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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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 July 31, 1997: 12,099,825.
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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>
PART I. FINANCIAL INFORMATION PAGE
<S> <C>
Item 1. Financial Statements.................................................. 3
Condensed Consolidated Balance Sheets at June 30, 1997 and
December 31, 1996..................................................... 3
Condensed Consolidated Statements of Operations for the three
and six months ended June 30, 1997 and 1996........................... 4
Condensed Consolidated Statements of Cash Flows for the three and
six months ended June 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..................................................... 23
Item 2. Changes in Securities................................................. 23
Item 3. Defaults upon Senior Securities....................................... 23
Item 4. Submission of Matters to a Vote of Security Holders................... 23
Item 5. Other Information..................................................... 24
Item 6. Exhibits and Reports on Form 8-K...................................... 24
SIGNATURES............................................................ 26
</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>
JUNE 30, DECEMBER 31,
1997 1996
-------- --------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 9,231 $ 9,682
Short-term investments 5,947 10,915
Accounts receivable, net 3,890 3,349
Prepaid expenses and other 382 168
-------- --------
Total current assets 19,450 24,114
-------- --------
PROPERTY AND EQUIPMENT, at cost:
Network equipment 21,169 17,974
Office furniture and equipment 2,301 2,093
Leasehold improvements 386 353
-------- --------
23,856 20,420
Less - Accumulated depreciation and amortization (11,309) (7,790)
-------- --------
Property and equipment, net 12,547 12,630
-------- --------
GOODWILL AND OTHER ASSETS, net 8,446 8,504
-------- --------
$ 40,443 $ 45,248
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 921 $ 1,546
Accrued liabilities 2,397 2,174
Note payable from acquisition of PDR 2,500 2,500
Current portion of long-term debt 5,166 3,694
-------- --------
Total current liabilities 10,984 9,914
-------- --------
LONG-TERM DEBT, net of current portion 9,067 8,495
-------- --------
SHAREHOLDERS' EQUITY:
Convertible preferred stock, no par value -
Authorized -- 5,000,000
Outstanding -- None outstanding
Common stock, no par value --
Authorized -- 30,000,000 shares
Outstanding -- 11,738,166 shares at June 30, 1997
and 11,653,625 shares at December 31, 1996 55,188 55,138
Receivable from issuance of common stock (175) (175)
Accumulated deficit (34,621) (28,124)
-------- --------
Total shareholders' equity 20,392 26,839
-------- --------
$ 40,443 $ 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 SIX MONTHS ENDED JUNE 30, 1997 AND 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
1997 1996 1997 1996
-------- -------- -------- --------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
REVENUES $ 5,405 $ 2,359 $ 10,011 $ 4,253
-------- -------- -------- --------
COSTS AND EXPENSES:
Delivery costs 1,813 732 3,288 1,327
Customer operations 2,104 948 4,239 1,868
Sales and marketing 1,126 970 2,141 1,953
Research and development 620 510 1,268 1,008
General and administrative 637 396 1,241 780
Depreciation and amortization 1,968 936 3,733 1,774
-------- -------- -------- --------
Total expenses 8,268 4,492 15,910 8,710
-------- -------- -------- --------
LOSS FROM OPERATIONS (2,863) (2,133) (5,899) (4,457)
-------- -------- -------- --------
OTHER INCOME (EXPENSE):
Interest income 215 434 466 697
Interest expense (553) (388) (1,064) (715)
-------- -------- -------- --------
NET LOSS $ (3,201) $ (2,087) $ (6,497) $ (4,475)
======== ======== ======== ========
NET LOSS PER SHARE $ (0.27) $ (0.18) $ (0.55) $ (0.39)
======== ======== ======== ========
WEIGHTED AVERAGE COMMON AND
COMMON EQUIVALENT SHARES 11,733 11,482 11,710 11,579
======== ======== ======== ========
</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 SIX MONTHS ENDED JUNE 30, 1997 AND 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-----------------------
1997 1996
-------- --------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (6,497) $ (4,475)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization of property and equipment 3,519 1,774
Amortization of goodwill and intangibles 213 --
Provision for doubtful accounts 89 60
Changes in operating assets and liabilities --
Accounts receivable (630) (566)
Prepaid expenses and other assets (369) 304
Accounts payable and accrued liabilities (402) 511
-------- --------
Net cash used in operating activities (4,077) (2,392)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of short-term investments (6,848) (12,817)
Maturities of short-term investments 11,816 --
Acquisition of property and equipment (3,036) (595)
-------- --------
Net cash provided by (used in) investing activities 1,932 (13,412)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 50 29,523
Proceeds from issuance of long-term debt 3,706 --
Payments on long-term debt (2,062) (994)
-------- --------
Net cash provided by (used in) financing activities 1,694 28,529
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (451) 12,725
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 9,682 6,205
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 9,231 $ 18,930
======== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Property and equipment financed with capitalized lease obligations $ 400 $ 2,572
</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 six month periods ended June 30, 1997. The results for the three and
six month periods ended June 30, 1997 are not necessarily indicative of the
results expected for the full fiscal year.
2. 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.
3. 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 are due 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 $213,000 is included in the
consolidated statement of operations for the three and six month periods ended
June 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.
The following table reflects unaudited pro forma combined results of operations
of the Company and PDR on the basis that the acquisition had taken place at the
beginning of the first fiscal period presented:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1997 1996 1997 1996
---- ---- ---- ----
(In thousands except per share data)
<S> <C> <C> <C> <C>
Revenues ................................... $ 5,405 $ 4,139 $ 10,011 $ 7,851
Net Loss ................................... $ (3,201) $ (2,264) $ (6,497) $ (4,899)
Net Loss per Share ......................... $ (0.27) $ (0.20) $ (0.55) $ (0.42)
Number of Shares used in Computation........ 11,733 11,482 11,710 11,579
</TABLE>
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DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 June 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 June 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 June 30, 1997 and June 30, 1996,
and the six months ended June 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 six months ended June 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. 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. 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 per the terms of agreement. The value of the warrants at the date
of issuance was nominal; therefore no value was assigned to the warrants for
accounting purposes.
7
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DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. SUBSEQUENT EVENTS
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 located in Chicago, Illinois.
The acquisition will be accounted for as a purchase.
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, which matures on October 1, 2001, is payable in equal
quarterly installments of $150,000 commencing on October 1, 1997. 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 equal installments of
$200,000 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.
PREFERRED STOCK
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 and
Dawson-Samberg in connection with the Mediatech Acquisition. Due to the
requirements of the National Association of Securities Dealers (the "NASD"), the
closing of the second of such tranches, in which the Company intends to issue
and sell up to an aggregate of 2,944,119 additional shares of its Series A
Convertible Preferred Stock, is contingent upon obtaining shareholder approval
for the issuance of such shares in connection with such second tranche. The
Company is aware that the holders of a majority of the issued and outstanding
shares of its capital
8
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DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
stock entitled to vote thereon have entered into a voting agreement pursuant to
which such shareholders have agreed to vote in favor of the issuance of shares
of Series A Convertible Preferred Stock in connection with such second tranche.
The Company intends to use 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 each tranche to be sold shall be 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 until the deposit amount
has been fully distributed or until the public market price of the Company's
common stock exceeds the conversion 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 SIX MONTHS ENDED
JUNE 30, JUNE 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 . 33.5 31.0 32.8 31.2
Customer operations ......... 38.9 40.2 42.3 44.0
Sales and marketing ......... 20.8 41.1 21.4 45.9
Research and development .... 11.5 21.6 12.7 23.7
General and administrative .. 11.8 16.8 12.4 18.3
Depreciation and amortization 36.4 39.7 37.3 41.7
------- ------- ------- -------
Total expenses ........... 152.9 190.4 158.9 204.8
Loss from operations ......... (52.9) (90.4) (58.9) (104.8)
------- ------- ------- -------
Other income (expense):
Interest income ............ 4.0 18.4 4.7 16.4
Interest expense ........... (10.2) (16.5) (10.6) (16.8)
------- ------- ------- -------
Net loss ..................... (59.1)% (88.5)% (64.8)% (105.2)%
======= ======= ======= =======
OPERATING DATA:
Deliveries ................... 286,000 187,000 530,000 336,000
</TABLE>
10
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Revenue
Revenues were $5,405,000 for the three months ended June 30, 1997, a 129%
increase from $2,359,000 for the three months ended June 30, 1996. The increase
is due to both a 53% increase in the volume of deliveries, including those made
from PDR, and an increase in average revenue per delivery over the prior year.
The Company made 286,000 and 187,000 deliveries in the three months ended June
30, 1997 and 1996, respectively. Revenues and deliveries for the six months
ended June 30, 1997 increased to $10,011,000 and 530,000, respectively, from
$4,253,000 and 336,000, respectively, for the six months ended June 30, 1996.
The increases in delivery volume are the result of additional deliveries
made through the DG Systems Network Operating Center ("NOC") and due to the
addition of deliveries made by PDR, acquired in November 1996. Additional
deliveries made through the NOC accounted for approximately 60% and 55% of the
volume increase versus the same period in the prior year in the quarter and six
months ended June 30, 1997, respectively. The Company believes that the increase
in the volume of deliveries made through the NOC is due to a number of factors,
including increased acceptance of the services offered by the Company and the
increased availability of an expanded network of Company equipment located in
broadcast stations.
Average revenue per delivery increased to $18.90 and $18.89 in the quarter
and six months ended June 30, 1997, respectively, from $12.61 and $12.66 in the
quarter and six months ended June 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 six months of 1996 were
deliveries of audio content. The retail list prices for the delivery of the
first video spot are 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 June 30, 1997, video deliveries and related services accounted for
approximately 17% of total deliveries and 39% of total revenue, including
approximately 40,000 video deliveries and $1.9 million of revenue recorded by
PDR. In the six months ended June 30, 1997, video deliveries and related
services accounted for approximately 18% of total deliveries and 41% of total
revenue, including approximately 86,000 video deliveries and $3.8 million of
revenue recorded by PDR.
Average revenue per audio delivery increased to $13.91 and $13.74 in the
quarter and six months ended June 30, 1997, respectively, from $12.61 and $12.66
in the quarter and six months ended June 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 13% of
audio volume in both the quarter and six months ended June 30, 1997 versus
approximately 9% of audio volume in the quarter and six months ended June 30,
1996. The Priority service, which accounted for approximately 3% of audio volume
in the quarter and six months ended June 30, 1997, was introduced in the fourth
quarter of 1996.
Delivery and Material Costs
Delivery and material costs were $1,813,000 and $732,000 for the quarters
ended June 30, 1997 and 1996, respectively, and $3,288,000 and $1,327,000 for
the six months ended June 30, 1997 and 1996, respectively. The 148% increase in
costs in each period versus the same period of the prior year is primarily due
to the increased volume of deliveries, in particular video deliveries dubbed and
shipped from PDR, as well as the increased volume of audio and video deliveries
performed through the DG Systems 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.
Delivery and material costs as a percentage of revenues increased to 34%
of revenues from 31% of revenues in the quarters ended June 30, 1997 and 1996,
respectively, and increased to 33% of revenues from 31% of revenues in the six
months ended June 30, 1997 and 1996, respectively. The increases in
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delivery and material costs as a percentage of revenues are primarily due to a
decrease in the proportion of the Company's consolidated deliveries performed
electronically, principally due to the addition of physical deliveries performed
by PDR. The percentage of deliveries performed electronically decreased to 73%
from 83% in the quarters ended June 30, 1997 and 1996, respectively, and to 71%
from 86% in the six months ended June 30, 1997 and 1996, respectively. This
shift is principally due to the addition of the 86,000 physical deliveries
performed by PDR in 1997.
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 $2,104,000 and $948,000 for the quarters
ended June 30, 1997 and 1996, respectively, and $4,239,000 and $1,868,000 for
the six months ended June 30, 1997 and 1996, respectively. These increases are
primarily the result of the consolidation of the costs of PDR operations. In
addition, these expenses have increased versus 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 costs as a percentage of revenues has
decreased to 39% of revenues from 40% of revenues in the quarters ended June 30,
1997 and 1996, respectively, and decreased to 42% of revenues from 44% of
revenues in the six months ended June 30, 1997 and 1996, respectively. These
decreases in customer operations expenses as a percentage of revenue are 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 which were 49% and 48% of PDR revenues in
the quarter and six months ended June 30, 1997.
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 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 16% to $1,126,000 for the quarter
ended June 30, 1997, from $970,000 for the quarter ended June 30, 1996, and
increased 10% to $2,141,000 in the six months ended June 30, 1997 from
$1,953,000 in the six months ended June 30, 1996. The increase in sales and
marketing expenses in the quarter and six months ended June 30, 1997 is due
primarily to the consolidation of the costs of the PDR sales group.
The Company expects to continue to expand sales and marketing programs
designed to introduce the Company's services to the marketplace and to attract
new customers for its services.* See "Certain Business Considerations --
Dependence on Emerging Markets." The Company expects that sales and marketing
expenses will increase in absolute dollars in future periods and may fluctuate
as a percentage of revenue in future periods.*
Research and Development
Research and development expenses increased 22% to $620,000 for the
quarter ended June 30, 1997, from $510,000 for the quarter ended June 30, 1996,
and increased 26% to $1,268,000 in the six months
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<PAGE> 13
ended June 30, 1997 from $1,008,000 in the six months ended June 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 61% to $637,000 for the
quarter ended June 30, 1997, from $396,000 for the quarter ended June 30, 1996,
and increased 59% to $1,241,000 in the six months ended June 30, 1997 from
$780,000 in the six months ended June 30, 1996. These increases are primarily
due to the consolidation of the expenses of PDR administrative staff and the
additional costs necessary to meet the reporting requirements of a publicly
traded company. 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 110% to $1,968,000 in the
quarter ended June 30, 1997 from $936,000 for the quarter ended June 30, 1996
and increased 110% to $3,733,000 for the six months ended June 30. 1997 from
$1,774,000 for the six months ended June 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
increased 98% to $21.2 million at June 30, 1997 from the $10.7 million balance
at June 30, 1996. In particular, the number of units located at broadcast
stations at June 30, 1997 has increased by approximately 24% from the number at
June 30, 1996 and the Company has made total capital additions of approximately
$7.5 million between June 30, 1996 and June 30, 1997 in support of its video
delivery service plan. In addition, the Company recorded amortization expense of
$213,000 in the six months ended June 30, 1997 related to the goodwill and other
intangible assets recorded in connection with the November 1996 acquisition of
PDR.
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."
Interest Income and Interest Expense
Interest income decreased 42% to $215,000 in the quarter ended June 30,
1997 from $434,000 for the quarter ended June 30, 1996 and decreased 33% to
$466,000 in the six months ended June 30, 1997 from $697,000 for the six months
ended June 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 43% to $553,000 in the quarter ended June 30,
1997 from $388,000 in the quarter ended June 30, 1996 and increased 49% to
$1,064,000 for the six months ended June 30, 1997, from $715,000 for the six
months ended June 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
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<PAGE> 14
necessary to support the Company's business growth. Debt outstanding under these
agreements has increased to $14.2 million at June 30, 1997 from $7.9 million at
June 30, 1996. In addition, during the first two quarters of 1997, the Company
incurred additional interest expense totaling $100,000 on the $2.5 million
promissory note given as consideration in the November 1996 acquisition of PDR.
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 $4.1 million in the six months ended
June 30, 1997 from $2.4 million in the six months ended June 30, 1996. The net
loss, exclusive of depreciation and amortization, increased to $2.8 million in
the six months ended June 30, 1997 from $2.7 million in the six months ended
June 30, 1996. In addition, changes in working capital balances used $1.4
million of cash in the six months ended June 30, 1997 versus $.2 million in the
same period of the prior year.
The Company used cash of $3.0 million for the purchase of property and
equipment in the six months ended June 30, 1997. In the six months ended June
30, 1996, the Company purchased $.6 million of property and equipment and an
additional $2.6 million of additions had been financed with capital lease
obligations. The capital additions for the six month periods ended June 30, 1997
were a result of the Company's continued expansion of its network, particularly
the video delivery service plan.
Proceeds from issuance of common stock were $50,000 and $29,523,000 for
the six month periods ended June 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 $2.1 million in the six months
ended June 30, 1997 versus $1.0 million in the six months ended June 30, 1996,
reflecting the increase in regularly scheduled repayment of the increased
capital lease liability and term debt incurred to finance equipment and property
acquisitions. 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 six months of 1997, this facility was used to finance a
total of $3.7 million of property and equipment which had been purchased late in
1996 as well as in the first six months of 1997.
At June 30, 1997, the Company's current sources of liquidity included cash
and cash equivalents of $9.2 million, short-term investments of $5.9 million,
and $2.3 million available to finance capital expenditures under a long-term
credit facility which can be drawn on through December 1997. As detailed in the
notes to the financial statements included in this document and Form 8K filed
August 1, 1997, the Company acquired 100% of the capital stock of Mediatech in
July 1997. The Company used $8.0 million of the cash and cash equivalents
available at June 30, 1997 in the transaction and funded the remainder of the
cash portion of the transaction with $6.0 of short-term borrowings which were
subsequently repaid with the proceeds of the first tranche of the Series A
preferred stock offering, which is also detailed in the notes to financial
statements and the Company's Form 8K filed August 1, 1997. In connection with
the purchase, the Company also issued a $2.2 million subordinated promissory
note and a $2.2 million secured subordinated promissory note and assumed $5.4
million of existing Mediatech debt.. Other than these 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 December 1997. * See "Certain Business Considerations -- Future Capital
Needs; Uncertainty of Additional Funding."
CERTAIN BUSINESS CONSIDERATIONS
The Company's business is subject to the following risks and, in addition
to those described elsewhere in this report.
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<PAGE> 15
History of Losses; Future Operating Results Uncertain. The Company was
founded in 1991 and has been unprofitable since its inception and expects to
continue to generate net losses for a minimum of the next twelve months. As of
June 30, 1997, the Company's accumulated deficit was $34.6 million. The Company
has had difficulty in accurately forecasting its future sales and operating
results due to its limited operating history. Accordingly, although the Company
has recently experienced significant growth in sales, such growth rates may not
be sustainable and should not be used as an indication of future sales growth,
if any, or of future operating results. The Company's future success will depend
in part on obtaining continued reductions in delivery and service costs,
particularly continued automation of order processing and reductions in
telecommunications costs.* There can be no assurance the Company's sales will
grow or be sustained in future periods or that the Company will achieve or
sustain profitability in any future period.
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 or experience a change in ownership, it could
materially adversely affect the Company's business, operating results and
financial condition.
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 delivery of video advertising content. However there can be no assurance
that this service offering will achieve adequate market acceptance. The
inability to place units in an adequate number of stations or the inability to
capture market share 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
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 successfully contract for and provide these services in each major
metropolitan area or be able to provide competitive video distribution services
throughout the major 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.
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
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 is not currently planned. The
Company does not foresee any material adverse impact to future operations as a
result of this decision.*
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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.*
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.
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
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<PAGE> 17
electronic delivery of digital audio and video transmissions, there can be no
assurance that the Company will be able to conform its products to such
standards in a timely fashion, or at all. The Company believes that its future
growth will depend, in part, on its ability to add these services and additional
customers in a timely and cost-effective manner, and there can be no assurance
that the Company will be successful in developing such services, in obtaining
new customers, or in obtaining a sufficient number of radio and television
stations, radio and television networks, advertisers, advertising agencies,
production studios, and audio and video distributors who are willing to bear the
costs of installing and supporting the Company's field receiving equipment,
including rooftop satellite antennae.
The Company's 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 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 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.
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 or other reasons, to develop and introduce new products and
services or enhancements of existing products and services in a timely manner or
if new versions of existing products do not achieve a significant degree of
market acceptance, there could be a material adverse effect on the Company's
business, financial condition and results of operations.
Competition. The Company currently competes in the market for the
distribution of audio advertising spots to radio stations 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
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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 is
deploying 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 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, in December
1996. 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 significantly
greater resources to the development and marketing of new competitive products
and services. The Company expects that competition will increase substantially
as a result of these and other industry consolidations and alliances, as well as
the emergence of new competitors. There can be no assurance that the Company
will be able to compete successfully with new or existing competitors or that
competitive pressures faced by the Company will not materially and adversely
affect its business, operating results and financial condition.
Ability to Maintain and Improve Service Quality. The Company's business is
dependent on its ability to make 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
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assurance that such insurance will be adequate to protect the Company from
significant loss in these circumstances or that a major catastrophe (such as an
earthquake or other natural disaster) would not result in a prolonged
interruption of the Company's business. In particular, the Company's network
operating center is located in the San Francisco Bay area, which has in the past
and may in the future experience significant, destructive seismic activity that
could damage or destroy the Company's network operating center. In addition, the
Company's ability to make deliveries to stations within the time periods
requested by customers depends on a number of factors, some of which are outside
of its control, including equipment failure, interruption in services by
telecommunications service providers, and the Company's inability to maintain
its installed base of Record Send Terminals ("RSTs"), 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.
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 force. In particular, the Company believes that to achieve these
objectives it must complete its automation of the customer order entry process
and the integration of the delivery fulfillment process into the customer
billing system. There can be no assurance that the Company's personnel, systems,
procedures and controls will be adequate to support the Company's existing and
future operations. Any failure to implement and improve the Company's
operational, financial and management systems or to expand, train, motivate or
manage employees could have a material adverse effect on the Company's business,
operating results and financial condition.
Future Capital Needs; Uncertainty of Additional Funding. The Company
intends to continue making capital expenditures to produce and install RSTs,
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. For example, the Company
recently acquired Mediatech, and funded a portion of the purchase price for such
acquisition with internal cash reserves. The Company has entered into an
agreement to sell shares of its Series A Convertible Preferred Stock to
replenish the cash reserves expended to finance the acquisition of Mediatech,
but there can be no assurance that the Company will be able to successfully
close this preferred stock financing. In the event that the Company is unable to
close such financing on a timely basis, the Company will be forced to seek
additional capital from alternative sources. There can be no assurance, however,
that the Company would be able to procure an alternative source of capital on
acceptable terms, if at all. The inability to obtain required financing as an
alternative to the preferred stock financing would have a material adverse
effect on the business, financial condition and results of operations of the
Company.
Assuming that the Company is able to successfully close the preferred
stock financing discussed above, and further 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 December 1997.
There can be no assurance, however, that the net proceeds of the Company's
initial public offering and such other sources of funding will be sufficient to
satisfy the Company's future capital requirements. Based on its current business
plan, the Company anticipates that it will eventually use the entire proceeds of
its initial public offering and 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. There can be no assurance that the
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Company will not require additional capital sooner than currently anticipated.
In addition, the Company is unable to predict the precise amount of future
capital that it will require, 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 required financing would have a material adverse effect on the Company's
business, financial condition and results of operations. Consequently, the
Company could be required to significantly reduce or suspend its operations,
seek a merger partner or sell additional securities on terms that are highly
dilutive to existing investors.
The terms of the Series A Convertible Preferred Stock issued by the
Company to finance the acquisition of Mediatech, contain certain rights which
require the Company to pay cash dividends in the event that certain performance
milestones are not satisfied. See Part II, Item 2(b) of this Report and
Exhibits 3.1.2 and 10.29 thereto. 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.
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.
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.
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 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
20
<PAGE> 21
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 information, the Company's
business, operating results and financial condition could be materially
adversely affected.
Concentration of Stock Ownership; Antitakeover Provisions. The present
executive officers and directors of the Company and their respective affiliates
own approximately 37% 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
21
<PAGE> 22
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.
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.
22
<PAGE> 23
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) On July 16, 1997, the Registrant filed a Certificate of
Determination of Rights of Series A Convertible Preferred Stock (the
"Certificate of Determination") with the Secretary of State of the State of
California pursuant to which the Registrant created a new series of Preferred
Stock designated "Series A Convertible Preferred Stock." On July 23, 1997, the
Registrant issued and sold an aggregate of 2,012,376 shares of its Series A
Convertible Preferred Stock, for an aggregate purchase price of $7,113,751, or
$3.535 per share.
The Certificate of Determination provides, among other things, that no
dividends or other distributions in respect of any shares of Common Stock of the
Registrant may be declared, paid or set aside for payment by the Registrant
unless a participating dividend or other distribution is also declared, paid or
set aside for payment in respect of shares of Series A Convertible Preferred
Stock. In the event of any such dividend or other distribution in respect of
shares of Series A Convertible Preferred Stock, the holders thereof are entitled
to receive such dividend or other distribution as if all such shares of Series A
Convertible Preferred Stock had been converted into shares of Common Stock in
accordance with the terms and conditions set forth in the Certificate of
Determination and at the then effective Conversion Price, as defined therein.
Notwithstanding the foregoing, in the event that the Registrant fails to satisfy
certain performance criteria set forth in the Certificate of Determination, the
holders of Series A Convertible Preferred Stock are entitled to receive, subject
to certain limitations set forth in the Certificate of Determination, cumulative
cash dividends, payable quarterly, at the annual rate of 7% of the then
effective Conversion Price, commencing on January 1, 2000.
The Certificate of Determination also provides that the holders of
shares of Series A Convertible Preferred Stock are entitled to vote on all
matters submitted to a vote of the holders of shares of Common Stock, as a
single class with the holders of shares of Common Stock, and as if all such
shares of Series A Convertible Preferred Stock had been converted into shares of
Common Stock. In addition to the foregoing participating voting rights, the
holders of Series A Convertible Preferred Stock have the right, voting as a
separate class, to elect one member of the Board of Directors of the Registrant
and to fill any vacancies created by the death, resignation or removal of the
director so elected.
The Certificate of Determination further provides for the preferential
payment of $3.535 per share in respect of shares of Series A Convertible
Preferred Stock in the event of a liquidation, dissolution or winding up of the
affairs of the Registrant.
(c) Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The 1997 Annual Meeting of Shareholders of the Registrant was held on April 11,
1997 (the "Annual
23
<PAGE> 24
Meeting"). The following matters were voted upon at the Annual Meeting: (i) the
election of the Board of Directors of Kevin R. Compton, Henry W. Donaldson,
Jeffrey M. Drazan, Richard H. Harris and Leonard S. Matthews; and (ii) the
amendment of the Company's 1992 Stock Option Plan (a) to increase by 700,000 the
number of shares of the Company's Common Stock reserved for issuance thereunder,
and (b) to limit the number of options that may be granted to participants
thereunder in any fiscal year; (iii) the amendment of the Company's 1995
Director Option Plan to increase by 25,000 the number of shares of the Company's
Common Stock reserved for issuance thereunder; and (iv) the ratification of the
appointment of Arthur Andersen, LLP as independent auditors of the Registrant.
The results of such votes were as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
VOTES AGAINST/ BROKER
MATTER VOTES FOR WITHHELD ABSTENTIONS NON-VOTES
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1. Elect Directors
Kevin R. Compton 10, 734,389 16,332 0
Henry W. Donaldson 10,711,056 39,665 0
Jeffrey M. Drazen 10,734,389 16,332 0
Richard H. Harris 10,734,764 15,957 0
Leonard S. Matthews 10,734,389 16,332 0
- ---------------------------------------------------------------------------------------------------------
2. Amend the Company's 1992 Stock 8,836,513 423,668 4,695 1,485,845
Option Plan
- ---------------------------------------------------------------------------------------------------------
3. Amend the Company's 1995 9,205,142 61,012 5,795 1,478,772
Director Option Plan
- ---------------------------------------------------------------------------------------------------------
4. Ratify the Appointment of Arthur 10,744,135 1,266 5,320 0
Andersen, LLP
- ---------------------------------------------------------------------------------------------------------
</TABLE>
ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
------ -------------
<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
</TABLE>
24
<PAGE> 25
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
------ -------------
<S> <C>
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.
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
25
<PAGE> 26
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 the 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) Filed herewith. 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.
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DIGITAL GENERATION SYSTEMS, INC.
Dated: August 14, 1997 BY: /S/ THOMAS P. SHANAHAN
-------------------------------
THOMAS P. SHANAHAN
VICE PRESIDENT & CHIEF FINANCIAL
OFFICER (PRINCIPAL FINANCIAL AND
CHIEF ACCOUNTING OFFICER)
26
<PAGE> 1
EXHIBIT 10.7
M C I
SPECIAL CUSTOMER ARRANGEMENT
This MCI Special Customer Arrangement together with all Attachments hereto (this
"Agreement") is made by and between MCI TELECOMMUNICATIONS CORPORATION ("MCI")
and DIGITAL GENERATION SYSTEMS, INC. ("Customer") and will be binding only upon
signature of both parties. The rates, discounts and certain other provisions
applicable to MCI tariffed services (the "Services") as set forth in this
Agreement will be effective one (1) month from Completed the first day of the
next billing cycle following Customer's signature date (the "Effective Date") if
Customer promptly delivers the signed Agreement to MCI. All capitalized terms
used in this Agreement and not defined herein will have the meaning ascribed to
them in the Tariff(as defined below).
1. SERVICE PROVISIONING AND RECEIPT. MCI will provide to Customer
international, or interstate, intrastate and local telecommunications
"service(s)" as hereinafter defined) pursuant to the applicable tariffs and
price lists of MCI and its U.S. based affiliates (individually, a "Tariff'
and collectively, the "Tariffs"), each as supplemented by this Agreement to
the extent permitted by law. This Agreement incorporates by reference the
terms of each such Tariff. MCI may modify its Tariff from time to time in
accordance with law and thereby affect the services furnished to Customer.
This Agreement is a "Specialized Customer Arrangement" as defined in
Section B-17.03 of the Tariff.
If prior to the expiration of the "Term" (as hereinafter defined) of this
Agreement, MCI voluntarily or involuntarily as a result of government or
judicial action cancels, in whole or in part, any tariff on file with the
Federal Communications Commission ("FCC"), where the affected provisions
prior to such cancellation applied to any service(s) MCI provides under
this Agreement, then effective on such cancellation and for the remainder
of the Termthis Agreement shall consist of the following. in order of
precedence from (a) through (c):
(a) MCI Tariff provisions that remain effect ("Effective Tariffs"), as
MCI may amend from time to time in accordance with law; and
(b) Specific provisions contained in this Agreement that expressly apply
in lieu of, or that apply in addition to, provisions contained in
Effective Tariffs and/or in MCI's standard Guide to Services and
Pricing ("Price Guide"); and
(c) Provisions contained in the Price Guide to the extent that (a) and
(b) above are not applicable. MCI may amend the Price Guide from time
to time and will maintain the Price Guide open for public inspection
at one or more offices during normal business hours. Immediately
prior to the cancellation of any tariff provisions applicable to
service(s) provided under this Agreement, MCI shall incorporate such
provisions into the Price Guide and if MCI fails to incorporate any
such provisions, such provisions shall be deemed incorporated into
this Agreement as if MCI had so incorporated such provisions in the
Price Guide.
In all events, the applicable rates and rate schedules shall continue to be
subject to any discounts, waivers, credits, or restrictions on rate changes
that may be contained in this Agreement. Where rate and/or discount
adjustments would have been made by reference to any canceled , tariff
rate, rate schedule, discount and/or discount schedule, these adjustments
shall instead be made by reference to the Price Guide. To the extent that
any adjustment to tariffed rates, rate schedules, discounts and/or discount
schedules is permitted under this Agreement, such adjustment may be made by
MCI to its Price Guide
2. TARIFF OPTION. MCI shall, if required, file a Tariff option (a "Tariff
Option") consistent with the terms of Attachment A, which is incorporated
into this Agreement by this reference, and applicable regulatory authority.
3. CONFIDENTIAL INFORMATION. Customer will not disclose to any third party
during the Term, or
MCI CONFIDENTIAL
<PAGE> 2
during the three in (3) year period after expiration or termination of this
Agreement, any of the terms and conditions of this Agreement unless such
disclosure is lawfully required by any federal governmental agency or is
otherwise required to be disclosed by law or isnecessary in any legal
proceeding establishing rights and obligations under this Agreement.
reserves the right to terminate this Agreement by giving written notice to
Customer the event of any unpermitted disclosure hereunder.
4. GOVERNING LAW. This Agreement, and all causes of action arising out of this
Agreement, will be subject to the Communications Act of 1934, as (the
"Act"), or, if any part of this Agreement is not governed by the Act, by
the domestic law of the State of New York without regard to its choice of
law principles.
5. WAIVER. No waiver of any of the provisions of this Agreement shall be
binding unless it is in writing and signed by the party making the waiver.
No waiver shall be deemed, shall constitute, a waiver of any other
provision, whether or not similar, and no waiver shall be deemed, or shall
constitute, a continuing waiver.
6. NOTICES. All notices, requests, or other communications (excluding
invoices) hereunder will be in writing and either transmitted via
facsimile, overnight courier, hand delivery or certified or registered
mail, postage prepaid and return receipt requested to the parties at the
addresses below or such other addresses as may be specified by written
notice. All notices will be effective when received.
7. SEVERABILITY. All provisions of this Agreement are severable, and the
unenforceability or invalidity of any of the provisions will not affect the
validity or enforceability of the remaining provisionsamended , The
remaining provisions will be construed in such a manner as to carry out the
full intention of the parties. Section titles or references used in this
Agreement will not have substantive meaning or content and are not a part
of this Agreement.
8. ENTIRE AGREEMENT. This Agreement, together with the Tariffs, constitutes
the entire agreement between the parties with respect to its subject matter
and supersedes all other representations, understandings or agreements
which are not expressed herein, whether oral or written. No amendment to
this Agreement will be valid unless in writing and signed by both parties.
9. ACCEPTANCE DEADLINE. This Agreement shall be of no force and effect and the
offer contained herein shall be withdrawn unless this Agreement is executed
by Customer and delivered to MCI on or before April 22, 1997.
IN WITNESS WHEREOF, the parties have caused this Agreement to be executed
by their duly authorized representatives as of the dates set forth below.
MCI TELECOMMUNICATIONS CORPORATION
201 Spear Street
San Francisco, CA 94105
By: /s/ Jon McGuire
----------------------------
Jon McGuire, Vice President, Finance
Date: 05/09/97
--------------------------
DIGITAL GENERATION SYSTEMS, INC.
875 Battery Street
San Francisco, CA 94111
By: /s/ Henry W. Donaldson
-----------------------------
Name: Henry W. Donaldson
----------------------------
Title: President and CEO
---------------------------
Date:per April 21, 1997
-------------------------
MCI CONFIDENTIAL
<PAGE> 3
ATTACHMENT A TO AGREEMENT
This Attachment A to the Agreement contains the rates, discounts and certain
other provisions applicable to the Services provided to Customer pursuant to the
Agreement.
1. Term; Ramp Period; Contract Year. The Term will begin on the Effective Date
and end fifty-four (54) months later (the "Term"). The first six (6) months
of the Term will constitute the "Ramp Period". Each consecutive twelve (12)
month period of the Term commencing on the expiration of the Ramp Period
MCI and on each anniversary of said expiration will be a "Contract Year".
Commencing with the Effective Date and at all times during the Ramp Period,
Customer will receive the rates, discounts, charges and credits set forth
herein and will not be subject to any minimum usage requirements.
2. Selected Definitions.
2.1 "Base Rates" shall mean the rates as reduced by the discounts (except
for the credits applied pursuant to paragraphs 5.4 and 5.5 below)
provided to Customer pursuant to this Agreement or for "Services" (as
hereinafter defined) not specifically set forth herein, the rates set
forth in the Tariffs following application of all applicable tariffed
discounts.
2.2 "Postalized Rates" shall refer to per minute rates for Services that
are not nondistance-sensitive.
2.3 "Services" shall refer to any one or more of those telecommunications
services provided to Customer pursuant to the Tariffs, including
MCI-provided domestic access.
2.4 "Usage Charges" shall mean Customer's recurring usage charges for the
Services calculated at Base Rates. Usage Charges do not include the
following: (i) taxes and tax related surcharges; (ii) charges for any
non-Tariffed services; (iii) charges for equipment and collocation;
and (iv) charges incurred where MCI or an MCI affiliate acts as agent
for Customer in the acquisition of goods or services.
3. Annual Minimum. During each Contract Year, Customer's Usage Charges must
equal or exceed a minimum volume amount depending on the Contract Year as
forth below (the "Annual Minimum")
Annual Minimum
--------------
First Contract Year [XXXXXXXXXX]**
Second Contract Year [XXXXXXXXXX]**
Third Contract Year [XXXXXXXXXX]**
Fourth Contract Year [XXXXXXXXXX]**
3.1 Frame Relay Subminimum. During each Contract Year, Customer's Usage
Charges for MCI HyperStream Frame Relay Service must equal or exceed a
minimum volume amount depending on the Contract Year as forth below
(the "Frame Relay Subminimum").
Frame Relay Subminimum
----------------------
First Contract Year [XXXXXXXX]**
Second Contract Year [XXXXXXXX]**
Third Contract Year [XXXXXXXX]**
Fourth Contract Year [XXXXXXXX]**
4. Rates and Discounts for the Services. Except as expressly provided to the
contrary, the rates, charges, discounts and/or credits set forth herein are
in lieu of, and not in addition to, any other rates, charges, discounts
and/or credits (tariffed or otherwise). For Services not specifically set
forth herein, Customer will be charged MCI's
MCI CONFIDENTIAL
ATT.A-1
**Omitted portions have been filed with the Securities and Exchange Commision.
<PAGE> 4
standard Tariffed rates. References in this Attachment A to standard
Tariffed rates and/or discounts refer to the corresponding standard rates
and/or discounts set forth in the applicable Tariffs for such Service(s)
and in the event that MCI voluntarily or involuntarily as a result of
government or judicial action cancels in whole or in part any tariff on
file with the Federal Communications Commission, such references shall
refer to the corresponding rates and/or discounts set forth in the Price
Guide for such Service(s). All references to "intrastate" and "interstate"
contained herein shall refer to domestic Services only. "Peak" rates apply
during the Business Day or standard rate periods and "Off-Peak" rates apply
during all other times.
4.1 MCI Vnet Service/MCI Outbound Switched Digital Service (54/64kbps).
Customer will pay the following for MCI Vnet Service/MCl Outbound
Switched Digital Service (54/64 kbps):
4.1.1 Interstate MCI Vnet Service/MCI Outbound Switched Digital
Service (54/64 kbps). Customer will pay the following
Postalized Rates for interstate MCI Vnet Service/MCI Outbound
Switched Digital Service (54/64 kbps), including interstate
Vnet Card Service, based on the origination/termination of the
call. These Postalized Rates will fluctuate with changes in
the Tariffs. These Postalized Rates will be adjusted on the
first day of each January during each calendar year of the
Term by an amount equal to the same percentage by which
standard Tariffed interstate MCI Vnet Service/MCI Outbound
Switched Digital Service (54/64 kbps) rates were adjusted
during the immediately preceding calendar year up to a maximum
fluctuation of three percent (3%).
<TABLE>
<CAPTION>
Origination/Termination Rate
----------------------- ----
<S> <C>
Dedicated/Dedicated [XXXXX]**
Switched/Dedicated [XXXXX]**
Dedicated/Switched [XXXXX]**
Switched/Switched [XXXXX]**
</TABLE>
4.1.2 International MCI Vnet Service. For international MCI Vnet
Service (Option 6, Vnet U.S. Originations, Section C-3.0739 of
MCI Tariff FCC No. 1), including international Vnet Card
Service, : Customer will pay standard networkMCI One Tariffed
rates less a thirty percent (30%) discount.
4.1.3 lntrastate MCI Vnet Service. For intrastate MCI Vnet Service,
including intrastate Vnet Card Service, Customer will pay
standard networkMCI One Tariffed rates without application of
any discounts (tariffed or otherwise).
4.1.4 Vnet Card Surcharge. Notwithstanding anything herein to the
contrary, Customer will pay the standard Tariffed per call
surcharge for all Vnet Card calls.
4.2 MCI Toll Free Service. Customer will pay the following rates for MCI
Toll Free Service:
4.2.1 Interstate MCI Toll Free Service. Customer will pay the
following Postalized Rates for MCI Toll Free Service, based on
termination type. These Postalized Rates will fluctuate with
changes in the Tariffs. These Postalized Rates will be
adjusted on the first day of each January of each calendar
year of the Term by an amount equal to the same percentage by
which standard Tariffed interstate MCI Toll Free Service rates
were adjusted during the immediately preceding calendar year
up to a maximum fluctuation of three percent (3%).
<TABLE>
<CAPTION>
Termination Rate
----------- ----
<S> <C>
Dedicated Access Line [XXXXX]**
Business Line [XXXXX]**
</TABLE>
MCI CONFIDENTIAL
ATT.A-2
**Omitted portions have been filed with the Securities and Exchange Commision.
<PAGE> 5
4.2.2 International MCI Toll Free Service. For international MCI
Toll Free Service, Customer will pay standard Tariffed rates
less a fixed thirty percent (in 30%) discount off standard
Tariffed rates.
4.2.3 Intrastate MCI Toll Free Service. For intrastate MCI Toll Free
Service, Customer will pay standard Tariffed rates without
application of any discounts (tariffed or otherwise).
4.3 Domestic networkMCI Audio Conferencing. For networkMCI Audio
Conferencing, the Customer will pay a per bridge port charge of
[XXXXXXXXXX]** minute of use, with rounding to the next higher full
minute for Unattended Meet-Me calls and [XXXXXXXXXX]** per minute of
use, with rounding to the next higher full minute for Dial-Out
networkMCl Conferencing calls. MCI will waive per bridge port set-up
fees.
4.4 Dedicated Access Services. Customer subscribes to and will receive
the discounts off local loop charges only for channelized and
unchannelized T-I access, DS0 access and DDS access and analog access
provided pursuant to MCI's five (5) year Access Pricing Plan ("APP").
On a semi-annual basis, MCI will review the number of Customer's T-1
access circuits that are in service under this Agreement. On a
going-forward basis only, MCI will provide Customer with the
following discounts off local loop charges and credits toward AC/COC
charges per T-1 circuit depending on the number of T-I circuits as
follows:
<TABLE>
<CAPTION>
Total T-I Circuits Local Loop Discoun Credit Per T- 1 Circuit
------------------ ------------------ -----------------------
<S> <C> <C>
less than 250 [XXXXXX]** [XXXXXXXXXXX]**
250 and greater [XXXXXX]** [XXXXXXXXXXX]**
</TABLE>
*discount provided pursuant to the 5 year APP.
4.5 Dedicated Leased Line Services. For MCI Dedicated Leased Line
Services, Customer will pay standard Tariffed rates less the
discounts associated with the four (4) year and [XXXXXXXXXXXXXX]**
[XXXXXXXXXXX]** Network Pricing Plan as set forth in the Tariff. The
standard term and volume commitments set forth in the Tariff will not
apply.
4.6 Domestic MCI HyperStream Frame Relay Service. For MCI HyperStream
Frame Relay Service, the Customer will receive a [XXXXXXXXXXXXXX]**
discount on tariffed HyperStream Frame Relay Service recurring port
and PVC charges.
4.7 Charges Not Eligible for Discount. The rates and discounts set forth
in this Section 4 do not apply to the following: charges for MCI
Services other than those set forth in Section 4; non-Tariffed
products; access or egress (or related) charges imposed by third
parties; standard Tariffed non-recurring charges, calling card
surcharges and taxes or tax-like surcharges.
5. Credits.
5.1 Installation Credit. Customer shall receive a credit of up
[XXXXXXXXXXX]** for the one-time installation and other one-time,
non-recurring, standard (non-expedite) charges associated with the
implementation of domestic Services under this Agreement. Such
credits will be issued from time to time throughout the Term as MCI
services are installed by Customer and shall be applied following
application of all standard Tariffed installation promotions.
5.2 Completion Credit. Provided that Customer completes the Term,
Customer will receive a credit of [XXXXXXXXX]** which will be applied
against Customer's interstate Usage Charges in the fifty-fourth
(54th) month of the Term.
MCI CONFIDENTIAL
ATT.A-3
**Omitted portions have been filed with the Securities and Exchange Commision.
<PAGE> 6
5.3 Interstate Service Credits. Customer will receive a monthly recurring
credit (the "Interstate Service Credit") to be applied to Customer's
interstate Usage Charges of Services hereunder equal to the sum of
(i) the product of a fixed [XXXXXXXX]** discount multiplied by
Customer's intrastate Vnet Usage Charges for the immediately
preceding month at standard networkMCI One Tariffed rates plus (ii) a
fixed discount of [XXXXXX]**multiplied by Customer's intrastate MCI
Toll Free Usage Charges for the immediately preceding month at
standard Tariffed rates. Notwithstanding the foregoing, in no event
shall the amount of any such Interstate Service Credit exceed
Customer's interstate Usage Charges for the month in which such
credit is to be applied.
5.4 Achievement CreditAt the completion of any Contract Year, if the
Customer's Usage Charges during such Contract year equals or exceeds
the applicable revenue tier set forth below, the Customer will
receive a credit, equal to five percent (5%) of Customer's Usage
Charges for such Contract Year. Such credit will be applied against
the Customer's Usage Charges (exclusive of applicable taxes,
surcharges, non-recurring charges and pass through access/egress or
related charges). The Customer may receive only one of these credits
for any Contract Year.
<TABLE>
<CAPTION>
Contract Year Qualifying Revenue Tier
------------- -----------------------
<S> <C>
1 [XXXXXXXX]**
2 [XXXXXXXX]**
3 [XXXXXXXX]**
4 [XXXXXXXX]**
</TABLE>
5.5 Off-Peak Achievement Credit: In any month of the Term after the Ramp
Period (each, a "Monthly Period"), if Customer's Off-Peak minutes of
MCI Vnet and MCI Outbound Switched Digital (54/64 kbps) Services
equals a percentage of Customer's total minutes of MCI Vnet and MCI
Outbound Switched Digital (54/64 kbps) Services, Customer will
receive a credit equal to a percentage of Customer's Usage Charges
for MCI Vnet and MCI Outbound Switched Digital (54/64 kbps) Services
as set forth below:
<TABLE>
<CAPTION>
Percentage of Off-Peak Usage Discount Percentage
---------------------------- -------------------
<S> <C>
40% [XXXX]**
50% [XXXX]**
60% [XXXX]**
70% [XXXX]**
80% [XXXX]**
</TABLE>
6. Underutilization. If in any Contract Year, Customer's Usage Charges are
less than the applicable Annual Minimum, then Customer will pay: (1) all
accrued but unpaid usage and other charges incurred by Customer; and (2) an
underutilization charge (which Customer agrees is reasonable) equal to the
difference between Customer's Usage Charges during such Contract Year and
the applicable Annual Minimum.
6.1 If in any Contract Year, Customer's Usage Charges for MCI HyperStream
Frame Relay Service are less than the applicable Frame Relay
Subminimum, then Customer will pay:
[XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX]**
6.2 Change in Technology: The Customer shall not be liable for the
underutilization charges to the extent that the Customer has failed
to satisfy the Annual Minimum or Frame Relay Subminimum solely as a
result of a New Technology Change, provided that in any case the
Customer shall use its best reasonable efforts to: (1) direct to MCI
new traffic or traffic not currently carried by MCI in order to
satisfy the
MCI CONFIDENTIAL
ATT.A-4
**Omitted portions have been filed with the Securities and Exchange Commision.
<PAGE> 7
Annual Minimum and Frame Relay Subminimum; and (2) retain MCI as the
provider of the services required pursuant to and/or as a result of
the New Technology Change. "New Technology Change" means a change by
Customer to a new technology which is not offered by MCI as a tariffed
service at the time of, or within six (6) months of, the Customer's
notice to MCI that the Customer intends to change to a new technology.
7. Termination Liability. If (1) Customer terminates this Agreement during the
Term, for reasons other than (i) for "Cause" (as hereinafter defined) or
(ii) to take service under another arrangement with MCI having equal or
greater term and volume requirements or (2) MCI terminates this Agreement
for Cause, Customer will pay within thirty (30) days after such
termination: (a) all accrued but unpaid usage and other charges incurred
through the date of such termination (b) an amount equal to one hundred and
ten percent (110%) of the aggregate of the Annual Minimum(s), (or pro rata
portion thereof for partial Contract Year) that would have been applicable
for the remaining unexpired portion of the Term on the date of such
termination. As used herein, "Cause" shall mean a failure of the other
Party to perform a material obligation under this Agreement which failure
is not remedied by the defaulting party within thirty (30) days after
receipt of written notice thereof.
8. Payment Arrangements. Customer is required to pay MCI for Services within
twenty-five (25) days after Customer's receipt of MCl's invoice.
9. Exclusivity Requirement.
9.1 Customer agrees it shall use MCI exclusively as its interexchange
carrier ("IXC) during the Term hereof for one hundred percent (100%)
of all IXC services for which Customer is not contractually committed
at the execution of this Agreement including, without limitation,
inbound toll free services, outbound voice services, conference
calling services, domestic and international outbound, and domestic
and international data services. Compliance with the foregoing
exclusivity covenant shall be measured on a monthly basis based on
Customer's dollar usage of all IXC services.
9.2 After the Effective Date of this Agreement, but not more than once
annually, MCI may request, and Customer shall provide to MCI in
writing, Customer records, data and invoices pertaining to its total
IXC service usage for the most recent twelve (12) month period
preceding the request. MCI may review this information for the sole
purpose of determining Customer's compliance with the exclusivity
covenant set forth in Section 9.1 hereof. In the event that Customer
breaches the covenant set forth in Section 9.1 above, Customer agrees
to pay standard Tariffed rates for all Services received hereunder
during the period of non-compliance with said covenants.
9.3 The exclusivity covenant set forth in Section 9.1 hereof shall not
apply to Customer's current satellite services. However, in the event
that Customer's places its satellite service requirements under a
competitive bidding process, Customer agrees to grant MCI the
opportunity to provide a bid to contract for such satellite services.
10. Monitoring Conditions. Customer must satisfy the following conditions
during each Contract Year. If Customer fails to satisfy any of the
following conditions during any Contract Year, Customer will be billed and
required to pay an additional Two Cents ($0.02) for each minute of usage of
Services hereunder during such Contract Year that fails to satisfy the
conditions below. Any additional charges assessed pursuant to this
provision will be billed as a lump sum charge to one Customer account
number.
10.1 [XXXXXXXXXXXXXXXXX]** of Customer's total outbound traffic with
dedicated origination and termination usage (as measured in minutes of
use) must be MCI Outbound Switched Digital Service (54/64 kbps) usage;
MCI CONFIDENTIAL
ATT.A-5
**Omitted portions have been filed with the Securities and Exchange Commision.
<PAGE> 8
10.2 [XXXXXXXXXXXXXX]** of Customer's total outbound traffic with
dedicated origination and switched termination usage (as measured in
minutes of use) must be MCI Outbound Switched Digital Service (54/64
kbps) usage;
10.3 [XXXXXXXXXXXXXX]** of Customer's total MCI Vnet and Outbound Switched
Digital Service (54/64 kbps) usage (as measured in minutes of use)
must be Off-Peak usage.
MCI CONFIDENTIAL
ATT.A-6
**Omitted portions have been filed with the Securities and Exchange Commision.
<PAGE> 1
EXHIBIT 11
DIGITAL GENERATION SYSTEMS, INC.
STATEMENTS OF COMPUTATION OF WEIGHTED AVERAGE AND
PRO FORMA COMMON SHARES AND EQUIVALENTS
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- ------------------------
1997 1996 1997 1996
--------- -------- --------- ---------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Net loss $ (3,201) $ (2,087) $ (6,497) $ (4,475)
======== ======== ======== ========
Weighted average common shares outstanding 11,733 11,482 11,710 7,169
Weighted average common equivalent shares:
Weighted average preferred stock outstanding 3,637
Adjustments to reflect requirements of the Securities and Exchange
Commission's Staff Accounting Bulletin No. 83:
Common stock issuances 98
Convertible preferred stock issuances 291
Preferred stock warrants 10
Common stock option grants 374
-------- -------- -------- --------
Total weighted average common shares and equivalents 11,733 11,482 11,710
======== ======== ========
Pro forma total weighted average common shares and equivalents 11,579
========
Net loss per share $ (0.27) $ (0.18) $ (0.55)
======== ======== ========
Pro forma net loss per share $ (0.39)
========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> APR-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 9,231
<SECURITIES> 5,947
<RECEIVABLES> 3,890
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 19,450
<PP&E> 23,856
<DEPRECIATION> (11,309)
<TOTAL-ASSETS> 40,443
<CURRENT-LIABILITIES> 10,984
<BONDS> 9,067
0
0
<COMMON> 55,188
<OTHER-SE> 34,796
<TOTAL-LIABILITY-AND-EQUITY> 0
<SALES> 0
<TOTAL-REVENUES> 40,443
<CGS> 0
<TOTAL-COSTS> 15,910
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,064
<INCOME-PRETAX> (6,497)
<INCOME-TAX> 0
<INCOME-CONTINUING> (6,497)
<DISCONTINUED> 0
<EXTRAORDINARY> (6,497)
<CHANGES> 0
<NET-INCOME> (6,497)
<EPS-PRIMARY> (0.55)
<EPS-DILUTED> (0.55)
</TABLE>
