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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 SEPTEMBER 30, 1997
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 OCTOBER 31, 1997: 12,116,221
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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>
PAGE
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<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.................................................................... 3
Condensed Consolidated Balance Sheets at September 30, 1997 and
December 31, 1996....................................................................... 3
Condensed Consolidated Statements of Operations for the three and nine months ended
September 30, 1997 and 1996............................................................. 4
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 1997 and 1996 ............................................................ 5
Notes to Condensed Consolidated Financial Statements ................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ..10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................................................... 24
Item 2. Changes in Securities.................................................................. 24
Item 3. Defaults Upon Senior Securities........................................................ 24
Item 4. Submission of Matters to a Vote of Security Holders.................................... 24
Item 5. Other Information...................................................................... 24
Item 6. Exhibits and Reports on Form 8-K....................................................... 25
SIGNATURES............................................................................. 27
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIGITAL GENERATION SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(Unaudited)
ASSETS
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents $ 9,241 $ 9,682
Short-term investments 2,989 10,915
Accounts receivable, net 7,584 3,349
Prepaid expenses and other 830 168
-------- --------
Total current assets 20,644 24,114
-------- --------
PROPERTY AND EQUIPMENT, at cost:
Network equipment 29,521 17,974
Office furniture and equipment 2,900 2,093
Leasehold improvements 405 353
-------- --------
32,826 20,420
Less - Accumulated depreciation and amortization (13,687) (7,790)
-------- --------
Property and equipment, net 19,139 12,630
-------- --------
GOODWILL AND OTHER ASSETS, net 26,003 8,504
-------- --------
$ 65,786 $ 45,248
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 5,607 $ 1,546
Accrued liabilities 3,503 2,174
Line of credit 2,493 --
Current portion of long-term debt 9,108 6,194
-------- --------
Total current liabilities 20,711 9,914
-------- --------
LONG-TERM DEBT, net of current portion 13,302 8,495
-------- --------
SHAREHOLDERS' EQUITY:
Convertible preferred stock, no par value -
Authorized -- 5,000,000
Outstanding -- 4,950,495 shares at September 30, 1997
and no shares outstanding at December 31, 1996 13,950 --
Common stock, no par value --
Authorized -- 30,000,000 shares
Outstanding -- 12,109,221 shares at September 30, 1997
and 11,653,625 shares at December 31, 1996 57,118 55,138
Receivable from issuance of common stock (175) (175)
Accumulated deficit (39,120) (28,124)
-------- --------
Total shareholders' equity 31,773 26,839
-------- --------
$ 65,786 $ 45,248
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
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DIGITAL GENERATION SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- --------------------
1997 1996 1997 1996
-------- -------- -------- --------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
REVENUES $ 8,798 $ 2,265 $ 18,809 $ 6,518
-------- -------- -------- --------
COSTS AND EXPENSES:
Delivery and material costs 3,886 694 7,174 2,021
Customer operations 3,241 904 7,480 2,772
Sales and marketing 1,232 905 3,373 2,858
Research and development 688 519 1,956 1,527
General and administrative 998 407 2,239 1,187
Depreciation and amortization 2,628 1,181 6,361 2,955
-------- -------- -------- --------
Total expenses 12,673 4,610 28,583 13,320
-------- -------- -------- --------
LOSS FROM OPERATIONS (3,875) (2,345) (9,774) (6,802)
-------- -------- -------- --------
OTHER INCOME (EXPENSE):
Interest income 138 399 604 1,096
Interest expense (762) (451) (1,826) (1,166)
-------- -------- -------- --------
NET LOSS $ (4,499) $ (2,397) $(10,996) $ (6,872)
======== ======== ======== ========
NET LOSS PER SHARE $ (0.37) $ (0.21) $ (0.93) $ (0.59)
======== ======== ======== ========
WEIGHTED AVERAGE COMMON AND
COMMON EQUIVALENT SHARES 12,035 11,575 11,818 11,577
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
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DIGITAL GENERATION SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPT 30, SEPT 30,
----------------------
1997 1996
-------- --------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(10,996) $ (6,872)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization of property and equipment 5,897 2,955
Amortization of goodwill and intangibles 465 --
Provision for doubtful accounts 106 75
Changes in operating assets and liabilities --
Accounts receivable 446 (470)
Prepaid expenses and other assets (424) 103
Accounts payable and accrued liabilities 351 322
-------- --------
Net cash used in operating activities (4,155) (3,887)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments (7,834) (19,340)
Maturities of short-term investments 15,760 6,372
Purchase of Mediatech (13,921) --
Acquisition of property and equipment (4,083) (900)
-------- --------
Net cash provided by (used in) investing activities (10,078) (13,868)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 74 29,563
Proceeds from issuance of preferred stock 13,950 --
Proceeds from line of credit 3,601 --
Payments on line of credit (4,283) --
Proceeds from short-term loans used to finance Mediatech acquisition 6,000 --
Repayment of short terms loans used to finance Mediatech acquisition (6,000) --
Proceeds from issuance of long-term debt 4,355 --
Payments on long-term debt (3,905) (1,595)
-------- --------
Net cash provided by (used in) financing activities 13,792 27,968
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (441) 10,213
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 9,682 6,205
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 9,241 $ 16,419
======== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Property and equipment financed with capitalized lease obligations $ 400 $ 5,588
Long term debt used to to finance Mediatech acquisition 3,850 --
Common Stock issued to finance Mediatech acquisition 1,906 --
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
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DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED 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 consolidated
financial statements should be read in conjunction with the financial statements
and the notes thereto included in the Company's financial statements included in
the Company's Annual Report on Form 10-K for the year ended December 31, 1996.
The unaudited condensed consolidated 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 nine month periods ended September 30, 1997. The results for the three
and nine month periods ended September 30, 1997 are not necessarily indicative
of the results expected for the full fiscal year.
2. ACQUISITIONS
PDR ACQUISITION
On November 8, 1996 the Company completed the acquisition of 100% of the stock
of PDR Productions, Inc. ("PDR"), a media duplication and distribution company
located in New York City, for consideration totaling $9.0 million. The
consideration was $6.5 million in cash and a $2.5 million promissory note with
interest payable at 8%. The note and accrued interest were paid in November
1997. The acquisition was accounted for as a purchase. The net book value of
assets and liabilities acquired was approximately $1.5 million. The excess of
purchase price and acquisition costs over the net book value of assets acquired
(including customer list, covenant not to compete and goodwill) of approximately
$7.9 million, has been included in Goodwill and Other Assets in the accompanying
consolidated balance sheet and is being amortized over a twenty year period.
Amortization of approximately $ 107,000 and $321,000 is included in the
consolidated statement of operations for the three and nine month periods ended
September 30, 1997. The operating results of PDR have been included in the
consolidated results of the Company from the date of the closing of the
transaction, November 8, 1996.
MEDIATECH ACQUISITION
On July 18, 1997, the Company acquired 100% of the capital stock of Starcom
Mediatech, Inc. ("Mediatech"), a wholly owned subsidiary of IndeNet, Inc.
("IndeNet"), for consideration totaling approximately $25.8 million ("Mediatech
Acquisition"). The consideration consisted of approximately $14.0 million in
cash, 324,355 shares of the Company's Common Stock, a $2.2 million subordinated
promissory note bearing interest at 9% payable to IndeNet (the "Company Note"),
a $2.2 million secured subordinated promissory note bearing interest at 9%
payable to Thomas H. Baur, a creditor of IndeNet (the "Baur Note"), and the
Company assumed approximately $5.4 million of existing Mediatech debt. Mediatech
is a media duplication and distribution company whose principal offices are
located in Chicago, Illinois.
On October 27, 1997, as provided for in the purchase agreement, the Company and
IndeNet agreed to reduce the aggregate purchase price by $625,000 based on
Mediatech's financial position at the acquisition date. The Company and IndeNet
entered into an agreement which provides that the adjustment will be made in the
form of a $25,000 immediate cash payment by IndeNet to the Company and a
reduction of the aggregate principal amount payable under the Company Note by an
amount equal to $600,000.
6
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DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Mediatech acquisition was accounted for as a purchase. The excess of
purchase price and acquisition costs over the net book value of assets acquired
of approximately $17.8 million, has been included in Goodwill and Other Assets
in the accompanying consolidated balance sheet and is being amortized over a
twenty year period. Amortization of approximately $144,000 is included in the
consolidated statement of operations for the three and nine month periods ended
September 30, 1997. The operating results of Mediatech have been included in the
consolidated results of the Company from the date of the closing of the
transaction, July 18, 1997.
Additionally, the Company granted IndeNet the right to request the registration
of the shares received in the transaction under the Securities Act of 1933, as
amended, in the event that the anticipated offering price of a registered sale
of such shares exceeds $500,000 in the aggregate, or in the event that the
Company registers any securities for its own account or the account of any other
security holders of the Company. Such registration rights, however, may not be
exercised until July 14, 1998, and are subject to certain restrictions resulting
from underwriting limitations on the size of a registered sale of the Company's
securities.
The Company Note, as amended, matures on March 31, 2001, and is payable in
installments of $150,000 principal plus accrued interest commencing on December
31, 1997. Subsequent payments are due June 30, 1998; December 31, 1998; and June
30, 1999; to be followed by quarterly payments until the note is paid in full on
March 31, 2001. The Baur Note, which matures on January 1, 2000, is also payable
in installments. The first installment of $350,000 was paid July 30, 1997;
subsequent installments of $200,000 of principal plus accrued interest are due
quarterly commencing January 1, 1998.
The Company drew upon two sources of funds to finance the cash portion of the
consideration for the Mediatech Acquisition. An entity affiliated with Kleiner
Perkins Caufield & Byers and another affiliated with Dawson-Samberg Capital
Management, Inc. each provided the Company with a $3.0 million cash loan in
exchange for a promissory note, each in the aggregate principal amount of $3.0
million and bearing interest at the rate of 10% per annum. The Company funded
the remaining portion of the cash consideration for the Mediatech Acquisition
from its internal cash reserves.
PRO FORMA RESULTS
The following table reflects unaudited pro forma combined results of operations
of the Company including PDR and Mediatech on the basis that the acquisitions of
both PDR and Mediatech had taken place at the beginning of the first fiscal
period presented:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
1997 1996 1997 1996
---- ---- ---- ----
(In thousands except per share data)
<S> <C> <C> <C> <C>
Revenues ................................ $ 8,798 $ 9,729 $ 30,755 $ 29,165
Net Loss ................................ ($ 4,499) ($ 4,474) ($12,635) ($10,332)
Net Loss per Share ...................... ($ .37) ($ .39) ($ 1.07) ($ .89)
Number of Shares used in Computation .... 12,035 11,575 11,818 11,577
</TABLE>
7
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DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. RECENT PRONOUNCEMENTS
In July 1997, the Statement of Financial Accounting Standards No. 130 "Reporting
Comprehensive Income" was issued and is effective for fiscal years ending after
December 15, 1997. Adoption of this standard is not expected to have a material
effect on the Company's financial statements.
In June 1997, the FASB also issued Statement of Financial Accounting Standards
No. 131 "Disclosures about Segments of an Enterprise and Related Information"
which establishes standards for reporting information about operating segments.
Adoption of this standard is not expected to have a material impact on the
Company's financial statements.
4. 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 using the amortized cost method. 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 September 30,
1997 and December 31, 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 September 30,
1997 and December 31, 1996, short-term investments consist principally of U.S.
Treasury bills and commercial paper and amortized cost approximates the fair
market value of these instruments at these balance sheet dates.
5. NET LOSS PER SHARE
Net loss per share for the three months ended September 30, 1997 and September
30, 1996, and the nine months ended September 30, 1997 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 nine months ended September 30, 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 February 1996 Form S-1 filing date as
if they were outstanding through the end of the quarter in which the offering
was completed, 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.
In February 1997, the FASB issued SFAS No. 128, Earnings Per Share, which
simplifies the standards for computing earnings per share previously found in
Accounting Principles Board Opinion ("APBO") No. 15. SFAS No. 128 replaces the
presentation of primary earnings per share with a presentation of basic earnings
per share, which excludes dilution. SFAS No. 128 also requires dual presentation
of basic and diluted earnings per share on the face of the income statement for
all entities with complex capital structures and requires a reconciliation.
Diluted earnings per share is computed similarly to fully diluted earnings per
share pursuant to APBO No. 15. SFAS No. 128 must be adopted for financial
statements issued for periods ending after December 15, 1997, including interim
period; earlier application is not permitted.
8
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DIGITAL GENERATION SYSTEMS, INC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SFAS No. 128 requires restatement of all prior period earnings per share
presented. The Company does not anticipate that SFAS No. 128 will have a
material impact on its earnings per share calculation.
6. LONG TERM DEBT
In January 1997, the Company completed an agreement to finance an additional
$6.0 million of equipment purchases through a long-term credit facility which
can be drawn against through December 31, 1997. In October 1997 the term of the
agreement was extended to June 30, 1998. Warrants to purchase 112,500 shares of
the Company's Common Stock at a price of $8.00 per share were issued to the
lender in January per the terms of agreement, and the warrants were subsequently
repriced at $4.51 per share in October 1997 in return for an extension of the
term of the agreement. The value of the warrants at the date of issuance and at
the date of repricing was nominal; therefore no value was assigned to the
warrants for accounting purposes.
7. PREFERRED STOCK AGREEMENT
On July 14, 1997, the Company entered into a Preferred Stock Purchase Agreement,
as amended on July 23, 1997 (as amended, the "Stock Purchase Agreement"), with
certain investors. The Company agreed to issue and sell, in two tranches, up to
an aggregate of 4,950,495 shares of its Series A Convertible Preferred Stock for
aggregate consideration of approximately $17.5 million in cash, or $3.535 per
share. The Company closed the first of such tranches on July 28, 1997 in which
it issued and sold an aggregate of 2,012,376 shares of its Series A Convertible
Preferred Stock for aggregate consideration of approximately $7,113,751 in cash.
The Company used the proceeds of this first tranche to repay the entire amount
owed under the promissory notes issued in favor of Kleiner Perkins Caulfield &
Byers and Dawson-Samberg Capital Management in connection with the Mediatech
Acquisition. The Company closed the second of such tranches on August 26-27,
1997 in which it issued and sold an aggregate of 2,938,119 shares of its Series
A Convertible Preferred Stock for aggregate consideration of approximately
$10,386,251 in cash. The Company used the proceeds from the sale of such shares
in the second tranche to replenish the cash reserves expended by the Company to
fund a portion of the cash consideration for the Mediatech Acquisition.
Pursuant to the Stock Purchase Agreement, fourteen percent (14%) of the proceeds
of the sale of Series A Convertible Preferred Stock was deposited in an escrow
account. These proceeds will be disbursed to the Company if certain sales and
performance goals are met by December 31, 1997. If these goals are not met, the
purchasers shall have the option to instruct the escrow agent to return one
eighth (1/8) of the deposit amount to the purchasers on a quarterly basis,
beginning on March 31, 1998, until the deposit amount has been fully distributed
or until the public market price of the Company's Common Stock exceeds the then
applicable conversion price of the Series A Convertible Preferred Stock
(currently equal to the $3.534 issue price) multiplied by two for at least 25
days out of 40 consecutive trading days as defined in the Stock Purchase
Agreement, at which time the balance remaining in escrow would be disbursed to
the Company.
9
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis of Financial
Condition and Results of Operations contains forward-looking statements 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 period 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."
STATEMENTS OF OPERATIONS:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- -------------------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues ..................... 100.0% 100.0% 100.0% 100.0%
Costs and Expenses:
Delivery and material costs . 44.2 30.6 38.1 31.0
Customer operations ......... 36.8 39.9 39.8 42.5
Sales and marketing ......... 14.0 40.0 17.9 43.8
Research and development .... 7.8 22.9 10.4 23.4
General and administrative .. 11.3 18.0 12.0 18.4
Depreciation and amortization 29.9 52.1 33.8 45.3
------- ------- ------- -------
Total expenses ........... 144.0 203.5 152.0 204.4
------- ------- ------- -------
Loss from operations ......... (44.0) (103.5) (52.0) (104.4)
Other income (expense):
Interest income ............ 1.6 17.6 3.2 16.8
Interest expense ........... (8.7) (19.9) (9.7) (17.8)
------- ------- ------- -------
Net loss ..................... (51.1%) (105.8%) (58.5%) (105.4%)
======= ======= ======= =======
OPERATING DATA:
Deliveries ................... 356,000 184,000 886,000 520,000
</TABLE>
Revenues
Revenues were $8,798,000 for the three months ended September 30, 1997,
a 288% increase from $2,265,000 for the three months ended September 30, 1996.
The increase is primarily due to a 93% increase in the volume of spot
advertising deliveries, including those made from PDR and Mediatech, and an
increase in average revenue per delivery versus the prior year. The Company made
356,000 and 184,000 deliveries in the three months ended September 30, 1997 and
1996, respectively. In addition, primarily as a result of the acquisition of
Mediatech, the Company recorded revenue of approximately $2.1 million for
services other than spot delivery, primarily tape duplication for the corporate
market and satellite uplink for the syndication market, in the quarter ended
September 30, 1997. Revenues and
10
<PAGE> 11
deliveries for the nine months ended September 30, 1997 increased to $18,809,000
and 886,000, respectively, from $6,518,000 and 520,000, respectively, for the
nine months ended September 30, 1996, which included approximately $2.7 million
of revenue for services other than spot delivery.
The increases in delivery volume are the result of additional
deliveries made through the DG Systems Network Operating Center ("NOC") and the
addition of deliveries made from PDR, acquired in November 1996, and Mediatech,
acquired in July 1997. Additional deliveries made through the NOC accounted for
approximately 37% and 34% of the volume increase in the quarter and nine months
ended September 30, 1997, respectively, versus the same periods in the prior
year. The Company believes that the increase in the volume of deliveries made
through the NOC is due to a number of factors, including the increased
acceptance of the services offered by the Company, the increased availability of
an expanded network of Company equipment located in broadcast stations, and the
ability to provide electronic distribution services to customers of Mediatech
and PDR.
Average revenue per spot delivery increased to $18.86 and $18.21 in the
quarter and nine months ended September 30, 1997, respectively, from $12.31 and
$12.53 in the quarter and nine months ended September 30, 1996, respectively.
The increases are primarily due to the addition of video deliveries and related
services to the delivery mix. All deliveries performed in the first nine months
of 1996 were deliveries of audio content. The retail list prices for the
delivery of the first video spot are as much as 50% to 100% greater than those
for an audio delivery and can be significantly higher, depending upon the level
of value added services (editing, close captioning, etc.) that may be included
in an order. In the quarter ended September 30, 1997, video deliveries and
related services accounted for approximately 29% of total deliveries and 38% of
total revenue, including approximately 80,000 video deliveries and $3.0 million
of the spot video revenue recorded by PDR and Mediatech. In the nine months
ended September 30, 1997, video deliveries and related services accounted for
approximately 22% of total deliveries and 36% of total revenue, including
approximately 164,000 video deliveries and $6.1 million of spot video revenue
recorded by PDR and Mediatech.
Average revenue per audio delivery increased to $13.41 and $13.70 in the
quarter and nine months ended September 30, 1997, respectively, from $12.31 and
$12.53 in the quarter and nine months ended September 30, 1996, respectively.
These increases are due primarily to an increased proportion of deliveries made
using the Company's Priority and Express services, which provide delivery within
one hour and four hours, respectively. Such deliveries accounted for
approximately 11% and 12% of audio volume in the quarter and nine months ended
September 30, 1997 versus approximately 12% and 10% of audio volume in the
quarter and nine months ended September 30, 1996, respectively. The Priority
service, which accounted for approximately 4% and 3% of audio volume in the
quarter and nine months ended September 30, 1997, respectively, was introduced
in the fourth quarter of 1996.
Delivery and Material Costs
Delivery and material costs were $3,886,000 and $694,000 for the
quarters ended September 30, 1997 and 1996, respectively, and $7,174,000 and
$2,021,000 for the nine months ended September 30, 1997 and 1996, respectively.
The 460% increase of delivery and material costs in the quarter ended September
30, 1997 over the same period in the prior year and the 255% increase for the
nine months ended September 30, 1997 over the same period of the prior year is
due to the increased volume of video deliveries, in particular video deliveries
dubbed and shipped from PDR and Mediatech, as well as the increased volume of
audio and video deliveries performed through the Company's NOC. The increased
costs include both delivery expenses and the direct materials costs required
when physically duplicating an audio or video spot. Such material costs are not
required in the case of electronic delivery. Additionally, costs related to
revenues other than spot delivery totaled approximately $1.3 million in the
quarter and nine months ended September 30, 1997, respectively.
Delivery and material costs as a percentage of revenues increased to
44% of revenues from 31% of revenues in the quarters ended September 30, 1997
and 1996, respectively, and increased to 38% of revenues from 31% of revenues in
the nine months ended September 30, 1997 and 1996, respectively. The increases
in delivery and material costs as a percentage of revenues are due to the
increased proportion of
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video deliveries in the delivery mix, most of which were performed physically by
PDR and Mediatech, and the additional costs incurred for services provided other
than spot delivery. All delivery and material costs in the periods ended
September 30, 1996 had been for the delivery of spot audio content. Delivery and
material costs as a percentage of audio delivery revenues was approximately the
same in the quarter and nine months ended September 30, 1997, 32% and 31%,
respectively, as in the same periods of the prior year because improvements in
costs as a percentage of revenue of audio spots delivered electronically were
offset by the increased costs of audio deliveries performed physically by
Mediatech and PDR and the additional costs incurred by the Company as a result
of the UPS strike in August. Video delivery and material costs as a percentage
of revenues were approximately 45% and 46% in the quarter and nine months ended
September 30, 1997, respectively, and such costs related to revenue other than
spot delivery were approximately 63% and 46% of the related revenues for the
quarter and nine months ended September 30, 1997, respectively.
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 were $3,241,000 and $904,000 for the
quarters ended September 30, 1997 and 1996, respectively, and $7,480,000 and
$2,772,000 for the nine months ended September 30, 1997 and 1996, respectively.
These increases are primarily the result of the consolidation of the costs of
PDR and Mediatech operations. In addition, these expenses have increased versus
the same periods of the prior year due to the addition of the personnel
necessary to establish the operational capacity to support growth in the
electronic video delivery business. These additional costs include the costs,
primarily labor expenses, of personnel involved in assembly of Advantage Video
Playback Systems ("DVPSs") as well as customer and technical support.
Customer operations expenses as a percentage of revenues decreased to
37% of revenues from 40% of revenues in the quarters ended September 30, 1997
and 1996, respectively, and decreased to 40% of revenues from 43% of revenues in
the nine months ended September 30, 1997 and 1996, respectively. These decreases
in customer operations expenses as a percentage of revenue are primarily the
result of improved efficiency in performing audio deliveries which has reduced
the related customer operations costs as the Company has realized the benefits
of economies of scale from the increased volume of audio deliveries and has also
improved the efficiency of its order processing procedures. These cost
reductions in the processing of audio orders and maintaining the audio units of
the network have more than offset the impact of the relatively more expensive
customer operations expenses of PDR and Mediatech which were 37% and 42% of
combined PDR and Mediatech revenues in the quarter and nine months ended
September 30, 1997, respectively.
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 necessary 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."
Sales and Marketing
Sales and marketing expenses increased 36% to $1,232,000 for the quarter
ended September 30, 1997, from $905,000 for the quarter ended September 30,
1996, and increased 18% to $3,373,000 in the nine months ended September 30,
1997 from $2,858,000 in the nine months ended September 30, 1996. The increase
in sales and marketing expenses in the quarter and nine months ended September
30, 1997 is due primarily to the consolidation of the costs of the PDR and
Mediatech sales groups.
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
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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 33% to $688,000 for the
quarter ended September 30, 1997, from $519,000 for the quarter ended September
30, 1996, and increased 28% to $1,956,000 in the nine months ended September 30,
1997 from $1,527,000 in the nine months ended September 30, 1996. These
increases are due primarily to the compensation expense associated with hiring
and retaining engineering staff and the testing costs, principally frame relay
and satellite transmissions, incurred in the continuing enhancement of the
network for the transmission of video content.
The Company expects that research and development expenses will
increase in absolute dollars and may fluctuate as a percentage of revenue in
future periods.*
General and Administrative
General and administrative expenses increased 145% to $998,000 for the
quarter ended September 30, 1997, from $407,000 for the quarter ended September
30, 1996, and increased 89% to $2,239,000 in the nine months ended September 30,
1997 from $1,187,000 in the nine months ended September 30, 1996. These
increases are primarily due to the consolidation of the expenses of PDR and
Mediatech administrative staff as well as the additional costs necessary to
meet the reporting requirements of a publicly traded company. In addition, the
Company recorded approximately $125,000 of severance expense in the third
quarter of 1997 related to management and staff changes in process as a result
of the acquisition and other organizational changes.
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 123% to $2,628,000 in
the quarter ended September 30, 1997 from $1,181,000 for the quarter ended
September 30, 1996 and increased 115% to $6,361,000 for the nine months ended
September 30. 1997 from $2,955,000 for the nine months ended September 30, 1996.
These increases versus the same periods in the prior year are due to the
continued expansion of the Company's network. The Company's total investment in
network equipment has more than doubled to $29.5 million at September 30, 1997
from $13.7 million at September 30, 1996. In particular, the Company has
acquired approximately $8.0 million of equipment as a result of the acquisitions
of Mediatech and PDR, has made capital additions of approximately $6.9 million
between September 30, 1996 and September 30, 1997 in support of its video
delivery service plan, and has increased the number of units located at
broadcast stations at September 30, 1997 by approximately 16% from the number at
September 30, 1996. In addition, the Company recorded amortization expense of
$251,000 and $465,000, respectively, in the three and nine months ended
September 30, 1997 related to the goodwill and other intangible assets recorded
in connection with the November 1996 acquisition of PDR and the July 1997
acquisition of Mediatech.
The Company expects to continue to invest in the expansion of its
network.* In particular, the Company is in the process of expanding its
infrastructure within the television broadcast industry that will require
additional DG Video Transmission Systems ("VTSs") and DVPSs to be built and
installed in production studios and 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 such investments will result in future revenue growth. See
"Certain Business Considerations -- Future Capital Need; Uncertainty of
Additional Funding."
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Interest Income and Interest Expense
Interest income decreased 65% to $138,000 in the quarter ended September
30, 1997 from $399,000 for the quarter ended September 30, 1996 and decreased
45% to $604,000 in the nine months ended September 30, 1997 from $1,096,000 for
the nine months ended September 30, 1996. These decreases are primarily the
result of reductions in levels of cash and cash equivalents and short term
investments versus the same periods of the prior year. The Company's initial
public offering was completed in February 1996 and since that time the
offering's proceeds have been used to fund the Company's operating, investing
and financing activities. 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 69% to $762,000 in the quarter ended
September 30, 1997 from $451,000 in the quarter ended September 30, 1996 and
increased 57% to $1,826,000 for the nine months ended September 30, 1997, from
$1,166,000 for the nine months ended September 30, 1996. These increases are
primarily due to increased debt resulting from leasing and loan 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 $14.1 million at September 30, 1997 from $10.3
million at September 30, 1996. Also, during the first three quarters of 1997,
the Company incurred additional interest expense totaling $332,000 on the
promissory notes given as consideration in the November 1996 acquisition of PDR
and the July 1997 acquisition of Mediatech. In addition, the Company incurred
$117,000 of interest expense in the quarter ended September 30, 1997 on the
Mediatech debt existing at the time of the acquisition. The Company expects
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, increased to $4.2 million in the nine months
ended September 30, 1997 from $3.9 million in the nine months ended September
30, 1996. The net loss, exclusive of depreciation and amortization, increased to
$4.6 million in the nine months ended September 30, 1997 from $3.9 million in
the nine months ended September 30, 1996. In addition, changes in working
capital balances provided $.4 million of cash in the nine months ended September
30, 1997.
As detailed in the notes to the financial statements included in this
document and the Company's Current Report on Form 8-K filed August 1, 1997, the
Company acquired 100% of the capital stock of Mediatech in July 1997. The
Company initially funded the cash portion of the purchase price from $8.0
million of the cash and cash equivalents available at June 30, 1997 and with
$6.0 million of short-term borrowings which were subsequently repaid with the
proceeds of the first tranche of the Company's private placement of the Series A
Preferred Stock, which is also detailed in the notes to financial statements and
the Company's Current Report on Form 8-K filed August 1, 1997. Total net
proceeds to the Company from closing two tranches of the Company's private
placement of Series A Preferred Stock totaled approximately $14.0 million,
essentially equal to the cash portion of the Mediatech purchase. In connection
with the purchase, the Company also issued a $1.6 million subordinated
promissory note and a $2.2 million secured subordinated promissory note and
assumed $5.4 million of existing Mediatech debt.
The Company used cash of $4.1 million for the purchase of property and
equipment in the nine months ended September 30, 1997. In the nine months ended
September 30, 1996, the Company purchased $ .9 million of property and equipment
and an additional $ 5.6 million of additions had been financed with capital
lease obligations. The capital additions for the nine month periods ended
September 30, 1997 were a result of the Company's continued expansion of its
network, particularly the video delivery service plan.
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Proceeds from issuance of common stock were $74,000 and $29,563,000 for
the nine month periods ended September 30, 1997 and 1996, respectively. Proceeds
in 1996 included $29,490,000 received from the Company's initial public offering
completed in February 1996.
Principal payments on long-term debt were $3.9 million in the nine
months ended September 30, 1997 versus $ 1.6 million in the nine months ended
September 30, 1996, primarily reflecting the increase in regularly scheduled
repayment of the increased capital lease liability and term debt incurred to
finance equipment and property acquisitions. Principal payments included the
first $350,000 payment on the secured subordinated note issued as part of the
Mediatech acquisition. In January 1997 the Company completed an agreement to
finance an additional $6.0 million of equipment purchases through a long-term
credit facility. In the first nine months of 1997, this facility was used to
finance a total of $4.4 million of property and equipment which had been
purchased late in 1996 as well as in the first nine months of 1997.
At September 30, 1997, the Company's current sources of liquidity
included cash and cash equivalents of $9.2 million, short-term investments of
$3.0 million, and $1.6 million available to finance capital expenditures under a
long-term credit facility which can be drawn on through June 1998. Other than
the commitments incurred in the acquisition of Mediatech, the commitments under
capital leases, term debt, and the note payable issued in connection with the
acquisition of PDR, the Company currently has no significant capital
commitments. The Company believes that its existing sources of liquidity,
including the expected closing of the second tranche of the Series A preferred
stock offering, will satisfy the Company's projected working capital, capital
lease and term loan commitments through June 1998. * See "Certain Business
Considerations -- Future Capital Needs; Uncertainty of Additional Funding."
CERTAIN BUSINESS CONSIDERATIONS
The Company's business is subject to the following risks in addition to
those described elsewhere in this Report.
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
September 30, 1997, the Company's accumulated deficit was $ 39.1 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, a significant portion
of which is due to acquisitions, 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 also 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, that the Company will be able to reduce delivery and service
costs, or that the Company will achieve or sustain profitability in any future
period.
Dependence on Video Advertising Delivery Service Deployment. The Company
has made a substantial investment in upgrading and expanding its network
operating center and populating television stations with the units necessary for
the receipt of electronically delivered video advertising content. However there
can be no assurance that placement of these units will cause this service to
achieve adequate market acceptance among customers which require video
advertising content delivery. The inability to place units in an adequate number
of stations or the inability to capture market share among content delivery
customers as a result of price competition or new product introductions from
competitors would have a material adverse effect on the Company's business,
operating results and financial position. In addition, the Company believes that
in order to more fully address the needs of potential video delivery customers
it will need to develop a set of ancillary services which are typically provided
today by dub and ship houses. These ancillary services, which include physical
archiving, closed captioning, modification of slates and format conversions,
will need to be provided on a localized basis in each of the major cities in
which the Company provides services directly to agencies and advertisers. The
Company currently has the capability to provide such services to the New York
City market through PDR and to the Los Angeles and Chicago markets through
Mediatech. However, there can be no assurance that the Company will
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<PAGE> 16
successfully contract for and provide these services in each major metropolitan
area or that the Company will be able to provide competitive video distribution
services in other U.S. markets. Unless the Company can successfully continue to
develop and provide video transmission services, it may be unable to retain
current or attract future audio delivery customers who may ultimately demand
delivery of both media content.
Uncertainties Relating to Integration of Operations. DG Systems acquired
PDR and Mediatech with the expectation that such strategic acquisitions would
result in enhanced efficiencies for the combined company. To date the Company
has not fully completed the integration of PDR, and has only begun the process
of integrating the operations of Mediatech with the Company. Achieving the
anticipated benefits of the PDR acquisition and the acquisition of Mediatech
will depend in part upon whether the integration of the organizations and
businesses of PDR and Mediatech with those of the Company is achieved in an
efficient, effective and timely manner; however, there can be no assurance that
this will occur. The successful integration and expansion of the Company's
business following its acquisition of PDR and Mediatech requires communication
and cooperation among the senior executives and key technical personnel of DG
Systems, PDR, and Mediatech. Given the inherent difficulties involved in
completing a business combination, there can be no assurance that such
cooperation will occur or that the integration of the respective organizations
will be successful and will not result in disruptions in one or more sectors of
the Company's business. Failure to effectively accomplish the integration of the
operations of PDR and Mediatech with those of the Company could have a material
adverse effect on DG Systems' results of operations and financial condition. In
addition, there can be no assurance that the market will favorably view DG
Systems' offering of duplication, distribution and editing services through PDR
and Mediatech or that DG Systems will realize any of the other anticipated
benefits of the PDR acquisition or the acquisition of Mediatech. As a result of
these acquisitions, certain DG Systems customers may perceive PDR or Mediatech
to be a competitor, and this could affect such customers' willingness to do
business with DG Systems in the future. The loss of significant customers could
have a material adverse effect on DG Systems' results of operations and
financial condition.
Future Capital Needs; Uncertainty of Additional Funding. The Company
intends to continue making capital expenditures to produce and install RSTs,
RPTs, and DVPS video units and to introduce additional services.* The Company
also continually analyzes the costs and benefits of acquiring certain
businesses, products or technologies that it may from time to time identify, and
its related ability to finance such acquisitions. Assuming that the Company does
not pursue one or more additional acquisitions funded by internal cash reserves,
the Company anticipates that the net proceeds from its initial public offering
completed in February 1996, together with its existing capital, cash from
operations, and the proceeds from the Company's Series A Convertible Preferred
Stock financing will be adequate to satisfy its capital requirements through at
least June 1998. 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 or that the
Company will not require additional capital sooner than currently anticipated.
Based on its current business plan, the Company anticipates that it will
eventually use the entire proceeds of its initial public offering and the Series
A Convertible Preferred Stock financing 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.* In addition, the Company is unable to predict
the precise amount of future capital that it will require, particularly if it
were to pursue one or more acquisitions, 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 financing for acquisitions on acceptable terms may
prevent the Company from completing advantageous acquisitions and consequently
may adversely effect the Company's prospects and future rates of growth. The
inability to obtain required financing for continuing operations or an
acquisition 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.
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The terms of the Series A Convertible Preferred Stock issued by the
Company to finance the acquisition of Mediatech, contain certain rights which
would prevent the Company from realizing the fourteen percent (14%) of the
proceeds of currently held in escrow and would require the Company to pay cash
dividends, commencing January 1, 2000, in the event that certain performance
milestones are not satisfied. If the company fails to meet such performance
milestones, the payment of cash dividends on its outstanding Series A
Convertible Preferred Stock could have a material adverse effect on the
Company's business, financial condition and results of operations. See "
Preferential Rights of Outstanding Preferred Stock."
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 in comparison
to the offerings of some dub and ship vendors. 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, and
in obtaining new customers for such services. See "Dependence on New Product
Introductions." There can also be no assurance that the Company will be
successful 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
expanding and increasing the integration of the Company's network, including the
Company's field receiving equipment and rooftop satellite antennae.
The Company's 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, TV station
system interface, and work on reliability and throughput enhancement of the
network. The Company's ability to successfully introduce electronic video
delivery services depends on its ability to obtain satellite delivery
capability. Work in satellite technology is oriented to development and
deployment of software to lower transmission costs and increase delivery
reliability. Work in video compression technology is directed toward integration
of emerging broadcast quality compression systems, which further improve picture
quality while increasing the compression ratio, with the Company's existing
network. Work in TV station system interface includes implementation of various
system control protocols such as the Sony RS422 Interface, which is a
requirement in many major TV stations. The Company has an agreement with Hughes
Network Systems, Inc. ("Hughes") which allows the Company to use Hughes'
satellite capacity for electronic delivery of
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digital audio and video transmissions by that media. The Company has developed
and incorporated software designed to enable the current RPTs to receive digital
satellite transmissions over the Hughes satellite system. There can be no
assurance that the Hughes satellite system will have the capacity to meet the
Company's future delivery commitments and broadcast quality requirements and to
do so on a cost-effective basis. See "Dependence on Certain Suppliers."
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 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.
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 significant portion 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, experience a change in ownership, or discontinue
the use of the Company's equipment in any way, 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 media archiving and the ability to
quickly and reliably give an agency the ability to preview and authorize
electronic delivery of video advertising spots. There can be no assurance that
the Company will successfully complete development of such products and
services, or that if any such development is completed, that 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. During the first quarter of 1997, the Company and ABC Radio Networks
("ABC") concluded field trials for an extension to the Company's existing
network through which ABC could distribute advertising and programming to ABC's
affiliate radio stations. Further development of these products for ABC was
formally ended in September 1997 The Company does not foresee any material
adverse impact to future operations as a result of this decision.*
Ability to Maintain and Improve Service Quality. The Company's business
is dependent on its ability to make cost-effective 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 that 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
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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"), RPTs and DVPS video units
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.
Competition. The Company currently competes in the market for the
distribution of audio advertising spots to radio stations and the distribution
of video advertising spots to television stations. The principal competitive
factors affecting these markets are ease of use, price, timeliness and accuracy
of delivery. The Company competes with a variety of dub and ship houses 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 deployed 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.
In the market for the electronic distribution of digital video
transmissions to television stations, the Company encounters competition from
VDI Media and Vyvx Advertising Distribution Services ("VADS"), a subsidiary of
The Williams Companies which includes CycleSat, Inc., 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. To the
extent that the Company is successful in entering new markets, such as the
delivery of other forms of content to radio and 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 products and services with functionality similar or superior
to that offered by the Company's products and services. Telecommunications
providers such as AT&T, MCI and Regional Bell Operating Companies could also
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 addition, Applied Graphics Technologies, Inc., a provider of
digital pre-press services, has indicated its intention to provide electronic
distribution services and acquired Spotlink, a dub and ship house and current
customer of the Company , in December 1996 as an entry to this market. In 1997,
Applied Graphics is reported to have acquired additional dub and ship
operations. Although Spotlink revenues were less than 5% of the Company's
revenues in 1996, the Company considers Spotlink to be a significant customer
for the Company's audio delivery service. There can be no assurance that
Spotlink will continue to be a customer of the Company, and the loss of Spotlink
as a customer could have a material adverse effect on the Company's operating
results.
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
19
<PAGE> 20
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 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 the automation of the customer order entry process
and the integration of the delivery fulfillment process into the customer
billing system and integrate these systems with those of PDR and Mediatech.
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.
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, August 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 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, particularly
engineering staff, 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 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, RPTs and video units. Although the Company's suppliers
are generally large, well-financed organizations, in the event that a
20
<PAGE> 21
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, RPTs and video units 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 has successfully completed 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 continue meeting the
Company's delivery commitments on a cost-effective basis 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 nine 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. During the quarter, the
Company renegotiated its agreement, which now expires in 2001. Any material
interruption in the supply or a material adverse change in the price 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
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
21
<PAGE> 22
information, the Company's business, operating results and financial condition
could be materially adversely affected.
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 work 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.
Concentration of Stock Ownership; Antitakeover Provisions. The present
executive officers and directors of the Company and their respective affiliates
own approximately 38% of the Company's Common Stock and recently-issued Series A
Convertible Preferred Stock, which votes together with Common Stock on all
matters submitted to the shareholders of the Company. As a result, these
shareholders will be able to control or significantly influence all matters
requiring shareholder approval, including the election of directors and the
approval of significant corporate transactions. Such concentration of ownership
may have the effect of delaying or preventing a change in control of the
Company. Furthermore, certain provisions of the Company's Amended and Restated
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.
Preferential Rights of Outstanding Preferred Stock. The Company has
issued and outstanding 4,950,495 shares of its Series A Convertible Preferred
Stock (the "Series A Preferred"). The rights of the Series A Preferred include
certain rights and preferences set forth in the Company's Certificate of
Determination of Rights of Series A Convertible Preferred Stock, which rights
could materially limit or qualify the rights of holders of the Company's Common
Stock and have a material adverse effect on the prevailing market price of the
Common Stock. Such rights include, without limitation, the right to participate,
on an as converted basis, in any and all dividends declared or paid, or set
aside for payment, in respect of outstanding shares of the Company's Common
Stock, and to receive a cumulative cash dividend, commencing January 1, 2000, in
a per annum amount equal to 7% of the then applicable conversion price of the
Series A Preferred in the event that the Company has less than $17.8 million in
total combined revenue for the Company's fiscal third and fourth quarters of
1997, or has failed to complete and make available for customer use by December
31, 1997 its Sony RS 422 Standard Video Transmission Interface (but only insofar
as it is possible to support a tape interface with an MPEG disk based system).
Not withstanding the foregoing, the holders of Series A Preferred will not be
entitled to receive a cumulative cash dividend if the market price of the
Company's Common Stock is more than two times the then applicable conversion
price of the Series A Preferred for 25 of 40 consecutive trading days at any
time following the Company's announcement of its fourth quarter earnings for its
fiscal year 1997. In the event that the Company is required to pay a cumulative
cash dividend in respect of the Series A Preferred, the business, financial
condition and results of operations of the Company may be materially and
adversely affected. The rights of the Series A Preferred also include the right
to receive a payment, prior to any
22
<PAGE> 23
payment to the holders of the Company's Common Stock, in a per share amount
equal to the purchase price paid per share of Series A Preferred in the event of
any voluntary or involuntary liquidation, distribution of assets (other than a
payment of dividends), dissolution or winding up of the affairs of the Company.
In addition, the Series A Preferred has certain special voting rights. The
rights of the holders of Common Stock are subject to, and may be adversely
affected by, the rights of the holders of Series A Preferred, which in turn
could adversely affect the prevailing market price for the Company's Common
Stock.
The Series A Preferred is convertible, at the option of the holder, into
shares of the Company's Common Stock. The Series A Preferred also will
automatically convert into shares of the Company's Common Stock upon the
satisfaction of certain conditions. The Series A Preferred, and the shares of
Common Stock issuable upon the conversion of such shares of Series A Preferred,
are "restricted securities" as that term is defined in Rule 144 promulgated by
the Securities and Exchange Commission under the Securities Act of 1933, as
amended. Accordingly, such shares, if sold pursuant to Rule 144, will be subject
to the resale provisions applicable to restricted securities under Rule 144. The
availability for sale, as well as actual sales, of the Company's Common Stock
issuable or issued upon the conversion of the Series A Preferred may depress the
prevailing market price for the Common Stock and could adversely affect the
terms upon which the Company would be able to obtain additional equity
financing.
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.
23
<PAGE> 24
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
(a) Not applicable.
(b) The information required to be reported in this Item 2(b), relating
to a change in the Articles of Incorporation of the Registrant in a manner that
materially limits or qualifies the rights of holders of Common Stock, has been
previously reported on the Registrant's Quarterly Report on Form 10-Q, which was
filed on August 14, 1997.
(c) Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The information required to be reported in this Item 4, relating to the
submission of certain matters for the approval of the Company's shareholders,
has been previously reported on the Registrant's Current Report on Form 8-K/A-1,
which was filed on September 11, 1997.
ITEM 5. OTHER INFORMATION
Not Applicable.
24
<PAGE> 25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT EXHIBIT TITLE
NUMBER -------------
-------
<S> <C>
3.1.1(d) Restated Articles of Incorporation of registrant.
3.1.2(h) Certificate of Determination of Rights of Series A Convertible
Preferred Stock of Digital Generation Systems, Inc., filed by the
Secretary of State of the State of California on July 16, 1997.
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(j) Special Customer Agreement between the Company and MCI
Telecommunications Corporation, dated May 5, 1997.
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.
10.17(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.
10.22(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.
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.
10.24(e) Digital Generation Systems, Inc. Supplemental Stock Option Plan.
10.25(e) Stock Purchase Agreement by and among Digital Generation Systems,
Inc. and PDR Productions, Inc. and Pat DeRosa dated as of October
15, 1996 and exhibits thereto.
</TABLE>
25
<PAGE> 26
<TABLE>
<CAPTION>
EXHIBIT EXHIBIT TITLE
NUMBER -------------
-------
<S> <C>
10.26(f) Amendment to Stock Purchase Agreement dated November 8, 1996,
among Digital Generation Systems, Inc., and Pat DeRosa.
10.27(h) Loan Agreement dated as of January 28, 1997 between Digital
Generation Systems, Inc. as Borrower, and Venture Lending and
Leasing, Inc. as Lender and exhibits thereto.
10.28(i) Stock Purchase Agreement, dated as of July 18, 1997, by and
between Digital Generation Systems, Inc., a California
corporation, IndeNet, Inc., a Delaware Corporation, and exhibits
thereto.
10.29(i) Preferred Stock Purchase Agreement, dated as of July 14, 1997, by
and among Digital Generation Systems, Inc. and the parties listed
on the Schedule of Purchasers attached, as Exhibit A thereto.
10.30(i) Amendment to Preferred Stock Purchase Agreement, dated as of July
23, 1997, by and among Digital Generation Systems, Inc. and the
purchasers listed on the Exhibit A thereto.
11.1(a) Statements of computation of pro forma common shares and
equivalents.
21.1(g) Subsidiaries of the Registrant.
27(a) Financial Data Schedule.
</TABLE>
- ----------
(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 exhibit bearing the same number filed
with registrant's Quarterly Report on Form 10-Q filed May 3, 1996, as
amended.
(e) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Quarterly report on Form 10-Q filed November 13, 1996.
(f) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Current Report on Form 8-K/A filed January 21, 1997.
(g) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Annual Report on Form 10-K filed March 18, 1997.
(h) Incorporated by reference to the exhibit bearing the same number filed
with registrant's quarterly report on Form 10-Q filed May 15, 1997.
(i) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Form 8-K filed August 1, 1997.
(j) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Quarterly report on Form 10-Q filed August 14, 1997.
Confidential treatment has been requested with respect to certain
portions of this exhibit pursuant to a request for confidential
treatment filed with the Securities and Exchange Commission. Omitted
portions have been filed separately with the Commission.
(b) Reports on Form 8-K.
(1) Current Report on Form 8-K filed on August 1, 1997, reporting that
Registrant had acquired all of the outstanding stock of Starcom
Mediatech, Inc. ("Mediatech"), on July 18, 1997 and entered into a
Preferred Stock Purchase Agreement dated July 14, 1997, as amended on
July 23, 1997, to fund a portion of the purchase price for Mediatech.
26
<PAGE> 27
(2) Current Report on Form 8-K/A-1 filed on September 11, 1997,
reporting the second closing under a Preferred Stock Purchase Agreement,
dated July 14, 1997, as amended on July 23, 1997, by and among the
Registrant and the Purchasers listed on Exhibit A thereto.
(3) Current Report on Form 8-K/A-2 filed on September 29, 1997,
providing audited financial statements for Mediatech and pro forma
combined financial statements for the period ended June 30, 1997.
(4) Current Report on Form 8-K/A-3 filed on November 7, 1997, reporting
a post-closing adjustment to the purchase price for the acquisition of
Mediatech.
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: November 14, 1997 BY: /s/ THOMAS P. SHANAHAN
-------------------------------
THOMAS P. SHANAHAN
VICE PRESIDENT & CHIEF FINANCIAL
OFFICER (PRINCIPAL FINANCIAL AND
CHIEF ACCOUNTING OFFICER)
27
<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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ----------------------
1997 1996 1997 1996
-------- -------- ------- ---------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Net loss $ (4,499) $ (2,397) $(10,996) $ (6,872)
======== ======== ======== ========
Weighted average common shares outstanding 12,035 11,575 11,818 8,638
Weighted average common equivalent shares:
Weighted average preferred stock outstanding 2,424
Adjustments to reflect requirements of the Securities and Exchange
Commission's Staff Accounting Bulletin No. 83:
Common stock issuances 65
Convertible preferred stock issuances 194
Preferred stock warrants 7
Common stock option grants 249
-------- -------- -------- --------
Total weighted average common shares and equivalents 12,035 11,575 11,818
======== ======== ========
Pro forma total weighted average common shares and equivalents 11,577
========
Net loss per share $ (0.37) $ (0.21) $ (0.93)
======== ======== ========
Pro forma net loss per share $ (0.59)
========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 9,241
<SECURITIES> 2,989
<RECEIVABLES> 7,584
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 20,644
<PP&E> 32,826
<DEPRECIATION> (13,687)
<TOTAL-ASSETS> 65,786
<CURRENT-LIABILITIES> 20,711
<BONDS> 13,302
13,950
0
<COMMON> 57,118
<OTHER-SE> (39,295)
<TOTAL-LIABILITY-AND-EQUITY> 65,786
<SALES> 0
<TOTAL-REVENUES> 18,809
<CGS> 0
<TOTAL-COSTS> 28,583
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,826
<INCOME-PRETAX> (10,996)
<INCOME-TAX> 0
<INCOME-CONTINUING> (10,996)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (10,996)
<EPS-PRIMARY> (.93)
<EPS-DILUTED> (.93)
</TABLE>
