indication of future performance. In any
period, the Company's revenues and delivery costs are subject to variation based
on changes in the volume and mix of deliveries performed during the period. In
particular, the Company's operating results have historically been significantly
influenced by the volume of deliveries ordered by television stations during the
"Sweeps" rating periods that currently take place in February, May and November.
The increased volume of these deliveries during such periods and the Company's
pricing for "Sweeps" advertisements have historically increased the total
revenues and revenues per delivery of the Company and tended to reduce delivery
costs as a percentage of revenues. The Company's expense levels are based, in
part, on its expectations of future sales levels. If sales levels are below
expectations, operating results are likely to be materially adversely affected.
In addition, the Company has historically operated with little or no backlog.
The absence of backlog increases the difficulty of predicting sales and
operating results. Fluctuations in sales due to seasonality may become more
pronounced as the growth rate of the Company's sales slows. Due to the unique
nature of the Company's products and services, the Company believes that it will
incur significant expenses for sales and marketing, including advertising, to
educate potential customers about such products and services.*
Dependence on Radio Advertising. The Company's revenues to
date have been derived principally from a single line of business, the delivery
of radio advertising spots from advertising agencies, production studios and dub
and ship houses to radio stations in the United States, and such services are
expected to continue to account for a substantial majority of the Company's
revenues for some time.* A decline in demand for, or average selling prices of,
the Company's radio advertising delivery services, whether as a result of
competition from new advertising media, new product introductions or price
competition from competitors, a shift in purchases by customers away from the
Company's premium services such as DG Express, technological change or
otherwise, would have a material adverse effect on the Company's business,
operating results and financial condition. Additionally, the Company is
dependent upon its relationship with and continued support of the radio stations
in which it has installed communications equipment. Should a substantial number
of these stations go out of business or experience a change in ownership, it
could materially adversely affect the Company's business, operating results and
financial condition.
Dependence on New Product Introductions. The Company's future
growth depends on its successful and timely introduction of new products and
services in markets that do not currently exist or are just emerging. The
Company's goals are to introduce new services, such as the delivery of
first-play
12
<PAGE> 13
music singles, and the delivery of video advertising spots to television
stations. The Company is currently evaluating a number of technologies to be
used in designing a system for electronic air play verification. The Company is
also designing and developing, together with ABC Radio Networks, an extension to
the Company's existing network, including satellite transmission capabilities,
through which ABC could electronically distribute advertising and programming to
ABC's affiliate radio stations. The Company, however, has not yet completed
development of these products or services, and there can be no assurance that
the Company will successfully complete any such development, or that if such
development is completed, the Company's planned introduction of these products
and services will realize market acceptance or will meet the technical or other
requirements of potential customers. Moreover, unless the Company can
successfully develop video transmission services, it is unlikely that it can
retain current or attract future audio delivery customers who may ultimately
demand delivery of both media content.
Dependence on Emerging Markets. The market for the electronic
delivery of digital audio and video transmissions by advertisers, advertising
agencies, production studios, and video and music distributors to radio and
television stations, is relatively new and alternative technologies are rapidly
evolving. The Company's marketing task requires it to overcome buyer inertia
related to the diffuse and relatively low level decision making regarding an
agency's choice of delivery services, long standing relationships with existing
dub and ship vendors, and, currently, a service offering which is limited to
audio in contrast to customers' needs for both audio and video delivery.
Therefore, it is difficult to predict the rate at which the market for the
electronic delivery of digital audio and video transmissions will grow, if at
all. If the market fails to grow, or grows more slowly than anticipated, the
Company's business, operating results and financial condition will be materially
adversely affected. Even if the market does grow, there can be no assurance that
the Company's products and services will achieve commercial success. Although
the Company intends to conform its products and services to meet existing and
emerging standards in the market for the electronic delivery of digital audio
and video transmissions, there can be no assurance that the Company will be able
to conform its products to such standards in a timely fashion, or at all. The
Company believes that its future growth will depend, in part, on its ability to
add these services and additional customers in a timely and cost-effective
manner, and there can be no assurance that the Company will be successful in
developing such services, in obtaining new customers, or in obtaining a
sufficient number of radio and television stations, radio and television
networks, advertisers, advertising agencies, production studios, and audio and
video distributors who are willing to bear the costs of installing and
supporting the Company's field receiving equipment, including rooftop satellite
antennae.
The Company's limited marketing efforts to date with regard to
the Company's products and services have involved identification and
characterization of specific market segments for these products and services
with a view to determining the target markets that will be the most receptive to
such products and services. There can be no assurance that the Company has
correctly identified such markets or that its planned products and services will
address the needs of such markets. Furthermore, there can be no assurance that
the Company's technologies, in their current form, will be suitable for specific
applications or that further design modifications, beyond anticipated changes to
accommodate different markets, will not be necessary. Broad commercialization of
the Company's products and services will require the Company to overcome
significant market development hurdles, many of which may not currently be
foreseen.
Dependence on Technological Developments. The market for the
distribution of digital audio and video transmissions is characterized by
rapidly changing technology. The Company's ability to remain competitive and its
future success will depend in significant part upon the technological quality of
its products and processes relative to those of its competitors and its ability
both to develop new and enhanced products and services and to introduce such
products and services at competitive prices and in a timely and cost-effective
fashion. The Company's development efforts have been focused on the areas of
satellite transmission technology, video compression technology and air-play
verification technology. A 30-second video file is substantially larger than a
30-second audio file, and because this size video file cannot currently be
delivered over the telephone lines in a manner that is cost competitive with
tape delivery, the Company's ability to successfully introduce electronic video
delivery services depends on its ability to obtain satellite delivery capability
and broadcast quality compression. Work in satellite technology is oriented to
beta testing of software developed to permit enhancement of the current Receive
Playback Terminals ("RPTs") to receive digital satellite transmissions. Work in
video compression technology is
13
<PAGE> 14
directed toward integration and field trials of broadcast quality compression
systems with the Company's existing network. The Company has an agreement with
Hughes Network Systems, Inc. ("Hughes") which allows the Company to use Hughes'
satellite capacity for electronic delivery of digital audio transmissions by
that media. The Company is currently testing development stage software designed
to enhance and enable the current RPTs to receive digital satellite
transmissions over the Hughes satellite system. There can be no assurance that
the Company will successfully complete such tests or that the Hughes satellite
system will have the capacity to meet the Company's delivery commitments and
broadcast quality requirements. Work in air-play verification technology is
directed toward proving an active encoding technology which allows a unique
identifier to be decoded to a high degree of reliability. There can be no
assurance that these technologies can be developed or applied in a timely and
cost-effective manner.
In addition, the Company has entered into an agreement with
ABC Radio Networks ("ABC") to jointly develop an extension to the Company's
existing network, including satellite transmission capabilities, through which
ABC could electronically distribute advertising and programming to ABC's
affiliate radio stations. There can be no assurance that the Company will
successfully complete the design, development, prototyping, testing or
deployment of the audio server network for ABC. In addition, there can be no
assurance that ABC will successfully develop and deploy an enhanced satellite
network with the capacity to meet the delivery and audio quality requirements of
the audio server network.
The Company must rely substantially on third party vendors for
the development of these technologies and there can be no assurance that such
vendors will be able to develop such technologies in a manner that meets the
needs of the Company and its customers. The failure to implement these
technologies or to obtain licenses on favorable economic terms from other
vendors, individually or in combination, could have a material adverse effect on
the Company's prospects for future growth. There can be no assurance that the
Company will be successful in selecting, developing and implementing new
products or in enhancing its existing products and services on a timely basis or
at all, or that such products will achieve market acceptance. Moreover, the
introduction of products embodying new technologies can render existing products
obsolete or unmarketable. There can be no assurance that the Company will be
successful in identifying, developing, contracting for the manufacture of, and
marketing product enhancements or new products that respond to technological
change, that the Company will not experience difficulties that could delay or
prevent the successful development, introduction and marketing of these
products, or that its new products and product enhancements will adequately meet
the requirements of the marketplace and achieve market acceptance. Delays in the
commencement of commercial availability of new products and services and
enhancements to existing products and services may result in customer
dissatisfaction and delay or loss of revenue. If the Company is unable, for
technological or other reasons, to develop and introduce new products and
services or enhancements of existing products and services in a timely manner or
if new versions of existing products do not achieve a significant degree of
market acceptance, there could be a material adverse effect on the Company's
business, financial condition and results of operations.
Competition. The Company currently competes in the market for
the distribution of audio advertising spots to radio stations. The principal
competitive factors affecting this market are ease of use, price, timeliness and
accuracy of delivery. The Company competes with a variety of dub and ship houses
such as Mediatech and Spotlink and production studios that have traditionally
distributed taped advertising spots via physical delivery. Although such dub and
ship houses and production studios do not currently offer electronic delivery,
they have long-standing ties to local distributors that will be difficult for
the Company to replace. Some of these dub and ship houses and production studios
have greater financial, distribution and marketing resources and have achieved a
higher level of brand recognition than the Company. Moreover, Digital Courier
International Corporation has begun deployment of a system to electronically
deliver audio content in Canada and the United States and several other
companies have announced such systems. As a result, there can be no assurance
that the Company will be able to compete effectively against these competitors
merely on the basis of ease of use, timeliness and accuracy of delivery.
To the extent that the Company is successful in entering new
markets, such as video delivery to television stations and content delivery to
radio and television stations, it would expect to face competition from
companies in related communications markets and/or package delivery markets
which could offer
14
<PAGE> 15
products and services with functionality similar or superior to that offered by
the Company's products and services. In addition, telecommunications providers
such as AT&T, MCI and Regional Bell Operating Companies could enter the market
as competitors with materially lower electronic delivery transportation costs.
The Company could also face competition from entities with package delivery
expertise such as Federal Express, United Parcel Service, DHL and Airborne if
any such companies enter the electronic data delivery market. Radio networks
such as ABC or Westwood One could also become competitors by selling and
transmitting advertisements as a complement to their content programming. In the
market for the electronic distribution of digital video transmissions to
television stations, the Company would expect to encounter competition from
CycleSat, Indenet and Broadcast One, in addition to dub and ship houses and
production studios, certain of which currently function as marketing partners
with the Company in the audio distribution market.
Many of the Company's current and potential competitors in the
markets for audio and video transmissions have substantially greater financial,
technical, marketing and other resources and larger installed customer bases
than the Company. There can be no assurance that the Company will be able to
compete successfully against current and future competitors based on these and
other factors. The Company expects that an increasingly competitive environment
will result in price reductions that could result in reduced unit profit margins
and loss of market share, all of which would have a material adverse effect on
the Company's business, results of operations and financial condition. Moreover,
the market for the distribution of audio and video transmissions has become
increasingly concentrated in recent years as a result of acquisitions, which are
likely to permit many of the Company's competitors to devote significantly
greater resources to the development and marketing of new competitive products
and services. The Company expects that competition will increase substantially
as a result of these and other industry consolidations and alliances, as well as
the emergence of new competitors. There can be no assurance that the Company
will be able to compete successfully with new or existing competitors or that
competitive pressures faced by the Company will not materially and adversely
affect its business, operating results and financial condition.
Ability to Maintain and Improve Service Quality. The Company's
business is dependent on its ability to make deliveries to broadcast stations
within the time periods requested by customers. Any failure to do so, whether or
not within the control of the Company, could result in an advertisement not
being run and in the station losing air-time which it could have otherwise sold.
Although the Company disclaims any liability for lost air-time, there can be no
assurance that claims by stations for lost air-time would not be asserted in
these circumstances or that dissatisfied advertisers would refuse to make
further deliveries through the Company in the event of a significant occurrence
of lost deliveries, either of which would have a material adverse effect on the
Company's business, results of operations and financial condition. Although the
Company maintains insurance against business interruption, there can be no
assurance that such insurance will be adequate to protect the Company from
significant loss in these circumstances or that a major catastrophe (such as an
earthquake or other natural disaster) would not result in a prolonged
interruption of the Company's business. In particular, the Company's network
operating center is located in the San Francisco Bay area, which has in the past
and may in the future experience significant, destructive seismic activity that
could damage or destroy the Company's network operating center. In addition, the
Company's ability to make deliveries to stations within the time periods
requested by customers depends on a number of factors, some of which are outside
of its control, including equipment failure, interruption in services by
telecommunications service providers, and the Company's inability to maintain
its installed base of Record Send Terminals ("RSTs") and RPTs that comprise its
distribution network. The result of the Company's failure to make timely
deliveries for whatever reason could be that dissatisfied advertisers would
refuse to make further deliveries through the Company which would have a
material adverse effect on the Company's business, results of operations and
financial condition.
Ability to Manage Growth. The Company has recently experienced
a period of rapid growth that has resulted in new and increased responsibilities
for management personnel and has placed and continues to place a significant
strain on the Company's management, operating and financial systems and
resources. To accommodate this recent growth and to compete effectively and
manage future growth, if any, the Company will be required to continue to
implement and improve its operational, financial and management information
systems, procedures and controls on a timely basis and to expand, train,
motivate and manage its work force. In particular, the Company believes that to
achieve these objectives it must complete its
15
<PAGE> 16
automation of the customer order entry process and the integration of the
delivery fulfillment process into the customer billing system. There can be no
assurance that the Company's personnel, systems, procedures and controls will be
adequate to support the Company's existing and future operations. Any failure to
implement and improve the Company's operational, financial and management
systems or to expand, train, motivate or manage employees could have a material
adverse effect on the Company's business, operating results and financial
condition.
Future Capital Needs; Uncertainty of Additional Funding. The
Company intends to continue making capital expenditures to produce and install
RSTs and RPTs and to introduce additional services.* Based on current plans and
assumptions relating to the timing of its operations, the Company anticipates
that the net proceeds of its initial public offering completed on February 9,
1996, together with its existing capital and cash from operations, will be
adequate to satisfy its capital requirements through at least the end of 1996.*
There can be no assurance, however, that the net proceeds of the Company's
initial public offering and such other sources of funding will be sufficient to
satisfy the Company's future capital requirements. Based on its current business
plan, the Company anticipates that it will eventually use the entire proceeds of
its initial public offering and there can be no assurance that other sources of
funding will be adequate to fund the Company's capital needs, which depend upon
numerous factors, including the progress of the Company's product development
activities, the cost of increasing the Company's sales and marketing activities
and the amount of revenues generated from operations, none of which can be
predicted with certainty. There can be no assurance that the Company will not
require additional capital sooner than currently anticipated. In addition, the
Company is unable to predict the precise amount of future capital that it will
require and there can be no assurance that any additional financing will be
available to the Company on acceptable terms, or at all. The inability to obtain
required financing would have a material adverse effect on the Company's
business, financial condition and results of operations. Consequently, the
Company could be required to significantly reduce or suspend its operations,
seek a merger partner or sell additional securities on terms that are highly
dilutive to existing investors.
Expansion into International Markets. Although the Company's
plans include expansion of its operations to Europe and Asia, it does not at
present have network operating center personnel experienced in operating in
these locations.* Telecommunications standards in foreign countries differ from
those in the United States and may require the Company to incur substantial
costs and expend significant managerial resources to obtain any necessary
regulatory approvals and comply with differing equipment interface and
installation standards promulgated by regulatory authorities of those countries.
Changes in government policies, regulations and telecommunications systems in
foreign countries could require the Company's products and services to be
redesigned, causing product and service delivery delays that could materially
adversely affect the Company's operating results. The Company's ability to
successfully enter these new markets will depend, in part, on its ability to
attract personnel with experience in these locations and to attract partners
with the necessary local business relationships.* There can be no assurance,
however, that the Company's products and services will achieve market acceptance
in foreign countries. The inability of the Company to successfully establish and
expand its international operations may also limit its ability to obtain
significant international revenues and could materially adversely affect the
business, operating results and financial condition of the Company. Furthermore,
international business is subject to a number of country-specific risks and
circumstances, including different tax laws, difficulties in expatriating
profits, currency exchange rate fluctuations, and the complexities of
administering business abroad. Moreover, to the extent the Company increases its
international sales, the Company's business, operating results and financial
condition could be materially adversely affected by these risks and
circumstances, as well as by increases in duties, price controls or other
restrictions on foreign currencies, and trade barriers imposed by foreign
governments, among other factors.
Dependence on Key Personnel. The Company's success depends to
a significant degree upon the continuing contributions of, and on its ability to
attract and retain, qualified management, sales, operations, marketing and
technical personnel. The competition for qualified personnel is intense and the
loss of any of such persons, as well as the failure to recruit additional key
personnel in a timely manner, could adversely affect the Company. There can be
no assurance that the Company will be able to continue to attract and retain
qualified management, sales and technical personnel for the development of its
business. The Company generally has not entered into employment or
noncompetition agreements with any of its employees. The Company does not
maintain key man life insurance on the lives of any of its key
16
<PAGE> 17
personnel. The Company's failure to attract and retain key personnel could have
a material adverse effect on its business, operating results and financial
condition.
Dependence on Certain Suppliers. The Company relies on certain
single or limited-source suppliers for certain integral components used for the
assembly of the Company's RSTs and RPTs. Although the Company's suppliers are
generally large, well-financed organizations, in the event that a supplier were
to experience financial or operational difficulties that resulted in a reduction
or interruption in component supply to the Company, it would delay the Company's
deployment of RSTs and RPTs which would have the effect of depressing the
Company's business until the Company established sufficient component supply
through an alternative source. The Company believes that there are alternative
component manufacturers that could supply the components required to produce the
Company's products, but the Company is not currently pursuing agreements or
understandings with such alternative sources. If a reduction or interruption of
supply were to occur, it could take a significant period of time for the Company
to qualify an alternative subcontractor, redesign its products as necessary and
contract for the manufacture of such products. The Company does not have
long-term supply contracts with its sole- or limited-source vendors and
purchases its components on a purchase order basis. The Company has experienced
component shortages in the past and there can be no assurance that material
component shortages or production or delivery delays will not occur in the
future. The inability in the future to obtain sufficient quantities of
components in a timely manner as required, or to develop alternative sources as
required, could result in delays or reductions in product shipments or product
redesigns, which would materially and adversely affect the Company's business,
operating results and financial condition.
Pursuant to its development efforts in the area of satellite
transmission technology, the Company is currently conducting live field trials
of software designed to enhance and enable the current RPTs to receive digital
satellite transmissions over the Hughes satellite system. The Company's
dependence on Hughes entails a number of significant risks. The Company's
business, results of operations and financial condition would be materially
adversely affected if Hughes were unable for any reason to meet the Company's
delivery commitments or if any transmissions failed to satisfy the Company's
quality requirements. In the event that the Company were unable to continue to
use Hughes' satellite capacity, the Company would have to identify, qualify and
transition deliveries to an acceptable alternative satellite transmission
vendor. This identification, qualification and transition process could take six
months or longer, and no assurance can be given that an alternative satellite
transmission vendor would be available to the Company or be in a position to
satisfy the Company's delivery requirements on a timely and cost-effective
basis.
The Company obtains its local access telephone transmission
services through Teleport Communications Group. The Company obtains its long
distance telephone access through an exclusive contract with MCI which expires
in 1997. Any material interruption in the supply of either local access or long
distance carrier service could have a material adverse effect on the Company's
business, results of operations and financial condition.
Dependence on Proprietary Technology, Protection of
Trademarks, Copyrights, and Other Proprietary Information; Risk of Third Party
Claims of Infringement. The Company considers its trademarks, copyrights,
advertising, and promotion design and artwork to be of value and important to
its business. The Company relies on a combination of trade secret, copyright and
trademark laws and nondisclosure and other arrangements to protect its
proprietary rights. The Company does not have any patents or patent applications
pending. Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy or obtain and use information that the
Company regards as proprietary. There can be no assurance that the steps taken
by the Company to protect its proprietary information will prevent
misappropriation of such information and such protection may not preclude
competitors from developing confusingly similar brand names or promotional
materials or developing products and services similar to those of the Company.
In addition, the laws of some foreign countries do not protect the Company's
proprietary rights to the same extent as do the laws of the United States. While
the Company believes that its trademarks, copyrights, advertising and promotion
design and artwork do not infringe upon the proprietary rights of third parties,
there can be no assurance that the Company will not receive future
communications from third parties asserting that the Company's trademarks,
copyrights, advertising and promotion design and artwork infringe, or may
infringe, on the proprietary rights of third
17
<PAGE> 18
parties. Any such claims, with or without merit, could be time-consuming,
require the Company to enter into royalty arrangements or result in costly
litigation and diversion of management personnel. No assurance can be given that
any necessary licenses can be obtained or that, if obtainable, such licenses can
be obtained on commercially reasonable terms. In the event of a successful claim
of infringement against the Company and failure or inability of the Company to
license the infringed or similar proprietary information, the Company's
business, operating results and financial condition could be materially
adversely affected.
Concentration of Stock Ownership; Potential Issuance of
Preferred Stock; Anti-Takeover Provisions. The present executive officers and
directors of the Company and their affiliates own approximately 37% of the
Company's Common Stock. As a result, these shareholders will be able to control
or significantly influence all matters requiring shareholder approval, including
the election of directors and approval of significant corporate transactions.
Such concentration of ownership may have the effect of delaying or preventing a
change in control of the Company. In addition, the Company's Board of Directors
has the authority to issue up to 5,000,000 shares of Preferred Stock and to
determine the price, rights, preferences, privileges and restrictions thereof,
including voting rights, without any further vote or action by the Company's
shareholders. Although the Company has no current plans to issue any shares of
Preferred Stock, the rights of the holders of Common Stock would be subject to,
and may be adversely affected by, the rights of the holders of any Preferred
Stock that may be issued in the future. Issuance of Preferred Stock could have
the effect of delaying, deferring or preventing a change in control of the
Company. Furthermore, certain provisions of the Company's Articles of
Incorporation and Bylaws and of California law could have the effect of
delaying, deferring or preventing a change in control of the Company.
Possible Volatility of Share Price. The trading prices of the
Company's Common Stock may be subject to wide fluctuations in response to a
number of factors, including variations in operating results, changes in
earnings estimates by securities analysts, announcements of extraordinary events
such as litigation or acquisitions, announcements of technological innovations
or new products or services by the Company or its competitors, as well as
general economic, political and market conditions. In addition, stock markets
have experienced extreme price and volume trading volatility in recent years.
This volatility has had a substantial effect on the market prices of the
securities of many high technology companies for reasons frequently unrelated to
the operating performance of specific companies. These broad market fluctuations
may adversely affect the market price of the Company's Common Stock.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time the Company has been, or may become,
involved in litigation proceedings incidental to the conduct of its business.
The Company does not believe that any such proceedings presently pending will
have a material adverse affect on the Company's financial position or its
results of operations.*
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
18
<PAGE> 19
ITEM 5. OTHER INFORMATION
As a result of a change in the Company's management structure,
the Company and John Blair, Vice President--Internet Services, agreed to end his
employment relationship with the Company effective July 26, 1996.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER EXHIBIT TITLE
------ -------------
3.1 (d) Restated Articles of Incorporation of registrant.
3.2 (b) Bylaws of registrant, as amended to date.
4.1 (b) Form of Lock-Up Agreement.
4.2 (b) Form of Common Stock Certificate.
10.1 (b) 1992 Stock Option Plan (as amended) and forms of
Incentive Stock Option Agreement and Nonstatutory
Stock Option Agreement.
10.2 (b) Form of Directors' and Officers' Indemnification
Agreement.
10.3 (b) 1995 Director Option Plan and form of Incentive
Stock Option Agreement thereto.
10.4 (b) Form of Restricted Stock Agreement.
10.5.1 (c) Content Delivery Agreement between the Company
and Hughes Network Systems, Inc., dated November 28,
1995.
10.5.2 (c) Equipment Reseller Agreement between the Company
and Hughes Network Systems,
Inc., dated November 28, 1995.
10.6 (b) Amendment to Warrant Agreement between the
Company and Comdisco, Inc., dated January 31, 1996.
10.7.1 (c) Corporate Service Plan Agreement between
the Company and MCI Telecommunications
Corporation, dated March 23, 1994.
10.7.2 (c) First Amendment to Corporate Service Plan
Agreement between the Company and MCI
Telecommunications Corporation, dated November
2, 1995.
10.8 (b) Master Lease Agreement between the Company
and Comdisco, Inc., dated October 20, 1994, and
Exhibits thereto.
10.9 (b) Loan and Security Agreement between the
Company and Comdisco, Inc., dated October 20,
1994, and Exhibits thereto.
10.10 (b) Master Equipment Lease between the Company
and Phoenix Leasing, Inc., dated January 7,
1993.
10.15 (c) Audio Server Network Prototype Vendor
Agreement and Satellite Vendor Agreement
between the Company and ABC Radio Networks,
dated December 15, 1995.
10.16 (b) Employee Stock Purchase Plan (as amended).
10.17 (b) Promissory Note between the Company and
Henry W. Donaldson, dated March 18, 1994,
December 5, 1994, December 5, 1994, and March
14, 1995.
10.18 (b) Warrant Agreement to purchase Series B
Preferred Stock between the Company and
Comdisco, Inc., dated as of October 20, 1994.
10.19 (b) Warrant Agreement to purchase Series C
Preferred Stock between the Company and
Comdisco, Inc., dated as of June 13, 1995.
10.20 (b) Warrant Agreement to purchase Series D
Preferred Stock between the Company and
Comdisco, Inc., dated as of January 11, 1996.
10.21 (d) Lease for 9,809 rentable square feet at 855
Battery Street, San Francisco, California
between the Company and Westinghouse Electric
Corporation dated October 10, 1995 and exhibits
thereto.
10.22 (d) Agreement of Sublease for 9,434 rentable square feet
at 855 Battery Street, San Francisco, California
between the Company and T.Y. Lin International dated
September 8, 1995 and exhibits thereto.
19
<PAGE> 20
EXHIBIT Title
NUMBER
10.23(d) Agreement of Sublease for 5,613 rentable square
feet at 855 Battery Street, San Francisco, California
between the Company and Law\Crandall, Inc. dated
September 29, 1995 and exhibits thereto.
11.1 (a) Statements of computation of weighted average and
pro forma common shares and equivalents.
27 (a) Financial Data Schedule.
- - - - - - - - - - - -
(a) Filed herewith.
(b) Incorporated by reference to the exhibit bearing the
same number filed with registrant's Registration
Statement on Form S-1 (Registration No. 33-80203).
(c) Incorporated by reference to the exhibit bearing the
same number filed with registrant's Registration
Statement on Form S-1 (Registration No. 33-80203).
The registrant has received confidential treatment
with respect to certain portions of this exhibit.
Such portions have been omitted from this exhibit and
have been filed separately with the Securities and
Exchange Commission.
(d) Incorporated by reference to the registrant's
Quarterly Report on Form 10-Q filed May 3, 1996, as
amended.
(b) Reports on Form 8-K.
None.
20
<PAGE> 21
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.
DIGITAL GENERATION SYSTEMS, INC.
Dated: August 6, 1996 BY: /s/ THOMAS P. SHANAHAN
-------------------------------
Thomas P. Shanahan
Vice President & Chief Financial
Officer (Principal Financial and
Chief Accounting Officer)
21
<PAGE> 1
Exhibit 11.1
DIGITAL GENERATION SYSTEMS, INC.
STATEMENTS OF COMPUTATION OF WEIGHTED AVERAGE AND
PRO FORMA COMMON SHARES AND EQUIVALENTS
(in thousands, except for per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ------------------------
1996 1995 1996 1995
---- ---- ---- ----
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Net loss $ (2,087) $(2,003) $(4,475) $(4,116)
======== ======= ======= =======
Weighted average common shares outstanding 11,482 896 7,169 892
Weighted average common equivalent shares:
Weighted average preferred stock outstanding 6,693 3,637 6,693
Adjustments to reflect requirements of the Securities and Exchange-
Commission's Staff Accounting Bulletin No. 83:
Common stock issuances 195 98 195
Convertible preferred stock issuances 581 291 581
Preferred stock warrants 20 10 20
Common stock option grants 748 374 748
-------- ------- ------- -------
Total weighted average common shares and equivalents 11,482
========
Pro forma total weighted average common shares and equivalents 9,133 11,579 9,129
======= ======= =======
Net loss per share $ (0.18)
========
Pro forma net loss per share $ (0.22) $ (0.39) $ (0.45)
======= ======= =======
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
<CASH> 18,930
<SECURITIES> 12,817
<RECEIVABLES> 1,874
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 33,954
<PP&E> 12,794
<DEPRECIATION> (5,388)
<TOTAL-ASSETS> 41,836
<CURRENT-LIABILITIES> 4,949
<BONDS> 5,466
0
0
<COMMON> 55,068
<OTHER-SE> (23,647)
<TOTAL-LIABILITY-AND-EQUITY> 41,836
<SALES> 0
<TOTAL-REVENUES> 4,253
<CGS> 0
<TOTAL-COSTS> 8,710
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 60
<INTEREST-EXPENSE> 715
<INCOME-PRETAX> (4,475)
<INCOME-TAX> 0
<INCOME-CONTINUING> (4,457)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,475)
<EPS-PRIMARY> (.39)
<EPS-DILUTED> (.39)
</TABLE>
