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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 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 __
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting Common Stock held by
non-affiliates of the registrant, based upon the closing sale price of the
Common Stock on March 27, 1998 as reported on the Nasdaq National Market, was
approximately $33,688,648. Shares of Common Stock held by each officer and
director of the registrant and by each person who may be deemed to be an
affiliate have been excluded. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
As of March 27, 1998, the registrant had 12,210,625 shares of Common
Stock, without par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
The registrant has incorporated by reference into Part III of this Form 10-K
portions of its Proxy Statement for the Annual Meeting of Shareholders to be
held on April 29, 1998 (the "Proxy Statement"). Except with respect to
information specifically incorporated by reference into this Form 10-K, the
Proxy Statement is not deemed to be filed as a part hereof.
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DIGITAL GENERATION SYSTEMS, INC.
This Form 10-K 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 Form 10-K.
TABLE OF CONTENTS
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PART I PAGE
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ITEM 1. BUSINESS ................................................. 1
Industry Background ...................................... 1
The Company .............................................. 2
Products and Services .................................... 3
The DG Systems Network ................................... 4
Markets and Customers .................................... 5
Sales, Marketing and Customer Service .................... 6
Competition .............................................. 7
Intellectual Property and Proprietary Rights ............. 8
ITEM 2. PROPERTIES 8
ITEM 3. LEGAL PROCEEDINGS 8
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 8
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT 9
PART II
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS 11
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ITEM 6. SELECTED FINANCIAL DATA
Statement of Operations .................................. 12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Overview ................................................. 13
Results of Operations .................................... 14
Liquidity and Capital Resources .......................... 20
Certain Business Considerations .......................... 21
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE 28
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 29
ITEM 11. EXECUTIVE COMPENSATION 29
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT 29
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 29
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
ON FORM 8-K. 30
SIGNATURES ................................................. 33
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PART I
ITEM 1. BUSINESS
Digital Generation Systems, Inc. ("DG Systems" or the "Company") operates a
nationwide, value added digital network which links hundreds of advertisers and
advertising agencies with more than 5,500 radio stations and 500 television
stations across the United States. The Company's fault-tolerant network
operations center delivers audio, video, image and data content which
facilitates transactions among advertising industry participants.
The Company is the leading provider of electronic distribution of audio
spot advertising to radio stations. In 1996 the Company entered the market for
the electronic distribution of video spots to television stations, cable systems
and networks. DG Systems generates its revenues principally from advertising
agencies, advertisers, tape duplication vendors and dealers, syndicated
programmers and music companies that principally service these markets. The
Company believes that its digital network enables rapid, cost-effective and
reliable transmission of audio and video broadcast content, and provides higher
levels of quality, control and flexibility than the other distribution methods
currently available. In July 1997, the Company purchased Starcom Mediatech, Inc.
("Mediatech"), a provider of broadcast video and audio duplication, syndicated
program distribution and corporate media duplication services with facilities in
Chicago, Los Angeles and New York, augmenting its November 1996 acquisition of
PDR Productions, Inc. ("PDR"), a New York City-based broadcast production
services company. As a result of these acquisitions the Company has become a
leading provider of video advertising distribution and is rapidly adding new
customers to its digital audio and video network. Moreover, the Company believes
it now offers the most complete range of post production services, including
editing, duplication, color control, close captioning, content review, quality
assurance, archiving and format conversions in this market. The Company
currently provides these services through its facilities in New York City,
Chicago, Louisville, Los Angeles and San Francisco.
INDUSTRY BACKGROUND
While many radio and television broadcasters now embrace digital technology
for much of their production processes and in-station media management, current
methods for the distribution of audio and video advertising content are based
primarily on the manual duplication and physical delivery of analog tapes.
According to industry sources, there are approximately 10,000 commercial radio
and 1,200 commercial television stations in the United States. These stations
generate revenue principally by selling air time to advertisers. Advertising is
most frequently produced under the direction of advertising agencies for large
national or regional advertisers or by station personnel for advertisers that
are local in nature. Advertising is characterized as "network" or "spot",
depending on how it is bought and distributed. Network advertising typically is
delivered to stations as part of a "network feed" (bundled with network
programming), while spot advertising is delivered to stations independently of
other programming content.
Spot advertising air time is typically purchased by advertising agencies or
media buying firms on behalf of advertisers. Advertisers and their agencies
select individual stations or groups of stations to support marketing
objectives, which usually are based on the stations' geographic and other
demographic characteristics. The actual commercials or "spots" are typically
produced at a production studio and recorded on tape. Variations of the spot
intended for specific demographic groups also are produced at this time. The
spots undergo a review of quality and content before being cleared for
transmission to broadcast stations, one submaster per market group. Tapes
containing the spot and its variations are then duplicated, packaged, labeled
and shipped to the radio and television stations and cable headends specified by
the advertiser or its agency.
The predominant method for distributing spot advertisements to radio and
television stations traditionally has been the physical delivery of analog audio
or video tapes. The Company estimates that more than 50% of radio spots and more
than 90% of video spots are delivered by air express services. The remainder are
produced within individual stations, delivered by local delivery services or
picked up from the originating studio by station employees. Many companies,
commonly known as "dub and ship houses", are in the business of duplicating
audio and video tapes and packing them for air express delivery. The Company
estimates that more than four million audio tapes and more than six million
video tapes were delivered via air express to radio and television stations in
1997 through the efforts of approximately 400 production studios and dub and
ship houses.
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THE COMPANY
DG Systems is a leading provider of electronic and physical distribution
and ancillary post-production services for audio and video content to
advertising agencies, production studios and broadcast stations throughout the
United States. The Company, a California corporation, was incorporated in 1991.
The Company has developed a digital network currently serving over 5,500 radio
stations and 500 television stations that is controlled through the Company's
network operating center. This network enables the rapid, cost-effective and
reliable electronic transmission of audio and video spots and other content and
provides a high level of quality, accountability and flexibility to both
advertisers and broadcasters. With DG Systems' network, transmissions are
automatically routed to stations through a computerized on-line transaction and
delivery system and arrive at stations in as little as one hour after an order
is received. Typically associated traffic (text) instructions are simultaneously
transmitted by facsimile to minimize station handling and scheduling errors.
Shortly after a spot is delivered to a station, the Company sends the customer a
confirmation specifying the time of delivery. Additionally, the Company's
digital network delivers close to "master" quality audio or video to broadcast
stations, which is superior to that currently delivered on analog tape.
DG Systems generates its revenues from advertising agencies as well as from
production studios and dub and ship houses that consolidate and forward the
deliveries to broadcast stations. The Company has historically operated and
currently operates without substantial backlog. The Company receives
distribution orders with specific routing and timing instructions provided by
the customer. These orders are then entered into the Company's computer system
and scheduled for electronic delivery if a station is on the Company's network,
or scheduled for physical delivery via the Company's various dub and ship
facilities if the station is not on the network.
Audio content is delivered electronically to the Company's network
operating center from Record Send Terminals ("RSTs") that are owned by the
Company and deployed primarily in production studios. When an audio spot is
received, Company personnel currently review the audio and then initiate the
electronic transaction to transmit the audio to the designated radio stations.
Audio transmissions currently are delivered over standard telephone or ISDN
lines.
Video content is delivered electronically to the Company's network
operating center primarily from DG Video Record Transmission Systems ("VRTSs")
that are owned by the Company and deployed primarily in production studios.
Video content also can be delivered to the Company's network operating center
through air freight carriers or through high-speed communication lines from
collection points in locations where VRTSs are not available. When a video spot
is received, Company personnel initiate the electronic transaction to transmit
the video to designated television stations. Video transmissions are sent via
high speed frame relay links to a satellite uplink facility and are then
delivered directly to television stations and cable headends via the satellite
network.
Audio and video transmissions are received at designated radio and
television stations on DG's Receive Playback Terminals ("RPTs") and ADvantage
Digital Video Playback Systems ("DVPS"), respectively, which enable stations to
receive and playback material delivered through the Company's digital
distribution network. The units are owned by the Company and typically are
installed in the "master control" or production area of the stations. Upon
receipt, station personnel generally review the content and transfer the spot to
a standardized internal station format for subsequent broadcast. Through its
network operating center, the Company monitors the spots stored in each Receive
Playback Terminal or Video Playback System and ensures that space is always
available for new transmissions. The Company can quickly transmit audio or video
at the request of a station or in response to the request of a customer who
wishes to alter an existing order.
DG Systems currently offers four primary levels of digital distribution
services to broadcast advertisers distributing content to broadcast stations: DG
Priority, a service which guarantees arrival of the first spot on an order
within one hour; DG Express, which guarantees arrival within four hours; DG
Standard, which guarantees arrival by noon the next day; and DG Economy, which
guarantees arrival by noon on the second day. The Company also offers a set of
premium services enabling advertisers to distribute audio or video spots
provided after normal business hours. The DG Priority service currently is
available only for audio distribution.
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In addition to its standard services, the Company has developed unique
products to service three vertical markets with particular time-sensitive
delivery needs. "Sweeps" delivery is a specialized service to television
stations that wish to advertise on radio to stimulate viewership during the
periods of ratings conducted by the A.C. Nielsen Company in February, May,
September, and November of each year. The Company also offers delivery of
advertising for daily newspapers seeking to expand their readership based on a
dissemination of breaking news during the morning rush hour. The Company
distributes first release music singles and uses unique software functionality
to insure that the singles are released throughout the network to all stations
simultaneously thereby eliminating concerns of favoritism or premature release.
Finally, the Company delivers political advertising during election campaigns,
providing a rapid response mechanism for candidates and issue groups.
The Company also provides audio and video duplication services, syndicated
programming distribution services, and a host of other ancillary post production
services through its nationwide facilities in New York, Chicago, Louisville and
Los Angeles.
PRODUCTS AND SERVICES
The Company's mission is to become the leading provider of electronic
delivery and related value-added services to broadcast advertisers. The Company
also seeks to become the industry standard for digital delivery of both audio
and video broadcast content.
Audio Advertising Distribution. Prior to the Company's acquisitions of PDR
and Mediatech, substantially all of the Company's revenues were derived from the
delivery of radio advertising 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 share of the Company's
revenues for some time. See "The Company" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Certain Business
Considerations -- Dependence on Radio Advertising." The Company also derives
revenue from its offering of audio distribution services in the three vertical
markets: sweeps; local/regional newspapers; and political advertising. See "The
Company." Finally, the Company derives limited revenue today through its studio
services, which enable production studios to directly exchange audio files with
each other without the intervention of Company personnel.
Video Advertising Distribution. The Company believes that the delivery of
television advertising is characterized by many of the same challenges facing
radio advertisers. The Company introduced its video distribution services in the
third quarter of 1996. To date the Company has deployed a video distribution
network consisting of over 500 television stations and cable systems, which
currently are on-line and able to receive video content through the Company's
network. The Company is actively marketing and selling its video services to
agencies, advertisers and dealers. As most of the Company's radio advertising
customers also are active television advertisers, many of its current customers
who already utilize the Company's audio spot distribution services are
candidates for or already are utilizing its video services. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Certain Business Considerations -- Dependence on Video Advertising Delivery
Service Deployment", and "-- Dependence on Technological Developments" and " --
Competition."
Further, the Company's acquisitions of PDR and Mediatech have enabled it to
provide digital delivery to a larger base of customers and to provide ancillary
post-production services in the major markets to allow "one-stop shopping" for
media preparation and distribution services.
Syndicated Program Distribution. The Company also generates revenue by
distributing syndicated programming. This service primarily consists of
integrating commercials into syndicated programs and uplinking the completed
programs to satellites for distribution to stations nationwide as well as the
physical duplication and shipping of shows to stations that do not receive a
satellite feed.
Corporate Duplication. The Company also generates revenues from the
duplication of corporate content. This service primarily consists of large
quantity duplication of training, corporate or product information tapes on
non-broadcast quality tape stock, such as VHS.
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Music Distribution. The Company also derives revenues from its "first
release music deliveries", in which it offers music labels the capability to
electronically distribute first-release music singles simultaneously to selected
radio stations. The release of a new album by an established musical artist is
often the focus of a marketing campaign culminating in the simultaneous release
of a hit single to radio stations in key markets. Music labels share the
concerns of advertisers and agencies regarding the timeliness and reliability of
delivery, and in addition seek to maximize publicity by employing a secure
delivery system that ensures all selected radio stations will receive the single
just in time for the scheduled release but prevent it from being aired before
that time. In addition, new or "up and coming" artists backed by major record
labels seek the opportunity to market their music to radio stations through
innovative means, including simultaneous, first release distribution.
The Company's future growth depends on its successful and timely
introduction of new products and services, often in markets that do not
currently exist or are just emerging. The Company currently is undertaking
efforts to develop new products and services. There can be no assurance,
however, that the Company will successfully complete such development or that,
if such development is completed, the Company's introduction of these products
and services will realize market acceptance or will meet the technical or other
requirements of potential customers. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Certain Business
Considerations -- Dependence on Emerging Markets."
THE DG SYSTEMS NETWORK
DG Systems has developed a sophisticated, highly scaleable network
communication system to provide network transaction services to the targeted
production studios and stations. Today this system supports two-way
communication to remote production studios and stations via standard telephone
lines, ISDN lines, digital data satellite and frame relay connections. The
Company intends to continue adding communications capabilities, such as Internet
links, as they become widely available and economically attractive. The modular
system design and use of industry standard technology enables system capacity to
be increased easily and quickly. DG Systems can maintain over 800 simultaneous
connections today. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Certain Business Considerations --
Ability to Manage Growth" and " -- Future Capital Needs; Uncertainty of
Additional Funding."
The Company's network consists of the following: (i) Record Send Terminals
(audio) and Video Record and Transmission Systems (video) owned by the Company
and installed primarily at production studios; (ii) a network operating center
at the Company's headquarters used to process, route and store digital content;
and (iii) ADvantage Receive Playback Terminals (audio) and ADvantage Digital
Video Playback Systems (video) owned by the Company and installed at broadcast
stations.
Record Send Terminal. The RST is a PC-based audio encoder and
communications server with a full screen monitor and keyboard. The RST accepts
audio in either analog or digital format and encodes the audio using an
efficient algorithm for transmissions to the Company's network operating center.
Video Record Transmission System. The VRTS is a video encoder and
communications server with a full screen monitor and keyboard. The VRTS accepts
video in either analog or digital format and encodes the video using a standard
MPEG-2 compression algorithm for transmissions to the Company's network
operating center.
Network Operating Center. DG systems has developed a fault-tolerant
client/server on-line transaction system based on relational databases and UNIX
servers from Sun Microsystems. The Company has developed software applications
incorporating critical operational capabilities such as transaction management,
communication facility monitoring, system security, intelligent network routing
and customer service databases. The major system components include (i) a
transaction scheduling, monitoring and management system, (ii) a media
collection, processing and delivery system which is designed to handle audio,
video, image and data organizing the delivery content by destination address,
and routing those deliveries by the most cost-effective route, and (iii) a
high-capacity media storage and archive system that indexes and archives every
media file delivered by the Company.
ADvantage Receive Playback Terminal. The RPT is a rack-mountable, PC-based
communication server and media decoder that enables radio stations to receive
and play back audio content delivered through the Company's digital distribution
network. The RPT communicates with the Company's network to exchange media and
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transactional information, and allows users to play back broadcast quality audio
on demand. RPT software consists of extensive remote capabilities such as system
diagnostics, storage management and remote software upgrade as well as enhanced
security features such as user authentication, network access security protocol
and media content encryption to prevent unauthorized access.
ADvantage Digital Video Playback System. The DVPS is a rack-mountable,
PC-based communication server and video decoder that enables television stations
and cable systems to receive and play back advertisements delivered through the
Company's digital distribution network. The DVPS communicates with the Company's
network to exchange media and transactional information, and allows users to
play broadcast quality video on demand. The DVPS includes a fully integrated
monitor and keyboard and has the disk capacity to store up to 250 30-second
spots. DVPS software consists of extensive remote capabilities such as system
diagnostics, storage management and remote software upgrades as well as enhanced
security features such as user authentication, network access security protocol
and media content encryption to prevent unauthorized access.
Hughes DirecPC Satellite Interface. The Company has a joint development and
deployment agreement with Hughes Network Systems, Inc. for satellite delivery to
its network of stations. The Company has developed an electronic interface
between its network operating center and the Hughes satellite uplink facility.
The Company also has integrated the Hughes DirecPC satellite technology into its
DVPSs to permit the receipt of media content from satellite as well as from
terrestrial connections.
DG's extensive network of digital audio receive playback terminals and
video playback systems strategically placed across the country in broadcast
stations, its record send terminals and video record transmission systems,
coupled with unique encoding, compression and complex communications software,
connected via its Network Operating Center described above, and an established
customer base, create important barriers to entry for potential competitors. The
transmission of content is controlled by a very comprehensive transaction
scheduling, routing, monitoring and delivery management system which the Company
believes would be very difficult to replicate. Additionally, DG's audio and
video capabilities now are complemented with facilities in New York City,
Chicago, Louisville, and Los Angeles to handle customers' other production
services needs. The Company believes that no single competitor today offers DG
System's audio, video, and production services capabilities which are
deliverable locally and nationally via several strategic locations.
MARKETS AND CUSTOMERS
A large portion of the Company's current revenue is derived from the
delivery of spot radio and television advertising to broadcast stations, cable
systems and networks. The Company derives revenue from advertising agencies
directly and from its marketing partners, which are typically dub and ship
houses that have signed agreements with the Company to consolidate and forward
the deliveries of their advertising agency customers to broadcast stations,
cable systems and networks via the Company's electronic delivery service in
exchange for price discounts from the Company. The advertisements distributed by
the Company are representative of the five leading national advertising
categories of automotive, retail, business and consumer services, food and
related products including soft drinks, and entertainment. The volume of
advertising from these segments is subject to substantial seasonal and cyclical
variations. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Certain Business Considerations -- Potential
Fluctuations in Quarterly Results; Seasonality."
In addition to its core distribution services, DG Systems has identified
vertical-market applications for services where same day delivery is used to
promote time-sensitive content. These applications include:
Sweeps Promotions. The A.C. Nielsen ratings periods take place during the
broadcast months of February, May, September, and November. The Company's
services allow local television stations, their affiliated networks and
syndicators, whose own advertising rates are based on their Nielsen ratings, to
promote viewership of their programs during ratings periods. In 1997, more than
100 television stations used the Company's sweeps delivery service.
Political Campaigns. Radio and television can provide a rapid response
mechanism for candidates and issue groups. The Company offers a same-day service
for the facilitation of such advertising during political campaigns.
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Newspaper Headlines. Newspapers use the Company's services to deliver
topical radio commercials to run during the morning or afternoon in local
markets to encourage readership for local newspapers. The producer typically
reads a special early edition of the paper. Stories are selected on the basis of
topical content with the best chance of encouraging listeners to become readers.
The spot is written, recorded, mixed and transmitted to DG Systems for
distribution to local radio stations. Delivery guarantees are typically between
one and two hours depending on the market.
THE COMPANY ALSO OFFERS THE FOLLOWING SERVICES:
Syndicated Programming Distribution. Syndicators distribute long form video
programming inclusive of advertising to local television, stations and cable
operators. The Company offers numerous post production services to prepare this
content for broadcast and distribute it across the country. Distribution
services include both satellite uplink and physical duplication and shipping to
those stations which do not or cannot receive the content via satellite.
Corporate Duplication. Corporations and other entities develop training
management communications and other general information programs for internal
and external distribution for various purposes. The Company provides high volume
duplication of such content on non-broadcast quality tape stock, typically VHS.
SALES, MARKETING AND CUSTOMER SERVICE
Brand Strategy. The Company's brand strategy is to position itself as the
standard delivery method for the radio, television, cable, and network broadcast
industry. The Company focuses its marketing messages and programs at multiple
segments within the broadcast industry. Each of the segments interacts with the
Company for a different reason. Agencies purchase services from the Company on
behalf of their advertisers. Production studios facilitate the transmission of
audio and video to the Company's network operating center. Production studios
and dub and ship houses resell delivery services to agencies. Stations join the
network to receive the content from their customers, the agencies and
advertisers. A key strategy to providing a consistent brand theme at all levels
is developing "DG" as a brand identity across these various product and services
offerings.
Sales. The Company employs a direct sales force that calls on various
departments at advertising agencies to communicate the capabilities and
comparative advantages of the Company's electronic distribution system and the
related products and services. In addition, the Company's sales force calls on
corporate advertisers who are in a position to either direct or influence
agencies in directing deliveries to the Company. The Company currently has field
sales offices in New York, Los Angeles, and Chicago, as well as sales personnel
in its San Francisco headquarters. The Company's sales force includes field
sales, inside sales, and telemarketing.
Marketing. The Company's marketing programs are directed toward demand
stimulation with an emphasis on popularizing the benefits of digital delivery,
including fast turnaround (same day services), increased flexibility, higher
quality, problem recovery, and greater reliability and accountability. These
marketing programs include direct mail and telemarketing campaigns, newsletters,
collateral material (including brochures, data sheets, etc.), application
stories, and corporate briefings in major U.S. cities. The Company also engages
in public relations activities including trade show participation, the
stimulation of articles in the trade and business press, press tours and partial
sponsorship of the annual Mercury Awards of the Radio Advertising Bureau. The
Company also engages in limited print advertising in advertising and broadcast
oriented trade publications.
The Company also markets to broadcast stations to arrange for the placement
of its RPTs and DVPSs. The service contract offers the station free use of the
RPT or DVPS, but stations generally are required to pay for a dedicated phone or
ISDN line to support the transmissions.
According to industry sources, there are over 5,200 commercial radio
stations that are located in Arbitron-rated "Areas of Dominant Influence," which
are the geographic areas in which national advertisers are most active. The
Company believes its installed base of RPTs located in an estimated 95% of these
geographic areas provides it with an important competitive advantage. The
Company similarly is focusing on the largest 100 television markets as rated by
A.C. Nielsen, along with the major cable interconnects and cable and broadcast
networks in the largest U.S. markets.
Customer Service.The Company's approach to customer service is based on a
distributed model designed to provide focused support from key market centered
offices, located in Los Angeles, San Francisco, Chicago, and New York. Clients
work with assigned account coordinators to place production service and
distribution orders. National distribution orders are electronically routed to
the San Francisco Network Operating Center for electronic distribution or the
Company's national duplication center in Louisville, Kentucky. The Company's
distributed
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service approach provides direct support in the key market cities enabling the
Company to develop closer relationships with clients as well as the ability to
support client needs for local production services, appropriate for that local
market. The Company also maintains a customer service team, dedicated to
supporting the needs of radio, television, and network stations. This support is
available 7 days a week, 24 hours a day, to respond to station requests for
information, traffic instructions or additional media. Providing direct support
alleviates the need for client traffic departments to deal with individual
stations or the challenges of staffing for off-hours support. The Company's San
Francisco customer service operation is linked to a common database system and
national distribution network. These resources enable the Company to manage the
distribution of client orders to the fulfillment location best suited to meet
critical customer requirements as well as providing order status and fulfillment
confirmation. This distributed model also provides the Company with significant
redundancy and re-route capability, enabling the Company to meet customer needs
when weather or other conditions prevent deliveries using traditional courier
services.
COMPETITION
The market for the distribution of advertising and other content to radio
and television stations and cable systems is highly competitive. The Company
currently competes in the market for the distribution of audio and video
advertising spots to broadcast stations, cable systems and networks. The
principal competitive factors affecting this market are ease of use, price, and
timeliness and accuracy of delivery.
The Company competes with a variety of dub and ship houses and production
studios that have traditionally distributed taped advertising spots via physical
delivery. As local distributors, these entities have long-standing ties with
advertising agencies that are often difficult for the Company to replace. In
addition, these dub and ship houses and production studios often provide an
array of ancillary video services, including archival storage and retrieval,
closed captioning and format conversions, enabling them to deliver to their
advertiser and agency customers a full range of customizable, media post
production, preparation, distribution and trafficking services. The Company's
acquisitions of Mediatech and PDR enable the Company to provide similar services
in the three largest domestic advertising markets: New York, Los Angeles and
Chicago. The Company plans to continue pursuing potential dub and ship house
partners where such partnerships make strategic sense.
The Company competes in the market for electronic audio distribution
services with Digital Courier International Corporation (DCI) and Musicam
Express (a subsidiary of Virtex). It competes with VDI Media and Vyvx
Advertising Distribution Services, a subsidiary of The Williams Companies, Inc.,
in the market for electronic distribution of video content.
To the extent that the Company is successful in entering new markets, such
as delivery of other content to radio and television stations, it expects to
face competition from companies in related communications markets and/or package
delivery markets which offer products and services with functionality similar to
that offered by the Company's products and services. Telecommunications
providers such as AT&T, MCI, and Regional Bell Operating Companies could enter
the market as competitors with significantly lower electronic delivery
transportation costs. The Company also could 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 also could become competitors by
selling and transmitting advertisements separately from their network content
programming.
Many of the Company's current and potential competitors in the markets for
audio and video distribution have substantially greater financial, technical,
marketing and other resources and larger installed customer bases than the
Company. The Company expects that an increasingly competitive environment may
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
markets for the distribution of audio and video content have 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 services. 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. See "Risk Factors--Competition."
7
<PAGE> 11
The Company believes it has the broadest coverage in broadcast radio and
the largest market share by a wide margin. The Company believes that while not
yet completely installed, its base of installed plus on order backlog gives it
the broadest coverage in video, plus the best technical solution for highest
quality and reliability.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
The Company primarily relies upon a combination of copyright, trademark and
trade secret laws and license agreements to establish and protect proprietary
rights in its technologies. The source code for the Company's software is
protected both as a trade secret and as an unpublished copyrighted work. Despite
these precautions, it may be possible for a third party to copy or otherwise
obtain and use the Company's hardware, software or technology without
authorization or to develop similar technology independently. In addition,
effective copyright and trade secret protection may be unavailable or limited in
certain foreign countries. The Company does not hold any patents.
Because the Company's business is characterized by rapid technological
change, the Company believes that factors such as the technological and creative
skills of its personnel, new computer hardware, software and telecommunications
developments, frequent hardware and software enhancements, name recognition, and
reliable customer service and support are more important to establishing and
maintaining a leadership position than the various legal protections of its
technology.
The Company believes that its software, trademarks and other proprietary
rights do not infringe the proprietary rights of third parties. There can be no
assurance, however, that third parties will not assert such infringement by the
Company with respect to current or future software, hardware or services. Any
such claims, with or without merit, could be time-consuming, result in costly
litigation, cause software release delays or might require the Company to enter
into royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to the Company.
ITEM 2. PROPERTIES
The Company's headquarters are located at leased office space located at
875 Battery Street in San Francisco. The Company's lease is for 15,000 square
feet and expires in 2001. In order to sustain uninterrupted network integrity,
the Company has an agreement for non-interruptible access to emergency power and
the Company has arranged for alternative fiber optic routes to maintain its
fiber connection between its computers and its long distance carrier. However,
there can be no assurance that a catastrophic earthquake or other natural
disaster could not interrupt the company's operations. The Company leases
approximately 5,000 square feet at a nearby facility on used for assembly of its
field equipment and for offsite storage which expires in 2001. In addition, the
Company leases approximately 3,000 square feet in Louisville, Kentucky for its
dub and ship facility which expires in 2002; approximately 22,000 square feet in
New York City which is occupied by DG East (formerly PDR) and expires in 2006;
and approximately 13,000 square feet in Los Angeles occupied by DG West
(formerly Mediatech) which expires in 2006. In addition, the Company leases
30,500 square feet in Chicago, which is occupied by DG Central (formerly
Mediatech) on a month to month rental agreement, pending finalization of a long
term lease. The Company believes that these facilities and offices, in addition
to alternative space available to it are adequate to meet its requirements for
the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to various legal proceedings and claims, either
asserted or unasserted, which arise in the ordinary course of business. While
the outcome of these claims cannot be predicted with certainty, management does
not believe that the outcome of any of these legal matters will have a material
adverse effect on the Company's consolidated financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
8
<PAGE> 12
None.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers and directors of the Company and their ages as of
December 31, 1997 are as follows:
<TABLE>
<CAPTION>
Name Age Title(s)
----- ----- ---------
<S> <C> <C>
Henry W. Donaldson 52 President, Chief Executive Officer and Director
Ken K. Cheng 42 Senior Vice President, Chief Operating Officer
Robert H. Howard 48 Vice President, Sales
Gregory G. Schott 33 Vice President, Marketing
Thomas P. Shanahan 51 Vice President, Finance and Chief Financial Officer
Kevin R Compton (1) 39 Director
Jeffrey M. Drazan (2) 39 Director
Richard H. Harris (2) 68 Director
Lawrence D. Lenihan, Jr 33 Director
Leonard S. Matthews (1)(2) 75 Director
</TABLE>
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
Henry W. Donaldson joined the Company in March 1993, and since such date
has served as its President and Chief Executive Officer and as a member of the
Company's Board of Directors. He was formerly President of the Data
Communications Division of Rexel, Inc., a provider of telecommunications and
local area networking products and services, from September 1989 through January
1993. Mr. Donaldson holds a B.A. in Mathematics from Hamilton College.
Ken K. Cheng joined the Company in December 1993 and as Vice President,
Engineering. Mr. Cheng was appointed Senior Vice President and Chief Operating
Officer in June 1996 and has served as such since that date. From December 1988
to December 1993, Mr. Cheng was Director of Engineering at Network Equipment
Technologies. Mr. Cheng holds a B.Sc. in Applied Mathematics from Queen's
University, Kingston, Ontario, Canada and an M.B.A. from Santa Clara University.
Robert H. Howard joined the Company in April 1997 as Vice President of
Sales. Mr. Howard held several positions with Columbine JDS, the world's leading
provider of software to the broadcast industry, from 1977 through 1996,
including Vice President of Sales and Marketing. Mr. Howard holds a B.A. in
Communications and an MBA from the University of Memphis.
Gregory G. Schott joined the Company in July 1994 as Director of
Operations. Mr. Schott later served as Director of Business Development from
December 1995 to June 1996 and as the Vice President of Operations from July
1996 to October 1997 and is now currently the Vice President of Marketing. From
June 1991 to July 1994, Mr. Schott was a consultant with the Boston Consulting
Group. Mr. Schott holds a B.S. in Mechanical Engineering from North Carolina
State University and an M.B.A. from Stanford University.
Thomas P. Shanahan joined the company in November 1994, and since such
date has served as its Chief Financial Officer. From May 1987 to February 1992,
Mr. Shanahan was Chief Financial Officer of SBT Corporation. From March 1992 to
April 1993, Mr. Shanahan was Chief Financial Officer of Ultra Network
Technologies, Inc. From May 1993 to October 1994, he was Chief Financial Officer
of Sherpa Corporation. Mr. Shanahan holds a BA in Economics from Stanford
University and an MBA from Harvard University.
Kevin R. Compton has been a member of the Board of Directors of the
Company since March 1994. Mr. Compton has been a general partner of Kleiner,
Perkins, Caufield & Byers, a venture capital investment firm, since December
1990. Mr. Compton currently serves as a director of: Global Village
Communication, Inc., a networking hardware and software company; Citrix Systems,
a developer of server software; Corsair
9
<PAGE> 13
Communications, Inc., a developer of hardware and software systems for the
wireless telecommunications industry; Verisign, a provider of digital
authentication services; and on numerous privately held companies. He holds a BS
in Business Administration from the University of Missouri.
Jeffrey M. Drazan has been a member of the Board of Directors of the
Company since July 1992. Mr. Drazan has been a general partner of Sierra
Ventures, a venture capital investment firm, since 1985. Mr. Drazan currently
serves as a director of FaxSav, Micromuse, and Retix, a telecommunications
equipment company. Mr. Drazan holds a BSE. in Engineering from Princeton and an
MBA from New York University.
Richard H. Harris has been a member of the Board of Directors of the
Company since July 1992. Since July 1992, Mr. Harris has been President and
Owner of Harris Classical Broadcasting, operating two FM audio stations in
Milwaukee, Wisconsin. From May 1984 to May 1986, Mr. Harris was Chairman of the
Radio Advertising Bureau. From June 1964 to April 1991, Mr. Harris held various
senior management positions with Westinghouse Broadcasting Company, including
Chairman of the Radio Group. Mr. Harris holds a BA in Communications and
Economics from the University of Denver and is a graduate of the Advanced
Management Program at Harvard University.
Lawrence D. Lenihan, Jr. has been a member of the Board of Directors of
the Company since July 1997. Mr. Lenihan has been a managing member of the
General Partner for Pequot Private Equity Fund, L.P. since February 1997. He is
also a Principal at Dawson-Samberg Capital Management, Inc. Mr. Lenihan was a
Principal at Broadview Associates, LLC, prior to joining Dawson-Samberg. He
currently serves as a Director of Direc-To-Phone and Sanctuary Woods Multimedia
Corporation. Mr. Lenihan holds a BSEE. from Duke University and an MBA from the
Wharton School of Business.
Leonard S. Matthews has been a member of the Board of Directors of the
Company since April 1993. From January 1979 to January 1989, Mr. Matthews was
President and Chief Executive Officer of the American Association of Advertising
Agencies. Previously, Mr. Matthews had been president of two of the world's
leading advertising agencies, Leo Burnett and Young & Rubicam. From May 1992 to
the present, Mr. Matthews has been Chairman of the Board of Next Century Media,
an interactive television company. Mr. Matthews holds a BS in Business
Administration & Marketing from Northwestern University.
10
<PAGE> 14
PART II
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock of the Company has been traded on Nasdaq National Market
under the symbol DGIT since the Company's initial public offering on February 6,
1996. Prior to that time there was no public market for the Company's Common
Stock or other securities.
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
FISCAL YEAR ENDED DECEMBER 31, 1997:
First Quarter ...................................... $8.38 $4.00
Second Quarter...................................... $5.19 $3.88
Third Quarter ...................................... $6.75 $4.50
Fourth Quarter...................................... $4.63 $2.38
</TABLE>
As of March 1, 1998, the Company had issued and outstanding 12,196,454
shares of its Common Stock held by 116 shareholders of record. The Company
estimates that there are approximately 2,000 beneficial shareholders.
The Company has never declared or paid cash dividends on its capital stock.
The Company currently expects to retain its future earnings for use in the
operation and expansion of its business and does not anticipate paying any cash
dividends in the foreseeable future.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations ---Certain Business Considerations --- Concentration of
Stock Ownership", "---Preferential Rights of Outstanding Preferred Stock" and
"---Possible Volatility of Share Price."
11
<PAGE> 15
ITEM 6. SELECTED FINANCIAL DATA
STATEMENTS OF OPERATIONS:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1993 1994 1995 1996 1997
------- ------- -------- -------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Revenues ....................... $ 315 $ 2,432 $ 5,144 $ 10,523 $ 29,175
------- ------- -------- -------- --------
Costs and expenses:
Delivery and material costs . 200 953 1,810 3,084 11,334
Customer operations ......... 735 1,886 2,974 4,164 11,388
Sales and marketing ......... 1,126 2,248 3,406 3,998 4,417
Research and development .... 505 1,048 1,590 2,092 2,473
General and administrative .. 672 1,054 1,380 1,677 3,169
Depreciation and amortization 329 913 2,345 4,331 9,306
------- ------- -------- -------- --------
Total expenses ........... 3,567 8,102 13,505 19,346 42,087
------- ------- -------- -------- --------
Loss from operations ........... (3,252) (5,670) (8,361) (8,823) (12,912)
------- ------- -------- -------- --------
Other income (expense):
Interest income ............. 35 129 417 1,422 744
Interest expense ............ (58) (71) (836) (1,726) (2,607)
------- ------- -------- -------- --------
Net Loss ....................... $(3,275) $(5,612) $ (8,780) $ (9,127) $(14,775)
======= ======= ======== ======== ========
Basic and diluted net loss per
common share (1).................... $(6.72) $(8.23) $(9.78) $(0.87) $(2.52)
====== ====== ====== ====== ======
Weighted average common shares ..... 487 682 898 10,488 11,893
====== ====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
BALANCE SHEET DATA:
------------------------------------------------------
1993 1994 1995 1996 1997
------ ------- ------- ------- --------
<S> <C> <C> <C> <C> <C>
Cash, cash equivalents and short-term $ 495 $ 9,221 $ 6,205 $20,597 $ 8,820
investments
Working capital ...................... 115 8,755 4,651 14,200 (879)
Property and equipment, net .......... 1,455 3,175 5,772 12,630 17,566
Total assets ......................... 2,222 13,572 14,459 45,248 60,697
Long-term debt, net of current portion 303 1,573 4,540 8,495 11,847
Shareholders' equity ................. 1,358 10,502 6,373 26,839 30,449
(1) See Note 11 of Notes to Consolidated Financial Statements - Net Loss Per Share.
</TABLE>
12
<PAGE> 16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company was incorporated in 1991. Through 1993, the Company was a
development-stage company, principally engaged in developing its network,
marketing its services to radio stations and advertising agencies, and producing
and deploying terminals for use at adverting agencies, production studios and
radio stations. In 1994, the Company first generated significant operating
revenues from the delivery of audio commercials and the related text traffic
instructions to radio stations through a nationwide network established by the
Company. In the third quarter of 1996, the Company began delivery of video
commercials to television stations. As the network expanded to include an
increasing number of radio and television stations, the number of deliveries
ordered by customers has increased. At the same time, the number of deliveries
performed via electronic delivery has increased relative to the number performed
by physical delivery through the Company's dub and ship facility in Louisville,
Kentucky.
The Company defines a delivery as the transmission, electronic or physical,
of a piece or pieces of audio or video content, generally a commercial ("spot")
or a set of commercials ("tied spots") to a destination, generally a radio or
television station, based on a single order from a customer. Each order usually
calls for the delivery of the same spots to multiple destinations, resulting in
multiple deliveries. The revenue earned per delivery is dependent upon the type
of service ordered, generally defined by the time interval between submission
and delivery (Priority, Express, Standard or Economy), the channel from which
the order is received (directly from an advertiser or advertising agency or
through a dub and ship house), and the quantity of audio or video being
delivered (a single spot or multiple tied spots.) DG Systems derives revenue
from advertising agencies, as well as production studios and dub and ship houses
that consolidate and forward deliveries for their agency customers. Because the
revenue earned for the delivery of the first spot is significantly greater than
the revenue earned for a tied spot and because the Company's per spot electronic
transmission cost is relatively constant regardless of volume, electronic
deliveries that comprise a single spot are generally more profitable that
deliveries which include tied spots. The Company recognizes revenue for each
order on the date the content is transmitted to the destinations ordered.
The Company assembles, owns and maintains Receive Playback Terminals
("RPTs"), which are located in radio stations, Record Send Terminals ("RSTs"),
which are located in advertising agencies and production studios, Video Record
Transmission Systems ("VRTSs"), which are located primarily in production
studios, and Digital Video Playback Systems ("DVPSs") which are located in
television stations. The capital required to build the network has been obtained
through various preferred stock offerings to investors, primarily venture
capital firms, leasing agreements, and the Company's initial public offering,
which was completed in February 1996.
In November 1996, the Company acquired 100% of the capital stock of PDR
Productions, Inc. ("PDR"), a New York City based media duplication and
distribution company. PDR's primary operations are services typical of the
traditional dub and ship house, including the physical duplication and
distribution of video content on a wide range of tape formats and performance of
a variety of audio and video editing services. The acquisition was accounted for
as a purchase and 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.
In July 1997, the Company acquired 100% of the capital stock of Starcom
Mediatech, Inc. ("Mediatech"), a wholly owned subsidiary of IndeNet, Inc.
("IndeNet") with operating facilities in Chicago, Los Angeles, New York and
Louisville. Mediatech's primary operations, similar to those of PDR, are also
services typical of a traditional dub and ship house. Although Mediatech's
revenues are generated primarily from the duplication and distribution of short
form content, consistent with those of DG Systems prior to this acquisition,
Mediatech's revenues also include a significant portion generated from the
distribution of long form syndicated programming of both live and previously
broadcast television shows. Such services include integrating commercials into
syndicated programs and uplinking the completed programs to satellites as well
as the physical duplication and distribution of such programs to those stations
which do not receive a satellite feed. The acquisition was accounted for as a
purchase and the operating results of Mediatech have been included in the
consolidated results of the Company from the date
13
<PAGE> 17
of the closing of the transaction, July 18, 1997.
The Company acquired PDR and Mediatech with the expectation that the
acquisitions would result in enhanced efficiencies for the combined company,
including those resulting from the capability of providing digital delivery to
new customers and the capability of providing ancillary services to new and
existing customers in the markets served by PDR and Mediatech. See the Notes to
Consolidated Financial Statements and the Company's Current Report on Form 8-K
filed on November 7, 1997. See "Certain Business Considerations ---
Uncertainties Relating to Integration of Operations" and "--Dependence on Video
Advertising Service Deployment."
RESULTS OF OPERATIONS
The following presents the statements of operations of the Company
expressed as a percentage of total revenues and the related operating data for
the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1995 1996 1997
------ ----- -----
<S> <C> <C> <C>
STATEMENTS OF OPERATIONS:
Revenues .................................... 100.0% 100.0% 100.0%
Cost and expenses:
Delivery and material costs ................. 35.2 29.3 38.8
Customer operations ......................... 57.8 39.6 39.0
Sales and marketing ......................... 66.2 38.0 15.1
Research and development .................... 30.9 19.9 8.5
General and administrative .................. 26.8 15.8 10.9
Depreciation and amortization................ 45.6 41.2 31.9
------ ----- -----
Total Expenses .............................. 262.5 183.8 144.2
------ ----- -----
Loss from operations ........................ (162.5) (83.8) (44.2)
Other income (expense):
Interest income ............................. 8.1 13.5 2.6
Interest expense ............................ (16.3) (16.4) (8.9)
------ ----- -----
Net loss .................................... (170.7)% (86.7)% (50.5)%
===== ===== =====
</TABLE>
Revenues
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1995 1996 1997
------ ------- -------
<S> <C> <C> <C>
Audio Distribution ................................ $5,144 $ 9,588 $13,707
Video Distribution ................................ -- 617 8,685
Ancillary Post-Production Services & Other Services -- 318 6,783
------ ------- -------
Total Revenues .................................... $5,144 $10,523 $29,175
====== ======= =======
</TABLE>
Revenues increased from $5,144,000 to $10,523,000 to $29,175,000 in 1995,
1996, and 1997 respectively. These increases in revenues were due primarily to
the increased volume of audio and video deliveries. Such deliveries are
generally of short form content used in the spot advertising market. The Company
made 390,000, 784,000 and 1,345,000 deliveries in 1995, 1996, and 1997
respectively. Average revenue per delivery also has been increasing,
particularly in 1997, due to the increased proportion of video deliveries in the
delivery mix. Video deliveries, which the Company began offering late in the
third quarter of 1996, accounted for approximately 4% and 25% of the delivery
volume in 1996 and 1997, respectively.
The Company believes that the substantial delivery and revenue increases
since 1995 are the result of a
14
<PAGE> 18
number of factors, including the increased acceptance by advertisers of the
services offered by the Company and the increased availability of an expanded
network of Company equipment located in radio and television stations.
Additionally, the acquisitions of PDR and Mediatech in November 1996 and July
1997, respectively, have brought the Company increased market share in video
distribution, given the Company the opportunity to provide digital distribution
services to new customers and allowed the Company to offer ancillary
post-production and other services.
The increase in delivery volume in 1996 versus 1995 was primarily due to
the increased volume of audio deliveries made via the DG Systems Network
Operating Center ("NOC") in San Francisco. Prior to the acquisition of PDR, all
deliveries were routed through the NOC. The increased volume of deliveries in
1997 versus 1996 is due to the addition of physical deliveries, particularly
video deliveries, made directly from the former PDR and Mediatech locations, as
well as additional deliveries made through the NOC. Additional deliveries made
through the NOC accounted for approximately 47% of the volume increase in 1997
over 1996.
Average revenue per audio delivery decreased from $13.19 in 1995 to $12.72
in 1996 and then increased to $13.55 in 1997. The decrease in average revenue in
1996 versus 1995 was primarily due to volume discounts offered to both direct
and indirect customers. The increase in average revenue per audio delivery in
1997 versus 1996 is due primarily to an increased proportion of deliveries made
using the Company's Priority Service, which provides delivery within one hour.
This service, which was introduced in the fourth quarter of 1996, accounted for
approximately 4% of audio volume in 1997 versus less than 1% of audio volume in
1996.
The Company began offering video delivery late in 1996. Average revenue per
video delivery was $26.00 in 1997. Retail list prices for the digital delivery
or physical duplication and distribution of a single video spot are 50% to 100%
greater than the list price for the delivery of audio. The average price per
delivery in 1997 is based on the significantly higher revenues resulting from
increased digital and physical delivery volume, including deliveries made
directly from the former PDR and Mediatech facilities.
In 1997, revenues include approximately $6.8 million recorded from other
services provided by the former PDR and Mediatech facilities. This consists of
$1.9 million of ancillary post-production services, $2.9 million of corporate
duplication, and $2.0 million of satellite distribution services. Ancillary
post-production services are generally related to the preparation of video
content for distribution. Corporate duplication includes high volume replication
of training or corporate and product information tapes on non-broadcast quality
tape stock, such as VHS. Satellite services include the integration of
commercials into syndicated programming and uplinking the completed programs to
satellites for distribution.
Delivery and Material Costs
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
------ ------ -------
<S> <C> <C> <C>
Audio Distribution ................................ $1,810 $2,840 $ 3,750
Video Distribution ................................ -- 191 4,536
Ancillary Post-Production Services & Other Services
-- 57 3,048
------ ------ -------
Total Delivery and Material Costs ................. $1,810 $3,088 $11,334
====== ====== =======
</TABLE>
Delivery costs consist of fees paid to other service providers for charges
incurred by the Company in the receipt, transmission and delivery of information
via the Company's distribution network. Delivery expenditures have principally
been for the telephone and satellite transmission of deliveries performed
electronically and for the air freight incurred in the physical delivery of
tapes to locations not directly linked to the DG network operating center.
Delivery costs also include fees paid to secure satellite transmission
capabilities in connection with the services offered by the Company. Material
costs consist primarily of audio and video tape, the related packaging, and the
direct materials and supplies used in providing the various services offered by
the Company. Material costs are not generally required in the case of electronic
distribution.
15
<PAGE> 19
Delivery and material costs were $1,810,000, $3,084,000, and $11,334,000 in
1995, 1996, and 1997 respectively. In 1996, the increase in cost versus 1995 is
primarily due to the increased volume of deliveries, particularly audio
deliveries performed through the NOC. In 1997, delivery and material costs
increased significantly as a result of increased electronic and physical
delivery volume, particularly video deliveries made directly from the former PDR
and Mediatech facilities, as well as the addition of the direct costs related to
the other services now provided by the Company as a result of the PDR and
Mediatech acquisitions. These increased costs include both delivery expenses and
direct materials costs required when physically duplicating and distributing a
video or audio spot as well as the direct materials and fees paid to other
services providers in connection with ancillary post-production services and
other services offered by the Company.
Delivery and material costs as a percentage of revenues decreased from 35%
in 1995 to 29% in 1996. This reduction primarily was due to reduced
telecommunications cost per electronic audio delivery. This decrease was due to
a rate reduction obtained from the Company's primary long distance provider,
implementation of ISDN transmission technology at high volume delivery
destinations, which reduced the average time necessary to transmit a minute of
audio over a phone line, and more efficient access to long distance carriers due
to equipment and switching improvements made by the Company. In addition, the
proportion of audio deliveries being performed electronically improved from 75%
in 1995 to 85% in 1996.
Delivery and material costs as a percentage of revenues increased from 29%
in 1996 to 39% in 1997. The increase in such costs as a percentage of total
revenues is due to the change in mix of services offered by the Company as a
result of the acquisitions and the ramp up of the electronic video distribution
service. The Company's audio distribution services primarily are performed
electronically, which has resulted in lower delivery and material costs as a
percentage of revenues than those of the Company's video distribution and other
service offerings.
Audio distribution delivery and material costs as a percentage of the
related revenues decreased in 1997 versus 1996. This decrease is a result of an
increase in the percentage of audio deliveries performed electronically via the
NOC, improvements in cost per electronic delivery, and due to an increase in
average revenue per audio delivery. Approximately 92% of the audio deliveries
performed by the Company in 1997 were routed through the DG Systems NOC; of
these deliveries, 88% were performed electronically. In 1996, 85% of the audio
deliveries routed through the NOC had been performed electronically.
Video distribution delivery and material costs as a percentage of related
revenues was approximately 25 percentage points higher than that for audio
distribution in 1997. Approximately 25% of the video deliveries performed by the
Company in 1997 were routed through the DG Systems NOC; of these deliveries, 47%
were performed electronically. During 1997, the Company began volume electronic
video delivery, continued to add television stations to its network and
developed network communications links between the NOC and the acquired
facilities in New York, Chicago and Los Angeles. Consequently, the number of
stations capable of receiving electronic delivery and the number of orders
received at the acquired facilities which were capable of being delivered via
the NOC was increasing over the course of 1997. As a result, video delivery and
material costs primarily resulted from the physical duplication and distribution
of tapes directly from the acquired facilities or from the Company's dub and
ship facility in Louisville, Kentucky. In addition, the fixed telecommunications
costs incurred by the Company in order to offer this service were not as well
leveraged over a volume of deliveries as those incurred to offer the Company's
audio distribution.
Delivery and material costs related to the other services provided by the
Company were 45% of the associated revenues in 1997. The direct costs as a
percentage of revenues associated with these services vary widely based on the
numerous services performed and the rates negotiated with the customers using
these services. In general, the direct costs of corporate duplication and
providing satellite services have higher costs as a percentage of revenues than
the Company's audio and video distribution services. The Company is actively
reviewing the rates charged for such services and the potential business impacts
of revising these service offerings.
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 ---Uncertainties Relating to Integration of Operations,"
"---Ability to Manage Growth," "---Dependence on Certain Suppliers" and
"---Potential Fluctuations in Quarterly Results; Seasonality."
16
<PAGE> 20
Customer Operations
Customer operations expenses consist primarily of salaries and the related
overhead costs incurred in performing deliveries and providing services,
including order entry, customer service and assembly and maintenance of network
equipment including the Company's RPTs, RSTs, VRTSs, DVPSs, tape dubbing and
editing equipment, and the network operating center.
Customer operations expenses were $2,974,000, $4,164,000 and $11,388,000 in
1995, 1996, and 1997 respectively. The increase in expenses in 1996 versus 1995
is primarily the result of adding the personnel necessary to respond to the
greater volume of orders and deliveries made by customers and the increased
volume of requests for network terminals made by radio and television stations.
The increase in expenses in 1997 versus 1996 is primarily the result of the
consolidation of the costs of the former PDR and Mediatech facilities. In
addition, these expenses increased in both 1996 and 1997 due to the addition of
the personnel necessary to establish the operational capacity to support growth
in the electronic video delivery business. These additional expenses include the
costs, primarily labor expenses, of personnel involved in assembly of the DVPSs
as well as customer and technical support.
Customer operations expenses as a percentage of revenues has decreased
from 58% to 40% to 39% in 1995, 1996 and 1997 respectively. In 1996, customer
operations expense as a percentage of revenues was reduced versus 1995, as the
Company was able to realize the benefits of economies of scale from the
increased delivery volume and to improve the efficiency of its order processing
procedures as a result of increased experience with the system and the hiring of
additional qualified management. In 1997, the Company reduced customer
operations expenses as a percentage of revenues to less than 35% for orders
processed through the San Francisco NOC, which serves as the primary support for
the digital network. These improvements in cost as a percentage of revenues,
however, were generally offset by the impact of the relatively more expensive
customer operations expenses of the former PDR and Mediatech facilities, which
have a different cost structure in order to provide the additional services
offered at these locations.
The Company expects that customer operations expenses will increase in
absolute dollars and may fluctuate as a percentage of revenues in future
periods. Moreover, the Company believes that in order to compete effectively and
manage future growth, the Company will be required to continue to implement
changes which improve and increase the efficiency of its customer operations.
See "Certain Business Considerations -- Ability to Maintain and Improve Service
Quality" and "-- Ability to Manage Growth."
Sales and Marketing
Sales and marketing expenses include salaries, incentive compensation,
professional fees and the related overhead costs incurred in promoting,
marketing and selling the Company and its services to customers and radio and
television stations. Sales and marketing expenses were $3,406,000, $3,998,000,
and $4,417,000 or 66%, 38%, and 15% of revenues for 1995, 1996 and 1997
respectively. These increases were the result of additional costs incurred in
introducing the Company's service to the marketplace, including the salaries of
expanded sales and marketing forces, increased incentive compensation resulting
from increased revenues and increased marketing program activity. The increase
in expenses in 1996 versus 1995 was due to additional personnel and the
expansion of promotional programs to meet the Company's growth objectives. The
increase in expenses in 1997 versus 1996 is due primarily to the consolidation
of the costs of the former Mediatech and PDR sales groups. During 1997, the
Company's sales forces were united under the direction of the DG Systems' Vice
President of Sales in order to more effectively and efficiently market the
Company's complete set of services throughout the country.
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 consist primarily of salaries, testing
costs, consulting fees, and the related
17
<PAGE> 21
overhead incurred in the development and enhancement of the delivery system
used to distribute information via the DG Systems' network. Research and
development costs are expensed as incurred until technological feasibility is
established, after which any additional costs are capitalized, in accordance
with Statement of Financial Accounting Standards No. 86, "Accounting for the
Costs of Computer Software to be sold, Leased or Otherwise Marketed." To date,
no software development costs have been capitalized by the Company as the
capitalizable amounts have been immaterial. Research and development expenses
were $1,590,000, $2,092,000, and $2,473,000 in 1995, 1996 and 1997,
respectively. Research and development expenses have increased in 1996 and 1997
primarily due to the hiring of additional staff, including increased
compensation and recruiting fees, and the development and testing costs,
principally frame relay and satellite transmissions, associated with preparing
the delivery system for the transmission of video content as well as the
continued costs of research on potential new methods of delivery and new
services to be offered
The Company expects that research and development expenses will increase
substantially in absolute dollars and may fluctuate as a percentage of revenues
in future periods.
General and Administrative
General and administrative expenses consist primarily of personnel and
related overhead costs for finance and general management of the Company.
General and administrative expenses were $1,380,000, $1,677,000 and $3,169,000
in 1995, 1996, and 1997 respectively. These increases were primarily due to the
addition of personnel to support the growth of the Company's business, including
the consolidation of certain staff of Mediatech and PDR, as well as the
additional costs necessary to meet the reporting requirements of a publicly
traded company. Although general and administrative expenses have increased in
absolute dollars, these expenses as a percentage of revenues have decreased from
27% to 16% to 11% in 1995, 1996, and 1997 respectively. The Company expects that
general and administrative expenses will increase in absolute dollars and may
fluctuate as a percentage of revenues in future periods.
Depreciation and Amortization
Depreciation and amortization expenses are attributable primarily to the
Company's distribution network, including RPTs, RSTs, DVPSs, VRTSs, video
dubbing and editing equipment and the network operating center. This equipment
is expensed over the estimated useful life, generally three years. Depreciation
and amortization expense was $2,345,000, $4,331,000 and $9,306,000 in 1995,
1996, and 1997 respectively. These increases were due to the continued expansion
of the Company's network. The Company's total investment in network equipment
has increased from $7.9 million to $18.0 million to $30.4 million at the end of
1995, 1996, and 1997 respectively. In particular, the Company made equipment
additions of $6.0 million and $4.7 million in 1996 and 1997, respectively, to
support its video delivery service plan and acquired approximately $2.3 million
and $7.5 million of equipment in connection with the acquisitions of PDR and
Mediatech, respectively.
In addition, the Company recorded amortization expense of $71,000 and
$787,000 in 1996 and 1997, respectively, related to the goodwill and other
intangible assets recorded in connection with the acquisitions of PDR and
Mediatech.
The Company expects to continue to invest in the expansion of its network.
In particular, the Company is in the process of expanding its infrastructure
within the television broadcast industry that will require additional VRTSs 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
Needs; Uncertainty of Additional Funding."
Interest Income and Interest Expense
The Company has derived interest income from the short-term investment of
the proceeds received in various preferred stock offerings, including the $16.4
million of net proceeds from the Series A offering in July 1997, and from the
investment of the $29.5 million of net proceeds from its initial public offering
in February 1996. Interest income was $417,000, $1,422,000 and $744,000 1995,
1996 and 1997, respectively. The fluctuations in interest
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<PAGE> 22
income were due to differences in the amounts raised and the timing of each
offering as well as the differences in the levels of cash used to fund Company
operations and strategic acquisitions. The Company expects that interest income
will decrease in the future in proportion to the levels of cash used to fund
operations and acquisition activity. See "Liquidity and Capital Resources."
Interest expense incurred by the Company was $836,000, $1,726,000 and
$2,607,000 in 1995, 1996, and 1997, respectively. This expense has been due
primarily to lease agreements used to fund the acquisition of components and
equipment needed to develop the network and to provide Company personnel with
the capital resources necessary to support the Company's business growth. Debt
outstanding under these agreements has increased from $6.3 million to $12.2
million to $13.8 million at the end of 1995, 1996, and 1997, respectively. In
addition, during 1997 the Company incurred additional interest expense totaling
$314,000 on the promissory notes given as consideration in the acquisitions of
PDR and Mediatech and incurred $277,000 of interest expense on the term debt and
line of credit assumed in conjunction with the Mediatech acquisition. The
Company expects interest expense will increase in the future based on the
increased levels of borrowing. See "Liquidity and Capital Resources."
QUARTERLY RESULTS OF OPERATIONS
The following table presents unaudited quarterly statements of
operations for the Company. The information has been prepared by the Company on
a basis consistent with the Company's audited financial statements and includes
all adjustments, consisting of only normal recurring adjustments that management
considers necessary for a fair presentation of the information for the periods
presented. 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 November television sweeps rating period and Christmas selling
season. As a result, the Company believes that period to period comparisons of
its results are not necessarily meaningful and should not be relied upon as an
indication of future performance.
19
<PAGE> 23
<TABLE>
<CAPTION>
THREE MONTHS ENDED
---------------------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1996 1996 1996 1996 1997 1997 1997 1997
-------- -------- -------- -------- -------- -------- -------- --------
(in thousands, except operating data)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS
Revenues ..................... $ 1,894 $ 2,359 $ 2,265 $ 4,005 $ 4,606 $ 5,405 8,798 $ 10,366
-------- -------- -------- -------- -------- -------- -------- --------
Costs and expenses:
Delivery and material
costs .................... 595 732 694 1,063 1,475 1,813 3,886 4,160
Customer operations ........ 920 948 904 1,392 2,135 2,104 3,241 3,908
Sales and marketing ........ 983 970 905 1,140 1,015 1,126 1,232 1,044
Research and development ... 498 510 519 565 648 620 688 517
General and administrative . 384 396 407 490 604 637 998 930
Depreciation and
amortization .............. 838 936 1,181 1,376 1,765 1,968 2,628 2,945
-------- -------- -------- -------- -------- -------- -------- --------
Total expenses ........... 4,218 4,492 4,610 6,026 7,642 8,268 12,673 13,504
-------- -------- -------- -------- -------- -------- -------- --------
Loss from operations.......... (2,324) (2,133) (2,345) (2,021) (3,036) (2,863) (3,875) (3,138)
Other income (expense):
Interest income ............ 263 434 399 326 251 215 138 140
Interest expense ........... (327) (388) (451) (560) (511) (553) (762) (781)
-------- -------- -------- -------- -------- -------- -------- --------
Net loss ..................... $ (2,388) $ (2,087) $ (2,397) $ (2,255) $ (3,296) $ (3,201) $ (4,499) $ (3,779)
Basic and diluted net loss.... $ (0.33) $ (0.18) $ (0.21) $ (0.19) $ (0.28) $ (0.27) $ (1.63) $ (0.31)
per common share(1)
Weighted average common shares 7,252 11,482 11,575 11,642 11,686 11,733 12,035 12,118
(1) See Note 11 to Consolidated Financial Statements - Net Loss Per Share.
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
From its inception through December 31, 1995, the Company financed its
operations and met its capital expenditure requirements primarily from the
proceeds of private sales of Preferred and Common Stock and through capital
lease agreements. Through December 31, 1995, the Company had raised $25.5
million from the sale of Preferred and Common Stock and had funded $7.6 million
of capital expenditures with long term lease agreements. In 1996, the Company
raised $29.6 million from the sale of Common Stock, primarily through it's
initial public offering, and an additional $8.0 million of capital equipment was
funded through capital lease agreements. In 1997, the Company raised $16.4
million from sale of Series A Preferred Stock and funded $5.8 million of capital
equipment through long-term credit facilities.
At December 31, 1997, the Company's current sources of liquidity included
cash and cash equivalents of $7.8 million and short-term investments of
$987,000. In addition, the Company has $900,000 and $1.7 million available to
fund capital expenditures remaining under two long-term credit facilities which
can be drawn against until June 30, 1998 and December 31, 1998, respectively.
The Company also has $3.5 million available for working capital under a
long-term credit agreement which can be drawn on through December 31, 1998 and
Mediatech, a wholly owned subsidiary, has a revolving line of credit available
to fund the working capital requirements of Mediatech. The maximum available
under the Mediatech line is $3,525,000, dependent upon the level of qualifying
receivables maintained by Mediatech; the balance outstanding at December 31,
1997 is $2,834,000, which is approximately equal to the maximum available under
the agreement at that time. The Company expects to fully utilize the funding
available under the existing credit agreements.
The Company's operating activities have used cash of $6.6 million, $4.3
million, and $6.3 million in 1995, 1996, and 1997. Net cash used in operating
activities decreased in 1996 versus 1995, primarily as a result of a reduced net
loss, exclusive of depreciation and amortization. Net cash used in operating
activities increased in 1997 versus 1996, primarily because net interest expense
increased by $1.6 million and offset improved operating results. The Company's
earnings before interest, taxes and depreciation has improved from a loss of
$6.0 million in 1995 to a loss of $4.5 million 1996 to a loss of $3.6 million in
1997. In addition, changes in working capital, principally payments on accounts
payable and accrued liabilities, used $.9 million of cash in 1997.
The Company used $2.4 million and $5.1 million of cash in 1996 and 1997,
respectively to purchase property and equipment. In 1995, substantially all of
the Company's equipment additions were financed through capital lease
agreements. In addition, $5.0 million, $8.0 million and $.4.million of property
and equipment has been acquired through term lease or credit agreements in 1995,
1996, and 1997, respectively. The capital additions for each of the three years
were a result of the Company's continued expansion of its network. In
particular, capital additions in 1996 and 1997 were primarily in support its
video delivery service plan.
The Company completed its initial public offering in February 1996. The net
proceeds to the Company in 1996 after underwriting discounts and offering
expenses were $29,490,000. The Company raised $16.4 million, net of offering
expenses,
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<PAGE> 24
through its Series A Preferred Stock offering in 1997. The proceeds from these
two offerings have been used in the acquisitions of PDR in November 1996 and
Mediatech in July 1997, as well as to fund the acquisition of property and
equipment, the payment of lease obligations and to fund the continuing
operations of the Company. Approximately, $20.5 million has been invested in the
purchases of PDR and Mediatech and an additional $2.5 million was used to repay
the promissory note payable in November 1997 as a result of the PDR acquisition.
In connection with the July 1997 acquisition of Mediatech, the Company also
issued 324,355 shares of the Company's Common Stock, $3.8 million of promissory
notes, and assumed $5.4 million of term and line of credit debt payable by
Mediatech. As of December 31, 1997, the remaining $8.8 million of the net
proceeds of the offerings were invested in short-term investments and cash and
cash equivalents. See the Notes to the Financial Statements.
The Company, through its Mediatech subsidiary, made net payments on the
Mediatech line of credit of $341,000 between the date of the Mediatech
acquisition and December 31, 1997. As mentioned above, the maximum available
under the Mediatech line is $3,525,000, dependent upon the level of qualifying
receivables maintained by Mediatech and the balance outstanding on the line at
December 31, 1997 was $2,834,000, which was approximately equal to the maximum
available under the agreement at that time
Principal payments on long-term debt were $1.0 million, $2.1 million and
$8.0 million in 1995, 1996, and 1997, respectively, reflecting the increases in
regularly scheduled repayment of the increased capital lease liability incurred
to finance equipment and property acquisitions. Principal payments in 1997 also
included the following scheduled payments: repayment of a $2.5 promissory note
issued in connection with the PDR acquisition, $500,000 of payments on the
promissory notes issued in connection with the Mediatech acquisition and
$346,000 of payments on other long-term debt of Mediatech assumed by the Company
in conjunction with the Mediatech acquisition.
The Company currently has no significant capital commitments other than the
commitments under capital leases and the debt assumed and notes payable issued
in conjunction with the purchase of Mediatech. Based on management's current
plans and forecasts, the Company believes that its existing sources of liquidity
will satisfy the Company's projected working capital, capital lease and term
loan commitments and other cash requirements through December 1998. To provide
additional flexibility for growth and other general corporate purposes, however,
the Company plans to raise additional capital in 1998. See "Certain Business
Considerations -- Future Capital Needs; Uncertainty of Additional Funding."
CERTAIN BUSINESS CONSIDERATIONS
The Company's business is subject to the following risks in addition to
those described elsewhere in this Form 10-K.
History of Losses; Future Operating Results Uncertain. The Company was
founded in 1991 and has been unprofitable since its inception. The Company
expects to continue to generate net losses for a minimum of the next twelve
months. As of December 31, 1997, the Company's accumulated deficit was $42.9
million. The Company has had difficulty in accurately forecasting its future
sales and operating results due to its limited operating history. Accordingly,
although the Company has recently experienced significant growth, a significant
portion of which is due to acquisitions, such growth rates may not be
sustainable and should not be used as an indication of future sales growth, if
any, or of future operating results. The Company's future success also will
depend in part on obtaining continued reductions in delivery and service costs,
particularly continued automation of order processing and reductions in
telecommunications costs. There can be no assurance that the Company's sales
will grow or be sustained in future periods, that the Company will be able to
reduce delivery and service costs, or that the Company will achieve or sustain
profitability in any future period.
Dependence on Electronic Video Advertising Delivery Service Deployment. The
Company has made a substantial investment in upgrading and expanding its network
operating center and populating television stations with the units necessary for
the receipt of electronically delivered video advertising content. However there
can be no assurance that placement of these units will cause this service to
achieve adequate market acceptance among customers which require video
advertising content delivery. The inability to place units in an adequate number
of stations or the inability to capture market share among content delivery
customers as a result of price competition or new product introductions from
competitors would have a material adverse effect on the Company's business,
operating results and financial position. In addition, the Company believes that
in order to more fully address the
21
<PAGE> 25
needs of potential video delivery customers it will need to develop a set
of ancillary services which typically are provided 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 through its facilities in New York, Los
Angeles and Chicago. However, there can be no assurance that the Company will
successfully contract for and provide these services in each major metropolitan
area or that the Company will be able to provide competitive video distribution
services in other U.S. markets. Unless the Company can successfully continue to
develop and provide video transmission services, it may be unable to retain
current or attract future audio delivery customers who may ultimately demand
delivery of both media content.
Uncertainties Relating to Integration of Operations. DG Systems acquired
PDR and Mediatech with the expectation that such strategic acquisitions would
result in enhanced efficiencies for the combined company. To date the Company
has not fully completed the integration of PDR and Mediatech with the Company.
Achieving the anticipated benefits of the PDR and Mediatech acquisitions 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 current and potential customers will
favorably view the Company's services as offered through PDR and Mediatech or
that DG Systems will realize any of the other anticipated benefits of the PDR or
Mediatech acquisitions. Moreover, as a result of these acquisitions, certain DG
Systems customers may perceive PDR or Mediatech to be a competitor, and this
could affect such customers' willingness to do business with DG Systems in the
future. The loss of significant customers could have a material adverse effect
on DG Systems' results of operations and financial condition.
Future Capital Needs; Uncertainty of Additional Funding. The Company
intends to continue making capital expenditures to produce and install RSTs,
RPTs, VRTSs and DVPS units and to introduce additional services. The Company
also continually analyzes the costs and benefits of acquiring certain
businesses, products or technologies that it may from time to time identify, and
its related ability to finance such acquisitions. Assuming that the Company does
not pursue one or more additional acquisitions funded by internal cash reserves,
the Company anticipates its existing capital, cash from operations, and funds
available under existing term loan and line of credit agreements should be
adequate to satisfy its capital requirements through December 1998.
There can be no assurance, however, that the net proceeds of the Company's
initial public offering and such other sources of funding will be sufficient to
satisfy the Company's future capital requirements or that the Company will not
require additional capital sooner than currently anticipated.
Based on its current business plan, the Company anticipates that it will
eventually use the entire proceeds of its initial public offering and the Series
A Convertible Preferred Stock financing and there can be no assurance that other
sources of funding will be adequate to fund the Company's capital needs, which
depend upon numerous factors, including the progress of the Company's product
development activities, the cost of increasing the Company's sales and marketing
activities and the amount of revenues generated from operations, none of which
can be predicted with certainty. In addition, the Company is unable to predict
the precise amount of future capital that it will require, particularly if it
were to pursue one or more acquisitions, and there can be no assurance that any
additional financing will be available to the Company on acceptable terms, or at
all. The inability to obtain financing for acquisitions on acceptable terms may
prevent the Company from completing advantageous acquisitions and consequently
may adversely effect the Company's prospects and future rates of growth. The
inability to obtain required financing for continuing operations or an
acquisition would have a material adverse effect on the Company's business,
financial condition and results of operations. Consequently, the Company could
be required to significantly reduce or suspend its operations, seek a merger
partner or sell additional securities on terms that are highly dilutive to
existing investors.
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
22
<PAGE> 26
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 and long standing
relationships with existing dub and ship vendors. Therefore, it is difficult to
predict the rate at which the market for the electronic delivery of digital
audio and video transmissions will grow, if at all. If the market fails to grow,
or grows more slowly than anticipated, the Company's business, operating results
and financial condition will be materially adversely affected. Even if the
market does grow, there can be no assurance that the Company's products and
services will achieve commercial success. Although the Company intends to
conform its products and services to meet existing and emerging standards in the
market for the electronic delivery of digital audio and video transmissions,
there can be no assurance that the Company will be able to conform its products
to such standards in a timely fashion, or at all. The Company believes that its
future growth will depend, in part, on its ability to add these services and
additional customers in a timely and cost-effective manner, and there can be no
assurance that the Company will be successful in developing such services, and
in obtaining new customers for such services. See "Dependence on New Product
Introductions." There can also be no assurance that the Company will be
successful in obtaining a sufficient number of radio and television stations,
radio and television networks, advertisers, advertising agencies, production
studios, and audio and video distributors who are willing to bear the costs of
expanding and increasing the integration of the Company's network, including the
Company's field receiving equipment and rooftop satellite antennae.
The Company's marketing efforts to date with regard to the Company's
products and services have involved identification and characterization of
specific market segments for these products and services with a view to
determining the target markets that will be the most receptive to such products
and services. There can be no assurance that the Company has correctly
identified such markets or that its planned products and services will address
the needs of such markets. Furthermore, there can be no assurance that the
Company's technologies, in their current form, will be suitable for specific
applications or that further design modifications, beyond anticipated changes to
accommodate different markets, will not be necessary. Broad commercialization of
the Company's products and services will require the Company to overcome
significant market development hurdles, many of which may not currently be
foreseen.
Dependence on Technological Developments. The market for the distribution
of digital audio and video transmissions is characterized by rapidly changing
technology. The Company's ability to remain competitive and its future success
will depend in significant part upon the technological quality of its products
and processes relative to those of its competitors and its ability both to
develop new and enhanced products and services and to introduce such products
and services at competitive prices and in a timely and cost-effective fashion.
The Company's development efforts have been focused on the areas of satellite
transmission technology, video compression technology, TV station system
interface, and work on reliability and throughput enhancement of the network.
The Company's ability to successfully grow electronic video delivery services
depends on its ability to obtain satellite delivery capability. Work in
satellite technology is oriented to development and deployment of software to
lower transmission costs and increase delivery reliability. Work in video
compression technology is directed toward integration of emerging broadcast
quality compression systems, which further improve picture quality while
increasing the compression ratio, with the Company's existing network. Work in
TV station system interface includes implementation of various system control
protocols and improvement of system throughput and reliability. 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 DVPSs to receive digital
satellite transmissions over the Hughes satellite system. There can be no
assurance that the Hughes satellite system will have the capacity to meet the
Company's future delivery commitments and broadcast quality requirements and to
do so on a cost-effective basis. See "Dependence on Certain Suppliers."
The introduction of products embodying new technologies can render existing
products obsolete or unmarketable. There can be no assurance that the Company
will be successful in identifying, developing, contracting for the manufacture
of, and marketing product enhancements or new products that respond to
technological change, that the Company will not experience difficulties that
could delay or prevent the successful development, introduction and marketing of
these products, or that its new products and product enhancements will
adequately meet the requirements of the marketplace and achieve market
acceptance. Delays in the commencement of commercial availability of new
products and services and enhancements to existing products and services may
result in customer dissatisfaction and delay or loss of revenue. If the Company
is unable, for other reasons, to develop and introduce new products and services
or enhancements of existing products and services in a timely
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<PAGE> 27
manner or if new versions of existing products do not achieve a significant
degree of market acceptance, there could be a material adverse effect on the
Company's business, financial condition and results of operations.
Dependence on Radio Advertising. Prior to the Company's acquisitions of PDR
and Mediatech, the Company's revenues were 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
Priority or DG Express, technological change or otherwise, would have a material
adverse effect on the Company's business, operating results and financial
condition. Additionally, the Company is dependent upon its relationship with and
continued support of the radio stations in which it has installed communications
equipment. Should a substantial number of these stations go out of business,
experience a change in ownership, or discontinue the use of the Company's
equipment in any way, it could materially adversely affect the Company's
business, operating results and financial condition.
Ability to Maintain and Improve Service Quality. The Company's business is
dependent on its ability to make cost-effective deliveries to broadcast stations
within the time periods requested by customers. Any failure to do so, whether or
not within the control of the Company, could result in an advertisement not
being run and in the station losing air-time which it could have otherwise sold.
Although the Company disclaims any liability for lost air-time, there can be no
assurance that claims by stations for lost air-time would not be asserted in
these circumstances or that dissatisfied advertisers would refuse to make
further deliveries through the Company in the event of a significant occurrence
of lost deliveries, either of which would have a material adverse that effect on
the Company's business, results of operations and financial condition. Although
the Company maintains insurance against business interruption, there can be no
assurance that such insurance will be adequate to protect the Company from
significant loss in these circumstances or that a major catastrophe (such as an
earthquake or other natural disaster) would not result in a prolonged
interruption of the Company's business. In particular, the Company's network
operating 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 RSTs, RPTs, VRTSs and DVPS video units that comprise its
distribution network. The result of the Company's failure to make timely
deliveries for whatever reason could be that dissatisfied advertisers would
refuse to make further deliveries through the Company which would have a
material adverse effect on the Company's business, results of operations and
financial condition.
Competition. The Company currently competes in the market for the
distribution of audio advertising spots to radio stations and the distribution
of video advertising spots to television stations. The principal competitive
factors affecting these markets are ease of use, price, timeliness and accuracy
of delivery. The Company competes with a variety of dub and ship houses and
production studios that have traditionally distributed taped advertising spots
via physical delivery. Although such dub and ship houses and production studios
do not currently offer electronic delivery, they have long-standing ties to
local distributors that will be difficult for the Company to replace. Some of
these dub and ship houses and production studios have greater financial,
distribution and marketing resources and have achieved a higher level of brand
recognition than the Company. Moreover, Digital Courier International
Corporation has deployed a system to electronically deliver audio content in
Canada and the United States and several other companies have announced such
systems. As a result, there can be no assurance that the Company will be able to
compete effectively against these competitors merely on the basis of ease of
use, timeliness and accuracy of delivery.
In the market for the distribution of video content 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
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<PAGE> 28
and content delivery to radio and television stations, it would expect to face
competition from companies in related communications markets and/or package
delivery markets which could offer products and services with functionality
similar or superior to that offered by the Company's products and services.
Telecommunications providers such as AT&T, MCI and Regional Bell Operating
Companies could also enter the market as competitors with materially lower
electronic delivery transportation costs. The Company could also face
competition from entities with package delivery expertise such as Federal
Express, United Parcel Service, DHL and Airborne if any such companies enter the
electronic data delivery market. Radio networks such as ABC or Westwood One
could also become competitors by selling and transmitting advertisements as a
complement to their content programming. In addition, Applied Graphics
Technologies, Inc., a provider of digital pre-press services, has indicated its
intention to provide electronic distribution services and acquired Spotlink, a
dub and ship house and current customer of the Company, in December 1996 as an
entry to this market. In 1997, Applied Graphics is reported to have acquired
additional dub and ship operations.
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 Manage Growth. The Company has recently experienced a period of
rapid growth that has resulted in new and increased responsibilities for
management personnel and has placed and continues to place a significant strain
on the Company's management, operating and financial systems and resources. To
accommodate this recent growth and to compete effectively and manage future
growth, if any, the Company will be required to continue to implement and
improve its operational, financial and management information systems,
procedures and controls on a timely basis and to expand, train, motivate and
manage its work force. In particular, the Company believes that to achieve these
objectives it must complete the automation of the customer order entry process
and the integration of the delivery fulfillment process into the customer
billing system and integrate these systems with those of PDR and Mediatech.
There can be no assurance that the Company's personnel, systems, procedures and
controls will be adequate to support the Company's existing and future
operations. Any failure to implement and improve the Company's operational,
financial and management systems or to expand, train, motivate or manage
employees could have a material adverse effect on the Company's business,
operating results and financial condition.
Potential Fluctuations in Quarterly Results; Seasonality. The Company's
quarterly operating results have in the past and may in the future vary
significantly depending on factors such as the volume of advertising in response
to seasonal buying patterns, the timing of new product and service
introductions, increased competition, the timing of the Company's promotional
efforts, general economic factors, and other factors. For example, the Company
has historically experienced lower sales in the first quarter and higher sales
in the fourth quarter, due to increased customer advertising volumes for the
Christmas selling season. As a result, the Company believes that period to
period comparisons of its results of operations are not necessarily meaningful
and should not be relied upon as an indication of future performance. In any
period, the Company's revenues and delivery costs are subject to variation based
on changes in the volume and mix of deliveries performed during the period. In
particular, the Company's operating results have historically been significantly
influenced by the volume of deliveries ordered by television stations during the
"Sweeps" rating periods that currently take place in February, May, August and
November. The increased volume of these deliveries during such periods and the
Company's pricing for "Sweeps" advertisements have historically increased the
total revenues and revenues per delivery of the Company and tended to reduce
delivery costs as a percentage of revenues. The Company's expense levels are
based, in part, on its expectations of future sales levels. If sales levels are
below expectations, operating results are likely to be materially adversely
affected. In addition, the Company has historically operated with little or no
backlog. The absence of backlog
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<PAGE> 29
increases the difficulty of predicting sales and operating results. Fluctuations
in sales due to seasonality may become more pronounced as the growth rate of the
Company's sales slows. Due to the unique nature of the Company's products and
services, the Company believes that it will incur significant expenses for sales
and marketing, including advertising, to educate potential customers about such
products and services.
Dependence on Key Personnel. The Company's success depends to a significant
degree upon the continuing contributions of, and on its ability to attract and
retain, qualified management, sales, operations, marketing and technical
personnel. The competition for qualified personnel, particularly engineering
staff, is intense and the loss of any of such persons, as well as the failure to
recruit additional key personnel in a timely manner, could adversely affect the
Company. There can be no assurance that the Company will be able to continue to
attract and retain qualified management, sales and technical personnel for the
development of its business. The Company generally has not entered into
employment or noncompetition agreements with any of its employees. The Company
does not maintain key man life insurance on the lives of any of its key
personnel. The Company's failure to attract and retain key personnel could have
a material adverse effect on its business, operating results and financial
condition.
Dependence on Certain Suppliers. The Company relies on certain single or
limited-source suppliers for certain integral components used for the assembly
of the Company's audio 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 audio and video units which would have the effect of depressing
the Company's business until the Company established sufficient component supply
through an alternative source. The Company believes that there are alternative
component manufacturers that could supply the components required to produce the
Company's products, but the Company is not currently pursuing agreements or
understandings with such alternative sources. If a reduction or interruption of
supply were to occur, it could take a significant period of time for the Company
to qualify an alternative subcontractor, redesign its products as necessary and
contract for the manufacture of such products. The Company does not have
long-term supply contracts with its sole- or limited-source vendors and
purchases its components on a purchase order basis. The Company has experienced
component shortages in the past and there can be no assurance that material
component shortages or production or delivery delays will not occur in the
future. The inability in the future to obtain sufficient quantities of
components in a timely manner as required, or to develop alternative sources as
required, could result in delays or reductions in product shipments or product
redesigns, which would materially and adversely affect the Company's business,
operating results and financial condition.
Pursuant to its development efforts in the area of satellite transmission
technology, the Company has successfully completed live field trials of software
designed to enhance and enable the current RPTs to receive digital satellite
transmissions over the Hughes satellite system. The Company's dependence on
Hughes entails a number of significant risks. The Company's business, results of
operations and financial condition would be materially adversely affected if
Hughes were unable for any reason to continue meeting the Company's delivery
commitments on a cost-effective basis or if any transmissions failed to satisfy
the Company's quality requirements. In the event that the Company were unable to
continue to use Hughes' satellite capacity, the Company would have to identify,
qualify and transition deliveries to an acceptable alternative satellite
transmission vendor. This identification, qualification and transition process
could take nine months or longer, and no assurance can be given that an
alternative satellite transmission vendor would be available to the Company or
be in a position to satisfy the Company's delivery requirements on a timely and
cost-effective basis.
The Company obtains its local access telephone transmission services
through Teleport Communications Group. The Company obtains its long distance
telephone access through an exclusive contract with MCI. During 1997, 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 New Product Introductions. The Company's future growth
depends on its successful and timely introduction of new products and services
in markets that do not currently exist or are just emerging. The Company's goals
are to introduce new services, such as media archiving and the ability to
quickly and reliably give an agency the ability to preview and authorize
electronic delivery of video advertising spots. There can be no assurance that
the Company will successfully complete development of such products and
services, or that if any such development is completed, that the Company's
planned introduction of these products and services will realize market
acceptance or will meet the technical or other requirements of potential
customers.
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<PAGE> 30
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.
Year 2000 Risk Compliance. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. Beginning in the year 2000, these date codes fields will need to accept
four digit entries to distinguish 21st century dates from 20th century dates. As
a result, in less than two years, many such currently installed computer systems
and software products used by many companies will need to be upgraded to enable
such systems and computer hardware and software products to avoid the potential
effects associated with this year 2000 coding problem. Although the Company has
begun taking the steps it believes are necessary to make its network and other
systems year 2000 compliant and despite the Company's belief that it utilizes
the most recently available hardware and software products of leading industry
providers, whom the Company believes are allocating significant resources to
address and resolve these issues, there can be no assurance that the Company's
computer hardware and software products will contain all necessary code changes
in their date code fields to avoid any or all damaging interruptions and other
problems associated with date entry limitations.
The Company believes that the purchasing pattern of its current and
potential customers may be affected by the year 2000 problem described above in
a variety of ways. For example, as the year 2000 approaches, some of the
Company's current customers may develop concerns about the reliability of the
Company's electronic delivery services and, as a result, shift their delivery
work to less technical dub and ship operations. Likewise, some potential
customers of the Company with the same concern may elect not to utilize the
Company's electronic delivery services until after year 2000 and beyond. If any
current customers of the Company shift some or all of their delivery work to
other delivery providers, the Company's business, financial condition and
results of operations will be adversely affected, and if any potential customers
elect to not utilize the Company's delivery services for any period of time on
the basis of year 2000 concerns, the Company's business and financial prospects
for growth could be adversely affected. In addition to the foregoing, in the
event that the Company does experience interruptions and problems with its
computer hardware and software products due to year 2000 limitations of such
products, some or all of the Company's current customers may shift some or all
of their delivery work to other delivery providers without year 2000 problems.
Moreover, potential customers of the Company may elect not to utilize the
Company's delivery services in the event of any such interruptions and problems.
Any of the foregoing could have a material adverse affect on the Company's
business, financial condition and results of operations.
Expansion into International Markets. Although the Company's long-term
plans include expansion of its operations to Europe and Asia, it does not at
present have network operating center personnel experienced in operating in
these locations. Telecommunications standards in foreign countries differ from
those in the United States and may work require the Company to incur substantial
costs and expend significant managerial resources to obtain any necessary
regulatory approvals and comply with differing equipment interface and
installation standards promulgated by regulatory authorities of those countries.
Changes in government policies, regulations and telecommunications systems in
foreign countries could require the Company's products and services to be
redesigned, causing product and service delivery delays that could materially
adversely affect the Company's operating results. The Company's ability to
successfully enter these new markets will depend, in part, on its ability to
attract personnel with experience in these locations and to attract partners
with the necessary local business relationships. There can be no assurance,
however, that the Company's products and services will achieve market acceptance
in foreign countries. The inability of the Company to successfully establish and
expand its international operations may also limit its ability to obtain
significant international revenues and could materially adversely affect the
business, operating results and financial condition of the Company. Furthermore,
international business is subject to a number of country-specific risks and
circumstances, including different tax laws, difficulties in expatriating
profits, currency exchange rate fluctuations, and the complexities of
administering business abroad. Moreover, to the extent the Company increases its
international sales, the Company's business, operating results and financial
condition could be materially adversely affected by these risks and
circumstances, as well as by increases in duties, price controls or other
restrictions on foreign currencies, and trade barriers imposed by foreign
governments, among other factors.
Concentration of Stock Ownership; Antitakeover Provisions. The present
executive officers and directors of the Company and their respective affiliates
own approximately 46% of the Company's Common Stock and recently-issued Series A
Convertible Preferred Stock, which votes together with Common Stock on all
matters submitted to the shareholders of the Company. As a result, these
shareholders will be able to control or significantly influence all matters
requiring shareholder approval, including the election of directors and the
approval of significant corporate transactions. Such concentration of ownership
may have the effect of delaying or preventing a change in control of the
Company. Furthermore, certain provisions of the Company's Amended and Restated
Articles of Incorporation and Bylaws, and of California law, could have the
effect of delaying, deferring or preventing a change in control of the Company.
Preferential Rights of Outstanding Preferred Stock. The Company has
issued and outstanding 4,950,495
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<PAGE> 31
shares of its Series A Convertible Preferred Stock (the "Series A Preferred").
The rights of the Series A Preferred include certain rights and preferences set
forth in the Company's Certificate of Determination of Rights of Series A
Convertible Preferred Stock, which rights could materially limit or qualify the
rights of holders of the Company's Common Stock and have a material adverse
effect on the prevailing market price of the Common Stock. Such rights include,
without limitation, the right to participate, on an as converted basis, in any
and all dividends declared or paid, or set aside for payment, in respect of
outstanding shares of the Company's Common Stock. The rights of the Series A
Preferred also include the right to receive payment prior to any payment to the
holders of the Company's Common Stock, in a per share amount equal to the
purchase price paid per share of the Series A Preferred in the event of any
voluntary or involuntary liquidation, distribution of assets (other than payment
of dividends), dissolution or winding up of the affairs of the Company. In
addition, the Series A Preferred have special voting rights which enable the
holders thereof to designate one member of the Board of Directors of the Company
for election by the holders of the Series A Preferred. The rights of the holders
of Common Stock are subject to, and may be adversely affected by, the rights of
the holders of Series A Preferred, which in turn could adversely affect the
prevailing market price for the Company's Common Stock.
The Series A Preferred is convertible, at the option of the holder, into
shares of the Company's Common Stock. The Series A Preferred also will
automatically convert into shares of the Company's Common Stock upon the
satisfaction of certain conditions. The Series A Preferred, and the shares of
Common Stock issuable upon the conversion of such shares of Series A Preferred,
are "restricted securities" as that term is defined in Rule 144 promulgated by
the Securities and Exchange Commission under the Securities Act of 1933, as
amended. Accordingly, such shares, if sold pursuant to Rule 144, will be subject
to the resale provisions applicable to restricted securities under Rule 144. The
availability for sale, as well as actual sales, of the Company's Common Stock
issuable or issued upon the conversion of the Series A Preferred may depress the
prevailing market price for the Common Stock and could adversely affect the
terms upon which the Company would be able to obtain additional equity
financing.
Possible Volatility of Share Price. The trading prices of the Company's
Common Stock may be subject to wide fluctuations in response to a number of
factors, including variations in operating results, changes in earnings
estimates by securities analysts, announcements of extraordinary events such as
litigation or acquisitions, announcements of technological innovations or new
products or services by the Company or its competitors, as well as general
economic, political and market conditions. In addition, stock markets have
experienced extreme price and volume trading volatility in recent years. This
volatility has had a substantial effect on the market prices of the securities
of many high technology companies for reasons frequently unrelated to the
operating performance of specific companies. These broad market fluctuations may
adversely affect the market price of the Company's Common Stock.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is set forth in the Company's
Consolidated Financial Statements and the Notes thereto beginning at Page F-1 of
this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item with respect to the Company's
directors is incorporated by reference to the information contained in the
section captioned "Proposal One -- Election of Directors by Common Shareholders"
and "Proposal Two -- Election of Director by Preferred Shareholders." in the
definitive proxy statement filed with the Securities and Exchange Commission by
the Company for its 1998 Annual Meeting of Shareholders (the "Proxy Statement").
For information with respect to executive officers of the Company, see Item 4A.
of this Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the
section captioned "Executive Compensation" contained in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from the
section captioned "Security Ownership of Certain Beneficial Owners and
Management" contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to the
information contained in the sections captioned "Compensation Committee
Interlocks and Insider Participation" and "Certain Transactions with Management"
contained in the Proxy Statement.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. FINANCIAL STATEMENTS
The following financial statements are filed as part of this Report:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Arthur Andersen LLP, Independent Public Accountants F-2
Consolidated Balance Sheets ................................. F-3
Consolidated Statements of Operations ....................... F-4
Consolidated Statements of Stockholders' Equity ............. F-5
Consolidated Statements of Cash Flows ....................... F-6
Notes to Consolidated Financial Statements .................. F-7
(a) 2. FINANCIAL STATEMENT SCHEDULES
II - Valuation and Qualifying Accounts ...................... S-1
</TABLE>
ITEM 14 (CONTINUED). EXHIBITS AND REPORTS ON FORM 8-K
(a) 3. 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 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.
</TABLE>
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<PAGE> 34
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
------- -------------
<S> <C>
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.
10.31(a) Loan Agreement dated as of December 1, 1997 between Digital
Generation Systems, Inc. as Borrower, and Venture Lending and
Leasing, Inc. as Lender and exhibits thereto.
10.32(a) First Amendment to 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.
11.1(a) Statements of computation of weighted average common shares.
21.1(a) Subsidiaries of the Registrant.
23.1(a) Consent of Independent Public Accountants.
27 (a) Financial Data Schedule.
27.96(a) Restated Financial Data Schedule for year ended December
31, 1996.
27.961(a) Restated Financial Data Schedule for quarter ended March
31, 1996.
</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
31
<PAGE> 35
omitted from this exhibit and have been filed separately with the
Securities and Exchange Commission.
(d) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Quarterly Report on Form 10-Q filed May 3, 1996, as
amended.
(e) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Quarterly report on Form 10-Q filed November 13, 1996.
(f) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Current Report on Form 8-K/A filed January 21, 1997.
(g) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Annual Report on Form 10-K filed March 18, 1997.
(h) Incorporated by reference to the exhibit bearing the same number filed
with registrant's quarterly report on Form 10-Q filed May 15, 1997.
(i) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Form 8-K filed August 1, 1997.
(j) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Quarterly report on Form 10-Q filed August 14, 1997.
Confidential treatment has been requested with respect to certain
portions of this exhibit pursuant to a request for confidential
treatment filed with the Securities and Exchange Commission. Omitted
portions have been filed separately with the Commission.
(b) Reports on Form 8-K
(1) Current Report on Form 8-K/A-3 filed on November 7, 1997, reporting
a post-closing adjustment to the purchase price for the acquisition of
Mediatech.
(2) Current Report on Form 8-K/A-4 filed on January 8, 1998, reporting
the release of Series A proceeds held in escrow to the registrant.
(c) EXHIBITS
See items 14 (a) (3) above
(d) FINANCIAL STATEMENT SCHEDULES
Financial Statement Schedules. See Item 14(a) (2) above.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: March 31, 1998 By: /s/ Henry W. Donaldson
-------------------------------
Henry W. Donaldson
President and Chief Executive
Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints Henry W. Donaldson as his
attorney-in-fact, with full power of substitution for him in any and all
capacities, to sign any and all amendments to this report on Form 10-K, and to
file the same, with exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Henry W. Donaldson March 31, 1998
- - ----------------------------- President, Chief Executive Officer and
Henry W. Donaldson Director (Principal Executive Officer)
/s/ Paul W. Emery, II
- - ----------------------------- Chief Financial Officer March 31, 1998
Paul W. Emery, II (Principal Financial and Accounting
Officer)
/s/ Kevin R. Compton
- - ----------------------------- Director March 31, 1998
Kevin R. Compton
/s/ Jeffrey M. Drazan
- - ----------------------------- Director March 31, 1998
Jeffrey M. Drazan
/s/ Richard H. Harris
- - ----------------------------- Director March 31, 1998
Richard H. Harris
/s/ Lawrence D. Lenihan, Jr.
- - ----------------------------- Director March 31, 1998
Lawrence D. Lenihan, Jr.
/s/ Leonard S. Matthews
- - ----------------------------- Director March 31, 1998
Leonard S. Matthews
</TABLE>
33
<PAGE> 37
DIGITAL GENERATION SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Public Accountants ............................. F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996 ........ F-3
Consolidated Statements of Operations for the three years ended
December 31, 1997 .................................................... F-4
Consolidated Statements of Shareholders' Equity for the three years
ended December 31, 1997 .............................................. F-5
Consolidated Statements of Cash Flows for the three years ended
December 31, 1997 .................................................... F-6
Notes to Consolidated Financial Statements ........................... F-7
</TABLE>
F-1
<PAGE> 38
DIGITAL GENERATION SYSTEMS, INC.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Digital Generation Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Digital
Generation Systems, Inc. (a California Corporation) and subsidiaries as of
December 31, 1997 and 1996, and the related consolidated statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements and the schedule
referred to below are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Digital Generation Systems,
Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed under Item 14(a)2 is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not a required part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied in our
audits of the basic financial statements and, in our opinion, fairly states in
all material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
San Jose, California
February 4, 1998
F-2
<PAGE> 39
DIGITAL GENERATION SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 7,833 $ 9,682
Short-term investments 987 10,915
Accounts receivable, less allowance for doubtful
accounts of $585 in 1997 and $257 in 1996 8,053 3,349
Prepaid expenses and other 649 168
-------- --------
Total current assets 17,522 24,114
-------- --------
PROPERTY AND EQUIPMENT, at cost:
Network equipment 30,405 17,974
Office furniture and equipment 2,963 2,093
Leasehold improvements 506 353
-------- --------
33,874 20,420
Less - Accumulated depreciation and amortization (16,308) (7,790)
-------- --------
Property and equipment, net 17,566 12,630
-------- --------
GOODWILL AND OTHER ASSETS, net 25,609 8,504
-------- --------
$ 60,697 $ 45,248
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 4,506 $ 1,546
Accrued liabilities 3,501 2,174
Line of credit 2,834 --
Note payable from acquisition of PDR -- 2,500
Current portion of long-term debt 7,560 3,694
-------- --------
Total current liabilities 18,401 9,914
-------- --------
LONG-TERM DEBT, net of current portion 11,847 8,495
-------- --------
COMMITMENTS AND CONTINGENCIES (Note 5)
SHAREHOLDERS' EQUITY:
Convertible preferred stock, no par value -
Authorized - 5,000,000 shares
Outstanding - 4,950,495 shares at December 31, 1997
and none outstanding at December 31, 1996 31,561 --
Common stock, no par value - -
Authorized - 30,000,000 shares
Outstanding - 12,122,679 shares at December 31, 1997
and 11,653,625 shares at December 31, 1996 57,123 55,138
Receivable from issuance of common stock (175) (175)
Accumulated deficit (58,060) (28,124)
-------- --------
Total shareholders' equity 30,449 26,839
-------- --------
$ 60,697 $ 45,248
======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
<PAGE> 40
DIGITAL GENERATION SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
REVENUES $ 29,175 $ 10,523 $ 5,144
-------- -------- --------
COSTS AND EXPENSES:
Delivery and material costs 11,334 3,084 1,810
Customer operations 11,388 4,164 2,974
Sales and marketing 4,417 3,998 3,406
Research and development 2,473 2,092 1,590
General and administrative 3,169 1,677 1,380
Depreciation and amortization 9,306 4,331 2,345
-------- -------- --------
Total expenses 42,087 19,346 13,505
-------- -------- --------
LOSS FROM OPERATIONS (12,912) (8,823) (8,361)
OTHER INCOME (EXPENSE):
Interest income 744 1,422 417
Interest expense (2,607) (1,726) (836)
-------- -------- --------
NET LOSS $(14,775) $ (9,127) $ (8,780)
======== ======== ========
BASIC AND DILUTED NET LOSS PER COMMON
SHARE (Note 11) $ (2.52) $ (0.87) $ (9.78)
======== ======== ========
WEIGHTED AVERAGE COMMON SHARES 11,893 10,488 898
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
<PAGE> 41
DIGITAL GENERATION SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
RECEIVABLE
FROM
CONVERTIBLE ISSUANCE
PREFERRED STOCK COMMON STOCK OF TOTAL
------------------------------------------------- COMMON ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT SHARES AMOUNT STOCK DEFICIT EQUITY
---------- -------- ---------- ------- ----- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1994 6,692,510 $ 20,690 885,833 $ 106 $ (77) $(10,217) $ 10,502
Issuance of common stock at $.30 to $.60
per share for services rendered -- -- 32,686 13 -- -- 13
Exercise of stock options at $.20 to $.30
per share -- -- 31,185 7 -- -- 7
Sale of common stock at $.60 per
share to a related party -- -- 162,500 98 (98) -- --
Sale of Series D preferred stock at $8.00
per share, net of issuance costs of $19 581,249 4,631 -- -- -- -- 4,631
Net loss -- -- -- -- -- (8,780) (8,780)
---------- -------- ---------- ------- ----- -------- --------
BALANCE AT DECEMBER 31, 1995 7,273,759 25,321 1,112,204 224 (175) (18,997) 6,373
Conversion of preferred stock to common stock (7,273,759) (25,321) 7,273,759 25,321 --
Issuance of common stock in connection
with initial public offering, net of
issuance costs of $1,200 -- -- 3,000,000 29,490 -- -- 29,490
Net exercise of stock warrants for surrender
of 5,839 additional warrants -- -- 29,161 -- -- -- --
Exercise of stock options at $.20 to $7.00
per share -- -- 238,501 103 -- -- 103
Net loss (9,127) (9,127)
---------- -------- ---------- ------- ----- -------- --------
BALANCE AT DECEMBER 31, 1996 -- 0 11,653,625 55,138 (175) (28,124) 26,839
Issuance of Series A preferred stock,
net of issuance costs of $1,100 4,950,495 16,400 16,400
Preferred stock deemed dividend -- 15,161 -- -- -- (15,161) --
Issuance of common stock in connection with
acquisition of Mediatech -- -- 324,355 1,906 -- -- 1,906
Exercise of stock options at $.20 to $5.00
per share -- -- 144,699 79 -- -- 79
Net loss (14,775) (14,775)
---------- -------- ---------- ------- ----- -------- --------
BALANCE AT DECEMBER 31, 1997 4,950,495 $ 31,561 12,122,679 $57,123 $(175) $(58,060) $ 30,449
========== ======== ========== ======= ===== ======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
<PAGE> 42
DIGITAL GENERATION SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
-------- -------- -------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(14,775) $ (9,127) $(8,780)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 8,519 4,260 2,345
Amortization of goodwill and intangibles 787 71 --
Stock issued for services rendered -- -- 13
Provision for doubtful accounts 246 97 137
Changes in operating assets and liabilities --
Accounts receivable (122) (779) (604)
Prepaid expenses and other assets (212) (27) (841)
Accounts payable and accrued liabilities (751) 1,241 1,128
-------- -------- -------
Net cash used in operating activities (6,308) (4,264) (6,602)
-------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments (8,810) (33,138) --
Maturities of short-term investments 18,738 22,223 --
Acquisition of PDR, net of cash acquired -- (6,394) --
Acquisition of Mediatech, net of cash acquired (13,921) -- --
Acquisition of property and equipment (5,131) (2,417) (13)
-------- -------- -------
Net cash used in investing activities (9,124) (19,726) (13)
-------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 79 29,593 7
Proceeds from issuance of convertible preferred stock 16,400 -- 4,631
Proceeds from line of credit 7,686 -- --
Payments on line of credit (8,027) -- --
Proceeds from short-term loans used to finance Mediatech acquisition 6,000 -- --
Repayment of short-term loans used to finance Mediatech acquisition (6,000) -- --
Proceeds from issuance of long term debt 5,419 -- --
Payments on long-term debt (7,974) (2,126) (1,039)
-------- -------- -------
Net cash provided by financing activities 13,583 27,467 3,599
-------- -------- -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,849) 3,477 (3,016)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 9,682 6,205 9,221
-------- -------- -------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 7,833 $ 9,682 $ 6,205
======== ======== =======
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
<PAGE> 43
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY:
Digital Generation Systems, Inc. (the "Company") was incorporated in 1991.
The Company operates a nationwide multimedia network designed to provide media
distribution and related services to the broadcast industry by linking content
providers to radio and television stations. The Company is primarily a provider
of electronic and physical distribution of audio and video spot advertising to
radio and television stations. The Company primarily generates its revenues from
advertising agencies, production studios.
The Company is subject to certain risks that include, but are not limited
to: the continued development of technology to enhance the delivery and variety
of the Company's services in the most cost-effective manner, including the
successful integration of the operations of its recently acquired subsidiaries;
the ability to compete successfully against current and future competitors; and
dependence on key personnel and the need for additional financing to fund
operations and its capital expenditure requirements. The Company obtains certain
components used in the assembly of the units which are placed at radio and
television stations and production studios from a few single or limited source
suppliers and obtains its primary long distance telephone access through an
exclusive contract with a telephone service provider which expires in 2001. Any
material interruption in these services could have a material adverse effect on
the Company's business. Although the Company believes that alternate vendors can
be obtained, the transition to alternative vendors could have a material adverse
impact on the Company's costs and shipping schedules. The Company regularly
evaluates the remaining life and recoverability of its network equipment. Given
the emerging nature of its markets, it is possible that the Company's estimate
that it will recover the net carrying value of the equipment from future
operations could change in the future.
2. ACQUISITIONS:
PDR ACQUISITION
On November 8, 1996 the Company completed the acquisition of 100% of the
capital stock of PDR Productions, Inc. ("PDR"), a media duplication and
distribution company located in New York City, for consideration totaling $9.0
million. The consideration was $6.5 million in cash and a $2.5 million
promissory note with interest payable at 8%. The note and accrued interest were
paid in November 1997. The acquisition was accounted for as a purchase. The net
book value of assets and liabilities acquired was approximately $1.5 million.
The excess of purchase price and acquisition costs over the net book value of
assets acquired (including customer list, covenant not to compete and goodwill)
of approximately $7.9 million, has been included in Goodwill and Other Assets in
the accompanying consolidated balance sheet and is being amortized over a twenty
year period. Amortization expense of approximately $427,000 and $71,000 is
included in the consolidated statements of operations for the years ended
December 31, 1997 and 1996, respectively. The operating results of PDR have been
included in the consolidated results of the Company from the date of the closing
of the transaction, November 8, 1996.
MEDIATECH ACQUISITION
On July 18, 1997, the Company acquired 100% of the capital stock of
Starcom Mediatech, Inc. ("Mediatech"), a wholly owned subsidiary of IndeNet,
Inc. ("IndeNet"), for consideration totaling approximately $25.8 million
("Mediatech Acquisition"). The consideration consisted of approximately $14.0
million in cash, 324,355 shares of the Company's Common Stock, a $2.2 million
subordinated promissory note bearing interest at 9% payable to IndeNet (the
"Company Note"), a $2.2 million secured subordinated promissory note bearing
interest at 9% payable to Thomas H. Baur, a creditor of IndeNet (the "Baur
Note"), and the Company assumed
F-7
<PAGE> 44
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
approximately $5.4 million of existing Mediatech debt. Mediatech is a media
duplication and distribution company whose principal offices are located in
Chicago, Illinois.
On October 27, 1997, as provided for in the purchase agreement, the Company
and IndeNet agreed to reduce the aggregate purchase price by $625,000 based on
Mediatech's financial position at the acquisition date. The Company and IndeNet
entered into an agreement which provides that the adjustment will be made in the
form of a $25,000 immediate cash payment by IndeNet to the Company and a
reduction of the aggregate principal amount payable under the Company Note by an
amount equal to $600,000.
The Mediatech acquisition was accounted for as a purchase. The excess of
purchase price and acquisition costs over the net book value of assets acquired
of approximately $17.8 million, has been included in Goodwill and Other Assets
in the accompanying consolidated balance sheet and is being amortized over a
twenty year period. Amortization of approximately $360,000 is included in the
consolidated statement of operations for the year ended December 31, 1997. The
operating results of Mediatech have been included in the consolidated results of
the Company from the date of the closing of the transaction, July 18, 1997.
Additionally, the Company granted IndeNet the right to request the
registration of the shares received in the transaction under the Securities Act
of 1933, as amended, in the event that the anticipated offering price of a
registered sale of such shares exceeds $500,000 in the aggregate, or in the
event that the Company registers any securities for its own account or the
account of any other security holders of the Company. Such registration rights,
however, may not be exercised until July 14, 1998, and are subject to certain
restrictions resulting from underwriting limitations on the size of a registered
sale of the Company's securities.
The Company Note, as amended, matures on March 31, 2001, and is payable in
installments of $150,000 principal plus accrued interest commencing on December
31, 1997. Subsequent payments are due June 30, 1998; December 31, 1998; and June
30, 1999; to be followed by quarterly payments until the note is paid in full on
March 31, 2001. The Baur Note, which matures on January 1, 2000, is also payable
in installments. The first installment of $350,000 was paid July 30, 1997;
subsequent installments of $200,000 principal plus accrued interest are due
quarterly commencing January 1, 1998.
The Company drew upon two sources of funds to finance the cash portion of
the consideration for the Mediatech Acquisition. An entity affiliated with
Kleiner Perkins Caufield & Byers and another affiliated with Dawson-Samberg
Capital Management, Inc. each provided the Company with a $3.0 million cash loan
in exchange for a promissory note, each in the aggregate principal amount of
$3.0 million and bearing interest at the rate of 10% per annum. The Company
funded the remaining portion of the cash consideration for the Mediatech
Acquisition from its internal cash reserves.
PRO FORMA RESULTS
The following table reflects unaudited pro forma combined results of
operations of the Company including PDR and Mediatech on the basis that the
acquisitions of both PDR and Mediatech had taken place at the beginning of the
first fiscal year presented:
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED
DECEMBER 31,
------------------------
1997 1996
-------- ---------
<S> <C> <C>
Revenues ............................ $ 41,121 $ 40,273
Net Loss ............................ (16,414) (13,059)
Basic and Diluted Net Loss Per
Common Share (See Note 11) ........ $ (2.65) $ (1.25)
Number of Shares used in
Computation ....................... 11,893 10,488
</TABLE>
F-8
<PAGE> 45
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The unaudited pro forma combined results of operations are not
necessarily indicative of the actual results that would have occurred had the
acquisitions of PDR and Mediatech been consummated at the beginning of 1996, or
of future operations of the combined companies under the ownership and
management of the Company.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
CONSOLIDATION
The consolidated financial statements include the accounts of the
Company and its subsidiaries, PDR and Mediatech, after elimination of
intercompany accounts and transactions.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
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 December 31, 1997 and December 31, 1996, cash and cash
equivalents and short term investments consist principally of U.S. Treasury
bills and various money market accounts; as a result, the amortized purchase
cost approximates the fair market value.
PROPERTY AND EQUIPMENT
Network equipment includes the network operating center, Record Send
Terminals, Receive Playback Terminals, Video Record Transmission Systems,
Digital Video Playback Systems and the related terminal and system components as
well as audio and video taping and dubbing equipment. The Company depreciates
its property and equipment on a straight-line basis over their estimated useful
lives, generally three years.
SOFTWARE DEVELOPMENT COSTS
Under the criteria set forth in Statement of Financial Accounting Standards
No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or
Otherwise Marketed," capitalization of software development costs begins upon
the establishment of technological feasibility of the product. The establishment
of technological feasibility and the ongoing assessment of the recoverability of
these costs requires considerable judgment by management with respect to certain
external factors, including, but not limited to, anticipated future gross
product revenues, estimated economic life, changes in software and hardware
technology and the losses that the Company has incurred to date. Amounts that
could have been capitalized under this statement after consideration of the
above factors were immaterial and, therefore, no software development costs have
been capitalized by the Company to date.
REVENUE RECOGNITION
Revenues for distribution services are recognized for each transaction
on the date audio, video or related information is successfully transmitted from
the Company's operating facilities to the destination ordered.
DELIVERY AND MATERIAL COSTS
Delivery costs consist of fees paid to other service providers for charges
incurred by the Company in the
F-9
<PAGE> 46
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
receipt, transmission and delivery of information via the company's distribution
network. Material costs consist primarily of audio and video tape and the
related packaging used in delivery.
CUSTOMER OPERATIONS
Customer operations expenses consist primarily of salaries and the related
overhead costs incurred in performing deliveries and providing services,
including order entry, customer service and assembly and maintenance of the
Company's network equipment.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to a
concentration of credit risk consist principally of cash and cash equivalents,
short-term investments and accounts receivable. The Company has an investment
policy that limits the amount of credit exposure to any one issuer and restricts
these investments to issuers evaluated as credit worthy.
The Company believes that a concentration of credit risk with respect to
accounts receivable is limited because its customers are geographically
disbursed and the end-users (the customer's clients) are diversified across
industries.
The Company's receivables are principally from advertising agencies, dub
and ship houses, and syndicated programmers. The timing of collections from its
customers is affected by the billing cycle in which the customer bills its
end-users (the customer's clients). The Company provides reserves for credit
losses and such losses have been insignificant.
SUPPLEMENTAL CASH FLOW INFORMATION
Noncash investing and financing activities for 1997, 1996 and 1995
consisted of the following (in thousands):
<TABLE>
<CAPTION>
FOR THE YEAR
ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
------ ------- ------
<S> <C> <C> <C>
Property and equipment financed with capitalized lease
obligations ......................................... $ 400 $ 8,028 $5,019
Long term debt used to finance Mediatech acquisition . 3,850 -- --
Common stock issued to finance Mediatech acquisition . 1,906 -- --
Preferred stock deemed dividend ...................... 15,161 -- --
Conversion of preferred stock to common stock ........ -- 25,321
Note payable used to finance PDR acquisition ......... -- 2,500 --
Common stock issued for notes receivable ............. -- -- 98
Common stock issued for services rendered ............ -- -- 13
</TABLE>
RECLASSIFICATIONS
Certain amounts in the prior years have been reclassified to conform with
the current year presentation.
F-10
<PAGE> 47
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. ACCRUED LIABILITIES:
Accrued liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
------ ------
<S> <C> <C>
Telecommunications costs ......................... $ 769 $ 621
Employee compensation ............................ 734 334
Legal and consulting fees ........................ 706 321
Other ............................................ 1,292 898
------ ------
$3,501 $2,174
====== ======
</TABLE>
5. COMMITMENTS AND CONTINGENCIES:
The Company leases its facilities and certain equipment under noncancelable
operating leases. As of December 31, 1997, future minimum annual rental payments
under these leases are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
------------------------
<S> <C>
1998.............................. $1,139
1999.............................. 1,049
2000.............................. 1,026
2001.............................. 735
2002.............................. 572
Thereafter........................ 1,960
-----
$6,481
======
</TABLE>
Rent expense totaled approximately $1,540,000, $477,000 and $361,000 in
1997, 1996 and 1995 respectively.
In addition, as of December 31, 1997 the Company had noncancelable future
minimum purchase commitments with its primary telephone service provider. These
commitments range between $2.4 million and $6.2 million per year and extend
through December 2001.
The Company is subject to legal proceedings and claims, either asserted or
unasserted, which arise in the ordinary course of business from time to time.
While the outcome of these claims cannot be predicted with certainty, management
does not believe that the outcome of any of the pending legal matters will have
a material adverse effect on the Company's consolidated results of operations or
consolidated financial position.
6. LINE OF CREDIT:
Mediatech, a wholly owned subsidiary of the Company, is party to a
financing agreement with a bank which provides a revolving line of credit
available to fund the working capital requirements of Mediatech. The maximum
available to Mediatech under this agreement is $3,525,000, dependent upon the
level of qualifying receivables maintained by Mediatech. The agreement is
collateralized by a security agreement covering substantially all of the assets
of Mediatech and is guaranteed by the Company. The interest rate on advances
under the agreement is the bank's reference rate, approximately equal to the
prime rate, plus 2.25% (10.75% at December 31, 1997) and interest payments are
due monthly. Advances under the agreement are due and payable on demand. The
balance outstanding under this agreement at December 31, 1997 is $2,834,000,
which is approximately equal to the maximum available under the agreement at
that time.
F-11
<PAGE> 48
DIGITAL GENERATION SYSTEMS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. LONG-TERM DEBT:
The Company has used several lease and loan agreements to finance the
purchase of certain property and equipment. Borrowings are secured by the
equipment. The cost of equipment under lease and term loan obligations at
December 31, 1997 and 1996 was $21,820,000 and $15,648,000 respectively. Related
accumulated depreciation at December 31, 1997 and 1996 was $11,593,000 and
$5,791,000 respectively. These loans have repayment terms of 36 to 60 months per
drawdown and the Company has the option at the end of the terms to purchase the
equipment at mutually agreed upon prices not to exceed 10 to 20% of the
equipment's original cost. As of December 31, 1997, approximately $2.6 million
remained available under these agreements to fund future capital requirements.
Of the balance remaining available at December 31, 1997, $.9 million expires on
June 30, 1998, and $1.7 million expires on December 31, 1998.
In December 1997, the Company entered a new loan agreement to finance an
additional $2 million of equipment purchases and $3.5 million of working capital
through a long-term facility which can be drawn upon through December 1998. As
of December 31, 1997, $300,000 of the equipment purchases discussed above have
been financed through this agreement and no borrowings have been made for
working capital purposes. The agreement has repayment terms consistent with
those discussed above.
In October 1994, the Company signed a $1.6 million secured term note to
finance the purchase of certain equipment. The note is due in monthly
installments of $46,000 through April 1998, with a final payment of the
remainder due in May 1998.
Mediatech, a wholly owned subsidiary of the Company, has long-term debt
outstanding per the terms of a promissory note signed in February 1997. The
remaining principal balance of the note was $2.125 million at December 31, 1997.
The note bears interest at the bank's reference rate, approximately equal to the
prime rate, plus 2.25% (10.75% at December 31, 1997) and principal and interest
payments are due monthly. This note is payable to the same bank which provides
the line of credit discussed in Note 6 and is collateralized by the same
security agreement as the line of credit. In addition the note is also
guaranteed by the Company.
F-12
<PAGE> 49
DIGITAL GENERATION SYSTEMS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Future minimum lease and term loan payments as of December 31, 1997, are as
follows (in thousands):
<TABLE>
<CAPTION>
Year Ending December 31,
- - ------------------------
<S> <C>
1998.........................................$9,760
1999......................................... 7,959
2000......................................... 4,619
2001......................................... 709
2002......................................... 127
------
Total minimum debt payments 23,174
Less -- Amount representing interest
(effective interest rates ranging from
9 percent to 19 percent) ................... (3,767)
-------
Present value of minimum lease payments .... 19,407
Less -- Current portion .................... (7,560)
-------
Long-term portion ..........................$11,847
=======
</TABLE>
Interest paid was $2,502,000, $1,716,000 and $766,000 in 1997, 1996 and
1995, respectively.
8. CAPITAL STOCK:
COMMON STOCK
In January 1996, the shareholders approved a one-for-two reverse split
of the Company's preferred and common stock. All share and per share amounts in
the accompanying financial statements have been adjusted retroactively to give
effect to this reverse stock split.
In February 1996, the Company completed the initial public offering of
its common stock. The Company sold 3,000,000 shares for net proceeds of
$29,490,000. Concurrent with the closing of the initial public offering
7,273,759 shares of convertible preferred stock and warrants to purchase 29,161
shares of preferred stock were converted into an equivalent number of shares of
common stock.
As of December 31, 1997, the Company has reserved the following shares
of common stock for future issuance:
<TABLE>
<CAPTION>
Number
of Shares
---------
<S> <C>
1992 Stock Option Plan .................................................... 2,015,458
1996 Supplemental Stock Option Plan ....................................... 750,000
Stock warrants ............................................................ 492,177
1995 Director Option Plan ................................................. 100,000
Common stock to be issued as incentives to certain dealers
and distributors......................................................... 20,000
---------
Total potential shares ............................................... 3,377,635
</TABLE>
F-13
<PAGE> 50
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SERIES A CONVERTIBLE PREFERRED STOCK
During 1997, the Company issued 4,950,495 shares of its Series A
Convertible Preferred Stock (the ''Series A Preferred''). The Series A Preferred
include certain rights and preferences. Such rights include, without limitation,
the right to participate, on an as converted basis, in any and all dividends
declared or paid, or set aside for payment, in respect of outstanding shares of
the Company's Common Stock. The rights of the Series A Preferred also include
the right to receive a payment, prior to any payment to the holders of the
Company's Common Stock, in a per share amount equal to the purchase price paid
per share of Series A Preferred in the event of any voluntary or involuntary
liquidation, distribution of assets (other than a payment of dividends),
dissolution or winding up of the affairs of the Company. The Series A Preferred
has voting rights equivalent to the number of shares of common stock into which
the preferred shares may be converted. In addition, the Series A Preferred has
certain special voting rights which enable the holders thereof to designate one
member of the Board of Directors of the Company for election by the holders of
the Series A Preferred. Finally, the Series A Preferred is convertible, at the
option of the holder thereof, into one share of common stock, or converts
automatically based on a defined conversion ratio in certain circumstances as
defined in the Series A Preferred agreement.
The Series A Preferred was issued at less than the publicly traded price
per share. The difference between the publicly traded price per share and the
sales price per share has been reflected as a deemed dividend to the preferred
shareholders in the accompanying consolidated statements of shareholders'
equity.
WARRANTS
In connection with certain financing and leasing transactions made in 1993
through 1996, the Company issued warrants to purchase at fair market value an
aggregate of 35,000 shares of Series A preferred stock at a range of $2.00 to
$3.00 per share in January 1993 and April 1994, 71,174 shares of Series B
preferred stock at $2.70 per share in October 1994, 60,000 shares of Series C
preferred stock at $6.00 per share in June 1995 and 67,500 shares of Series D
preferred stock at $8.00 per share in January 1996. On December 31, 1995,
warrants to purchase 15,000 shares of Series C preferred stock were canceled
pursuant to the terms of the warrant agreement. A total of 29,161 of the Series
A warrants were exercised in return for surrender of the remaining 5,839
warrants upon the closing of the Company's initial public offering in February
1996. The remaining Series B, C and D warrants, which expire on the earlier of
ten years from the date of the related warrant agreement or five years from the
effective date of the Company's initial public offering, were converted to
warrants for common stock of the Company as per the conversion terms of the
agreements.
In December 1996, the Company issued 9,351 warrants to purchase common
stock at $8.02 per share in connection with an increase in an existing lease
line. The warrants expire in 2006.
In January 1997, the Company completed an agreement to finance an
additional $6.0 million of equipment purchases through a long-term credit
facility which can be drawn against through December 31, 1997. In December 1997
the term of the agreement was extended to June 30, 1998. Warrants to purchase
112,500 shares of the Company's Common Stock at a price of $8.00 per share were
issued to the lender per the terms of the agreement and the warrants were
subsequently repriced at $4.42 per share in return for the extension of the
agreement.
In December 1997, 186,652 warrants were issued at a price of $4.42 in
connection with a new loan agreement to finance an additional $2 million of
equipment purchases and $3.5 million of working capital through a long-term
facility which can be drawn upon through December 1998.
F-14
<PAGE> 51
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. STOCK PLANS:
The Company has three Stock Option Plans:
1992 STOCK OPTION PLAN
Under the Company's 1992 Stock Option (the "1992 Plan"), the Company may
issue up to 2,450,000 shares of common stock to employees, officers, directors
and consultants. At the Company's Annual Shareholders' Meeting in April 1997 the
shareholders approved an increase of 700,000 shares to be authorized under this
plan from the previously authorized total of 1,750,000 shares. The exercise
price and terms of the options granted is determined by the Board of Directors,
provided that such price cannot be less than the fair value of the common stock
on the date of grant for incentive stock options or, in the case of nonstatutory
options, less than 85 percent of the fair value of the common stock on the date
of grant. The options generally vest over four to five years. In January 1996,
the Board of Directors amended the 1992 Plan to provide that, in the event of a
change in control of the Company, executive officers of the Company will receive
accelerated vesting for a portion of their unvested option shares. The term of
the options granted is seven years.
1996 SUPPLEMENTAL OPTION PLAN
In July 1996, the Company's Board of Directors adopted the 1996
Supplemental Option Plan. Under this Plan, the Company may issue up to 750,000
shares of common stock to employees, officers, directors and consultants. The
exercise price and terms of the options granted is determined by the Board of
Directors. The options generally vest over four YEARS. The term of the options
granted is seven years.
1995 DIRECTOR OPTION PLAN
In September 1995, the Company's Board of Directors adopted the 1995
Director Option Plan (the "Director Plan"). A total of 100,000 shares of common
stock has been reserved for issuance under the Director Plan. At the Company's
Annual Shareholders' Meeting in April 1997 the shareholders approved an increase
of 25,000 shares to be authorized under this plan from the previously authorized
total of 75,000 shares. The Director Plan provides that each future nonemployee
director of the Company will be automatically granted an option to purchase
10,000 shares of common stock (the "First Option") on the date on which the
optionee first becomes a nonemployee director of the Company and an additional
option to purchase 2,500 shares of common stock (the "Subsequent Option") on the
next anniversary. The exercise price per share of all options granted under the
Director Plan shall be equal to the fair market value of a share of the
Company's common stock on the date of grant of the option. Shares subject to the
First Option vest over 36 months, and the Subsequent Option shares vest over 12
months beginning with the month following the second anniversary of its date of
grant. The terms of the options granted is ten years.
ACCOUNTING FOR STOCK OPTION COMPENSATION EXPENSE
Effective January 1, 1996, the Company adopted the disclosure provisions of
Financial Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for
Stock-Based Compensation." The adoption did not have a significant effect on the
Company's results of operations as the Company continues to apply the principles
of APB Opinion No. 25 and related interpretations in accounting for the
Company's stock options plans. Had compensation cost for the Company's stock
option plans been determined based on the fair value at the date of grant of the
stock options consistent with the method of SFAS No. 123, the Company's net loss
and loss per share would have been reduced to the pro forma amounts (in
thousands) indicated below:
F-15
<PAGE> 52
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C> <C>
Net Loss As reported $(14,775) $ (9,127) $(8,780)
Pro forma $(15,696) $(10,174) $(8,831)
Basic and diluted net loss
per common share (See
Note 11) As reported $(2.52) $(0.87) $(9.78)
Pro forma $(2.59) $(0.97) $(9.83)
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the multiple option approach of the Black-Scholes option pricing model with the
following assumptions used for grants in 1997, 1996 and 1995: risk-free interest
rates, based upon the grant dates, ranging from 5.2% to 7.8%; expected dividend
yields of zero percent; expected lives of one year from the vesting date;
expected volatility of zero percent prior to the filing date of the Company's
February 1996 initial public offering and sixty-five percent for grants made
subsequent to the filing through December 31, 1996; and seventy-five percent for
grants made between January 1, 1997 and December 31, 1997.
A Summary of the Company's fixed stock options plans at December 31, 1997,
1996 and 1995 and changes during the years then ended is presented below:
<TABLE>
<CAPTION>
1997 1996 1995
------------------------ ------------------------ ------------------------
WTD AVG WTD AVG WTD AVG
SHARES EX. PRICE SHARES EX. PRICE SHARES EX. PRICE
--------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of 1,806,355 $ 5.29 1,456,500 $ 1.73 550,500 $ 0.26
the year
Granted 2,037,000 $ 4.87 842,500 9.14 965,000 2.48
Exercised (144,699) $ .55 (238,501) 0.43 (31,185) 0.20
Canceled (1,163,949) $ 7.71 (254,144) 2.20 (27,815) 0.26
--------- -------- --------- -------- --------- --------
Outstanding at end of the year 2,534,707 $ 4.11 1,806,355 $ 5.29 1,456,500 $ 1.73
--------- -------- --------- -------- --------- --------
Exercisable at end of the year 494,276 $2.54 378,797 $2.29 194,112 $0.34
Weighted average fair value
of options granted $2.65 $4.41 $0.44
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- - ---------------------------------------------------------------- -------------------------------
Number Number
Outstanding Weighted-Average Exercisable
Range of at Remaining Weighted-Average at December Weighted-Average
Exercise December Contractual Exercise 31, 1997 Exercise
Prices 31, 1997 Life Price Price
- - --------------- ------------ -------------- -------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
$0.20 - $2.00 470,020 3.86 $0.68 297,143 $0.69
$3.875 - $5.00 1,705,812 6.74 $4.58 177,918 $5.00
$5.625 - $10.125 358,875 6.57 $6.41 19,215 $8.48
---------- --------
$0.20 - $10.125 2,534,707 494,276
========= =======
</TABLE>
As of December 31, 1997, there were 330,751 shares available for future
grant under the stock option plans.
Subsequent to December 31, 1997, 112,625 options were canceled and the Board
of Directors granted options to purchase 300,000 shares at $2.75 per share and
88,000 shares at $3.875 per share. The Board of Directors also authorized a
grant of options to purchase 200,000 additional shares pending the availability
of such shares for grant.
10. INCOME TAXES:
F-16
<PAGE> 53
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company accounts for taxes using a liability approach under which
deferred income taxes are provided based upon enacted tax laws and rates
applicable to the periods in which the taxes become payable.
The provision for income taxes differs from the statutory U.S. federal
income tax rate due to the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Provision at US statutory rate................................. 34.0% 34.0% 34.0%
State income taxes, net of federal benefit..................... 5.9 6.1 6.1
Change in valuation allowance.................................. (39.9) (40.1) (40.1)
------ ------ ------
--% --% --%
====== ====== ======
</TABLE>
Components of the net deferred income tax asset are as follows:
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Deferred income tax assets:
Net operating loss carryforwards ................ $ 12,702 $ 8,670
Cumulative temporary differences ................ 2,175 1,782
Capitalized start-up costs ...................... -- 37
Research and development credit ................. 543 324
Valuation allowance, equity ......................... (411) (292)
Valuation allowance, provision for income taxes ..... (15,009) (10,521)
-------- --------
Net deferred income tax asset ....................... $ -- $ --
======== ========
</TABLE>
The net operating loss and research and development credit carryforwards of
approximately $49.7 million expire on various dates through December 31, 2012.
Utilization of these carryforwards may be annually limited if there is a change
in the Company's ownership, as defined by the Internal Revenue Code.
A valuation allowance has been recorded for the entire deferred tax asset
as a result of uncertainties regarding the realization of the asset including
the limited operating history of the Company, the lack of profitability to date
and the variability of operating results. The portion of the valuation allowance
which will affect equity and which will not be available to offset future
provisions of income tax is stated in the above table as "Valuation allowance,
equity".
11. NET LOSS PER SHARE:
In 1997, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 128 "Earnings per Share." SFAS No. 128 requires companies to compute
earnings per share under two different methods (basic and diluted). Basic
earnings per share is calculated by dividing net income (loss) by the weighted
average shares of common stock outstanding during the period. Diluted earnings
per share is calculated by dividing net income (loss) by the weighted average
shares of outstanding common stock and common stock equivalents during the
period. As a result, the 1996 and 1995 pro forma net loss per share amounts have
been restated. The effect of this accounting change on previously reported
earnings per share (EPS) data was as follows:
<TABLE>
<CAPTION>
1996 1995
------ ------
<S> <C> <C>
Pro forma net loss per share as previously reported $(0.79) $(0.94)
Effect of SFAS No. 128 ............................ (0.08) (8.84)
------ ------
Basic and diluted net loss per common share ....... $(0.87) $(9.78)
===== =====
</TABLE>
Net loss per share was calculated on net loss available to common
stockholders. For the year ended December 31, 1997, the net loss per share was
computed as net loss of $14,775,000 plus $15,161,000 relating to the preferred
stock deemed dividend (Note 8) divided by the weighted average common shares
outstanding.
F-17
<PAGE> 54
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. NEW ACCOUNTING STANDARDS:
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income," which establishes standards for reporting comprehensive
income and its components (revenues, expenses, gains and losses) in financial
statements. SFAS No. 130 requires classification of other comprehensive income
in a financial statement, and the display of the accumulated balance of other
comprehensive income separately from retained earnings and additional paid-in
capital. SFAS No. 130 is effective for fiscal years beginning after December 15,
1997. The Company believes this pronouncement will not have a material effect on
its financial statements.
In June 1997, the FASB also issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," which established standards
for reporting information about operating segments in annual financial
statements and requires that enterprises report selected information about
operating segments in interim financial reports to shareholders. SFAS No. 131
also establishes standards for related disclosures about products and services,
geographic areas and major customers. SFAS No. 131 is effective for fiscal years
beginning after December 15, 1997, although earlier application is encouraged.
The Company believes this pronouncement will not have a material effect on its
financial statements.
F-18
<PAGE> 55
DIGITAL GENERATION SYSTEMS, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT ADDITIONS BALANCE
BEGINNING CHARGED AT END
CLASSIFICATION OF PERIOD TO OPERATIONS OTHER(a) WRITEOFFS OF PERIOD
-------------- --------- ------------- -------- --------- ---------
<S> <C> <C> <C> <C> <C>
Allowance for Doubtful Accounts
Year Ended:
December 31, 1995....... $ 73,000 $ 137,000 $ -- $ (75,000) $ 135,000
December 31, 1996....... $ 135,000 $ 97,000 $ 25,000 $ -- $ 257,000
December 31, 1997....... $ 257,000 $ 246,000 $259,000 $(177,000) $ 585,000
</TABLE>
(a) Additions resulting from acquisitions of PDR in 1996 and Mediatech in
1997.
S-1
<PAGE> 1
EXHIBIT 10.31
================================================================================
LOAN AGREEMENT
Dated as of December 1, 1997
between
DIGITAL GENERATION SYSTEMS, INC.,
as Borrower,
and
VENTURE LENDING & LEASING II, INC.,
as Lender
================================================================================
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
ARTICLE 1 - DEFINITIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
ARTICLE 2 - THE LOANS AND RELATED TERMS AND CONDITIONS . . . . . . . . . . . . . . . . . . . . . . . . . 6
2.1 Equipment Loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
2.2 Term Loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
2.3 Limitations on Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
2.4 Notes Evidencing Loans; Repayment . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
2.5 Procedures for Borrowing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
2.6 Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
2.7 Terminal Payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
2.8 Interest Rate Calculation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
2.9 Default Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
2.10 Prepayment of Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
2.11 Lender's Records . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.12 Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.13 Issuance of Warrant to Lender . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
ARTICLE 3 - REPRESENTATIONS AND WARRANTIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
3.1 Due Organization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
3.2 Authorization, Validity and Enforceability . . . . . . . . . . . . . . . . . . . . . . . 9
3.3 Compliance with Applicable Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
3.4 Copyrights, Patents, Trademarks and Licenses . . . . . . . . . . . . . . . . . . . . . . 10
3.5 No Conflict . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
3.6 No Litigation, Claims or Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . 10
3.7 Correctness of Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . 10
3.8 No Subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
3.9 Environmental Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
3.10 No Event of Default . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
3.11 Full Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
ARTICLE 4 - CONDITIONS PRECEDENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
4.1 Conditions to Initial Loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
4.2 Conditions to All Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
ARTICLE 5 - AFFIRMATIVE COVENANTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
5.1 Notice to Lender . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
5.2 Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
5.3 Managerial Assistance from Lender . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
5.4 Existence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
5.5 Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
5.6 Accounting Records . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
5.7 Compliance With Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
5.8 Taxes and Other Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
5.9 Use of Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
5.10 Locations of Collateral . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
</TABLE>
i
<PAGE> 3
TABLE OF CONTENTS
-----------------
(continued)
<TABLE>
<CAPTION>
Page
----
<S> <C>
ARTICLE 6 - NEGATIVE COVENANTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
ARTICLE 7 - EVENTS OF DEFAULT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
7.1 Events of Default . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
ARTICLE 8 - GENERAL PROVISIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
8.1 Notices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
8.2 Binding Effect . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
8.3 No Waiver . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
8.4 Rights Cumulative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
8.5 Unenforceable Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
8.6 Accounting Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
8.7 Indemnification; Exculpation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
8.8 Reimbursement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
8.9 Execution in Counterparts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
8.10 Entire Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
8.11 Governing Law and Jurisdiction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
8.12 Waiver of Jury Trial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
</TABLE>
LIST OF EXHIBITS
Exhibit "A" Form of Note
Exhibit "B" Form of Borrowing Request
Exhibit "C" Form of Security Agreement
Exhibit "D" Form of Warrant
Exhibit "E" Form of Borrowing Base Certificate
<PAGE> 4
LOAN AGREEMENT
This LOAN AGREEMENT is entered into as of December 1, 1997,
between DIGITAL GENERATION SYSTEMS, INC., a California corporation
("Borrower"), and VENTURE LENDING & LEASING II, INC., a Maryland corporation
("VLLI" or "Lender").
WHEREAS, Lender has agreed to make available to Borrower
equipment acquisition term loan and working capital term loan facilities upon
the terms and conditions set forth in this Agreement.
NOW, THEREFORE, in consideration of the mutual agreements,
provisions and covenants contained herein, the parties agree as follows:
ARTICLE 1 - DEFINITIONS
The definitions appearing in this Agreement or any supplement
or addendum to this Agreement, shall be applicable to both the singular and
plural forms of the defined terms:
"AFFILIATE" means any Person directly or indirectly
controlling, controlled by, or under common control with, Borrower.
"Controlling," "controlled by" and "under common control with" means direct or
indirect possession of the power to direct or cause the direction of management
or policies (whether through ownership of voting securities, by contract or
otherwise); provided that control shall be conclusively presumed when any
Person or affiliated group directly or indirectly owns ten percent (10%) or
more of the securities having ordinary voting power for the election of
directors of a corporation.
"ACCOUNT" means, for purposes of calculating the Borrowing
Base, a right to payment for goods sold or leased or for services rendered by
Borrower or any wholly owned subsidiary of Borrower in the ordinary course of
its business, provided that such Account is free and clear of all Liens except
those in favor of Lender.
"AGREEMENT" means this Loan Agreement as it may be amended or supplemented from
time to time.
"BANKRUPTCY CODE" means the Federal Bankruptcy Reform Act of
1978 (11 U.S.C. Section 101, et seq.), as amended.
"BASIC INTEREST" means the interest payable on the outstanding
balance of each Loan at the applicable Designated Rate.
"BORROWING BASE" means, as of any date of determination, an
amount equal to eighty percent (80%) of Accounts existing as of such date.
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<PAGE> 5
"BORROWING DATE" means the Business Day on which the proceeds
of a Loan are disbursed by Lender.
"BORROWING REQUEST" means a written request from Borrower in
substantially the form of Exhibit "B" hereto, requesting the funding of one or
more Loans on a particular Borrowing Date.
"BUSINESS DAY" means any day other than a Saturday, Sunday or
other day on which commercial banks in New York City or San Francisco are
authorized or required by law to close.
"CLOSING DATE" means the date of this Agreement.
"COLLATERAL" has the meaning ascribed thereto in the Security
Agreement.
"COMMITMENT" means, with respect to each of the Equipment Loan
and the Term Loan facilities described in Sections 2.1 and 2.2 hereof, the
obligation of Lender to make Loans to Borrower in an aggregate, original
principal amount not exceeding Five Million Five Hundred Thousand Dollars
($5,500,000).
"DEFAULT" means an event which with the giving of notice,
passage of time, or both would constitute an Event of Default.
"DEFAULT RATE" is defined in Section 2.9.
"DESIGNATED RATE" means a fixed rate of interest per annum
that is (i) for each Equipment Loan, eight and 50/100 percent (8.50%) and (ii)
for each Term Loan, eight and 50/100 percent (8.50%).
"ENVIRONMENTAL LAWS" means all federal, state or local laws,
statutes, common law duties, rules, regulations, ordinances and codes, together
with all administrative orders, directed duties, requests, licenses,
authorizations and permits of, and agreements with, any governmental
authorities, in each case relating to environmental, health, or safety matters.
"EQUIPMENT LOAN" means the credit facility in the maximum
original principal amount of Two Million Dollars ($2,000,000) provided for in
Section 2.1 of this Agreement, and any advance thereunder by Lender.
"EVENT OF DEFAULT" means any event described in Article 7.
"GAAP" means generally accepted accounting principles and
practices consistent with those principles and practices promulgated or adopted
by the Financial Accounting Standards Board and the Board of the American
Institute of Certified Public Accountants, their respective
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<PAGE> 6
predecessors and successors. Each accounting term used but not otherwise
expressly defined herein shall have the meaning given it by GAAP.
"INDEBTEDNESS" of any Person means at any date, without
duplication and without regard to whether matured or unmatured, absolute or
contingent: (i) all obligations of such Person for borrowed money; (ii) all
obligations of such Person evidenced by bonds, debentures, notes, or other
similar instruments; (iii) all obligations of such Person to pay the deferred
purchase price of property or services, except trade accounts payable arising
in the ordinary course of business; (iv) all obligations of such Person as
lessee under capital leases; (v) all obligations of such Person to reimburse or
prepay any bank or other Person in respect of amounts paid under a letter of
credit, banker's acceptance, or similar instrument, whether drawn or undrawn;
(vi) all obligations of such Person to purchase securities which arise out of
or in connection with the sale of the same or substantially similar securities;
(vii) all obligations of such Person to purchase, redeem, or otherwise acquire,
for cash on a present or deferred basis, any capital stock of such Person or
any warrants, rights or options to acquire such capital stock, now or hereafter
outstanding, except to the extent that such obligations remain performable
solely at the option of such Person; (viii) all obligations to repurchase
assets previously sold (including any obligation to repurchase any accounts or
chattel paper under any factoring, receivables purchase, or similar
arrangement); (ix) obligations of such Person under interest rate swap, cap,
collar or similar hedging arrangements; and (x) all obligations of others of
any type described in clause (i) through clause (ix) above guaranteed by such
Person.
"INSOLVENCY PROCEEDING" means (a) any case, action or
proceeding before any court or other governmental authority relating to
bankruptcy, reorganization, insolvency, liquidation, receivership, dissolution,
winding-up or relief of debtors, or (b) any general assignment for the benefit
of creditors, composition, marshalling of assets for creditors, or other,
similar arrangement in respect of its creditors generally or any substantial
portion of its creditors, undertaken under U.S. Federal, state or foreign law,
including the Bankruptcy Code.
"LIEN" means any voluntary or involuntary security interest,
mortgage, pledge, claim, charge, encumbrance, title retention agreement, lease
having the same economic effect as the foregoing or third party interest,
covering all or any part of the property of Borrower or any other Person.
"LOAN" means, as applicable, any advance under the Equipment
Loan or the Term Loan pursuant to Section 2.1 or 2.2 hereof.
"LOAN DOCUMENTS" means, individually and collectively, this
Agreement, each Note, the Security Agreement and any other security or pledge
agreement(s), and all other contracts, instruments, addenda and documents
executed in connection with this Agreement or the extensions of credit which
are the subject of this Agreement.
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<PAGE> 7
"MATERIAL ADVERSE EFFECT" or "MATERIAL ADVERSE CHANGE" means
(a) a material adverse change in, or a material adverse effect upon, the
operations, business, properties, or financial condition of Borrower; (b) a
material impairment of the ability of Borrower to perform under any Loan
Document; or (c) a material adverse effect upon the legality, validity, binding
effect or enforceability against Borrower of any Loan Document.
"MATURITY DATE" means, with regard to a Loan, the earlier of
(i) its maturity by reason of acceleration, or (ii) its stated maturity date.
"NOTE" means a promissory note substantially in the form of
Exhibit "A" hereto, executed by Borrower evidencing a Loan.
"OBLIGATIONS" means all advances, debts, liabilities,
obligations, covenants and duties arising under any Loan Document, owing by
Borrower to Lender, whether direct or indirect (including those acquired by
assignment), absolute or contingent, due or to become due, liquidated or
unliquidated, now existing or hereafter arising.
"PERMITTED LIEN" means
(a) Involuntary Liens which, in the aggregate,
would not have a Material Adverse Effect and which in any event would
not exceed Three Hundred Thousand Dollars ($300,000);
(b) Liens for current taxes or other governmental
or regulatory assessments which are not delinquent, or which are
contested in good faith by the appropriate procedures and for which
appropriate reserves are maintained;
(c) Purchase money security interests on (or
capital leases of) any property held or acquired by Borrower in the
ordinary course of business securing Indebtedness incurred or assumed
for the purpose of financing all or any part of the cost of acquiring
such property; provided, that such Lien attaches solely to the
property acquired with such Indebtedness and that the principal amount
of such Indebtedness does not exceed one hundred percent (100%) of the
cost of such property; and further provided, that such property is not
equipment which has been financed with proceeds of an Equipment Loan.
(d) Liens in favor of Lender;
(e) bankers' liens, rights of setoff and similar
Liens incurred on deposits made in the ordinary course of business;
(f) materialmen's, mechanics', repairmen's,
employees' or other like Liens arising in the ordinary course of
business and which are not delinquent for more than 45 days or are
being contested in good faith by appropriate proceedings;
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<PAGE> 8
(g) any judgment, attachment or similar Lien,
unless the judgment it secures has not been discharged or execution
thereof effectively stayed and bonded against pending appeal within 30
days of the entry thereof;
(h) licenses or sublicenses of Patents, Patent
Licenses, Trademarks or Trademark Licenses permitted under the
Trademark Collateral Assignment or the Patent Collateral Assignment
(all as defined in the Security Agreement); and
(i) Liens which have been approved by Lender
prior to the Closing Date, including Liens against assets of MediaTech
Inc., a wholly-owned subsidiary of Borrower, in favor of Republic
Acceptance Corporation or a successor commercial or institutional
lender to secure a working capital credit facility; and Liens in favor
of Venture Lending & Leasing, Inc., to secure Borrower's obligations
under that certain Loan Agreement dated as of January 28, 1997, as
amended.
"PERSON" means any individual or entity.
"RELATED PERSON" means any Affiliate of Borrower, or any
officer, employee, director or security holder of Borrower or any Affiliate.
"REPORTING COMPANY" means an issuer subject to the periodic
reporting requirements of the Securities Exchange Act of 1934, as amended.
"SEC" means the Securities and Exchange Commission.
"SECURITY AGREEMENT" means the Security Agreement
substantially in the form of Exhibit "C" hereto.
"TERM LOAN" means the working capital credit facility in the
maximum original principal amount of Three Million Five Hundred Thousand
Dollars ($3,500,000) provided for in Section 2.2 of this Agreement and any
advance by Lender thereunder.
"TERMINAL PAYMENT" means, with respect to each Loan, an amount
payable on the Maturity Date of such Loan equal to fifteen percent (15%) of the
original principal amount of such Loan; provided, however that any Terminal
Payment that is paid with respect to a Loan prior to its originally scheduled
Maturity Date (for example, as a result of acceleration or a permitted
voluntary prepayment) shall be payable in an amount equal to the lesser of (i)
fifteen percent (15%) of the original principal amount of such Loan, or (ii) an
amount which when added to the Basic Interest actually paid to date on the Loan
will provide Lender with a return of fifteen percent (15%) per annum on the
principal amount of the Loan (excluding from such calculation any value
associated with the warrant issued to Lender under Section 2.13).
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<PAGE> 9
"TERMINATION DATE" means the earlier of: (a) the date Lender
may terminate making Loans or extending credit pursuant to the rights of Lender
under Article 7, or (b) December 31, 1998.
"UCC" means the Uniform Commercial Code as enacted in the
applicable jurisdiction, in effect on the Closing Date and as amended from time
to time.
ARTICLE 2 - THE LOANS AND RELATED TERMS AND CONDITIONS
Subject to the terms and conditions of this Agreement, the
following Loans shall be available to Borrower:
2.1 EQUIPMENT LOAN. Subject to the terms and conditions
of this Agreement, Lender agrees to make Loans to Borrower from time to time
from the Closing Date and to the Termination Date in an aggregate principal
amount not exceeding Two Million Dollars ($2,000,000), the proceeds of which
shall be used to finance Borrower's acquisition or carrying of equipment
located at Borrower's customer sites, computer equipment and general purpose
office equipment and related software imbedded in or necessary to the use or
operation of such equipment; provided the aggregate amount advanced to finance
software shall at no time exceed fifty percent (50%) of all Loans advanced
under the Equipment Loan. The Commitment is not a revolving credit commitment,
and Borrower shall not have the right to repay and reborrow hereunder.
2.2 TERM LOAN. Subject to the terms and conditions of
this Agreement, Lender agrees to make Loans to Borrower from time to time from
the Closing Date and to the Termination Date in an aggregate principal amount
not exceeding the lesser of (a) Three Million Five Hundred Thousand Dollars
($3,500,000), and (b) the Borrowing Base. The proceeds of the Term Loan shall
be used by Borrower for working capital and general corporate purposes. The
Commitment is not a revolving credit commitment, and Borrower shall not have
the right to repay and reborrow hereunder.
2.3 LIMITATIONS ON LOANS.
(a) Each Equipment Loan shall be in an amount not
to exceed one hundred percent (100%) of the amount paid or payable by
Borrower to a non-affiliated manufacturer, vendor or dealer for an
item of equipment as shown on an invoice therefor (excluding any
commissions and any portion of the payment relating to the servicing
of the equipment and sales taxes payable by Borrower upon acquisition,
and delivery charges).
(b) Lender shall not be obligated to make any Loan if
at the time of or after giving effect to the proposed Loan Lender
would no longer qualify as: (A) a "venture capital operating company"
under U.S. Department of Labor Regulations Section 2510.3- 101(d),
Title 29 of the
6
<PAGE> 10
Code of Federal Regulations, as amended; and (B) a "business
development company" under the provisions of federal Investment
Company Act of 1940, as amended; and (C) a "regulated investment
company" under the provisions of the Internal Revenue Code of 1986, as
amended.
(c) Lender's commitment to advance any Term Loan is
subject to the condition that the aggregate outstanding principal
balance of all Term Loans (both before and after giving effect to any
proposed Term Loan) shall not exceed the Borrowing Base.
(d) Each Term Loan requested by Borrower to be made on
a single Business Day shall be for a minimum principal amount of Five
Hundred Thousand Dollars ($500,000), except to the extent the
remaining Commitment is a lesser amount.
2.4 NOTES EVIDENCING LOANS; REPAYMENT. Each Loan and
Basic Interest and the Terminal Payment thereon, shall be evidenced by a
separate Note payable to the order of Lender substantially in the form of
Exhibit "A" to this Agreement, in the principal amount of the Loan. Each Note
shall be payable as follows: Principal and Basic Interest shall be paid in
thirty-six (36) equal and successive monthly payments, in advance, beginning on
the Borrowing Date and continuing on the first Business Day of each month
thereafter; provided, that the first and last such amortization installment
payments shall be paid in advance on the Borrowing Date. If the Borrowing Date
is not the first day of a month, then the 36-month amortization period shall
commence on the first day of the first full month following the Borrowing Date,
and interest only shall accrue and be payable for the period from the Borrowing
Date to the first Business Day of the next month. Borrower shall pay to
Lender, in advance, on the Borrowing Date a payment of Basic Interest on the
amount of any Loan that is not made on the first day of the month for interest
that will accrue on such Loan from the Borrowing Date through the last day of
the same month. The Terminal Payment with respect to a Loan shall be paid on
the applicable Maturity Date.
2.5 PROCEDURES FOR BORROWING.
(a) Borrower shall give Lender, at least five (5)
Business Days' prior to a proposed Borrowing Date, written notice of
any request for a Loan hereunder (a "Borrowing Request"). Each
Borrowing Request shall be in substantially the form of Exhibit "B"
hereto, shall be executed by the chief financial officer of Borrower,
and shall state whether the Loan requested is an Equipment Loan or a
Term Loan, and the amount of the proposed Loan, and (if the proposed
Loan is a Term Loan) shall certify the amount of the Borrowing Base
and that the aggregate principal amount of all outstanding Term Loans
before and after giving effect to the proposed Term Loan is less than
the Borrowing Base. In the case of each proposed Equipment Loan, to
the best of Borrower's knowledge after due inquiry of its senior
officers, the Borrowing Request shall also certify that all equipment
to be financed thereby is,
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<PAGE> 11
or will upon acquisition be, owned by Borrower free and clear of all
Liens except in favor of Lender or as otherwise permitted hereunder.
(b) No later than 1:00 p.m. Pacific Standard Time
on the Borrowing Date, if Borrower has satisfied the conditions
precedent in Article 4, Lender shall make the Loan proceeds available
to Borrower in immediately available funds.
2.6 INTEREST. Basic Interest on the outstanding
principal balance of the each Loan shall accrue daily at the Designated Rate
from the Borrowing Date until the Maturity Date. On the Maturity Date (whether
at stated maturity, prepayment or acceleration) of a Loan, Borrower shall pay
all amounts due thereunder.
2.7 TERMINAL PAYMENT. Borrower shall pay in full the
Terminal Payment with respect to each Loan on or before the Maturity Date of
such Loan.
2.8 INTEREST RATE CALCULATION. Basic Interest, along
with charges and fees under this Agreement and any Loan Document, shall be
calculated for actual days elapsed on the basis of a 360-day year, which
results in higher interest, charge or fee payments than if a 365-day year were
used. In no event shall Borrower be obligated to pay Lender any interest,
charges or fees at a rate in excess of the highest rate permitted by applicable
law from time to time in effect.
2.9 DEFAULT INTEREST. Any unpaid payments of principal
or interest with respect to any Loan shall bear interest from their respective
maturities, whether scheduled or accelerated, at the Designated Rate for such
Loan plus five percent (5.00%) per annum, until paid in full, whether before or
after judgment (the "Default Rate"). Unpaid Terminal Payments shall also bear
interest at the Default Rate. Borrower shall pay such interest on demand.
2.10 PREPAYMENT OF LOANS. Borrower may prepay any Term or
Equipment Loan, in whole but not in part at any time upon at least 30 days'
prior written notice to Lender. Borrower shall prepay one or more Term Loans,
in whole or in part, from time to time as necessary to the extent of the amount
by which the aggregate outstanding principal balance of all Term Loans exceeds
at any time the Borrowing Base. Notwithstanding the provisions of Article 6,
Borrower may (x) sell, transfer, lease or otherwise dispose of all or
substantially all of Borrower's assets or (y) enter into a merger in which
Borrower will not be the surviving corporation if, immediately prior to the
consummation of such transaction Borrower prepays all Loans then outstanding.
Any prepayment, including any prepayment pursuant to this Section 2.10, whether
voluntary or involuntary as a result of acceleration or otherwise, must be
accompanied by payment of: (i) accrued Basic Interest to the date of such
prepayment; and (ii) the Terminal Payment on the Loan so prepaid.
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<PAGE> 12
2.11 LENDER'S RECORDS. Principal, Basic Interest,
Terminal Payments and all other sums owed under any Loan Document shall be
evidenced by entries in records maintained by Lender for such purpose. Each
payment on and any other credits with respect to principal, Basic Interest,
Terminal Payments and all other sums outstanding under any Loan Document shall
be evidenced by entries in such records. Absent manifest error, Lender's
records shall be conclusive evidence thereof.
2.12 SECURITY. As security for all Obligations to Lender,
Borrower shall grant to Lender perfected security interests of first priority
in all of the Collateral defined in the Security Agreement, subject only to
Permitted Liens and as required under Article 4. If upon payment in full of
all Obligations in respect of all Equipment Loans there remain outstanding
Obligations in respect of the Term Loans, and if no Event of Default then
exists, then Lender shall release its security interests in all Collateral
securing any Equipment Loan Indebtedness. If upon payment in full of all
Obligations in respect of the Term Loans there remain outstanding Obligations
in respect of the Equipment Loans, and if no Event of Default then exists, then
Lender shall release its security interests in all Collateral except Equipment
and Proceeds and Records relating solely to Equipment.
2.13 ISSUANCE OF WARRANT TO LENDER. As additional
consideration for the making of the Loans under this Agreement, upon the making
of the first Loan and as a condition thereto, Borrower shall issue to Lender a
warrant to purchase 186,652 shares of common stock of Borrower at an initial
exercise price of $4.42 per share ("Warrant Shares"). The warrant issued under
this Agreement shall be in substantially the form attached hereto as Exhibit
"D"; shall be transferable by Lender, subject to compliance with applicable
securities laws; shall expire not earlier than December 31, 2003; and shall
include piggy-back registration rights, and "net issuance" provisions
reasonably satisfactory to Lender and its counsel.
ARTICLE 3 - REPRESENTATIONS AND WARRANTIES
Borrower represents and warrants that as of the Closing Date
and each Borrowing Date:
3.1 DUE ORGANIZATION. Borrower is a corporation duly
organized and validly existing in good standing under the laws of California,
and is duly qualified to conduct business and is in good standing in each other
jurisdiction in which its business is conducted or its properties are located,
except where the failure to be so qualified would not reasonably be expected to
have a Material Adverse Effect.
3.2 AUTHORIZATION, VALIDITY AND ENFORCEABILITY. The
execution, delivery and performance of all Loan Documents executed by Borrower
are within Borrower's powers, have been duly authorized, and are not in
conflict with Borrower's certificate of incorporation or by-laws, or the terms
of any charter or other organizational document of Borrower, as amended from
time to
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<PAGE> 13
time; and all such Loan Documents constitute valid and binding obligations of
Borrower, enforceable in accordance with their terms (except as may be limited
by bankruptcy, insolvency and similar laws affecting the enforcement of
creditors' rights in general, and subject to general principles of equity).
3.3 COMPLIANCE WITH APPLICABLE LAWS. Borrower has
complied with all licensing, permit and fictitious name requirements necessary
to lawfully conduct the business in which it is engaged, and to any sales,
leases or the furnishing of services by Borrower, including without limitation
those requiring consumer or other disclosures, the noncompliance with which
would have a Material Adverse Effect.
3.4 COPYRIGHTS, PATENTS, TRADEMARKS AND LICENSES.
(a) Borrower owns or is licensed or
otherwise has the right to use all of the patents, trademarks, service
marks, trade names, copyrights, contractual franchises, authorizations
and other similar rights that are reasonably necessary for the
operation of its business, without, to the best of Borrower's
knowledge, conflict with the rights of any other Person.
(b) To Borrower's knowledge, no slogan
or other advertising device, product, process, method, substance, part
or other material now employed, or now contemplated to be employed, by
Borrower infringes upon any rights held by any other Person.
(c) No claim or litigation regarding any of the
foregoing is pending or, to Borrower's knowledge, threatened, and to
Borrower's knowledge no patent, invention, device, application,
principle or any statute, law, rule, regulation, standard or code is
pending or proposed which, in either case, would reasonably be
expected to have a Material Adverse Effect.
3.5 NO CONFLICT. The execution, delivery, and
performance by Borrower of all Loan Documents are not in conflict with any law,
rule, regulation, order or directive, or any indenture, agreement, or
undertaking to which Borrower is a party or by which Borrower may be bound or
affected.
3.6 NO LITIGATION, CLAIMS OR PROCEEDINGS. There is no
litigation, tax claim, proceeding or dispute pending, or, to the knowledge of
Borrower, threatened against or affecting Borrower or its property.
3.7 CORRECTNESS OF FINANCIAL STATEMENTS. Borrower's
financial statements which have been delivered to Lender fairly and accurately
reflect Borrower's financial condition as of September 30, 1997; and, since
that date there has been no Material Adverse Change.
3.8 NO SUBSIDIARIES. Borrower is not an Affiliate of or
a majority owner of or in a control relationship with any other business
entity, except that Borrower owns all of the outstanding capital stock of: (i)
PDR
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<PAGE> 14
Productions, Inc., a New York corporation (the name of which Borrower intends
to change to "Digital Generation Systems of New York"); and (ii) MediaTech
Inc., a Delaware corporation.
3.9 ENVIRONMENTAL MATTERS. Borrower is in compliance
with all applicable Environmental Laws, except to the extent a failure to be in
such compliance would not reasonably be expected to have a Material Adverse
Effect on Borrower's operations, properties or financial condition.
3.10 NO EVENT OF DEFAULT. No Default or Event of Default
has occurred and is continuing.
3.11 FULL DISCLOSURE. None of the representations or
warranties made by Borrower in the Loan Documents as of the date such
representations and warranties are made or deemed made, and none of the
statements contained in any exhibit, report, statement or certificate furnished
by or on behalf of Borrower in connection with the Loan Documents (including
disclosure materials delivered by or on behalf of Borrower to Lender prior to
the Closing Date), contains any untrue statement of a material fact or omits
any material fact required to be stated therein or necessary to make the
statements made therein, in light of the circumstances under which they are
made, not misleading as of the time when made or delivered.
ARTICLE 4 - CONDITIONS PRECEDENT
4.1 CONDITIONS TO INITIAL LOAN. The obligation of Lender
to make its first Loan hereunder is, in addition to the conditions precedent
specified in Section 4.2, subject to the fulfillment of the following
conditions and to the receipt by Lender of the documents described below, duly
executed and in form and substance satisfactory to Lender and its counsel:
(a) RESOLUTIONS. A certified copy of
the resolutions of the Board of Directors of Borrower authorizing the
execution, delivery and performance by Borrower of the Loan Documents.
(b) INCUMBENCY AND SIGNATURES. A
certificate of the secretary of Borrower certifying the names of the
officer or officers of Borrower authorized to sign the Loan Documents,
together with a sample of the true signature of each such officer.
(c) OPINION OF COUNSEL. The opinion of
Wilson, Sonsini, Goodrich & Rosati, counsel for Borrower, together
with any opinions, certificates and other matters on which such
opinion relies.
(d) ARTICLES AND BY-LAWS. Certified
copies of the Articles of Incorporation and bylaws of Borrower, as
amended through the Closing Date.
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<PAGE> 15
(e) THE AGREEMENT. A duly executed
counterpart of this Agreement with all applicable schedules completed
and attached thereto, disclosing such information as is acceptable to
Lender.
(f) SECURITY AGREEMENT; FINANCING
STATEMENTS. A counterpart of the Security Agreement executed by
Borrower, substantially in the form of Exhibit "C", together with
filing copies (or other evidence of filing satisfactory to Lender and
its counsel) of such Uniform Commercial Code financing statements,
collateral assignments and termination statements, with respect to the
Collateral (as defined in such Security Agreement) as Lender shall
request.
(g) LIEN SEARCHES. Uniform Commercial
Code lien, judgment, bankruptcy and tax lien searches of Borrower from
the California Secretary of State, and such other jurisdictions as
Lender may reasonably request, all as of a date reasonably
satisfactory to Lender and its counsel.
(h) GOOD STANDING CERTIFICATE. A
Certificate of Good Standing as of a date acceptable to Lender with
respect to Borrower from the California Secretary of State.
(i) WARRANT. The warrant issued by
Borrower to Lender exercisable for 186,652 Warrant Shares, as
described in Section 2.13 hereof.
(j) INTERCREDITOR AGREEMENT. Lender and
Venture Lending & Leasing, Inc., shall have entered into an
intercreditor agreement setting forth the relative priorities of their
respective Liens in the Collateral on terms satisfactory to Lender.
4.2 CONDITIONS TO ALL LOANS. The obligation of Lender to
make its initial Loan and each subsequent Loan is subject to the following
further conditions precedent that:
(a) NO DEFAULT. No Default or Event of
Default has occurred and is continuing or will result from the making
of any such Loan, and the representations and warranties of Borrower
contained in Article 3 of this Agreement are true and correct as of
the Borrowing Date of such Loan.
(b) NO ADVERSE MATERIAL CHANGE. No
Material Adverse Change shall have occurred since the date of the most
recent financial statements submitted to Lender.
(c) NOTE. Borrower shall have delivered an
executed Note evidencing such Loan, in form and substance satisfactory
to Lender.
(d) BORROWING REQUEST. Borrower shall have
delivered to Lender a Borrowing Request for such Loan.
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<PAGE> 16
(e) VCOC LIMITATION. The making of the
Loan will not result in a violation of the condition applicable to
Lender described in Section 2.3(b).
ARTICLE 5 - AFFIRMATIVE COVENANTS
During the term of this Agreement and until its performance of
all obligations to Lender, Borrower will:
5.1 NOTICE TO LENDER. Promptly give written notice to
Lender of:
(a) Any litigation or administrative or
regulatory proceeding affecting Borrower where the granting of the
relief requested could reasonably be expected to have a Material
Adverse Effect.
(b) Any dispute which may exist between
Borrower or any governmental or regulatory authority which could
reasonably be expected to have a Material Adverse Effect.
(c) The occurrence of any Default or
Event of Default.
(d) Any change in the location of any of
Borrower's places of business at least thirty (30) days in advance of
such change, or of the establishment of any new, or the discontinuance
of any existing, place of business.
(e) Any other matter which has resulted
or might reasonably result in a Material Adverse Change.
5.2 FINANCIAL STATEMENTS. Deliver to the Lender or cause
to be delivered to Lender, in form and detail satisfactory to Lender the
following financial information, which Borrower warrants shall be accurate and
complete in all material respects:
(a) MONTHLY FINANCIAL STATEMENTS. As
soon as available but no later than forty-five (45) days after the end
of each month, Borrower's balance sheet as of the end of such period,
and Borrower's income statement for such period and for that portion
of Borrower's financial reporting year ending with such period,
prepared and attested by a responsible financial officer of Borrower
as being complete and correct and fairly presenting Borrower's
financial condition and the results of Borrower's operations;
provided, however, that, so long as Borrower is a Reporting Company,
Borrower may satisfy its obligations under this Section 5.2(a) by
delivering to Lender promptly after filing with the SEC, copies of
Borrower's Quarterly Reports on Form 10-Q (without exhibits) and any
amendments thereto.
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<PAGE> 17
(b) YEAR-END FINANCIAL STATEMENTS. As
soon as available but no later than one hundred twenty (120) days
after and as of the end of each financial reporting year, a complete
copy of Borrower's audit report, which shall include balance sheet,
income statement, statement of changes in equity and statement of cash
flows for such year, prepared and certified by an independent
certified public accountant selected by Borrower and satisfactory to
Lender (the "Accountant"). The Accountant's certification shall not
be qualified or limited due to a restricted or limited examination by
the Accountant of any material portion of Borrower's records or
otherwise. Notwithstanding the foregoing, so long as Borrower is a
Reporting Company, Borrower may satisfy its obligations under this
Section 5.2(b) by delivering to Lender promptly after filing with the
SEC copies of Borrower's Annual Reports on Form 10-K (without
exhibits) and any amendments thereto.
(c) COMPLIANCE CERTIFICATES.
Simultaneously with the delivery of each set of financial statements
referred to in paragraphs (a) and (b) above, a certificate of the
chief financial officer of Borrower as to the amount of the Borrowing
Base as of the date of such financial statement (in the form of
Exhibit "E" attached hereto), and stating whether any Default or Event
of Default exists on the date of such certificate, and if so, setting
forth the details thereof and the action which Borrower is taking or
proposes to take with respect thereto.
(d) OTHER INFORMATION. Such other
statements, lists of property and accounts, budgets, forecasts,
reports, or other information as Lender may reasonably from time to
time request.
5.3 MANAGERIAL ASSISTANCE FROM LENDER. Solely to permit
Lender, as a "venture capital operating company" to participate in, and
influence the conduct of management of Borrower through the exercise of
"management rights," as such terms are defined in 29 C.F.R. Section
2510.3-101(d) Borrower will:
(a) Permit Lender to make available to
Borrower, at no cost to Borrower, "significant managerial assistance",
as defined in Section 2(a)(47) of the Investment Company Act of 1940,
as amended, either in the form of: (i) consulting arrangements with
Lender or any of its officers, directors, employees or affiliates,
(ii) Borrower's allowing Lender to provide recommendations of
prospective candidates for election to Borrower's Board of Directors,
or (iii) Lender, at Borrower's request, seeking the services of
third-party consultants to aid Borrower with respect to its management
and operations;
(b) Permit Lender to make available
consulting and advisory services to officers of Borrower regarding
Borrower's equipment acquisition and financing plans, and such other
matters affecting the business, financial condition and prospects of
Borrower as Lender shall reasonably deem relevant; and
14
<PAGE> 18
(c) If Lender reasonably believes that
financial or other developments affecting Borrower have impaired or
are likely to impair Borrower's ability to perform its obligations
under this Agreement, permit Lender reasonable access to Borrower's
management and/or Board of Directors and opportunity to present
Lender's views with respect to such developments.
5.4 EXISTENCE. Maintain and preserve Borrower's
existence, present form of business, and all rights and privileges necessary or
desirable in the normal course of its business; and keep all Borrower's
property in good working order and condition, ordinary wear and tear excepted.
5.5 INSURANCE. Obtain and keep in force insurance in
such amounts and types as is usual in the business carried on by Borrower with
an insurance carrier having a policyholder rating of not less than "A" and
financial category rating of Class VII in "Best's Insurance Guide," unless
otherwise approved by Lender. Such insurance policies must be in form and
substance satisfactory to Lender, and shall list Lender as an additional
insured or loss payee, as applicable, on endorsement(s) in form reasonably
acceptable to Lender. Borrower shall furnish to Lender such endorsements, and
upon Lender's request, copies of any or all such policies.
5.6 ACCOUNTING RECORDS. Maintain adequate books,
accounts and records, and prepare all financial statements delivered to Lender
pursuant to Section 5.2 in accordance with GAAP, and in compliance with the
regulations of any governmental or regulatory authority having jurisdiction
over Borrower or Borrower's business; and permit employees or agents of Lender
at such reasonable times as Lender may request, at Borrower's expense, to
inspect Borrower's properties, and to examine and make copies and memoranda of
Borrower's books, accounts and records.
5.7 COMPLIANCE WITH LAWS. Comply with all laws
(including Environmental Laws), rules, regulations applicable to, and all
orders and directives of any governmental or regulatory authority having
jurisdiction over, Borrower or Borrower's business, and with all material
agreements to which Borrower is a party, except where the failure to so comply
would not have a Material Adverse Effect.
5.8 TAXES AND OTHER LIABILITIES. Except as may be
contested in good faith by the appropriate procedures and for which Borrower
shall maintain appropriate reserves under GAAP: (i) pay all Borrower's
obligations when due; (ii) pay all material taxes and other governmental or
regulatory assessments before delinquency or before any penalty attaches
thereto; and (iii) timely file all required tax returns.
5.9 USE OF PROCEEDS. Use the proceeds of Loans only as
set forth in Article 2 of this Agreement; and not directly or indirectly to
purchase or carry any margin stock, as defined from time to time by the Board
of Governors of the Federal Reserve System in Federal Regulation U.
15
<PAGE> 19
5.10 LOCATIONS OF COLLATERAL. Not later than June 15 and
December 15 of each year during the term of this Agreement, Borrower shall
deliver to Lender a list of the location of each item of Equipment (as defined
in the Security Agreement) as of June 1 and December 1, respectively, of such
year.
ARTICLE 6 - NEGATIVE COVENANTS
During the term of this Agreement and until the performance of
all obligations to Lender, Borrower will not without Lender's approval (i)
sell, transfer, lease or otherwise dispose of all or substantially all of
Borrower's assets, or (ii) enter into any merger unless Borrower is the
surviving corporation thereof, or (iii) liquidate or dissolve.
ARTICLE 7 - EVENTS OF DEFAULT
7.1 EVENTS OF DEFAULT. Upon the occurrence and during
the continuation of any Default, the obligation of Lender to make any
additional Loan shall be suspended. The occurrence of any of the following
shall terminate any obligation of Lender to make any additional Loan; and
shall, at the option of Lender (1) make all sums of Basic Interest, principal,
Terminal Payments and any other amounts owing under any Loan Documents
immediately due and payable without notice of default, presentment or demand
for payment, protest or notice of nonpayment or dishonor or any other notices
or demands, and (2) give Lender the right to exercise any other right or remedy
provided by contract or applicable law:
(a) Borrower shall fail to make any
payment required under this Agreement, or to pay any fees or other
charges when due under any Loan Document, and such failure continues
for five (5) Business Days or more after the same first becomes due;
or an Event of Default as defined in any other Loan Document shall
have occurred.
(b) Any representation, warranty,
financial statement, certificate or other document provided by
Borrower under any Loan Document shall prove to have been false or
misleading in any material respect when made or deemed made herein.
(c) Borrower shall fail to pay its debts
generally as they become due or shall commence any Insolvency
Proceeding with respect to itself; an involuntary Insolvency
Proceeding shall be filed against Borrower, or a custodian, receiver,
trustee, assignee for the benefit of creditors, or other similar
official, shall be appointed to take possession, custody or control of
the properties of Borrower, and such involuntary Insolvency
Proceeding, petition or appointment is acquiesced to by Borrower or is
not dismissed within ninety (90) days; or the dissolution or
termination of the business of Borrower.
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<PAGE> 20
(d) Borrower shall be in default beyond
any applicable period of grace or cure under any other agreement
involving the borrowing of money, the purchase of property, the
advance of credit or any other monetary liability of any kind to
Lender or to any Person which results in the acceleration of payment
of such obligation in an amount in excess of Five Hundred Thousand
Dollars ($500,000).
(e) Any governmental or regulatory
authority shall take any judicial or administrative action, or any
defined benefit pension plan maintained by Borrower shall have any
unfunded liabilities, any of which, in the reasonable judgment of
Lender, could reasonably be expected to have a Material Adverse
Effect.
(f) Any judgment in excess of Five
Hundred Thousand Dollars ($500,000) shall be entered against Borrower
which remains unsatisfied, unvacated or unstayed pending appeal for
thirty (30) or more days after entry thereof.
(g) Borrower shall fail to perform or
observe any covenant contained in Article 6 of this Agreement.
(h) Borrower shall fail to perform or observe
any covenant contained in this Agreement or any other Loan Document
(other than a covenant which is dealt with specifically elsewhere in
this Article 7) and the breach of such covenant is not cured within
thirty (30) days after the sooner to occur of Borrower's receipt of
notice of such breach from Lender or the date on which such breach
first becomes known to any officer of Borrower; provided, however that
if such breach is not capable of being cured within such thirty (30)
day period and Borrower timely notifies Lender of such fact and
Borrower diligently pursues such cure, then the cure period shall be
extended to the date requested in Borrower's notice but in no event
more than ninety (90) days from the initial breach; provided, further,
that such additional ninety (90) day opportunity to cure shall not
apply in the case of any failure to perform or observe any covenant
which has been the subject of a prior failure within the preceding one
hundred eighty (180) days or which is a willful and knowing breach by
Borrower.
ARTICLE 8 - GENERAL PROVISIONS
8.1 NOTICES. Any notice given by any party under any
Loan Document shall be in writing and personally delivered, sent by overnight
courier, or United States mail, postage prepaid, or sent by facsimile, to be
promptly confirmed in writing, or other authenticated message, charges prepaid,
to the other party's or parties' addresses shown on the signature pages hereto.
Each party may change the address or facsimile number to which notices,
requests and other communications are to be sent by giving written notice of
such change to each other party. Notice given by hand delivery shall be deemed
received on the date delivered; if sent by overnight courier,
17
<PAGE> 21
on the next business day after delivery to the courier service; if by first
class mail, on the third business day after deposit in the U.S. Mail; and if
by facsimile, on the date of transmission.
8.2 BINDING EFFECT. The Loan Documents shall be binding
upon and inure to the benefit of Borrower and Lender and their respective
successors and assigns; provided, however, that Borrower may not assign or
transfer Borrower's rights or obligations under any Loan Document without
Lender's prior written consent. Lender reserves the right to sell, assign,
transfer, negotiate or grant participations in all or any part of, or any
interest in, Lender's rights and obligations under the Loan Documents. In
connection with any of the foregoing, Lender may disclose all documents and
information which Lender now or hereafter may have relating to the Loans,
Borrower, or its business; provided that any person who receives such
information shall have agreed in writing in advance to maintain the
confidentiality of such information on terms reasonably acceptable to Borrower.
8.3 NO WAIVER. Any waiver, consent or approval by Lender
of any Event of Default or breach of any provision, condition, or covenant of
any Loan Document must be in writing and shall be effective only to the extent
set forth in writing. No waiver of any breach or default shall be deemed a
waiver of any later breach or default of the same or any other provision of any
Loan Document. No failure or delay on the part of Lender in exercising any
power, right, or privilege under any Loan Document shall operate as a waiver
thereof, and no single or partial exercise of any such power, right, or
privilege shall preclude any further exercise thereof or the exercise of any
other power, right or privilege. Lender has the right at its sole option to
continue to accept interest and/or principal payments due under the Loan
Documents after default, and such acceptance shall not constitute a waiver of
said default or an extension of the Maturity Date unless Lender agrees
otherwise in writing.
8.4 RIGHTS CUMULATIVE. All rights and remedies existing
under the Loan Documents are cumulative to, and not exclusive of, any other
rights or remedies available under contract or applicable law.
8.5 UNENFORCEABLE PROVISIONS. Any provision of any Loan
Document executed by Borrower which is prohibited or unenforceable in any
jurisdiction, shall be so only as to such jurisdiction and only to the extent
of such prohibition or unenforceability, but all the remaining provisions of
any such Loan Document shall remain valid and enforceable.
8.6 ACCOUNTING TERMS. Except as otherwise provided in
this Agreement, accounting terms and financial covenants and information shall
be determined and prepared in accordance with GAAP.
8.7 INDEMNIFICATION; EXCULPATION. Borrower shall pay and
protect, defend and indemnify Lender and Lender's employees, officers,
directors, shareholders, affiliates, correspondents, agents and representatives
(other than Lender, collectively "Agents") against, and hold
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<PAGE> 22
Lender and each such Agent harmless from, all claims, actions, proceedings,
liabilities, damages, losses, expenses (including, without limitation,
reasonable attorneys' fees and costs) and other amounts incurred by Lender and
each such Agent, arising from (i) the matters contemplated by this Agreement or
any other Loan Documents or (ii) any contention that Borrower has failed to
comply with any law, rule, regulation, order or directive applicable to
Borrower's business; PROVIDED, HOWEVER, that this indemnification shall not
apply to any of the foregoing incurred solely as the result of Lender's or any
Agent's gross negligence or willful misconduct. This indemnification shall
survive the payment and satisfaction of all of Borrower's Obligations to
Lender.
8.8 REIMBURSEMENT. Borrower shall reimburse Lender its
actual out of pocket expenses and reasonable legal fees and costs in connection
with the preparation and negotiation of the Loan Documents; provided that such
expenses (other than the attorneys' fees and costs) shall not exceed Two
Thousand Dollars ($2,000). Borrower shall also reimburse Lender for all costs
and expenses, including without limitation reasonable attorneys' fees and
disbursements expended or incurred by Lender in (a) any arbitration, mediation,
judicial reference, legal action or otherwise in connection with the amendment,
interpretation and enforcement of the Loan Documents, including without
limitation during any workout, attempted workout, and/or in connection with the
rendering of legal advice as to Lender's rights, remedies and obligations under
the Loan Documents, (b) collecting any sum which becomes due Lender under any
Loan Document, (c) any proceeding for declaratory relief, any counterclaim to
any proceeding, or any appeal, or (d) the protection, preservation or
enforcement of any rights of Lender. For the purposes of this section,
attorneys' fees shall include, without limitation, fees incurred in connection
with the following: (1) contempt proceedings; (2) discovery; (3) any motion,
proceeding or other activity of any kind in connection with an Insolvency
Proceeding; (4) garnishment, levy, and debtor and third party examinations; and
(5) postjudgment motions and proceedings of any kind, including without
limitation any activity taken to collect or enforce any judgment. All of the
foregoing costs and expenses shall be payable upon demand by Lender, and if not
paid within forty-five (45) days of presentation of invoices shall bear
interest at the highest applicable Default Rate.
8.9 EXECUTION IN COUNTERPARTS. This Agreement may be
executed in any number of counterparts which, when taken together, shall
constitute but one agreement.
8.10 ENTIRE AGREEMENT. The Loan Documents are intended by
the parties as the final expression of their agreement and therefore contain
the entire agreement between the parties and supersede all prior understandings
or agreements concerning the subject matter hereof. This Agreement may be
amended only in a writing signed by Borrower and Lender.
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<PAGE> 23
8.11 GOVERNING LAW AND JURISDICTION.
(a) THIS AGREEMENT AND THE LOAN
DOCUMENTS SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE
INTERNAL LAWS OF THE STATE OF CALIFORNIA.
(b) ANY LEGAL ACTION OR PROCEEDING WITH
RESPECT TO THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT MAY BE BROUGHT IN
THE COURTS OF THE STATE OF CALIFORNIA OR OF THE UNITED STATES FOR THE
NORTHERN DISTRICT OF CALIFORNIA, AND BY EXECUTION AND DELIVERY OF THIS
AGREEMENT, EACH OF BORROWER AND LENDER CONSENTS, FOR ITSELF AND IN
RESPECT OF ITS PROPERTY, TO THE NON-EXCLUSIVE JURISDICTION OF THOSE
COURTS. EACH OF BORROWER AND LENDER IRREVOCABLY WAIVES ANY OBJECTION,
INCLUDING ANY OBJECTION TO THE LAYING OF VENUE OR BASED ON THE GROUNDS
OF FORUM NON CONVENIENS, WHICH IT MAY NOW OR HEREAFTER HAVE TO THE
BRINGING OF ANY ACTION OR PROCEEDING IN SUCH JURISDICTION IN RESPECT
OF THIS AGREEMENT OR ANY DOCUMENT RELATED HERETO. BORROWER AND LENDER
EACH WAIVE PERSONAL SERVICE OF ANY SUMMONS, COMPLAINT OR OTHER
PROCESS, WHICH MAY BE MADE BY ANY OTHER MEANS PERMITTED BY CALIFORNIA
LAW.
8.12 WAIVER OF JURY TRIAL. BORROWER AND LENDER EACH
WAIVES ITS RESPECTIVE RIGHTS TO A TRIAL BY JURY OF ANY CLAIM OR CAUSE OF ACTION
BASED UPON OR ARISING OUT OF OR RELATED TO THIS AGREEMENT, THE OTHER LOAN
DOCUMENTS, OR THE TRANSACTIONS CONTEMPLATED HEREBY OR THEREBY, IN ANY ACTION,
PROCEEDING OR OTHER LITIGATION OF ANY TYPE BROUGHT BY ANY OF THE PARTIES
AGAINST ANY OTHER PARTY OR ANY PARTICIPANT OR ASSIGNEE, WHETHER WITH RESPECT TO
CONTRACT CLAIMS, TORT CLAIMS, OR OTHERWISE. BORROWER AND LENDER EACH AGREES
THAT ANY SUCH CLAIM OR CAUSE OF ACTION SHALL BE TRIED BY A COURT TRIAL WITHOUT
A JURY. WITHOUT LIMITING THE FOREGOING, THE PARTIES FURTHER AGREE THAT THEIR
RESPECTIVE RIGHT TO A TRIAL BY JURY IS WAIVED BY OPERATION OF THIS SECTION AS
TO ANY ACTION, COUNTERCLAIM OR OTHER PROCEEDING WHICH SEEMS, IN WHOLE OR IN
PART, TO CHALLENGE THE VALIDITY OR ENFORCEABILITY OF THIS AGREEMENT OR THE
OTHER LOAN DOCUMENTS OR ANY PROVISION HEREOF OR THEREOF. THIS WAIVER SHALL
APPLY TO ANY SUBSEQUENT AMENDMENTS, RENEWALS, SUPPLEMENTS OR MODIFICATIONS TO
THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS.
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<PAGE> 24
IN WITNESS WHEREOF, Borrower and Lender have executed this
Agreement as of the date set forth in the preamble.
<TABLE>
<S> <C>
ADDRESSES FOR NOTICES: DIGITAL GENERATION SYSTEMS, INC.
---------------------
Digital Generation Systems, Inc.
875 Battery Street
San Francisco, CA 94111 By: ___________________________________
Attn: Thomas P. Shanahan Thomas P. Shanahan,
Fax No. 415-276-6601 Chief Financial Officer
Venture Lending & Leasing II, Inc. VENTURE LENDING & LEASING II, INC.
2010 North First Street, Suite 310
San Jose, CA 95131
Attn: Salvador O. Gutierrez,
President By: ______________________________
Fax No. 408-435-8625 Salvador O. Gutierrez,
President
</TABLE>
21
<PAGE> 25
[Note No. X-XXX]
FORM OF PROMISSORY NOTE
$____________________ ____________________, 199___
San Jose, California
The undersigned ("Borrower") promises to pay to the order of VENTURE
LENDING & LEASING II, INC., a Maryland corporation ("Lender") at its office at
2010 North First Street, Suite 310, San Jose, California 95131, or at such
other place as Lender may designate in writing, in lawful money of the United
States of America, the principal sum of _____________________________________
Dollars ($__________), with Basic Interest thereon from the date hereof until
maturity, whether scheduled or accelerated, at a fixed rate of eight and 50/100
percent (8.50%) per annum,, and on the Maturity Date a Terminal Payment as set
forth in the Loan Agreement defined below.
This Note is one of the Notes referred to in, and is entitled to all
the benefits of, a Loan Agreement dated as of December 1, 1997, between
Borrower and Lender (the "Loan Agreement"). Each capitalized term not
otherwise defined herein shall have the meaning set forth in the Loan
Agreement. The Loan Agreement contains provisions for the acceleration of the
maturity of this Note upon the happening of certain stated events.
Except as set forth below, principal and interest shall be payable in
36 equal monthly installments, as follows:
On the Borrowing Date, Borrower shall pay (i) Basic Interest, in
advance, on the outstanding principal balance of this Note at the Designated
Rate for the period from the Borrowing Date through [THE LAST DAY OF THE
SAME MONTH] ; (ii) a first (1st) amortization installment of principal and
Basic Interest in the amount of $_________________, in advance for the month of
[ FIRST FULL MONTH AFTER BORROWING DATE ]; and (iii) the thirty-sixth
amortization installment of principal and Basic Interest in the amount of
$_________________ in advance for the month of [36TH FULL MONTH AFTER THE
BORROWING DATE].
Commencing on the first Business Day of the second full month after
the Borrowing Date, and continuing on the first Business Day of each
consecutive month thereafter, principal and Basic Interest shall be payable, in
advance, in thirty-three (33) equal consecutive installments of
________________________________________ Dollars ($__________) each, with a
thirty-fourth (34th) installment equal to the entire unpaid principal balance
and accrued Basic Interest on _______________, 200_. The Terminal Payment
shall be payable on the first day of the 36th full month after the Borrowing
Date.
Any unpaid payments of principal, interest, or the Terminal Payment,
if any, on this Note shall bear interest from their respective maturities,
EXHIBIT A
TO LOAN AGREEMENT
<PAGE> 26
whether scheduled or accelerated, at a rate per annum equal to the Default
Rate. Borrower shall pay such interest on demand.
Interest, charges and fees shall be calculated for actual days elapsed
on the basis of a 360-day year, which results in higher interest, charge or fee
payments than if a 365-day year were used. In no event shall Borrower be
obligated to pay any interest, charges or fees at a rate in excess of the
highest rate permitted by applicable law from time to time in effect.
After an Event of Default, the holder of this Note shall be entitled
to all costs of collection, including but not limited to reasonable attorney's
fees, incurred in connection with the holder's collection efforts, whether or
not suit on this Note is filed, and all such costs and expenses shall be
payable on demand.
This Note shall be governed by, and construed in accordance with, the
laws of the State of California.
DIGITAL GENERATION SYSTEMS, INC.
By:
____________________________________
Its:
____________________________________
2
<PAGE> 27
FORM OF BORROWING REQUEST
________________, 1997
Venture Lending & Leasing II, Inc.
2010 North First Street, Suite 310
San Jose, CA 95131
Re: DIGITAL GENERATION SYSTEMS, INC.
Gentlemen:
Reference is made to the Loan Agreement dated as of December 1, 1997
(as it has been and may be amended from time to time, the "Loan Agreement", the
capitalized terms used herein as defined therein), between Venture Lending &
Leasing II, Inc. and Digital Generation Systems, Inc. (the "Company").
The undersigned is the Chief Financial Officer of the Company, and
hereby requests a Loan under the Loan Agreement, and in that connection
certifies as follows:
1. The amount of the proposed Loan is $__________________. The
proposed Loan is [a Term] [an Equipment] Loan. The Business Day of the
proposed Loan is _____________________, 199___.
2. As of this date, no Default or Event of Default has occurred
and is continuing, or will result from the making of the proposed Loan, and the
representations and warranties of the Company contained in Article 3 of the
Loan Agreement are true and correct.
3. No Material Adverse Change has occurred since the date of the
most recent financial statements submitted to you by the Company.
[4. After giving effect to the proposed Term Loan, the aggregate
principal balance of all Term Loans will not exceed the Borrowing Base.
Attached hereto is a current Borrowing Base Certificate pursuant to Section
2.5(a) of the Loan Agreement.]
The Company agrees to notify you promptly before the funding of the
Loan if any of the matters to which I have certified above shall not be true
and correct on the Borrowing Date.
Very truly yours,
__________________________
Chief Financial Officer
EXHIBIT B
to Loan Agreement
<PAGE> 28
SECURITY AGREEMENT
This Agreement is made as of December 1, 1997 by Digital Generation
Systems, Inc., a California corporation ("Debtor"), in favor of Venture Lending
& Leasing II, Inc., a Maryland corporation ("Lender").
1 - DEFINITIONS
The following definitions shall be applicable to both the singular and plural
forms of the defined terms:
"ACCOUNT" means a right to payment for goods sold or leased by
Debtor or for services rendered by Debtor, which right is not evidenced by an
instrument or chattel paper, whether or not earned by performance.
"AGREEMENT" means this Security Agreement, as it may be amended
from time to time.
"COLLATERAL" means all Debtor's Accounts, Deposit Accounts,
Equipment, Fixtures, General Intangibles, Goods, Inventory, Rights to Payment,
and securities now owned or hereafter acquired, wherever located, and whether
held by Debtor or any third party, and all royalties, proceeds and products
thereof, including all insurance and condemnation proceeds ("Proceeds"), and all
monies now or at any time hereafter in the possession or under the control of
Lender or a bailee or affiliate of Lender, including any cash collateral in any
cash collateral or other account, and all Records. Notwithstanding the
foregoing, "Collateral" shall not include (i) any equipment, property or assets
of the Debtor leased from or financed by a third party to the extent the
contracts evidencing such lease or financing prohibit the granting by Debtor of
any other security interest therein, (ii) any rights of Debtor under any license
or contract if and to the extent that the granting of a security interest
therein in favor of Lender would violate the terms of such license or contract,
or (iii) any other rights or property the assignment of which for security
purposes is prohibited by law.
"DEPOSIT ACCOUNTS" means all Debtor's demand, time, savings,
passbook or similar accounts maintained with a financial institution or credit
union.
"EQUIPMENT" means all of Debtor's equipment now owned or
hereafter acquired, including but not limited to machinery, machine parts,
furniture, furnishings and all tangible personal property used in the business
of Debtor and all such property which is or is to become fixtures on real
property, and all improvements, replacements, accessions and additions thereto,
wherever located, and all proceeds thereof arising from the sale, lease, rental
or other use or disposition of any such property, including all rights to
payment with respect to insurance or condemnation, returned premiums, or any
cause of action relating to any of the foregoing.
"EVENT OF DEFAULT" means an event described in Article 6.
"FIXTURES" means all items of personal property of Debtor that
are so related to the real property upon which they are located that an interest
in them arises under real property law, and improvements, replacements, parts,
accessions and additions thereto, and substitutions therefor.
"GENERAL INTANGIBLES" means all personal property of Debtor,
other than Goods, not otherwise defined as Collateral, including without
limitation all interests or claims in insurance policies; literary property;
tradenames, tradename rights; Trademarks, Trademark rights, copyrights, Patents,
and all applications therefor; licenses, permits, franchises and like privileges
or rights issued by any governmental or regulatory authority; income tax
refunds; customer lists; claims and causes of action (whether in contract, tort
or otherwise), judgments and all guaranty claims, leasehold interests in
personal property, security interests or other security held by or guaranteed to
the Debtor to secure the payment by an account debtor of any of the Accounts.
EXHIBIT C
TO LOAN AGREEMENT
<PAGE> 29
"GOODS" means all money and other personal property of Debtor,
other than General Intangibles, not otherwise defined as Collateral.
"INDEBTEDNESS" means all debts, obligations and liabilities of
Debtor to Lender currently existing or now or hereafter made, incurred or
created under, pursuant to or in connection with the Loan Agreement, whether
voluntary or involuntary and however arising or evidenced, whether direct or
acquired by Lender by assignment or succession, whether due or not due, absolute
or contingent, liquidated or unliquidated, determined or undetermined, and
whether Debtor may be liable individually or jointly, or whether recovery upon
such debt may be or become barred by any statute of limitations or otherwise
unenforceable; and all renewals, extensions and modifications thereof; and all
attorneys' fees and costs incurred by Lender in connection with the collection
and enforcement thereof as provided for in any Loan Document.
"INVENTORY" means all Debtor's raw materials, advertising,
packaging and shipping materials, work in process, finished goods and goods held
for sale or lease or furnished under contracts of service, and all returned and
repossessed goods, and all goods covered by documents of title, including
warehouse receipts, bills of lading and all other documents of every type
covering all or any part of the Collateral.
"LIEN" means any voluntary or involuntary security interest,
mortgage, pledge, claim, charge, encumbrance, title retention agreement, or
third party interest covering all or any part of the property of Debtor or any
other Person.
"LOAN AGREEMENT" means that certain Loan Agreement between Debtor
and Lender of even date herewith, as amended from time to time.
"LOAN DOCUMENTS" means this Agreement, the Loan Agreement, any
evidence of Indebtedness, any guaranty, security or pledge agreement, or deed of
trust delivered in connection with any Indebtedness, and all other contracts,
instruments, addenda and documents executed in connection therewith.
"PATENT LICENSE" means any written agreement now or hereafter in
existence granting to Debtor any right to make, use, sell or practice any
invention on which a Patent is in existence, including, without limitation, the
agreements described in Schedule 1 to Exhibit A hereto.
"PATENTS" means all of the following: (i) all letters patent of
the United States or any other country, all registrations and recordings
thereof, and all applications for letters patent of the United States or any
other country, including, without limitation, registrations, recordings and
applications in the United States Patent and Trademark Office or in any similar
office or agency of the United States, any state thereof or any other country or
any political subdivision thereof, and (ii) all reissues, divisions,
continuations, continuations-in-part, renewals or extensions thereof.
"PERMITTED LIENS" is defined in the Loan Agreement.
"PERSON" means any individual or entity.
"RECORDS" means all Debtor's computer programs, software,
hardware, source codes and data processing information, all written documents,
books, invoices, ledger sheets, financial information and statements, and all
other writings concerning Debtor's business.
"RIGHTS TO PAYMENT" means all Debtor's accounts, instruments,
contract rights, documents, chattel paper and all other rights to payment,
including, without limitation, the Accounts, all negotiable certificates of
deposit and all rights to payment under any Patent License, any Trademark
License, or any commercial or standby letter of credit.
2
<PAGE> 30
"TRADEMARK LICENSE" means any written agreement now or hereafter
in existence granting to Debtor any right to use any Trademark.
"TRADEMARKS" means all of the following: (i) all trademarks,
trade names, corporate names, company names, business names, fictitious business
names, trade styles, service marks, logos, other source or business identifiers,
prints and labels on which any of the foregoing have appeared or will appear,
designs and general intangibles of like nature, now existing or hereafter
adopted or acquired, all registrations and recordings thereof, and all
applications in connection therewith, including, without limitation,
registrations, recordings and applications in the United States Patent and
Trademark Office or in any similar office or agency of the United States, any
state thereof or any other country or any political subdivision thereof, and
(ii) all reissues, divisions, continuations, continuations-in-part, renewals or
extensions thereof.
"UNIFORM COMMERCIAL CODE" means the California Uniform Commercial
Code, as amended from time to time.
Terms not specifically defined in this Agreement have the meanings ascribed
thereto in the Loan Agreement and the Uniform Commercial Code.
2 - GRANT OF SECURITY INTEREST
To secure the timely payment of the Indebtedness and performance of all
obligations of Debtor to Lender, Debtor grants to Lender security interests in
the Collateral.
3 - REPRESENTATIONS AND WARRANTIES
Debtor represents and warrants that, at all times during the term of this
Agreement:
3.1 GOVERNMENTAL ACTIONS. Debtor has obtained all consents and actions
of, and has performed all filings with, any governmental or regulatory authority
that are required to authorize the execution, delivery or performance of this
Agreement or the granting or perfecting of Lender's security interest in the
Collateral.
3.2 TITLE. Except for the security interests created by this Agreement,
and Permitted Liens, (i) Debtor is and will be the unconditional legal and
beneficial owner of the Collateral, and (ii) the Collateral is genuine and
subject to no Liens, rights or defenses of others. There exist no prior
assignments or encumbrances of record with the U.S. Patent and Trademark Office
affecting any Collateral in favor of any third party other than Lender.
3.3 RIGHTS TO PAYMENT. The names of the obligors, amount owing to
Debtor, due dates and all other information with respect to the Rights to
Payment are and will be correctly stated in all material respects in all Records
relating to the Rights to Payment. Debtor further represents and warrants, to
its knowledge, that each Person appearing to be obligated on a Right to Payment
has authority and capacity to contract and is bound as it appears to be.
3.4 CHIEF EXECUTIVE OFFICE. Debtor's chief executive office is located
at:
<TABLE>
<CAPTION>
Address City County State Zip
------- ---- ------ ----- ---
<S> <C> <C> <C> <C>
875 Battery Street San Francisco San Francisco CA 94111
</TABLE>
3
<PAGE> 31
3.5 INVENTORY LOCATION. Other than as set forth in Section 3.4,
Inventory is located at:
<TABLE>
<CAPTION>
Address City County State Zip
------- ---- ------ ----- ---
<S> <C> <C> <C> <C>
901 Sansome Street San Francisco San Francisco CA 94111
10545 Burbank Blvd. N. Hollywood Los Angeles CA 91601 (MediaTech
West)
219 E. 44th Street New York New York NY 10017 (PDR)
216 W. 18th Street New York New York NY 10011 (MediaTech
East)
110 W. Hubbard St. Chicago IL 60610 (MediaTech
Central)
100 High Rise Dr., Louisville KY 40213
Suite 124
</TABLE>
3.6 RECORDS LOCATION. Other than as set forth in Section 3.4, Records
are maintained at:
<TABLE>
<CAPTION>
Address City County State Zip
------- ---- ------ ----- ---
<S> <C> <C> <C> <C>
219 E. 44th Street New York New York NY 10017 (PDR)
110 W. Hubbard St. Chicago IL 60610 (MediaTech
Central)
</TABLE>
3.7 EQUIPMENT OR FIXTURES LOCATION. Other than as set forth in Section
3.4, Equipment or Fixtures are located at:
<TABLE>
<CAPTION>
Address City County State Zip
------- ---- ------ ----- ---
<S> <C> <C> <C> <C>
</TABLE>
3.8 OTHER PLACES OF BUSINESS. In addition to the locations set forth in
Sections 3.4 through 3.7, Debtor maintains the following place(s) of business:
<TABLE>
<CAPTION>
Address City County State Zip
------- ---- ------ ----- ---
<S> <C> <C> <C> <C>
</TABLE>
3.9 BUSINESS NAMES. Debtor has conducted business in the following names
other than the name stated in the preamble to this Agreement:
MediaTech, Inc.
Starcom Television
PDR Productions, Inc.
4 - AFFIRMATIVE COVENANTS
During the term of this Agreement and until payment of all the Indebtedness and
performance of all obligations to Lender, Debtor will:
4.1 DELIVERY OF CERTAIN ITEMS. Deliver to Lender promptly (a) upon
Lender's request, duplicate invoices with respect to each Account bearing such
language of assignment as Lender shall reasonably specify; (b) the originals of
all commercial and standby letters of credit, instruments, documents and chattel
paper constituting Collateral, endorsed and assigned as Lender shall reasonably
specify; (c) after an Event of Default, all Proceeds; (d) upon Lender's request,
returned property resulting from, or payment equal to any allowance or credit
on, Rights to Payment; (e) such specific acknowledgments, assignments or other
agreements as Lender may reasonably request relating to
4
<PAGE> 32
the Collateral; and (f) such Records and other reports in such form and detail
and at such times as Lender may reasonably require relating to the Collateral,
including without limitation reports of acquisition, and disposition, agings,
and collection of any Collateral. If any of the Rights to Payment become
evidenced by an instrument, Debtor will notify Lender thereof and, upon request
by Lender promptly deliver such instrument to Lender appropriately endorsed to
the order of Lender as further security for the satisfaction in full of the
Indebtedness.
4.2 MAINTENANCE OF COLLATERAL; INSPECTION. Do all things reasonably
necessary to maintain, preserve, protect and keep all Collateral in good working
order and salable condition, ordinary wear and tear excepted, deal with the
Collateral in all ways as are considered good practice by owners of like
property, and use the Collateral lawfully and, to the extent applicable, only as
permitted by Debtor's insurance policies. Upon reasonable prior notice at
reasonable times during normal business hours, Debtor hereby authorizes Lender's
officers, employees, representatives and agents to inspect the Collateral and to
discuss the Collateral and the Records relating thereto with Debtor's officers
and employees, and, in the case of any Right to Payment, with any Person which
is or may be obligated thereon.
4.3 MAINTENANCE OF RECORDS; INSPECTION. Maintain, or cause to be
maintained, complete and accurate Records relating to the Collateral. Upon
reasonable prior notice at reasonable times during normal business hours,
Lender, its officers, employees, agents and representatives shall have the
right, from time to time, to examine the Records and to make copies or extracts
therefrom.
4.4 DEBTOR'S DUTY TO GIVE NOTICE. Give prompt notice to Lender of: (a)
except as permitted in Section 5.5, any material discount, credit, rebate or
other reduction in the amount owing on a material Right to Payment; (b) any
threatened or asserted dispute, setoff, claim, counterclaim or defense with
respect to a Right to Payment; (c) any material decrease in the value of any
Collateral and the amount of such decrease (other than depreciation calculated
in the ordinary course of business under applicable tax laws and regulations and
in accordance with generally accepted accounting principles); (d) any litigation
or administrative or regulatory proceeding which may have a material adverse
effect on Debtor or its business; (e) to the extent Debtor has actual knowledge
thereof, any change in the ownership of any property on which Debtor's chief
executive office is located; and (f) the occurrence of any Default or Event of
Default or of any other development, financial or otherwise, which might
materially adversely affect the Collateral or Debtor's ability to pay the
Indebtedness or perform its obligations to Lender.
4.5 FINANCING STATEMENTS AND OTHER ACTIONS. Execute and deliver to
Lender, and file or record at Debtor's expense, all financing statements,
notices and other documents (including, without limitation, any filings with the
United States Patent and Trademark Office) from time to time reasonably
requested by any Lender to maintain a first perfected security interest in the
Collateral in favor of Lender, all in form and substance satisfactory to Lender;
perform such other acts, and execute and deliver to Lender such additional
conveyances, assignments, agreements and instruments, as Lender may at any time
request in connection with the administration and enforcement of this Agreement
or Lender's rights, powers and remedies hereunder.
5 - NEGATIVE COVENANTS
During the term of this Agreement and until payment of all the Indebtedness and
performance of all obligations to Lender, Debtor will not:
5.1 LIENS. Create, incur, assume or permit to exist any Lien on any
Collateral, except Permitted Liens.
5.2 DOCUMENTS OF TITLE. Sign or authorize the signing of any financing
statement or other document naming Debtor as debtor or obligor, or acquiesce or
cooperate in the issuance of any bill of lading, warehouse receipt or other
document or instrument of title with respect to any Collateral, except those
negotiated to Lender, or those naming Lender as secured party.
5
<PAGE> 33
5.3 DISPOSITION OF COLLATERAL. Sell, transfer, lease or otherwise
dispose of any Collateral except for fair consideration or in the ordinary
course of its business.
5.4 CHANGE IN LOCATION OR NAME. Fail to give written notice to Lender
within 30 days after the occurrence of any: (a) change in the location of any
Collateral or Records, its chief executive office, or a place of business other
than as specified in Article 3; or (b) change its name, mailing address,
location of Collateral, or its legal structure.
5.5 CERTAIN AGREEMENTS ON RIGHTS TO PAYMENT. Other than in the ordinary
course of business, make or arrange to make any material discount, credit,
rebate or other reduction in the original amount owing on a Right to Payment or
accept in satisfaction of a Right to Payment less than the original amount
thereof, except as disclosed to Lender in writing from time to time.
6 - EVENTS OF DEFAULT
6.1 EVENT OF DEFAULT. The occurrence of any "Event of Default" as
defined in the Loan Agreement, failure by Debtor to perform any of its duties or
obligations under this Agreement, or breach by Debtor of any of its
representations hereunder shall constitute an Event of Default hereunder.
6.2 ACCELERATION AND REMEDIES. Upon the occurrence and during the
continuance of an Event of Default, Lender shall be entitled to, at its option,
(a) declare all or any part of the Indebtedness immediately due and payable; (b)
exercise any or all of the rights and remedies available to a secured party
under the Uniform Commercial Code or any other applicable law; and (c) exercise
any or all of its rights and remedies provided for in this Agreement and in any
other Loan Document. The obligations of Debtor under this Agreement shall
continue to be effective or be reinstated, as the case may be, if at any time
any payment of any Indebtedness is rescinded or must otherwise be returned by
Lender upon, on account of, or in connection with, the insolvency, bankruptcy or
reorganization of Debtor or otherwise, all as though such payment had not been
made.
6.3 SALE OF COLLATERAL. Upon the occurrence and during the continuance
of an Event of Default, Lender may sell all or any part of the Collateral, at
public or private sales, to itself, a wholesaler, retailer or investor, for
cash, upon credit or for future delivery, and at such price or prices as Lender
may deem commercially reasonable. To the extent permitted by law, Debtor hereby
specifically waives all rights of redemption and any rights of stay or appraisal
which it has or may have under any applicable law in effect from time to time.
Any such public or private sales shall be held at such times and at such
place(s) as Lender may determine. In case of the sale of all or any part of the
Collateral on credit or for future delivery, the Collateral so sold may be
retained by Lender until the selling price is paid by the purchaser, but Lender
shall not incur any liability in case of the failure of such purchaser to pay
for the Collateral and, in case of any such failure, such Collateral may be
resold. Lender may, instead of exercising its power of sale, proceed to enforce
its security interest in the Collateral by seeking a judgment or decree of a
court of competent jurisdiction. Without limiting the generality of the
foregoing, if an Event of Default is in effect,
(1) Subject to the rights of any third parties, Lender may
license, or sublicense, whether general, special or otherwise, and
whether on an exclusive or non-exclusive basis, any Patents or
Trademarks included in the Collateral throughout the world for such term
or terms, on such conditions and in such manner as Lender shall in its
sole discretion determine;
(2) Lender may (without assuming any obligations or
liability thereunder), at any time and from time to time, enforce (and
shall have the exclusive right to enforce) against any licensee or
sublicensee all rights and remedies of Debtor in, to and under any
Patent Licenses or Trademark Licenses and take or refrain from taking
any action under any thereof, and Debtor hereby releases Lender from,
and agrees to hold Lender free and harmless from and
6
<PAGE> 34
against any claims arising out of, any lawful action so taken or omitted
to be taken with respect thereto other than claims arising out of
Lender's gross negligence or willful misconduct; and
(3) upon request by Lender, Debtor will execute and
deliver to Lender a power of attorney, in form and substance reasonably
satisfactory to Lender for the implementation of any lease, assignment,
license, sublicense, grant of option, sale or other disposition of a
Patent or Trademark. In the event of any such disposition pursuant to
this clause 3, Debtor shall supply its know-how and expertise relating
to the products or services made or rendered in connection with Patents,
the manufacture and sale of the products bearing Trademarks, and its
customer lists and other records relating to such Patents or Trademarks
and to the distribution of said products, to Lender.
6.4 DEBTOR'S OBLIGATIONS UPON DEFAULT. Upon the request of Lender after
the occurrence and during the continuance of an Event of Default, Debtor will:
(a) Assemble and make available to Lender the Collateral
at such place(s) as Lender shall reasonably designate, segregating all
Collateral so that each item is capable of identification; and
(b) Subject to the rights of any lessor, permit Lender,
by Lender's officers, employees, agents and representatives, to enter
any premises where any Collateral is located, to take possession of the
Collateral, to complete the processing, manufacture or repair of any
Collateral, and to remove the Collateral, or to conduct any public or
private sale of the Collateral, all without any liability of Lender for
rent or other compensation for the use of Debtor's premises.
7 - SPECIAL COLLATERAL PROVISIONS
7.1 COMPROMISE AND COLLECTION. Debtor and Lender recognize that setoffs,
counterclaims, defenses and other claims may be asserted by obligors with
respect to certain of the Rights to Payment; that certain of the Rights to
Payment may be or become uncollectible in whole or in part; and that the expense
and probability of success of litigating a disputed Right to Payment may exceed
the amount that reasonably may be expected to be recovered with respect to such
Right to Payment. Debtor hereby authorizes Lender, after and during the
continuance of an Event of Default, to compromise with the obligor, accept in
full payment of any Right to Payment such amount as Lender shall negotiate with
the obligor, or abandon any Right to Payment. Any such action by Lender shall be
considered commercially reasonable so long as Lender acts in good faith based on
information known to it at the time it takes any such action.
7.2 PERFORMANCE OF DEBTOR'S OBLIGATIONS. Without having any obligation
to do so, upon reasonable prior notice to Debtor, Lender may perform or pay any
obligation which Debtor has agreed to perform or pay under this Agreement,
including, without limitation, the payment or discharge of taxes or Liens levied
or placed on or threatened against the Collateral. In so performing or paying,
Lender shall determine the action to be taken and the amount necessary to
discharge such obligations. Debtor shall reimburse Lender on demand for any
amounts paid by Lender pursuant to this Section, which amounts shall constitute
Indebtedness secured by the Collateral and shall bear interest from the date of
demand at the rate applicable to overdue payments under the Loan Agreement.
7.3 POWER OF ATTORNEY. For the purpose of protecting and preserving the
Collateral and Lender's rights under this Agreement, Debtor hereby irrevocably
appoints Lender, with full power of substitution, as its attorney-in-fact with
full power and authority, after the occurrence and during the continuance of an
Event of Default, to do any act which Debtor is obligated to do hereunder; to
exercise such rights with respect to the Collateral as Debtor might exercise; to
use such Inventory, Equipment, Fixtures or other property as Debtor might use;
to enter Debtor's premises; to give notice of Lender's security interest in, and
to collect the Collateral; and to execute and file in Debtor's name any
financing statements, amendments and continuation statements necessary or
desirable to perfect or continue the perfection
7
<PAGE> 35
of Lender's security interests in the Collateral. Debtor hereby ratifies all
that Lender shall lawfully do or cause to be done by virtue of this appointment.
7.4 AUTHORIZATION FOR LENDER TO TAKE CERTAIN ACTION. The power of
attorney created in Section 7.3 is a power coupled with an interest and shall be
irrevocable. The powers conferred on Lender hereunder are solely to protect its
interests in the Collateral and shall not impose any duty upon Lender to
exercise such powers. Lender shall be accountable only for amounts that it
actually receives as a result of the exercise of such powers and in no event
shall Lender or any of its directors, officers, employees, agents or
representatives be responsible to Debtor for any act or failure to act, except
for gross negligence or willful misconduct. After the occurrence and during the
continuance of an Event of Default, Lender may exercise this power of attorney
without notice to or assent of Debtor, in the name of Debtor, or in Lender's own
name, from time to time in Lender's sole discretion and at Debtor's expense. To
further carry out the terms of this Agreement, after the occurrence and during
the continuance of an Event of Default, Lender may:
(a) Execute any statements or documents or take
possession of, and endorse and collect and receive delivery or payment
of, any checks, drafts, notes, acceptances or other instruments and
documents constituting Collateral, or constituting the payment of
amounts due and to become due or any performance to be rendered with
respect to the Collateral.
(b) Sign and endorse any invoices, freight or express
bills, bills of lading, storage or warehouse receipts; drafts,
certificates and statements under any commercial or standby letter of
credit relating to Collateral; assignments, verifications and notices in
connection with Accounts; or any other documents relating to the
Collateral, including without limitation the Records.
(c) Use or operate Collateral or any other property of
Debtor for the purpose of preserving or liquidating Collateral.
(d) File any claim or take any other action or proceeding
in any court of law or equity or as otherwise deemed appropriate by
Lender for the purpose of collecting any and all monies due or securing
any performance to be rendered with respect to the Collateral.
(e) Commence, prosecute or defend any suits, actions or
proceedings or as otherwise deemed appropriate by Lender for the purpose
of protecting or collecting the Collateral. In furtherance of this
right, upon the occurrence and during the continuance of an Event of
Default, Lender may apply for the appointment of a receiver or similar
official to operate Debtor's business.
(f) Prepare, adjust, execute, deliver and receive payment
under insurance claims, and collect and receive payment of and endorse
any instrument in payment of loss or returned premiums or any other
insurance refund or return, and apply such amounts at Lender's sole
discretion, toward repayment of the Indebtedness or replacement of the
Collateral.
7.5 APPLICATION OF PROCEEDS. Any Proceeds and other monies or property
received by Lender pursuant to the terms of this Agreement or any Loan Document
may be applied by Lender first to the payment of expenses of collection,
including without limitation reasonable attorneys' fees, and then to the payment
of the Indebtedness in such order of application as Lender may elect.
7.6 DEFICIENCY. If the Proceeds of any disposition of the Collateral are
insufficient to cover all costs and expenses of such sale and the payment in
full of all the Indebtedness, plus all other sums required to be expended or
distributed by Lender, then Debtor shall be liable for any such deficiency.
7.7 LENDER TRANSFER. Upon the transfer of all or any part of the
Indebtedness, Lender may transfer all or part of the Collateral and shall be
fully
8
<PAGE> 36
discharged thereafter from all liability and responsibility with respect to such
Collateral so transferred, and the transferee shall be vested with all the
rights and powers of Lender hereunder with respect to such Collateral so
transferred, but with respect to any Collateral not so transferred, Lender shall
retain all rights and powers hereby given.
7.8 LENDER'S DUTIES.
(a) Lender shall use reasonable care in the custody and
preservation of any Collateral in its possession. Without limitation on
other conduct which may be considered the exercise of reasonable care,
Lender shall be deemed to have exercised reasonable care in the custody
and preservation of such Collateral if such Collateral is accorded
treatment substantially equal to that which Lender accords its own
property, it being understood that Lender shall not have any
responsibility for ascertaining or taking action with respect to calls,
conversions, exchanges, maturities, declining value, tenders or other
matters relative to any Collateral, regardless of whether Lender has or
is deemed to have knowledge of such matters; or taking any necessary
steps to preserve any rights against any Person with respect to any
Collateral. Under no circumstances shall Lender be responsible for any
injury or loss to the Collateral, or any part thereof, arising from any
cause beyond the reasonable control of Lender.
(b) Lender may at any time deliver the Collateral or any
part thereof to Debtor and the receipt of Debtor shall be a complete and
full acquittance for the Collateral so delivered, and Lender shall
thereafter be discharged from any liability or responsibility therefor.
(c) Neither Lender, nor any of its directors, officers,
employees, agents, attorneys or any other person affiliated with or
representing Lender shall be liable for any claims, demands, losses or
damages, of any kind whatsoever, made, claimed, incurred or suffered by
Debtor or any other party through the ordinary negligence of Lender, or
any of its directors, officers, employees, agents, attorneys or any
other person affiliated with or representing Lender.
8 - GENERAL PROVISIONS
8.1 NOTICES. Any notice given by any party under this Agreement shall be
given in the manner prescribed in the Loan Agreement.
8.2 BINDING EFFECT. This Agreement shall be binding upon Debtor, its
permitted successors, representatives and assigns, and shall inure to the
benefit of Lender and its successors and assigns.
8.3 RIGHTS CUMULATIVE. All rights and remedies existing under this
Agreement are cumulative to, and not exclusive of, any other rights or remedies
available under contract or applicable law.
8.4 UNENFORCEABLE PROVISIONS. Any provision of this Agreement which is
prohibited or unenforceable in any jurisdiction shall be so only as to such
jurisdiction and only to the extent of such prohibition or unenforceability, but
all the remaining provisions of this Agreement shall remain valid and
enforceable.
8.5 GOVERNING LAW. Except as may be otherwise provided by the Uniform
Commercial Code, this Agreement shall be governed by and construed in accordance
with the laws of the State of California.
8.6 TERMINATION. Subject to Section 6.2 of this Agreement, upon the
payment in full of the Indebtedness and if Lender has no further obligations
under its Commitment, the security interest granted hereby shall terminate and
all rights to the Collateral shall revert to Debtor. Upon any such termination,
the Lender shall, at Debtor's expense, execute and deliver to Debtor such
documents as Debtor shall reasonably request to evidence such termination.
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<PAGE> 37
8.7 ENTIRE AGREEMENT. This Agreement is intended by Debtor and Lender as
the final expression of Debtor's obligations to Lender in connection with the
Collateral and supersedes all prior understandings or agreements concerning the
subject matter hereof. This Agreement may be amended only by a writing signed by
Debtor and accepted by Lender in writing.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date set
forth in the preamble.
DIGITAL GENERATION SYSTEMS, INC.
By: ___________________________
Name: Thomas P. Shanahan
Title: Chief Financial Officer
VENTURE LENDING & LEASING II, INC.
By: ___________________________
Name: Salvador O. Gutierrez
Title: President
10
<PAGE> 38
THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR INVESTMENT
AND HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR ANY STATE
SECURITIES LAWS. SUCH SECURITIES MAY NOT BE SOLD OR TRANSFERRED IN THE ABSENCE
OF SUCH REGISTRATION OR AN EXEMPTION THEREFROM UNDER SAID ACT AND ANY APPLICABLE
STATE SECURITIES LAWS.
WARRANT TO PURCHASE
186,652 SHARES OF COMMON STOCK OF
DIGITAL GENERATION SYSTEMS, INC.
(Void after December 31, 2003)
This certifies that VENTURE LENDING & LEASING II, INC., a Maryland
corporation, or assigns (the "Holder"), for value received, is entitled to
purchase from DIGITAL GENERATION SYSTEMS, INC., a California corporation (the
"Company"),186,652 fully paid and nonassessable shares of the Company's Common
Stock ("Common Stock") for cash at a price of $4.42 per share (the "Stock
Purchase Price") at any time or from time to time up to and including 5:00 p.m.
(Pacific time) on December 31, 2003 (the "Expiration Date"), upon surrender to
the Company at its principal office at 875 Battery Street, San Francisco, CA
94111 (or at such other location as the Company may advise Holder in writing) of
this Warrant properly endorsed with the Form of Subscription attached hereto
duly filled in and signed and upon payment in cash or by check of the aggregate
Stock Purchase Price for the number of shares for which this Warrant is being
exercised determined in accordance with the provisions hereof. The Stock
Purchase Price and the number of shares purchasable hereunder are subject to
adjustment as provided in Section 4 of this Warrant.
This Warrant is subject to the following terms and conditions:
1. Exercise; Issuance of Certificates; Payment for Shares.
(a) Unless an election is made pursuant to clause (b) of this
Section 1, this Warrant shall be exercisable at the option of the Holder, at any
time or from time to time, on or before the Expiration Date for all or any
portion of the shares of Common Stock (but not for a fraction of a share) which
may be purchased hereunder for the Stock Purchase Price multiplied by the number
of shares to be purchased. The Company agrees that the shares of Common Stock
purchased under this Warrant shall be and are deemed to be issued to the holder
hereof as the record owner of such shares as of the close of business on the
date on which this
EXHIBIT D
TO LOAN AGREEMENT
<PAGE> 39
Warrant shall have been surrendered and payment made for such shares. Subject to
the provisions of Section 2, certificates for the shares of Common Stock so
purchased, together with any other securities or property to which the Holder
hereof is entitled upon such exercise, shall be delivered to the Holder hereof
by the Company at the Company's expense within a reasonable time after the
rights represented by this Warrant have been so exercised. Except as provided in
clause (b) of this Section 1, in case of a purchase of less than all the shares
which may be purchased under this Warrant, the Company shall cancel this Warrant
and execute and deliver a new Warrant or Warrants of like tenor for the balance
of the shares purchasable under the Warrant surrendered upon such purchase to
the Holder hereof within a reasonable time. Each stock certificate so delivered
shall be in such denominations of Common Stock as may be requested by the Holder
hereof and shall be registered in the name of such Holder or such other name as
shall be designated by such Holder, subject to the limitations contained in
Section 2.
(b) The Holder, in lieu of exercising this Warrant by the payment
of the Stock Purchase Price pursuant to clause (a) of this Section 1, may elect,
at any time on or before the Expiration Date, to receive, through conversion of
this Warrant or any portion hereof into that number of shares of Common Stock
equal to the quotient of: (i) the difference between (A) the Per Share Price (as
hereinafter defined) of the Common Stock, less (B) the Stock Purchase Price then
in effect, multiplied by the number of shares of Common Stock the Holder would
otherwise have been entitled to purchase hereunder pursuant to clause (a) of
this Section 1 (or such lesser number of shares as the Holder may designate in
the case of a partial exercise of this Warrant); over (ii) the Per Share Price.
(c) For purposes of clause (b) of this Section 1, "Per Share
Price" means (i) if the Company's Common Stock is then listed or admitted to
trading on any national securities exchange or traded on any national market
system, the average of the closing bid and asked prices of the Company's Common
Stock as reported on such exchange or market system for the ten (10) consecutive
trading days prior to the date of the Holder's election to convert hereunder;
(ii) if this Warrant is being converted in conjunction with a public offering of
stock, the price to the public per share pursuant to the offering; or (iii) if
no shares of the Company's Common Stock are listed or admitted to trading on any
national securities exchange or traded on any national market system, the price
per share which the Company would obtain from a willing buyer for shares sold by
the Company from authorized but unissued shares as such price shall be agreed
upon by the Holder and the Company or, if agreement cannot be reached within ten
(10) business days of the Holder's election hereunder, as such price shall be
determined by a panel of three (3)
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<PAGE> 40
appraisers, one (1) to be chosen by the Company, one (1) to be chosen by the
Holder and the third to be chosen by the first two (2) appraisers. If the
appraisers cannot reach agreement within 30 days of the Holder's election
hereunder, then each appraiser shall deliver its appraisal and the appraisal
which is neither the highest nor the lowest shall constitute the Per Share
Price. In the event either party fails to choose an appraiser within 30 days of
the Holder's election hereunder, then the appraisal of the sole appraiser shall
constitute the Per Share Price. Each party shall bear the cost of the appraiser
selected by such party and the cost of the third appraiser shall be borne
one-half by each party. In the event either party fails to choose an appraiser,
the cost of the sole appraiser shall be borne one-half by each party.
2. Limitation on Transfer.
(a) The Warrant and the Common Stock shall not be transferable
except upon the conditions specified in this Section 2, which conditions are
intended to insure compliance with the provisions of the Securities Act. Each
holder of this Warrant or the Common Stock issuable hereunder will cause any
proposed transferee of the Warrant or Common Stock to agree to take and hold
such securities subject to the provisions and upon the conditions specified in
this Section 2.
(b) Each certificate representing this Warrant
or the Common Stock shall (unless otherwise permitted by the provisions of this
Section 2 or unless such securities have been registered under the Securities
Act or sold under Rule 144) be stamped or otherwise imprinted with a legend
substantially in the following form (in addition to any legend required under
applicable state securities laws):
THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR
INVESTMENT AND HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR
ANY STATE SECURITIES LAWS. SUCH SECURITIES MAY NOT BE SOLD OR TRANSFERRED
IN THE ABSENCE OF SUCH REGISTRATION OR AN EXEMPTION THEREFROM UNDER SAID
ACT AND ANY APPLICABLE STATE SECURITIES LAWS.
(c) The Holder of this Warrant and each person to whom this
Warrant is subsequently transferred represents and warrants to the Company (by
acceptance of such transfer) that it will not transfer the Warrant (or
securities issuable upon exercise hereof unless a registration statement under
the Securities Act was in effect with respect to such securities at the time of
issuance thereof) except pursuant to (i) an effective registration statement
under the Securities Act, (ii) Rule 144 under the Securities Act (or any other
rule under the Securities Act relating to the disposition of
3
<PAGE> 41
securities), or (iii) an opinion of counsel, reasonably satisfactory to counsel
for the Company, that an exemption from such registration is available.
3. Shares to be Fully Paid; Reservation of Shares. The Company covenants
and agrees that all shares of Common Stock which may be issued upon the exercise
of the rights represented by this Warrant will, upon issuance, be duly
authorized, validly issued, fully paid and nonassessable and free from all
preemptive rights of any shareholder and free of all taxes, liens and charges
with respect to the issue thereof. The Company further covenants and agrees that
during the period within which the rights represented by this Warrant may be
exercised, the Company will at all times have authorized and reserved, for the
purpose of issue or transfer upon exercise of the subscription rights evidenced
by this Warrant, a sufficient number of shares of authorized but unissued Common
Stock, or other securities and property, when and as required to provide for the
exercise of the rights represented by this Warrant. The Company will take all
such action as may be necessary to assure that such shares of Common Stock may
be issued as provided herein without material violation of any applicable law or
regulation, or of any requirements of any domestic securities exchange upon
which the Common Stock may be listed. The Company will not take any action which
would result in any adjustment of the Stock Purchase Price (as defined in
Section 4 hereof) (i) if the total number of shares of Common Stock issuable
after such action upon exercise of all outstanding warrants, together with all
shares of Common Stock then outstanding and all shares of Common Stock then
issuable upon exercise of all options and upon the conversion of all convertible
securities then outstanding, would exceed the total number of shares of Common
Stock then authorized by the Company's Articles of Incorporation.
4. Adjustment of Stock Purchase Price Number of Shares. The Stock Purchase
Price and the number of shares purchasable upon the exercise of this Warrant
shall be subject to adjustment from time to time upon the occurrence of certain
events described in this Section 4. Upon each adjustment of the Stock Purchase
Price, the Holder of this Warrant shall thereafter be entitled to purchase, at
the Stock Purchase Price resulting from such adjustment, the number of shares
obtained by multiplying the Stock Purchase Price in effect immediately prior to
such adjustment by the number of shares purchasable pursuant hereto immediately
prior to such adjustment, and dividing the product thereof by the Stock Purchase
Price resulting from such adjustment.
4.1 Subdivision or Combination of Stock. In case the Company
shall at any time subdivide its outstanding shares of Common Stock into a
greater number of shares, the Stock Purchase Price in effect immediately prior
to such
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<PAGE> 42
subdivision shall be proportionately reduced, and conversely, in case the
outstanding shares of Common Stock of the Company shall be combined into a
smaller number of shares, the Stock Purchase Price in effect immediately prior
to such combination shall be proportionately increased.
4.2 Dividends in Preferred Stock, Other Stock, Property,
Reclassification. If at any time or from time to time the holders of Common
Stock (or any shares of stock or other securities at the time receivable upon
the exercise of this Warrant) shall have received or become entitled to receive,
without payment therefor,
(a) by way of dividend or other distribution
any shares of stock or other securities, whether or not such securities are at
any time directly or indirectly convertible into or exchangeable for Common
Stock, or any rights or options to subscribe for, purchase or otherwise acquire
any of the foregoing, or
(b) any cash paid or payable otherwise than as a cash
dividend, or
(c) additional stock or other securities or property
(including cash) by way of spinoff, split-up, reclassification, combination of
shares or similar corporate rearrangement, (other than shares of Common Stock
issued as a stock split, adjustments in respect of which shall be covered by the
terms of Section 4.1 above),
then and in each such case, the Holder hereof shall, upon the exercise of this
Warrant, be entitled to receive, in addition to the number of shares of Common
Stock receivable thereupon, and without payment of any additional consideration
therefore, the amount of stock and other securities and property (including cash
in the cases referred to in clauses (b) and (c) above) which such Holder would
hold on the date of such exercise had he been the holder of record of such
Common Stock as of the date on which holders of Common Stock received or became
entitled to receive such shares and/or all other additional stock and other
securities and property.
4.3 Reorganization,Reclassification, Consolidation, Merger or
Sale. If any capital reorganization of the capital stock of the Company, or any
consolidation or merger of the Company with another corporation, or the sale of
all or substantially all of its assets to another corporation shall be effected
in such a way that holders of Common Stock shall be entitled to receive stock,
securities or assets with respect to or in exchange for Common Stock, then, as a
condition of such reorganization, reclassification, consolidation, merger or
sale, lawful and adequate provisions shall be made whereby the holder hereof
shall thereafter have
5
<PAGE> 43
the right to purchase and receive (in lieu of the shares of the Common Stock of
the Company immediately theretofore purchasable and receivable upon the exercise
of the rights represented hereby) such shares of stock, securities or assets as
may be issued or payable with respect to or in exchange for a number of
outstanding shares of such Common Stock equal to the number of shares of such
stock immediately theretofore purchasable and receivable upon the exercise of
the rights represented hereby. In any such case, appropriate provision shall be
made with respect to the rights and interests of the Holder of this Warrant to
the end that the provisions hereof (including, without limitation, provisions
for adjustments of the Stock Purchase Price and of the number of shares
purchasable and receivable upon the exercise of this Warrant) shall thereafter
be applicable, as nearly as may be possible, in relation to any shares of stock,
securities or assets thereafter deliverable upon the exercise hereof. The
Company will not effect any such consolidation, merger or sale unless, prior to
the consummation thereof, the successor corporation (if other than the Company)
resulting from such consolidation or the corporation purchasing such assets
shall assume by written instrument, executed and mailed or delivered to the
registered Holder hereof at the last address of such Holder appearing on the
books of the Company, the obligation to deliver to such Holder such shares of
stock, securities or assets as, in accordance with the foregoing provisions,
such Holder may be entitled to purchase.
4.4 Intentionally Deleted.
4.5 Notice of Adjustment. Upon any adjustment of the Stock
Purchase Price, and/or any increase or decrease in the number of shares
purchasable upon the exercise of this Warrant the Company shall give written
notice thereof, by first class mail, postage prepaid, addressed to the
registered holder of this Warrant at the address of such holder as shown on the
books of the Company. The notice shall be signed by the Company's chief
financial officer and shall state the Stock Purchase Price resulting from such
adjustment and the increase or decrease, if any, in the number of shares
purchasable at such price upon the exercise of this Warrant, setting forth in
reasonable detail the method of calculation and the facts upon which such
calculation is based.
4.6 Other Notices. If at any time:
(a) the Company shall declare any cash dividend upon any
of its stock;
(b) the Company shall declare any dividend upon its stock
payable in stock, or make any special dividend or other distribution to the
holders of its stock;
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<PAGE> 44
(c) the Company shall offer for subscription pro rata to the
holders of its Common Stock any additional shares of stock of any class or other
rights;
(d) there shall be any capital reorganization or
reclassification of the capital stock of the Company, or consolidation or merger
of the Company with, or sale of all or substantially all of its assets to,
another corporation;
(e) there shall be a voluntary or involuntary dissolution,
liquidation or winding up of the Company; or
(f) the Company shall take or propose to take any other
action, notice of which is actually provided to holders of the Common Stock;
then, in any one or more of said cases, the Company shall give, by first class
mail, postage prepaid, addressed to the holder of this Warrant at the address of
such holder as shown on the books of the Company, (i) at least 20 day's prior
written notice of the date on which the books of the Company shall close or a
record shall be taken for such dividend, distribution or subscription rights or
for determining rights to vote in respect of any such reorganization,
reclassification, consolidation, merger, sale, dissolution, liquidation or
winding up, or other action and (ii) in the case of any such reorganization,
reclassification, consolidation, merger, sale, dissolution, liquidation or
winding up, or other action, at least 20 day's written notice of the date when
the same shall take place. Any notice given in accordance with the foregoing
clause (i) shall also specify, in the case of any such dividend, distribution or
subscription rights, the date on which the holders of stock shall be entitled
thereto. Any notice given in accordance with the foregoing clause (ii) shall
also specify the date on which the holders of Common Stock shall be entitled to
exchange their Common Stock for securities or other property deliverable upon
such reorganization, reclassification, consolidation, merger, sale, dissolution,
liquidation or winding-up, or other action as the case may be. Notwithstanding
anything to the contrary, the Company's failure to give any notice required
under Section 4.5 or 4.6 shall not affect the validity of any Company action
requiring such notice to be given.
4.7 Certain Events. If in the reasonable judgment of the
Company's Board of Directors any change in the outstanding Common Stock of the
Company or any other event occurs as to which the other provisions of this
Section 4 are not strictly applicable or if strictly applicable would not fairly
protect the purchase rights of the Holder of the Warrant in accordance with the
essential intent and principles of such provisions, then the Board of Directors
of
7
<PAGE> 45
the Company shall make an adjustment in the number and class of shares available
under the Warrant, the Stock Purchase Price and/or the application of such
provisions, in accordance with such essential intent and principles, so as to
protect such purchase rights as aforesaid. The adjustment shall be such as will
give the Holder of the Warrant upon exercise for the same aggregate Stock
Purchase Price the total number, class and kind of shares as he would have owned
had the Warrant been exercised prior to the event and had he continued to hold
such shares until after the event requiring adjustment.
5. Issue Tax. The issuance of certificates for shares of Common Stock upon
the exercise of the Warrant shall be made without charge to the Holder of the
Warrant for any issue tax in respect thereof; provided, however, that the
Company shall not be required to pay any tax which may be payable in respect of
any transfer involved in the issuance and delivery of any certificate in a name
other than that of the then Holder of the Warrant being exercised.
6. Closing of Books. The Company will at no time close its transfer books
against the transfer of any warrant or of any shares of Common Stock issued or
issuable upon the exercise of any warrant in any manner which interferes with
the timely exercise of this Warrant.
7. No Voting or Dividend Rights; Limitation of Liability. Nothing contained
in this Warrant shall be construed as conferring upon the Holder hereof the
right to vote or to consent as a shareholder in respect of meetings of
shareholders for the election of directors of the Company or any other matters
or any rights whatsoever as a shareholder of the Company. No dividends or
interest shall be payable or accrued in respect of this Warrant or the interest
represented hereby or the shares purchasable hereunder until, and only to the
extent that, this Warrant shall have been exercised. No provisions hereof, in
the absence of affirmative action by the holder to purchase shares of Common
Stock, and no mere enumeration herein of the rights or privileges of the Holder
hereof, shall give rise to any liability of such Holder for the Stock Purchase
Price or as a shareholder of the Company, whether such liability is asserted by
the Company or by its creditors.
8. Amendment of Articles of Incorporation. Unless the Holder of this
Warrant consents thereto in writing, the Company shall not amend its Articles of
Incorporation prior to the exercise of this Warrant in any manner that would
adversely affect the Holder's rights hereunder.
9. Registration Rights. The Holder hereof shall be entitled, with respect
to the shares of Common Stock issued upon exercise hereof to all of the
registration rights set
8
<PAGE> 46
forth in the Amendment and Restatement No. 4 to Rights Agreement dated as of
July 27, 1995 to the same extent and on the same terms and conditions as
possessed by the Holders thereunder pursuant to Section 1.3 ("Company
Registration") thereto. The Company shall take such action as may be reasonably
necessary to assure that the granting of such registration rights to the Holder
does not violate the provisions of such agreement or any of the Company's
charter documents or rights of prior grantees of registration rights.
10. Rights and Obligations Survive Exercise of Warrant.
The rights and obligations of the Company, of the Holder of this Warrant and of
the holder of shares of Common Stock issued upon exercise of this Warrant,
contained in Sections 8 and 9 shall survive the exercise of this Warrant.
11. Modification and Waiver. This Warrant and any
provision hereof may be changed, waived, discharged or terminated only by an
instrument in writing signed by the party against which enforcement of the same
is sought.
12. Notices. Any notice, request or other document
required or permitted to be given or delivered to the holder hereof or the
Company shall be deemed to have been given (i) upon receipt if delivered
personally or by courier, (ii) upon confirmation of receipt if by telecopy, or
(iii) three business days after deposit in the U.S. mail, with postage prepaid
and certified or registered, to each such holder at its address as shown on the
books of the Company or to the Company at the address indicated therefor in the
first paragraph of this Warrant.
13. Binding Effect on Successors. This Warrant shall be binding upon any
corporation succeeding the Company by merger, consolidation or acquisition of
all or substantially all of the Company's assets. All of the obligations of the
Company relating to the Common Stock issuable upon the exercise of this Warrant
shall survive the exercise and termination of this Warrant. All of the covenants
and agreements of the Company shall inure to the benefit of the successors and
assign of the holder hereof. The Company will, at the time of the exercise of
this Warrant, in whole or in part, upon request of the Holder hereof but at the
Company's expense, acknowledge in writing its continuing obligation to the
Holder hereof in respect of any rights (including, without limitation, any right
to registration of the shares of Common Stock) to which the holder hereof shall
continue to be entitled after such exercise in accordance with this Warrant;
provided, that the failure of the holder hereof to make any such request shall
not affect the continuing obligation of the Company to the Holder hereof in
respect of such rights.
14. Descriptive Headings and Governing Law. The
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<PAGE> 47
descriptive headings of the several sections and paragraphs of this Warrant are
inserted for convenience only and do not constitute a part of this Warrant. This
Warrant shall be construed and enforced in accordance with, and the rights of
the parties shall be governed by, the internal laws of the State of California.
15. Lost Warrants or Stock Certificates. The Company represents and
warrants to the Holder hereof that upon receipt of evidence reasonably
satisfactory to the Company of the loss, theft, destruction, or mutilation of
any Warrant or stock certificate and, in the case of any such loss, theft or
destruction, upon receipt of an indemnity reasonably satisfactory to the
Company, or in the case of any such mutilation upon surrender and cancellation
of such Warrant or stock certificate, the Company at its expense will make and
deliver a new Warrant or stock certificate, of like tenor, in lieu of the lost,
stolen, destroyed or mutilated Warrant or stock certificate.
16. Fractional Shares. No fractional shares shall be
issued upon exercise of this Warrant. The Company shall, in lieu of issuing any
fractional share, pay the holder entitled to such fraction a sum in cash equal
to such fraction multiplied by the then effective Stock Purchase Price.
17. Representations of Holder. With respect to this Warrant, Holder by
acceptance of this Warrant represents and warrants to, and covenants with, the
Company as follows:
17.1 Experience. It is experienced in evaluating and investing
in companies engaged in businesses similar to that of the Company; it
understands that investment in the Warrant involves substantial risks; it has
made detailed inquiries concerning the Company, its business and services, its
officers and its personnel; the officers of the Company have made available to
Holder any and all written information it has requested; the officers of the
Company have answered to Holder's satisfaction all inquiries made by it; in
making this investment it has relied upon information made available to it by
the Company; it has such knowledge and experience in financial and business
matters that it is capable of evaluating the merits and risks of investment in
the Company and it is able to bear the economic risk of that investment; and it
is an "accredited investor", as that term is defined in Section 501 of
Regulation D promulgated under the Securities Act of 1933, as amended.
17.2 Investment. It is acquiring the Warrant for investment for
its own account and not with a view to, or for resale in connection with, any
distribution thereof. It understands that the Warrant, the shares of Common
Stock issuable upon exercise thereof, have not been registered
10
<PAGE> 48
under the Securities Act of 1933, as amended, nor qualified under applicable
state securities laws.
17.3 Rule 144. It acknowledges that the Warrant and the Common
Stock must be held indefinitely unless they are subsequently registered under
the Securities Act or an exemption from such registration is available. It has
been advised or is aware of the provisions of Rule 144 promulgated under the
Securities Act.
17.4 Access to Data. It has had an opportunity to discuss the
Company's business, management and financial affairs with the Company's
management and has had the opportunity to inspect the Company's facilities.
17.5 Neither Holder nor anyone acting on its behalf will take
any action hereafter that would cause the loss of the exemptions referred to in
Section 18.3.
18. Additional Representations and Covenants of the Company. The Company
hereby represents, warrants and agrees as follows:
18.1 Corporate Power. The Company has all requisite corporate
power and corporate authority to issue this Warrant and to carry out and perform
its obligations hereunder.
18.2 Authorization. All corporate action on the part of the
Company, its directors and shareholders necessary for the authorization,
execution, delivery and performance by the Company of this has been taken. This
Warrant is a valid and binding obligation of the Company, enforceable in
accordance with its terms (except as may be limited by bankruptcy, insolvency
and similar laws affecting the enforcement of creditors' rights in general, and
subject to general principals of equity).
18.3 Offering. Subject in part to the truth and accuracy of
Holder's representations set forth in Section 17 hereof, the offer, issuance and
sale of the Warrant is, and the issuance of Common Stock upon exercise of the
Warrant will be exempt from the registration requirements of the Securities Act,
and are exempt from the qualification requirements of any applicable state
securities laws; and neither the Company nor anyone acting on its behalf will
take any action hereafter that would cause the loss of such exemptions.
18.4 Stock Issuance. Upon exercise of the Warrant, the Company
will use its reasonable commercial efforts to cause stock certificates
representing the shares of Common Stock purchased pursuant to the exercise to be
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<PAGE> 49
issued in the individual names of Holder, its nominees or assignees, as
appropriate at the time of such exercise.
IN WITNESS WHEREOF, the Company has caused this Warrant to be
duly executed by its officers, thereunto duly authorized this ___ day of
December, 1997.
DIGITAL GENERATION SYSTEMS, INC.
By:________________________________
Title:_____________________________
12
<PAGE> 50
FORM OF SUBSCRIPTION
(To be signed only upon exercise of Warrant)
To:_____________________________
The undersigned, the holder of the within Warrant, hereby
irrevocably elects to exercise the purchase right represented by such Warrant
for, and to purchase thereunder, __________________________________ (_____) (1)
shares of Common Stock of __________________________________ and herewith makes
payment of _____________________________________ Dollars ($________) therefor,
and requests that the certificates for such shares be issued in the name of, and
delivered to, __________________________________________, whose address is
_____________________________.
The undersigned represents that it is acquiring such Common Stock
for its own account for investment and not with a view to or for sale in
connection with any distribution thereof (subject, however, to any requirement
of law that the disposition thereof shall at all times be within its control.
DATED:_________________________________
_______________________________________
(Signature must conform in all respects
to name of holder as specified on the
face of the Warrant)
_______________________________________
_______________________________________
(Address)
- - ----------------
(1) Insert here the number of shares called for on the face of the Warrant
(or, in the case of a partial exercise, the portion thereof as to which
the Warrant is being exercised), in either case without making any
adjustment for additional Common Stock or any other stock or other
securities or property or cash which, pursuant to the adjustment
provisions of the Warrant, may be deliverable upon exercise.
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<PAGE> 51
ASSIGNMENT
FOR VALUE RECEIVED, the undersigned, the holder of the within
Warrant, hereby sells, assigns and transfers all of the rights of the
undersigned under the within Warrant, with respect to the number of shares of
Common Stock covered thereby set forth hereinbelow, unto:
Name of Assignee Address No. of Shares
Dated:_________________________________
_______________________________________
(Signature must conform in all respects
to name of holder as specified on the
face of the Warrant)
14
<PAGE> 52
FORM OF BORROWING BASE CERTIFICATE
_________________, 199___
To: Venture Lending & Leasing II, Inc., as Lender under a certain Loan
Agreement dated as of December 1, 1997 (the "Loan Agreement").
Terms used in this certificate shall have the same meaning as ascribed
thereto in the Loan Agreement.
The undersigned officer of the Borrower certifies that the information
furnished herein as of __________________________, 199___ is true and
correct and that as of the date hereof no Event of Default, or Default
exists under the Loan Agreement.
A. Computation of Borrowing Base
<TABLE>
<S> <C> <C>
I. 80% of Accounts (calculated
as per Agreement) $___________
II. Term Loan Facility
(a) Term Loan Commitment $3,500,000
(b) Aggregate Principal Amount
of Prior Term Loans $___________
(c) Unused Commitment [(a) less (b)] $___________
III. Additional Term Loan Availability:
Lesser of Borrowing Base (I) and
Unused Commitment (II(c)) $___________
[IV. Principal amount of Term Loan
requested] $___________
V. Aggregate Principal Balance of
Term Loans Outstanding $___________
</TABLE>
DIGITAL GENERAL SYSTEMS, INC.
By: ________________________
Name: _______________________
Title: ______________________
EXHIBIT E
to Loan Agreemeent
<PAGE> 1
EXHIBIT 10.32
THIS FIRST AMENDMENT TO LOAN AGREEMENT (this "Amendment") is dated as
of December 1, 1997, by and between Venture Lending & Leasing, Inc., a Maryland
corporation ("Lender"), and Digital Generation Systems, Inc., a California
corporation ("Borrower").
Recitals
A. Borrower is currently indebted to Lender pursuant to a Loan
Agreement dated as of January 28, 1997 (the "Loan Agreement"). Capitalized
terms not specifically defined herein shall have the meanings ascribed to them
in the Loan Agreement.
B. Pursuant to the Loan Agreement, Lender committed to make
advances under a term loan facility up to $6,000,000 from time to time through
December 31, 1997. As of the date of this Amendment, advances in the aggregate
principal amount of approximately $5,000,000 have been made under the Loan
Agreement. To secure its borrowings under the Loan Agreement, Borrower
executed a Security Agreement (Equipment) dated as of January 28, 1997,
granting to Lender a security interest in specific items of equipment financed
with the proceeds of the advances.
C. Borrower has requested that Lender extend the availability of
its lending commitment from December 31, 1997 through June 30, 1998. Lender is
willing to so extend its commitment on the terms and conditions set forth in
this Amendment.
NOW, THEREFORE, the parties agree as follows:
1. The date in clause (b) of the definition of "Termination Date" is
amended to replace the phrase "December 31, 1997" with "June 30, 1998."
2. The form of Security Agreement (Equipment) attached to the Loan
Agreement as Exhibit "C", and required under Sections 2.10 and 4.1(f) of the
Loan Agreement, is hereby replaced with the form of Amended and Restated
Security Agreement attached to this Amendment as Exhibit C.
3. As conditions to the effectiveness of this Amendment, (a) Borrower
shall have executed and delivered to Lender the Amended and Restated Security
Agreement described in Section 2 above, and an amendment to that certain
warrant issued by Borrower to Lender on or about January 28, 1997, to purchase
112,500 shares of common stock of Borrower, which amendment shall adjust the
Stock Purchase Price (as defined therein) to $4.42 per share, and (b) Lender
shall have entered into an intercreditor agreement with Venture Lending &
Leasing II, Inc. setting forth the relative priorities of their respective
Liens in the Collateral on terms satisfactory to Lender.
<PAGE> 2
4. Borrower hereby confirms all representations and warranties
contained in the Loan Agreement, and reaffirms all covenants set forth therein.
Borrower certifies that as of the date of this Amendment there exists no Default
or Event of Default.
5. Except as specifically provided in this Amendment, all terms,
provisions and conditions of the Loan Agreement remain in full force and
effect, without waiver or modification. This Amendment and the Loan Agreement
shall be read together as one document.
IN WITNESS WHEREOF, Borrower and Lender have executed this Amendment
as of the date set forth in the preamble.
Digital Generation Systems, Inc.
By: _______________________
Thomas P. Shanahan,
Chief Financial Officer
Venture Lending & Leasing, Inc.
By: _______________________
Salvador O. Gutierrez,
President
<PAGE> 3
AMENDED AND RESTATED
SECURITY AGREEMENT
This Amended and Restated Security Agreement is made as of December 1,
1997 by Digital Generation Systems, Inc., a California corporation ("Debtor"),
in favor of Venture Lending & Leasing, Inc., a Maryland corporation ("Lender").
RECITALS
A. Debtor and Lender are parties to a Loan Agreement dated January 28,
1997, pursuant to which Lender committed to make and has made certain term loans
to Debtor (the "Loan Agreement"). Debtor's obligations to Lender are secured
pursuant to a Security Agreement (Equipment) dated January 28, 1997 (the "Prior
Security Agreement"), pursuant to which Debtor has granted to Lender Liens on
equipment financed under the Loan Agreement.
B. Debtor has asked Lender to extend the availability of the unfunded
portion of Lender's commitment, which Lender is willing to do on the terms set
forth in a First Amendment to the Loan Agreement of even date herewith. Debtor
also desires to incur up to an additional $5,500,000 of indebtedness to Venture
Lending & Leasing II, Inc., a Maryland corporation ("VLL II"), to be secured by
a lien on substantially all of Debtor's assets now owned and hereafter acquired.
C. As a condition to the effectiveness of the First Amendment, Debtor
and Lender have agreed that the Prior Security Agreement shall be amended to
expand the scope of collateral covered thereby, pursuant to this complete
amendment and restatement of the Prior Security Agreement.
D. Debtor acknowledges that Lender and VII II are entering into a
separate Intercreditor Agreement pursuant to which Lender and VLL II will agree,
as between themselves, that Lender's Liens on items of equipment financed by it
under the Loan Agreement will be senior in priority to the Liens of VLL II in
such items of Equipment Collateral, and that the Liens of VLL II in all other
Collateral securing its loans to Debtor will be senior in priority to the Liens
of Lender in such other Collateral.
II. - DEFINITIONS
The following definitions shall be applicable to both the singular and plural
forms of the defined terms:
"ACCOUNT" means a right to payment for goods sold or leased by
Debtor or for services rendered by Debtor, which right is not evidenced by an
instrument or chattel paper, whether or not earned by performance.
"AGREEMENT" means this Amended and Restated Security Agreement,
as it may be amended from time to time.
"COLLATERAL" means all Debtor's Accounts, Deposit Accounts,
Equipment, Fixtures, General Intangibles, Goods, Inventory, Rights to Payment,
and securities now owned or hereafter acquired, wherever located, and whether
held by Debtor or any third party, and all royalties, proceeds and products
thereof, including all insurance and condemnation proceeds ("Proceeds"), and all
monies now or at any time hereafter in the possession or under the control of
Lender or a bailee or affiliate of Lender, including any cash collateral in any
cash collateral or other account, and all Records. Notwithstanding the
foregoing, "Collateral" shall not include (i) any equipment, property or assets
of the Debtor leased from or financed by a third party to the extent the
contracts evidencing such lease or financing prohibit the granting by Debtor of
any other security interest therein, (ii) any rights of Debtor under any license
or contract if and to the extent that the granting of a security interest
therein in favor of Lender would violate the terms of such license or contract,
or (iii) any other rights or property the assignment of which for security
purposes is prohibited by law.
EXHIBIT C
TO LOAN AGREEMENT
<PAGE> 4
"DEPOSIT ACCOUNTS" means all Debtor's demand, time, savings,
passbook or similar accounts maintained with a financial institution or credit
union.
"EQUIPMENT" means all of Debtor's equipment now owned or
hereafter acquired, including but not limited to machinery, machine parts,
furniture, furnishings and all tangible personal property used in the business
of Debtor and all such property which is or is to become fixtures on real
property, and all improvements, replacements, accessions and additions thereto,
wherever located, and all proceeds thereof arising from the sale, lease, rental
or other use or disposition of any such property, including all rights to
payment with respect to insurance or condemnation, returned premiums, or any
cause of action relating to any of the foregoing.
"EVENT OF DEFAULT" means an event described in Article 6.
"FIXTURES" means all items of personal property of Debtor that
are so related to the real property upon which they are located that an interest
in them arises under real property law, and improvements, replacements, parts,
accessions and additions thereto, and substitutions therefor.
"GENERAL INTANGIBLES" means all personal property of Debtor,
other than Goods, not otherwise defined as Collateral, including without
limitation all interests or claims in insurance policies; literary property;
tradenames, tradename rights; Trademarks, Trademark rights, copyrights, Patents,
and all applications therefor; licenses, permits, franchises and like privileges
or rights issued by any governmental or regulatory authority; income tax
refunds; customer lists; claims and causes of action (whether in contract, tort
or otherwise), judgments and all guaranty claims, leasehold interests in
personal property, security interests or other security held by or guaranteed to
the Debtor to secure the payment by an account debtor of any of the Accounts.
"GOODS" means all money and other personal property of Debtor,
other than General Intangibles, not otherwise defined as Collateral.
"INDEBTEDNESS" means all debts, obligations and liabilities of
Debtor to Lender currently existing or now or hereafter made, incurred or
created under, pursuant to or in connection with the Loan Agreement, whether
voluntary or involuntary and however arising or evidenced, whether direct or
acquired by Lender by assignment or succession, whether due or not due, absolute
or contingent, liquidated or unliquidated, determined or undetermined, and
whether Debtor may be liable individually or jointly, or whether recovery upon
such debt may be or become barred by any statute of limitations or otherwise
unenforceable; and all renewals, extensions and modifications thereof; and all
attorneys' fees and costs incurred by Lender in connection with the collection
and enforcement thereof as provided for in any Loan Document.
"INVENTORY" means all Debtor's raw materials, advertising,
packaging and shipping materials, work in process, finished goods and goods held
for sale or lease or furnished under contracts of service, and all returned and
repossessed goods, and all goods covered by documents of title, including
warehouse receipts, bills of lading and all other documents of every type
covering all or any part of the Collateral.
"LIEN" means any voluntary or involuntary security interest,
mortgage, pledge, claim, charge, encumbrance, title retention agreement, or
third party interest covering all or any part of the property of Debtor or any
other Person.
"LOAN AGREEMENT" means that certain Loan Agreement between Debtor
and Lender dated January 28, 1997, as amended from time to time.
"LOAN DOCUMENTS" means this Agreement, the Loan Agreement, any
evidence of Indebtedness, any guaranty, security or pledge agreement, or deed of
trust delivered in connection with any Indebtedness, and all other contracts,
instruments, addenda and documents executed in connection therewith.
2
<PAGE> 5
"PATENT LICENSE" means any written agreement now or hereafter in
existence granting to Debtor any right to make, use, sell or practice any
invention on which a Patent is in existence.
"PATENTS" means all of the following: (i) all letters patent of
the United States or any other country, all registrations and recordings
thereof, and all applications for letters patent of the United States or any
other country, including, without limitation, registrations, recordings and
applications in the United States Patent and Trademark Office or in any similar
office or agency of the United States, any state thereof or any other country or
any political subdivision thereof, and (ii) all reissues, divisions,
continuations, continuations-in-part, renewals or extensions thereof.
"PERMITTED LIENS" is defined in the Loan Agreement, and includes
without limiting the provisions of the Loan Agreement, (i) Liens in favor of VLL
II, and (ii) Liens on assets of Debtor's wholly-owned subsidiary, MediaTech,
Inc., in favor of Republic Acceptance Corporation or any successor commercial or
institutional lender to secure a working capital credit facility to MediaTech.
"PERSON" means any individual or entity.
"RECORDS" means all Debtor's computer programs, software,
hardware, source codes and data processing information, all written documents,
books, invoices, ledger sheets, financial information and statements, and all
other writings concerning Debtor's business.
"RIGHTS TO PAYMENT" means all Debtor's accounts, instruments,
contract rights, documents, chattel paper and all other rights to payment,
including, without limitation, the Accounts, all negotiable certificates of
deposit and all rights to payment under any Patent License, any Trademark
License, or any commercial or standby letter of credit.
"TRADEMARK LICENSE" means any written agreement now or hereafter
in existence granting to Debtor any right to use any Trademark.
"TRADEMARKS" means all of the following: (i) all trademarks,
trade names, corporate names, company names, business names, fictitious business
names, trade styles, service marks, logos, other source or business identifiers,
prints and labels on which any of the foregoing have appeared or will appear,
designs and general intangibles of like nature, now existing or hereafter
adopted or acquired, all registrations and recordings thereof, and all
applications in connection therewith, including, without limitation,
registrations, recordings and applications in the United States Patent and
Trademark Office or in any similar office or agency of the United States, any
state thereof or any other country or any political subdivision thereof, and
(ii) all reissues, divisions, continuations, continuations-in-part, renewals or
extensions thereof.
"UNIFORM COMMERCIAL CODE" means the California Uniform Commercial
Code, as amended from time to time.
Terms not specifically defined in this Agreement have the meanings ascribed
thereto in the Loan Agreement and the Uniform Commercial Code.
III. - GRANT OF SECURITY INTEREST
To secure the timely payment of the Indebtedness and performance of all
obligations of Debtor to Lender, Debtor grants to Lender security interests in
the Collateral.
IV. - REPRESENTATIONS AND WARRANTIES
Debtor represents and warrants that, at all times during the term of this
Agreement:
A. GOVERNMENTAL ACTIONS. Debtor has obtained all consents and actions
of, and has performed all filings with, any governmental or regulatory authority
that
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<PAGE> 6
are required to authorize the execution, delivery or performance of this
Agreement or the granting or perfecting of Lender's security interest in the
Collateral.
B. TITLE. Except for the security interests created by this Agreement,
and Permitted Liens, (i) Debtor is and will be the unconditional legal and
beneficial owner of the Collateral, and (ii) the Collateral is genuine and
subject to no Liens, rights or defenses of others. There exist no prior
assignments or encumbrances of record with the U.S. Patent and Trademark Office
affecting any Collateral in favor of any third party other than Lender.
C. RIGHTS TO PAYMENT. The names of the obligors, amount owing to Debtor,
due dates and all other information with respect to the Rights to Payment are
and will be correctly stated in all material respects in all Records relating to
the Rights to Payment. Debtor further represents and warrants, to its knowledge,
that each Person appearing to be obligated on a Right to Payment has authority
and capacity to contract and is bound as it appears to be.
D. CHIEF EXECUTIVE OFFICE. Debtor's chief executive office is located
at:
<TABLE>
<CAPTION>
Address City County State Zip
------- ---- ------ ----- ---
<S> <C> <C> <C> <C>
875 Battery Street San Francisco San Francisco CA 94111
</TABLE>
E. INVENTORY LOCATION. Other than as set forth in Section 3.4, Inventory
is located at:
<TABLE>
<CAPTION>
Address City County State Zip
------- ---- ------ ----- ---
<S> <C> <C> <C> <C>
901 Sansome Street San Francisco San Francisco CA 94111
10545 Burbank Blvd. N. Hollywood Los Angeles CA 91601 (MediaTech
West)
219 E. 44th Street New York New York NY 10017 (PDR)
216 W. 18th Street New York New York NY 10011 (MediaTech
East)
110 W. Hubbard St. Chicago IL 60610 (MediaTech
Central)
100 High Rise Dr., Louisville KY 40213
Suite 124
</TABLE>
F. RECORDS LOCATION. Other than as set forth in Section 3.4, Records are
maintained at:
<TABLE>
<CAPTION>
Address City County State Zip
------- ---- ------ ----- ---
<S> <C> <C> <C> <C>
219 E. 44th Street New York New York NY 10017 (PDR)
110 W. Hubbard St. Chicago IL 60610 (MediaTech
Central)
</TABLE>
G. EQUIPMENT OR FIXTURES LOCATION. Other than as set forth in Section
3.4, Equipment or Fixtures are located at:
<TABLE>
<CAPTION>
Address City County State Zip
------- ---- ------ ----- ---
<S> <C> <C> <C> <C>
</TABLE>
4
<PAGE> 7
H. OTHER PLACES OF BUSINESS. In addition to the locations set forth in
Sections 3.4 through 3.7, Debtor maintains the following place(s) of business:
<TABLE>
<CAPTION>
Address City County State Zip
------- ---- ------ ----- ---
<S> <C> <C> <C> <C>
</TABLE>
I. BUSINESS NAMES. Debtor has conducted business in the following names
other than the name stated in the preamble to this Agreement:
MediaTech, Inc.
Starcom Television
PDR Productions, Inc.
V. - AFFIRMATIVE COVENANTS
During the term of this Agreement and until payment of all the Indebtedness and
performance of all obligations to Lender, Debtor will:
A. DELIVERY OF CERTAIN ITEMS. Deliver to Lender promptly (a) upon
Lender's request, duplicate invoices with respect to each Account bearing such
language of assignment as Lender shall reasonably specify; (b) the originals of
all commercial and standby letters of credit, instruments, documents and chattel
paper constituting Collateral, endorsed and assigned as Lender shall reasonably
specify; (c) after an Event of Default, all Proceeds; (d) upon Lender's request,
returned property resulting from, or payment equal to any allowance or credit
on, Rights to Payment; (e) such specific acknowledgments, assignments or other
agreements as Lender may reasonably request relating to the Collateral; and (f)
such Records and other reports in such form and detail and at such times as
Lender may reasonably require relating to the Collateral, including without
limitation reports of acquisition, and disposition, agings, and collection of
any Collateral. If any of the Rights to Payment become evidenced by an
instrument, Debtor will notify Lender thereof and, upon request by Lender
promptly deliver such instrument to Lender appropriately endorsed to the order
of Lender as further security for the satisfaction in full of the Indebtedness.
B. MAINTENANCE OF COLLATERAL; INSPECTION. Do all things reasonably
necessary to maintain, preserve, protect and keep all Collateral in good working
order and salable condition, ordinary wear and tear excepted, deal with the
Collateral in all ways as are considered good practice by owners of like
property, and use the Collateral lawfully and, to the extent applicable, only as
permitted by Debtor's insurance policies. Upon reasonable prior notice at
reasonable times during normal business hours, Debtor hereby authorizes Lender's
officers, employees, representatives and agents to inspect the Collateral and to
discuss the Collateral and the Records relating thereto with Debtor's officers
and employees, and, in the case of any Right to Payment, with any Person which
is or may be obligated thereon.
C. MAINTENANCE OF RECORDS; INSPECTION. Maintain, or cause to be
maintained, complete and accurate Records relating to the Collateral. Upon
reasonable prior notice at reasonable times during normal business hours,
Lender, its officers, employees, agents and representatives shall have the
right, from time to time, to examine the Records and to make copies or extracts
therefrom.
D. DEBTOR'S DUTY TO GIVE NOTICE. Give prompt notice to Lender of: (a)
except as permitted in Section 5.5, any material discount, credit, rebate or
other reduction in the amount owing on a material Right to Payment; (b) any
threatened or asserted dispute, setoff, claim, counterclaim or defense with
respect to a Right to Payment; (c) any material decrease in the value of any
Collateral and the amount of such decrease (other than depreciation calculated
in the ordinary course of business under applicable tax laws and regulations and
in accordance with generally accepted accounting principles); (d) any litigation
or administrative or regulatory proceeding which may have a material adverse
effect on Debtor or its business; (e) to the extent Debtor has actual knowledge
thereof, any change in the ownership of any property on
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<PAGE> 8
which Debtor's chief executive office is located; and (f) the occurrence of any
Default or Event of Default or of any other development, financial or otherwise,
which might materially adversely affect the Collateral or Debtor's ability to
pay the Indebtedness or perform its obligations to Lender.
E. FINANCING STATEMENTS AND OTHER ACTIONS. Execute and deliver to
Lender, and file or record at Debtor's expense, all financing statements,
notices and other documents (including, without limitation, any filings with the
United States Patent and Trademark Office) from time to time reasonably
requested by any Lender to maintain a first perfected security interest in the
Collateral in favor of Lender, all in form and substance satisfactory to Lender;
perform such other acts, and execute and deliver to Lender such additional
conveyances, assignments, agreements and instruments, as Lender may at any time
request in connection with the administration and enforcement of this Agreement
or Lender's rights, powers and remedies hereunder.
VI. - NEGATIVE COVENANTS
During the term of this Agreement and until payment of all the Indebtedness and
performance of all obligations to Lender, Debtor will not:
A. LIENS. Create, incur, assume or permit to exist any Lien on any
Collateral, except Permitted Liens.
B. DOCUMENTS OF TITLE. Sign or authorize the signing of any financing
statement or other document naming Debtor as debtor or obligor, or acquiesce or
cooperate in the issuance of any bill of lading, warehouse receipt or other
document or instrument of title with respect to any Collateral, except those
negotiated to Lender, or those naming Lender as secured party.
C. DISPOSITION OF COLLATERAL. Sell, transfer, lease or otherwise dispose
of any Collateral except for fair consideration or in the ordinary course of its
business.
D. CHANGE IN LOCATION OR NAME. Fail to give written notice to Lender
within 30 days after the occurrence of any: (a) change in the location of any
Collateral or Records, its chief executive office, or a place of business other
than as specified in Article 3; or (b) change its name, mailing address,
location of Collateral, or its legal structure.
E. CERTAIN AGREEMENTS ON RIGHTS TO PAYMENT. Other than in the ordinary
course of business, make or arrange to make any material discount, credit,
rebate or other reduction in the original amount owing on a Right to Payment or
accept in satisfaction of a Right to Payment less than the original amount
thereof, except as disclosed to Lender in writing from time to time.
VII. - EVENTS OF DEFAULT
A. EVENT OF DEFAULT. The occurrence of any "Event of Default" as defined
in the Loan Agreement, failure by Debtor to perform any of its duties or
obligations under this Agreement, or breach by Debtor of any of its
representations hereunder shall constitute an Event of Default hereunder.
B. ACCELERATION AND REMEDIES. Upon the occurrence and during the
continuance of an Event of Default, Lender shall be entitled to, at its option,
(a) declare all or any part of the Indebtedness immediately due and payable; (b)
exercise any or all of the rights and remedies available to a secured party
under the Uniform Commercial Code or any other applicable law; and (c) exercise
any or all of its rights and remedies provided for in this Agreement and in any
other Loan Document. The obligations of Debtor under this Agreement shall
continue to be effective or be reinstated, as the case may be, if at any time
any payment of any Indebtedness is rescinded or must otherwise be returned by
Lender upon, on account of, or in connection with, the insolvency, bankruptcy or
reorganization of Debtor or otherwise, all as though such payment had not been
made.
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<PAGE> 9
C. SALE OF COLLATERAL. Upon the occurrence and during the continuance of
an Event of Default, Lender may sell all or any part of the Collateral, at
public or private sales, to itself, a wholesaler, retailer or investor, for
cash, upon credit or for future delivery, and at such price or prices as Lender
may deem commercially reasonable. To the extent permitted by law, Debtor hereby
specifically waives all rights of redemption and any rights of stay or appraisal
which it has or may have under any applicable law in effect from time to time.
Any such public or private sales shall be held at such times and at such
place(s) as Lender may determine. In case of the sale of all or any part of the
Collateral on credit or for future delivery, the Collateral so sold may be
retained by Lender until the selling price is paid by the purchaser, but Lender
shall not incur any liability in case of the failure of such purchaser to pay
for the Collateral and, in case of any such failure, such Collateral may be
resold. Lender may, instead of exercising its power of sale, proceed to enforce
its security interest in the Collateral by seeking a judgment or decree of a
court of competent jurisdiction. Without limiting the generality of the
foregoing, if an Event of Default is in effect,
(1) Subject to the rights of any third parties,
Lender may license, or sublicense, whether general, special or
otherwise, and whether on an exclusive or non-exclusive basis, any
Patents or Trademarks included in the Collateral throughout the world
for such term or terms, on such conditions and in such manner as Lender
shall in its sole discretion determine;
(2) Lender may (without assuming any obligations or
liability thereunder), at any time and from time to time, enforce (and
shall have the exclusive right to enforce) against any licensee or
sublicensee all rights and remedies of Debtor in, to and under any
Patent Licenses or Trademark Licenses and take or refrain from taking
any action under any thereof, and Debtor hereby releases Lender from,
and agrees to hold Lender free and harmless from and against any claims
arising out of, any lawful action so taken or omitted to be taken with
respect thereto other than claims arising out of Lender's gross
negligence or willful misconduct; and
(3) upon request by Lender, Debtor will execute and
deliver to Lender a power of attorney, in form and substance reasonably
satisfactory to Lender for the implementation of any lease, assignment,
license, sublicense, grant of option, sale or other disposition of a
Patent or Trademark. In the event of any such disposition pursuant to
this clause 3, Debtor shall supply its know-how and expertise relating
to the products or services made or rendered in connection with
Patents, the manufacture and sale of the products bearing Trademarks,
and its customer lists and other records relating to such Patents or
Trademarks and to the distribution of said products, to Lender.
D. DEBTOR'S OBLIGATIONS UPON DEFAULT. Upon the request of Lender after
the occurrence and during the continuance of an Event of Default, Debtor will:
1. Assemble and make available to Lender the
Collateral at such place(s) as Lender shall reasonably designate,
segregating all Collateral so that each item is capable of
identification; and
2. Subject to the rights of any lessor, permit
Lender, by Lender's officers, employees, agents and representatives, to
enter any premises where any Collateral is located, to take possession
of the Collateral, to complete the processing, manufacture or repair of
any Collateral, and to remove the Collateral, or to conduct any public
or private sale of the Collateral, all without any liability of Lender
for rent or other compensation for the use of Debtor's premises.
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<PAGE> 10
VIII. - SPECIAL COLLATERAL PROVISIONS
A. COMPROMISE AND COLLECTION. Debtor and Lender recognize that setoffs,
counterclaims, defenses and other claims may be asserted by obligors with
respect to certain of the Rights to Payment; that certain of the Rights to
Payment may be or become uncollectible in whole or in part; and that the expense
and probability of success of litigating a disputed Right to Payment may exceed
the amount that reasonably may be expected to be recovered with respect to such
Right to Payment. Debtor hereby authorizes Lender, after and during the
continuance of an Event of Default, to compromise with the obligor, accept in
full payment of any Right to Payment such amount as Lender shall negotiate with
the obligor, or abandon any Right to Payment. Any such action by Lender shall be
considered commercially reasonable so long as Lender acts in good faith based on
information known to it at the time it takes any such action.
B. PERFORMANCE OF DEBTOR'S OBLIGATIONS. Without having any obligation to
do so, upon reasonable prior notice to Debtor, Lender may perform or pay any
obligation which Debtor has agreed to perform or pay under this Agreement,
including, without limitation, the payment or discharge of taxes or Liens levied
or placed on or threatened against the Collateral. In so performing or paying,
Lender shall determine the action to be taken and the amount necessary to
discharge such obligations. Debtor shall reimburse Lender on demand for any
amounts paid by Lender pursuant to this Section, which amounts shall constitute
Indebtedness secured by the Collateral and shall bear interest from the date of
demand at the rate applicable to overdue payments under the Loan Agreement.
C. POWER OF ATTORNEY. For the purpose of protecting and preserving the
Collateral and Lender's rights under this Agreement, Debtor hereby irrevocably
appoints Lender, with full power of substitution, as its attorney-in-fact with
full power and authority, after the occurrence and during the continuance of an
Event of Default, to do any act which Debtor is obligated to do hereunder; to
exercise such rights with respect to the Collateral as Debtor might exercise; to
use such Inventory, Equipment, Fixtures or other property as Debtor might use;
to enter Debtor's premises; to give notice of Lender's security interest in, and
to collect the Collateral; and to execute and file in Debtor's name any
financing statements, amendments and continuation statements necessary or
desirable to perfect or continue the perfection of Lender's security interests
in the Collateral. Debtor hereby ratifies all that Lender shall lawfully do or
cause to be done by virtue of this appointment.
D. AUTHORIZATION FOR LENDER TO TAKE CERTAIN ACTION. The power of
attorney created in Section 7.3 is a power coupled with an interest and shall be
irrevocable. The powers conferred on Lender hereunder are solely to protect its
interests in the Collateral and shall not impose any duty upon Lender to
exercise such powers. Lender shall be accountable only for amounts that it
actually receives as a result of the exercise of such powers and in no event
shall Lender or any of its directors, officers, employees, agents or
representatives be responsible to Debtor for any act or failure to act, except
for gross negligence or willful misconduct. After the occurrence and during the
continuance of an Event of Default, Lender may exercise this power of attorney
without notice to or assent of Debtor, in the name of Debtor, or in Lender's own
name, from time to time in Lender's sole discretion and at Debtor's expense. To
further carry out the terms of this Agreement, after the occurrence and during
the continuance of an Event of Default, Lender may:
1. Execute any statements or documents or take
possession of, and endorse and collect and receive delivery or payment
of, any checks, drafts, notes, acceptances or other instruments and
documents constituting Collateral, or constituting the payment of
amounts due and to become due or any performance to be rendered with
respect to the Collateral.
2. Sign and endorse any invoices, freight or express
bills, bills of lading, storage or warehouse receipts; drafts,
certificates and statements under any commercial or standby letter of
credit relating to Collateral; assignments, verifications and notices
in connection with Accounts; or any other documents relating to the
Collateral, including without limitation the Records.
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<PAGE> 11
3. Use or operate Collateral or any other property of
Debtor for the purpose of preserving or liquidating Collateral.
4. File any claim or take any other action or
proceeding in any court of law or equity or as otherwise deemed
appropriate by Lender for the purpose of collecting any and all monies
due or securing any performance to be rendered with respect to the
Collateral.
5. Commence, prosecute or defend any suits, actions
or proceedings or as otherwise deemed appropriate by Lender for the
purpose of protecting or collecting the Collateral. In furtherance of
this right, upon the occurrence and during the continuance of an Event
of Default, Lender may apply for the appointment of a receiver or
similar official to operate Debtor's business.
6. Prepare, adjust, execute, deliver and receive
payment under insurance claims, and collect and receive payment of and
endorse any instrument in payment of loss or returned premiums or any
other insurance refund or return, and apply such amounts at Lender's
sole discretion, toward repayment of the Indebtedness or replacement of
the Collateral.
E. APPLICATION OF PROCEEDS. Any Proceeds and other monies or property
received by Lender pursuant to the terms of this Agreement or any Loan Document
may be applied by Lender first to the payment of expenses of collection,
including without limitation reasonable attorneys' fees, and then to the payment
of the Indebtedness in such order of application as Lender may elect.
F. DEFICIENCY. If the Proceeds of any disposition of the Collateral are
insufficient to cover all costs and expenses of such sale and the payment in
full of all the Indebtedness, plus all other sums required to be expended or
distributed by Lender, then Debtor shall be liable for any such deficiency.
G. LENDER TRANSFER. Upon the transfer of all or any part of the
Indebtedness, Lender may transfer all or part of the Collateral and shall be
fully discharged thereafter from all liability and responsibility with respect
to such Collateral so transferred, and the transferee shall be vested with all
the rights and powers of Lender hereunder with respect to such Collateral so
transferred, but with respect to any Collateral not so transferred, Lender shall
retain all rights and powers hereby given.
H. LENDER'S DUTIES.
1. Lender shall use reasonable care in the custody
and preservation of any Collateral in its possession. Without
limitation on other conduct which may be considered the exercise of
reasonable care, Lender shall be deemed to have exercised reasonable
care in the custody and preservation of such Collateral if such
Collateral is accorded treatment substantially equal to that which
Lender accords its own property, it being understood that Lender shall
not have any responsibility for ascertaining or taking action with
respect to calls, conversions, exchanges, maturities, declining value,
tenders or other matters relative to any Collateral, regardless of
whether Lender has or is deemed to have knowledge of such matters; or
taking any necessary steps to preserve any rights against any Person
with respect to any Collateral. Under no circumstances shall Lender be
responsible for any injury or loss to the Collateral, or any part
thereof, arising from any cause beyond the reasonable control of
Lender.
2. Lender may at any time deliver the Collateral or
any part thereof to Debtor and the receipt of Debtor shall be a
complete and full acquittance for the Collateral so delivered, and
Lender shall thereafter be discharged from any liability or
responsibility therefor.
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<PAGE> 12
3. Neither Lender, nor any of its directors,
officers, employees, agents, attorneys or any other person affiliated
with or representing Lender shall be liable for any claims, demands,
losses or damages, of any kind whatsoever, made, claimed, incurred or
suffered by Debtor or any other party through the ordinary negligence
of Lender, or any of its directors, officers, employees, agents,
attorneys or any other person affiliated with or representing Lender.
IX. - GENERAL PROVISIONS
A. NOTICES. Any notice given by any party under this Agreement shall be
given in the manner prescribed in the Loan Agreement.
B. BINDING EFFECT. This Agreement shall be binding upon Debtor, its
permitted successors, representatives and assigns, and shall inure to the
benefit of Lender and its successors and assigns.
C. RIGHTS CUMULATIVE. All rights and remedies existing under this
Agreement are cumulative to, and not exclusive of, any other rights or remedies
available under contract or applicable law.
D. UNENFORCEABLE PROVISIONS. Any provision of this Agreement which is
prohibited or unenforceable in any jurisdiction shall be so only as to such
jurisdiction and only to the extent of such prohibition or unenforceability, but
all the remaining provisions of this Agreement shall remain valid and
enforceable.
E. GOVERNING LAW. Except as may be otherwise provided by the Uniform
Commercial Code, this Agreement shall be governed by and construed in accordance
with the laws of the State of California.
F. TERMINATION. Subject to Section 6.2 of this Agreement, upon the
payment in full of the Indebtedness and if Lender has no further obligations
under its Commitment, the security interest granted hereby shall terminate and
all rights to the Collateral shall revert to Debtor. Upon any such termination,
the Lender shall, at Debtor's expense, execute and deliver to Debtor such
documents as Debtor shall reasonably request to evidence such termination.
G. ENTIRE AGREEMENT. This Agreement is intended by Debtor and Lender as
the final expression of Debtor's obligations to Lender in connection with the
Collateral and supersedes all prior understandings or agreements concerning the
subject matter hereof. This Agreement may be amended only by a
10
<PAGE> 13
writing signed by Debtor and accepted by Lender in writing.
IN WITNESS WHEREOF, the parties have executed this Amended and Restated Security
Agreement as of the date set forth in the preamble.
DIGITAL GENERATION SYSTEMS, INC.
By: ___________________________
Name: Thomas P. Shanahan
Title: Chief Financial Officer
VENTURE LENDING & LEASING, INC.
By: ___________________________
Name: Salvador O. Gutierrez
Title: President
11
<PAGE> 1
EXHIBIT 11.1
DIGITAL GENERATIONS SYSTEMS, INC.
STATEMENTS OF COMPUTATION OF WEIGHTED
AVERAGE COMMON SHARES
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1996 1995
-------- -------- -------
<S> <C> <C> <C>
Net loss $(14,775) $ (9,127) $(8,780)
======== ======== =======
Weighted average common shares outstanding 11,893 10,488 898
======== ======== =======
Basic and diluted net loss per, share (1) $ (2.52) $ (0.87) $ (9.78)
======== ======== =======
</TABLE>
(1) For the year ended December 31, 1997, the net loss per share was
computed as net loss of $14,775,000 plus $15,161,000 relating to the
preferred stock deemed dividend (See Note 8 to the Consolidated
Financial Statements) divided by the weighted average common shares
outstanding.
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES OF THE REGISTRANT
The registrant's subsidiaries are PDR Productions, Inc., a New York
Corporation and Mediatech, Inc., a Delaware Corporation.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the
incorporation of our report included in this Form 10-K, into the Company's
previously filed Registration Statement on Form S-8, File No 333-04676.
ARTHUR ANDERSEN LLP
San Jose, CA
March 30, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 7,833
<SECURITIES> 987
<RECEIVABLES> 8,638
<ALLOWANCES> 585
<INVENTORY> 398
<CURRENT-ASSETS> 17,522
<PP&E> 33,874
<DEPRECIATION> (16,308)
<TOTAL-ASSETS> 60,697
<CURRENT-LIABILITIES> 18,401
<BONDS> 11,847
31,561
0
<COMMON> 57,123
<OTHER-SE> (58,235)
<TOTAL-LIABILITY-AND-EQUITY> 60,697
<SALES> 0
<TOTAL-REVENUES> 29,175
<CGS> 0
<TOTAL-COSTS> 42,087
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 246
<INTEREST-EXPENSE> 2,607
<INCOME-PRETAX> (14,775)
<INCOME-TAX> 0
<INCOME-CONTINUING> (14,775)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (14,775)
<EPS-PRIMARY> (2.52)
<EPS-DILUTED> (2.52)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 9,682
<SECURITIES> 10,915
<RECEIVABLES> 3,606
<ALLOWANCES> (257)
<INVENTORY> 0
<CURRENT-ASSETS> 24,114
<PP&E> 20,420
<DEPRECIATION> (7,790)
<TOTAL-ASSETS> 45,248
<CURRENT-LIABILITIES> 9,914
<BONDS> 8,495
0
0
<COMMON> 55,138
<OTHER-SE> (28,299)
<TOTAL-LIABILITY-AND-EQUITY> 45,248
<SALES> 0
<TOTAL-REVENUES> 10,523
<CGS> 0
<TOTAL-COSTS> 19,346
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 97
<INTEREST-EXPENSE> 1,726
<INCOME-PRETAX> (9,127)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,127)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,127)
<EPS-PRIMARY> (0.87)
<EPS-DILUTED> (0.87)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<CASH> 33,593
<SECURITIES> 0
<RECEIVABLES> 1,550
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 35,529
<PP&E> 11,157
<DEPRECIATION> (4,452)
<TOTAL-ASSETS> 42,707
<CURRENT-LIABILITIES> 4,160
<BONDS> 5,060
0
0
<COMMON> 550,470
<OTHER-SE> (21,550)
<TOTAL-LIABILITY-AND-EQUITY> 42,707
<SALES> 0
<TOTAL-REVENUES> 1,894
<CGS> 0
<TOTAL-COSTS> 4,218
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 33
<INTEREST-EXPENSE> 327
<INCOME-PRETAX> (2,388)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,324)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,388)
<EPS-PRIMARY> (0.33)
<EPS-DILUTED> (0.33)
</TABLE>
