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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
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)
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<S> <C>
CALIFORNIA 94-3140772
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
</TABLE>
875 BATTERY STREET
SAN FRANCISCO, CALIFORNIA 94111
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(415) 276-6600
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
NOT APPLICABLE
(FORMER NAME, FORMER ADDRESS, FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Number of shares of registrant's Common Stock, without par value,
outstanding as of August 14, 1998: 22,261,436
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DIGITAL GENERATION SYSTEMS, INC.
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Actual results could differ materially from those
indicated in the forward-looking statements as a result of certain factors,
including those set forth under "Certain Business Considerations" in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and elsewhere in this Form 10-Q.
TABLE OF CONTENTS
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PAGE
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements........................................ 3
Condensed Consolidated Balance Sheets at June 30, 1998 and
December 31, 1997......................................... 3
Condensed Consolidated Statements of Operations for the
three and six months ended June 30, 1998 and 1997......... 4
Condensed Consolidated Statements of Cash Flows for the six
months ended June 30, 1998 and 1997....................... 5
Notes to Condensed Consolidated Financial Statements........ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 23
Item 2. Changes in Securities....................................... 23
Item 3. Defaults upon Senior Securities............................. 23
Item 4. Submission of Matters to a Vote of Security Holders......... 23
Item 5. Other Information........................................... 23
Item 6. Exhibits and Reports on Form 8-K............................ 24
SIGNATURES.................................................. 27
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIGITAL GENERATION SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ASSETS
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<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
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CURRENT ASSETS:
Cash and cash equivalents................................. $ 4,188 $ 7,833
Short-term investments.................................... -- 987
Accounts receivable, net.................................. 8,683 8,053
Prepaid expenses and other................................ 557 649
-------- --------
Total current assets.............................. 13,428 17,522
-------- --------
PROPERTY AND EQUIPMENT, at cost:
Network equipment......................................... 31,112 30,405
Office furniture and equipment............................ 3,082 2,963
Leasehold improvements.................................... 555 506
-------- --------
34,749 33,874
Less -- Accumulated depreciation and amortization......... (21,357) (16,308)
-------- --------
Property and equipment, net....................... 13,392 17,566
-------- --------
GOODWILL AND OTHER ASSETS, net.............................. 25,088 25,609
-------- --------
$ 51,908 $ 60,697
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 3,020 $ 4,506
Accrued liabilities....................................... 3,964 3,501
Line of credit............................................ 1,672 2,834
Current portion of long-term debt......................... 7,915 7,560
-------- --------
Total current liabilities......................... 16,571 18,401
-------- --------
LONG-TERM DEBT, net of current portion...................... 12,025 11,847
-------- --------
SHAREHOLDERS' EQUITY:
Convertible preferred stock, no par value --
Authorized -- 15,000,000 at June 30, 1998; 5,000,000 at
December 31, 1997....................................
Outstanding -- 4,950,495 at June 30, 1998 and December
31, 1997.............................................. 31,561 31,561
Common stock, no par value --
Authorized -- 40,000,000 shares at June 30, 1998 and
30,000,000 shares at December 31, 1997................
Outstanding -- 12,216,249 shares at June 30, 1998 and
12,122,679 shares at December 31, 1997................ 57,208 57,123
Receivable from issuance of common stock.................. (175) (175)
Accumulated deficit....................................... (65,282) (58,060)
-------- --------
Total shareholders' equity........................ 23,312 30,449
-------- --------
$ 51,908 $ 60,697
======== ========
</TABLE>
The accompanying notes are an integral part of
these condensed consolidated financial statements.
3
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DIGITAL GENERATION SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1998 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ------------------
1998 1997 1998 1997
------- ------- ------- -------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
REVENUES............................................ $10,097 $ 5,405 $19,971 $10,011
------- ------- ------- -------
COSTS AND EXPENSES:
Delivery costs.................................... 3,666 1,813 7,412 3,288
Customer operations............................... 3,468 2,104 7,043 4,239
Sales and marketing............................... 1,235 1,126 2,499 2,141
Research and development.......................... 601 620 1,189 1,268
General and administrative........................ 1,015 637 2,044 1,241
Depreciation and amortization..................... 2,880 1,968 5,713 3,733
------- ------- ------- -------
Total expenses............................ 12,865 8,268 25,900 15,910
------- ------- ------- -------
LOSS FROM OPERATIONS................................ (2,768) (2,863) (5,929) (5,899)
------- ------- ------- -------
OTHER INCOME (EXPENSE):
Interest income................................... 45 215 114 466
Interest expense.................................. (696) (553) (1,407) (1,064)
------- ------- ------- -------
NET LOSS............................................ $(3,419) $(3,201) $(7,222) $(6,497)
======= ======= ======= =======
BASIC AND DILUTED NET LOSS PER COMMON SHARE......... $ (0.28) $ (0.27) $ (0.59) $ (0.55)
======= ======= ======= =======
WEIGHTED AVERAGE COMMON SHARES...................... 12,216 11,733 12,196 11,710
======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of
these condensed consolidated financial statements.
4
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DIGITAL GENERATION SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997
(IN THOUSANDS)
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SIX MONTHS ENDED
JUNE 30,
------------------
1998 1997
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(UNAUDITED)
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(7,222) $(6,497)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization of property and
equipment........................................... 5,059 3,519
Amortization of goodwill and intangibles............. 654 213
Provision for doubtful accounts...................... 83 89
Changes in operating assets and liabilities --
Accounts receivable............................... (713) (630)
Prepaid expenses and other assets................. (41) (369)
Accounts payable and accrued liabilities.......... (1,033) (402)
------- -------
Net cash used in operating activities............. (3,223) (4,077)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of short-term investments........................ (2,003) (6,848)
Maturities of short-term investments...................... 3,000 11,816
Acquisition of property and equipment..................... (874) (3,036)
------- -------
Net cash provided by investing activities......... 113 1,932
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock.................... 85 50
Proceeds from line of credit.............................. 6,985 --
Payments on line of credit................................ (8,147) --
Proceeds from issuance of long-term debt.................. 4,465 3,706
Payments on long-term debt................................ (3,933) (2,062)
------- -------
Net cash provided by (used in) financing
activities....................................... (545) 1,694
------- -------
NET DECREASE IN CASH AND CASH EQUIVALENTS................... (3,645) (451)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD............ 7,833 9,682
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 4,188 $ 9,231
======= =======
SUPPLEMENTAL CASH FLOW INFORMATION
Property and equipment financed with capitalized lease
obligations............................................ $ -- $ 400
</TABLE>
The accompanying notes are an integral part of
these condensed consolidated financial statements.
5
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DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The financial statements included herein have been prepared by the Company,
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. However, the Company believes that the disclosures are adequate to
make the information presented not misleading. These condensed consolidated
financial statements should be read in conjunction with the financial statements
and the notes thereto included in the Company's financial statements included in
the Company's Annual Report on Form 10-K for the year ended December 31, 1997.
The unaudited condensed consolidated financial statements included herein
reflect all adjustments (which include only normal, recurring adjustments) which
are, in the opinion of management, necessary to state fairly the results for the
three and six month periods ended June 30, 1998. The results for the three and
six month periods ended June 30, 1998, are not necessarily indicative of the
results expected for the full fiscal year.
2. 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 June 30, 1998 and December 31, 1997, cash and cash
equivalents consist principally of U.S. Treasury bills and various money market
accounts; as a result, the amortized purchase cost approximates the fair market
value. As of December 31, 1997, 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.
3. ACQUISITION
On July 18, 1997, the Company acquired 100% of the capital stock of Starcom
Mediatech, Inc. ("Mediatech"), a wholly owned subsidiary of IndeNet, Inc.
("IndeNet"), for consideration totaling approximately $25.8 million ("Mediatech
Acquisition"). The consideration consisted of approximately $14.0 million in
cash, 324,355 shares of the Company's Common Stock, a $2.2 million subordinated
promissory note bearing interest at 9% payable to IndeNet (the "Company Note"),
a $2.2 million secured subordinated promissory note bearing interest at 9%
payable to Thomas H. Baur, a creditor of IndeNet (the "Baur Note"), and the
Company assumed approximately $5.4 million of existing Mediatech debt. Mediatech
is a media duplication and distribution company whose principal offices are
located in Chicago, Illinois. On October 27, 1997, as provided for in the
purchase agreement, the Company and IndeNet agreed to reduce the aggregate
purchase price by $625,000 based on Mediatech's financial position at the
acquisition date.
The 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 $432,000 is included in the
consolidated statement of operations for the six months ended June 30, 1998. 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.
6
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DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PRO FORMA RESULTS
The following table reflects unaudited pro forma combined results of
operations of the Company including Mediatech on the basis that the acquisition
of Mediatech had taken place at the beginning of the first fiscal period
presented:
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<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------ ------------------
1998 1997 1998 1997
------- ------- ------- -------
(IN THOUSANDS EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenues.................................... $10,097 $11,241 $19,971 $21,957
Net Loss.................................... (3,419) (3,926) (7,222) (8,183)
Net Loss per Share.......................... $ (0.28) $ (0.33) $ (0.59) $ (0.70)
Number of Shares used in Computation........ 12,216 11,733 12,196 11,710
</TABLE>
The unaudited pro forma combined results of operations are not necessarily
indicative of the actual results that would have occurred had the acquisition of
Mediatech been consummated at the beginning of 1997, or of future operations of
the combined companies under the ownership and management of the Company.
4. SUBSEQUENT EVENTS
PRIVATE PLACEMENT OF COMMON STOCK
In July and August 1998, the Company's Board of Directors authorized the
sale and issuance of up to $ 13.0 million worth of Common Stock in a private
placement transaction. The Company has received subscriptions from current
institutional and closely associated investors for approximately 4.6 million
shares. These additional common shares will be issued at $2.80 per share. Total
proceeds to the Company, net of issuance costs, will be approximately $12.7
million. The proceeds of this subscription were held in escrow pending the
closing of the transaction on August 14, 1998.
CONVERSION OF PREFERRED STOCK TO COMMON STOCK
In July 1998, the Company's Board of Directors authorized conversion of all
the Company's Series A Preferred Stock to Common Stock pursuant to the terms of
the Series A Preferred Stock Conversion Agreement effective August 12, 1998.
Each Series A Preferred Shareholder will receive 1.1 shares of Common Stock for
each Preferred share converted. The Company's Board deemed this action necessary
and appropriate in order to assure conversion by these shareholders which held
certain preferred stock rights which could have delayed the closing of the
Private Placement transaction discussed above.
The conversion of the Series A Preferred Stock to Common Stock at a ratio
greater than 1:1 results in a deemed dividend equal to the value of the
additional shares granted to the Preferred Shareholders on the date of
conversion. This deemed dividend will be considered a reduction in earnings in
the computation of basic and diluted earnings per share for the quarter ended
September 30, 1998.
7
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DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PRO FORMA RESULTS
The following table presents selected unaudited pro forma Consolidated
Balance Sheet data for the Company as if the above transactions described above
in the subsequent events note took place effective June 30, 1998 compared to the
actual Consolidated Balance Sheet as of June 30, 1998 per the financial
statements in this Form 10-Q:
<TABLE>
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PER JUNE 30, 1998 PRO FORMA JUNE 30, 1998
BALANCE SHEET BALANCE SHEET
----------------- -----------------------
<S> <C> <C>
Cash and Cash Equivalents....................... $ 4,188 $15,638
Short term notes receivable..................... -- 1,250
Total Assets.................................... $51,908 $64,608
Preferred Stock
Outstanding -- 4,950,495 shares at 6/30/98
Pro forma outstanding -- none at 6/30/98... 31,561 15,161
Common Stock
Outstanding -- 12,216,249 shares at 6/30/98
Pro forma outstanding -- 22,251,081 at
6/30/98.................................... 57,208 87,948
Total Shareholders' Equity...................... 23,312 36,012
Total Liabilities and Shareholders' Equity...... $51,908 $64,608
</TABLE>
8
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations contains forward-looking statements that involve risks
and uncertainties. Actual results could differ materially from those indicated
in the forward-looking statements as a result of certain factors, including
those set forth under "Certain Business Considerations in Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
elsewhere in this Form 10-Q.
The following table presents unaudited financial information expressed as a
percentage of total revenues and operating data for the period indicated. The
information and operating data has been prepared by the Company on a basis
consistent with the Company's audited financial statements and includes all
adjustments, consisting only of normal recurring adjustments, that management
considers necessary for a fair presentation for the periods presented. The
operating results for any period presented should not be relied on as indicative
of results for any future period.
STATEMENTS OF OPERATIONS:
<TABLE>
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THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ----------------
1998 1997 1998 1997
------ ------ ----- -----
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Revenues...................................... 100.0% 100.0% 100.0% 100.0%
Costs and Expenses:
Delivery and material costs................. 36.3 33.5 37.1 32.8
Customer operations......................... 34.3 38.9 35.3 42.3
Sales and marketing......................... 12.2 20.8 12.5 21.4
Research and development.................... 6.0 11.5 6.0 12.7
General and administrative.................. 10.1 11.8 10.2 12.4
Depreciation and amortization............... 28.5 36.4 28.6 37.3
----- ----- ----- -----
Total expenses........................... 127.4 152.9 129.7 158.9
----- ----- ----- -----
Loss from operations.......................... (27.4) (52.9) (29.7) (58.9)
Other income (expense):
Interest income............................. 0.4 4.0 0.6 4.7
Interest expense............................ (6.9) (10.2) (7.0) (10.6)
----- ----- ----- -----
Net loss...................................... (33.9)% (59.1)% (36.1)% (64.8)%
===== ===== ===== =====
</TABLE>
ACQUISITION
In July 1997, the Company acquired 100% of the capital stock of Starcom
Mediatech, Inc. ("Mediatech"), a wholly owned subsidiary of IndeNet, Inc. with
operating facilities in Chicago, Los Angeles, New York and Louisville.
Mediatech's primary operations are services typical of a traditional dub and
ship house, including the physical duplication and distribution of audio and
video content on a wide range of tape formats and performance of a variety of
audio and video editing services. 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 of the closing of the transactions, July
18, 1997.
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Revenues
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- ------------------
1998 1997 1998 1997
-------- ------- ------- -------
(IN THOUSANDS) (IN THOUSANDS)
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Audio Distribution........................... $ 4,611 $3,363 $ 8,258 $ 6,028
Video Distribution........................... 3,145 1,396 6,375 2,679
Ancillary Post-Production Services and
Other Services............................. 2,341 646 5,338 1,304
------- ------ ------- -------
Total Revenues..................... $10,097 $5,405 $19,971 $10,011
======= ====== ======= =======
</TABLE>
Revenues were $10,097,000, for the three months ended June 30, 1998, an 87%
increase from $5,405,000 for the three months ended June 30, 1997, and revenues
for the six months ended June 30, 1998 were $19,971,000, a 99% increase from
$10,011,000 for the six months ended June 30, 1997. This revenue growth is due
to increases of 60% and 61% in the combined volume of audio and video deliveries
performed as well as the addition of revenue for other services now offered by
the Company for the three and six months ended June 30, 1998 over the same
periods in 1997. Of the total volume increases, for the three and six months
ended June 30, 1998, approximately, 76% and 71% respectively, relate to orders
delivered through the DG Systems Network Operating Center ("NOC") in San
Francisco, primarily as a result of orders received at the former Mediatech
facilities. The Company believes that the increases in delivery volumes are due
to a number of factors, including the increased acceptance of the services
offered by the Company, the increased availability of an expanded network of
Company equipment located in radio and television stations and the increased
market presence resulting from the Mediatech acquisition and the November 1996
acquisition of PDR Productions, Inc. ("PDR").
Average revenue per audio delivery decreased approximately 5% and 4% in the
three and six months ended June 30, 1998, versus the three and six months ended
June 30, 1997, respectively. The decreases are due primarily to changes in the
mix of digital audio distribution services provided, particularly an increase in
the proportion of deliveries made as a result of orders for the Company's
Economy Service. This service, which guarantees delivery by noon of the second
business day following the order, accounted for approximately 23% and 22% of
digital audio deliveries in the quarter and six months ended June 30, 1998
versus 17% and 18%, respectively, in the same periods of 1997. The Company
attributes this fluctuation to increased use of the Company's services for
routine distribution in addition to selective usage of the Company's more
expensive premium services. The other audio service categories had smaller
fluctuations versus the prior year periods.
Average revenue per video delivery decreased approximately 9% and 7% for
the three months and six months ended June 30, 1998 from the three and six
months ended June 30, 1997. The average price per delivery for the three months
ended June 30, 1998 is based on the significantly higher revenues resulting from
increased digital and physical delivery volume, including deliveries made
directly from the former Mediatech facilities. The decrease in average revenue
per video delivery is due to changes in the mix of video delivery services
provided and the related customer pricing agreements resulting from the
acquisition of Mediatech.
For the three and six months ended June 30, 1998, revenues included
approximately $2.3 million and $5.3 million, respectively, from other services
provided by the Company, primarily as a result of the Mediatech acquisition. For
the three months ended June 30, 1998, this revenue consisted of $.7 million for
corporate duplication, $.8 million for post-production services, and $.8 million
for satellite distribution services. For the six months ended June 30, 1998,
revenues included approximately $1.9 million for corporate duplication, $1.7
million for post-production services, and $1.7 million for satellite
distribution services.
10
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Delivery and Material Costs
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ----------------
1998 1997 1998 1997
------- ------- ------ ------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C>
Audio Distribution.............................. $1,123 $ 960 $1,961 $1,696
Video Distribution.............................. 1,641 668 3,148 1,340
Ancillary Post-Production Services and
Other Services................................ 902 185 2,303 252
------ ------ ------ ------
Total Delivery and Materials Costs.... $3,666 $1,813 $7,412 $3,288
====== ====== ====== ======
</TABLE>
Delivery and material costs were $3,666,000 for the three months ended June
30, 1998, a 102% increase from the $1,813,000 for the three months ended June
30, 1997. Delivery and materials costs were $7,412,000 for the six months ended
June 30, 1998 a 125% increase from the $3,288,000 for the six months ended June
30, 1997. The increase in costs in each period versus the same period of the
prior year is primarily due to the increased delivery volumes, as well as the
addition of the direct costs related to the other services now provided by the
Company, in particular, as a result of the Mediatech acquisition. The increased
costs include both delivery expenses and direct materials costs required when
physically duplicating an audio or video spot as well as the direct materials
and fees paid to other service providers in connection with ancillary post-
production services and other services offered by the Company.
Delivery and material costs as a percentage of revenues increased to 36% of
revenues from 34% of revenues in the quarters ended June 30, 1998 and 1997,
respectively; and increased to 37% of revenues from 33% of revenues in the six
months ended June 30, 1998 and 1997, respectively. The increases 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 acquisition of Mediatech and the ramp
up of the video distribution service. The Company's audio distribution services
are performed primarily 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 delivery and material costs as a percentage of audio revenues
decreased to approximately 24% from approximately 29% in the three months ended
June 30, 1998, and 1997, respectively; and decreased to approximately 24% from
28% in the six months ended June 30, 1998, and 1997, respectively. This decrease
is primarily the result of improvements in cost per electronic delivery
resulting from rate improvements when the Company renewed its contract with its
primary telephone service provider in May 1997.
Video delivery and material costs as a percentage of video revenues has
increased to approximately 52% from 48% in the three months ended June 30, 1998,
and 1997, respectively; and decreased to approximately 49% from 50% in the six
months ended June 30, 1998, and 1997, respectively. The increase in costs as a
percentage of revenues in the quarter ended June 30, 1998 is due primarily to an
increase in the volume of deliveries being performed electronically through the
Company's NOC. Such deliveries increased by approximately 52% for both the three
and six months ending June 30, 1998 over the same periods in the prior year.
Although costs per NOC video delivery were significantly reduced versus those of
the same periods in the prior year, these deliveries are still cost more than
traditional physical delivery because volume has not yet reached the levels
necessary to efficiently cover the fixed costs related to such deliveries.
Approximately 48% and 64% of the Company's video deliveries were made through
the NOC in the three and six months ended June 30, 1998 as opposed to
approximately 19% and 14% in the same three and six month periods of 1997.
Delivery and material costs related to the other services provided by the
Company were 39% and 43% of the associated revenue for the three and six months
ended June 30, 1998, and 29% and 19% of the associated revenues for the three
and six months ended June 30, 1997, respectively. 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
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.
11
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Customer Operations
Customer operations expenses were $3,468,000 and $2,104,000 for the
quarters ended June 30, 1998 and 1997, respectively, and $7,043,000 and
$4,239,000 for the six months ended June 30, 1998 and 1997, respectively. These
increases are primarily the result of the consolidation of the costs of the
former Mediatech operations. In addition, expenses have increased versus the
same periods of the prior year due to the addition of the personnel necessary to
respond to the greater volume of orders and deliveries. Additional costs are
primarily the labor and overhead expenses of personnel involved in customer and
technical support and fulfillment of orders for all services offered by the
former Mediatech locations.
Customer operations expenses as a percentage of revenues decreased to 34%
from 39% of revenues in the quarters ended June 30, 1998 and 1997, respectively;
and decreased to 35% of revenues from 42% of revenues in the six months ended
June 30, 1998 and 1997, respectively. These decreases are primarily due to the
reduced cost of customer operations as a percentage of revenues for orders
processed through the Company's NOC, which serves as the primary support for the
digital network. These improvements in cost as a percentage of revenues,
however, were offset slightly by the impact of the relatively more expensive
customer operations expenses of the Company's other facilities, which have a
different cost structure in order to provide the additional services offered at
these locations.
The Company believes that in order to compete effectively and manage future
growth it will be necessary to continue to implement changes which improve and
increase the efficiency of its customer operations.
Sales and Marketing
Sales and marketing expenses were $1,235,000 for the three months ended
June 30, 1998, a 10% increase from $1,126,000 for the quarter ended June 30,
1997, and increased 17% to $2,499,000 from $2,141,000 in the six months ended
June 30, 1998 and 1997, respectively. The increase in sales and marketing
expenses in the quarter and six months ended June 30, 1998 is due primarily to
the consolidation of the costs of the former Mediatech sales group. However,
sales and marketing expenses as a percentage of revenues was reduced to 12% from
21% of revenues for the three months ended June 30, 1998 and 1997, respectively
and was reduced to 13% from 21% of revenues for the six months ended June 30,
1998 and 1997, respectively. The Company united its sales forces in 1997 and
believes it is now more capable of effectively and efficiently marketing 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.
Research and Development
Research and development expenses decreased 3% to $601,000 for the quarter
ended June 30, 1998 from $620,000 for the quarter ended June 30, 1997, and
decreased 6% to $1,189,000 from $1,268,000 for the six months ended June 30,
1998 and June 30, 1997 respectively. The decrease is primarily due to a
reduction in development and testing costs, principally frame relay and
satellite transmission testing, versus those incurred in the three and six
months ended June 30, 1997 to prepare the NOC for video delivery. The decreased
testing costs were partially offset by other spending increases, primarily
engineering labor costs.
The Company expects that additional research and development spending will
be necessary 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.
General and Administrative
General and administrative expenses increased 59% to $1,015,000 for the
quarter ended June 30, 1998, from $637,000 for the quarter ended June 30, 1997;
and increased 65% to $2,044,000 from $1,241,000 in the six months ended June 30,
1997. The increase is primarily due to the consolidation of the costs of certain
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former Mediatech staff, as well as system conversion costs for consolidating and
upgrading the Company's order entry, billing and financial reporting systems.
The Company expects to continue to spend on the consolidation and upgrade of the
Company's systems over the course of 1998 to improve reporting and operating
efficiency.
Depreciation and Amortization
Depreciation and amortization expenses increased 46% to $2,880,000 in the
quarter ended June 30, 1998 from $1,968,000 in the quarter ended June 30, 1997;
and increased 53% to $5,713,000 for the six months ended June 30, 1998 from
$3,733,000 for the six months ended June 30, 1997. These increases are due to
the continued expansion of the Company's network. The Company's total investment
in network equipment has increased 47% to $31.1 million at June 30, 1998, from
$21.2 million at June 30, 1997. In particular, the Company has acquired
approximately $7.5 million of network equipment as a result of the acquisition
of Mediatech, has made capital additions of approximately $2.2 million between
June 30, 1997 and June 30, 1998, in support of its video delivery service plan,
and has increased the number of units located at broadcast stations at June 30,
1998. In addition, amortization expense increased by $220,000 and $440,000 in
the three and six months ended June 30, 1998 over the same periods last year, as
a result of the goodwill recorded in connection with the July 1997 acquisition
of Mediatech.
The Company expects to continue to invest in the expansion of its network.
In particular, the Company is in the process of expanding its infrastructure
within the television broadcast industry that will require additional DG Video
Transmission Systems and Digital Video Playback Systems 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.
Interest Income and Interest Expense
Interest income decreased 79% to $45,000 in the quarter ended June 30, 1998
from $215,000 for the quarter ended June 30, 1997 and decreased 76% to $114,000
for the six months ended June 30, 1998, from $466,000 in the six months ended
June 30, 1997. These decreases are primarily the result of reductions in the
levels of cash and cash equivalents and short-term investments versus the same
periods of the prior year. The Company's initial public offering was completed
in February 1996 and since that time the offering's proceeds have been used to
fund the Company's operating, investing and financing activities. The Company
expects that interest income will fluctuate in the future based on the levels of
cash raised and used in the Company's operations.
Interest expense increased 26% to $696,000 for the quarter ended June 30,
1998, from $553,000 in the quarter ended June 30, 1997 and increased 32% to
$1,407,000 for the six months ended June 30, 1998, from $1,064,000 for the six
months ended June 30, 1997. The increases are due primarily to interest expense
totaling $213,000 on the term debt and line of credit assumed in conjunction
with the Mediatech acquisition, as well as $127,000 of interest expense on the
promissory notes given as consideration in the July 1997 acquisition of
Mediatech. The remaining increases result from interest expense incurred from
leasing and loan agreements used to fund the acquisition of components and
equipment needed to develop the Company's network and to provide Company
personnel with the capital resources necessary to support the Company's business
growth. Debt outstanding under these agreements has increased to $14.9 million
at June 30, 1998 from $14.2 million at June 30, 1997. The Company expects
interest expense will increase in the future based on the increased levels of
borrowing.
Liquidity and Capital Resources
Net cash used in operating activities, including the adjustment for
depreciation and amortization, decreased to $3.2 million in the six months ended
June 30, 1998 from $4.1 million in the six months ended June 30, 1997. This
change is primarily the result of a reduced net loss, exclusive of depreciation
and amortization. The Company's earnings before interest, taxes and depreciation
improved from a loss of
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$2.2 million for the six months ended June 30, 1997 to a loss of $216,000 for
the six months ended June 30, 1998.
The Company used cash of $874,000 for the purchase of property and
equipment in the six months ended June 30, 1998. In the six months ended June
30, 1997, the Company used cash of $3.0 million for the purchase of property and
equipment. The capital additions for both periods were the result of the
Company's continued expansion of its network. As the primary video network
infrastructure is now in place, fiscal 1998 capital equipment additions are not
expected to reach the levels of fiscal 1997.
Principal payments on long-term debt were $3.9 million for the six months
ended June 30, 1998 versus $2.1 million in the six months ended June 30, 1997.
Such payments increased due primarily to $450,000 of payments on other long-term
debt of Mediatech assumed by the Company in conjunction with the Mediatech
acquisition and principal payments of $400,000 on the promissory notes issued in
connection with the Mediatech acquisition. In addition, there was an increase in
regularly scheduled repayment of the increased capital lease liability and term
debt incurred to finance equipment and property acquisitions.
At June 30, 1998, the Company's current sources of liquidity included cash
and cash equivalents of $4.2 million and $1.7 million available to finance
capital expenditures under a long-term credit facility which can be drawn
against until December 1998. Mediatech 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. During the six months ended June 30, 1998,
$1.2 million of net paydown was made on the line of credit, and the outstanding
balance at June 30, 1998 of $1,672,000 was 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.
As discussed in the Notes to the Condensed Consolidated Financial
Statements, in August 1998 the Company raised approximately $12.7 million
through a Private Placement of Common Stock. The Company expects to use these
proceeds to fund the Company's operating, investing and financing requirements.
The Company believes that its current sources of liquidity will satisfy the
Company's projected working capital, capital lease and term loan commitments and
other cash requirements through June 1999.
CERTAIN BUSINESS CONSIDERATIONS
The Company's business is subject to the following risks in addition to
those described elsewhere in this Form 10-Q.
History of Losses; Future Operating Results Uncertain. The Company was
founded in 1991 and has been unprofitable since its inception. The Company
expects to generate continued, but decreased net losses for the next several
quarters. As of June 30, 1998, the Company's accumulated deficit was $65.3
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
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on the Company's business, operating results and financial position. In
addition, the Company believes that in order to more fully address the needs of
potential video delivery customers it will need to develop a set of ancillary
services which 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, the Series A
Convertible Preferred Stock financing and the August 1998 private placement of
Common Stock, 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
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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.
Potential for Additional Nasdaq Review. In connection with the potential
delisting of the Company's securities from the Nasdaq National Market, as
explained further in "Part II. Item 5. Other Information - Nasdaq National
Market Listing Qualifications", the Company received a letter from Nasdaq on
August 12, 1998, containing a written decision allowing the continued inclusion
of the Company's Common Stock on the Nasdaq National Market based upon the
determination of the Nasdaq Listing Qualifications Panel (the "Nasdaq Panel")
after a hearing was held on August 7, 1998. However, in accordance with Nasdaq
rules, the Nasdaq Listing and Hearing Review Council (the "Review Council") may,
on its own motion, determine to review any Nasdaq Panel decision within 45
calendar days after issuance of the written decision. If the Review Council
determines to review any aspect of the decision of the Nasdaq Panel, it may
affirm, modify, reverse, dismiss, or remand the decision to the Nasdaq Panel.
The holders of the registered Common Stock of the Company currently enjoy
a substantial benefit in terms of liquidity by having such Common Stock listed
on the Nasdaq National Market trading system which would be lost if the Company
were to be delisted. While the Company fully expects to comply with the written
decision of Nasdaq, and to be able to demonstrate compliance with all
requirements for the continued listing on the Nasdaq National Market and does
not expect any further review of this matter, there can be no assurance that the
Company will be able to continue to have its registered Common Stock listed on
the Nasdaq National Market or similar public securities exchange.
Concentration of Stock Ownership; Antitakeover Provisions. At June 30, 1998
present executive officers and directors of the Company and their respective
affiliates own approximately 41% 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. After
the August 1998 closing of the private placement of the Company's Common Stock
and the conversion of all of the Series A Preferred Stock, as described in Note
4 of the Condensed Consolidated Financial Statements, the ownership will be
approximately 35%. 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 Preferred Stock. As of June 30, 1998, the Company
had 5,000,000 shares of Series A Convertible Preferred Stock (the "Series A
Preferred") authorized of which 4,950,495 shares were then issued and
outstanding. The rights of such Series A Preferred included certain rights and
preferences set forth in the Company's Certificate of Determination of Rights of
Series A Convertible Preferred Stock. At the Company's 1998 Annual Meeting of
Shareholders held on April 29, 1998, the Company's shareholders approved an
amendment to the Company's Articles of Incorporation which increased the
authorized number of shares of the Company's Preferred Stock to 15,000,000. On
August 12, 1998 holders of all the outstanding shares of Series A Preferred
elected to convert such shares of Series A Preferred into shares of the
Company's Common Stock, as further described in "Part II. Item 5. Other
Information - Nasdaq National Market Listing Qualifications". Accordingly,
pursuant to the Company's articles of incorporation, the Company's Board of
Directors has the authority to issue up to 10,049,505 additional shares of
Preferred Stock and may divide such 10,049,505 remaining authorized shares of
Preferred Stock into any number of series, to fix the number of and determine
the rights, preferences, privileges and restrictions granted to or imposed upon,
any such series.
The rights of the holders of the Company's Common Stock will be subject to,
and may be adversely affected by, the rights of the holders of any such
Preferred Stock that may be issued in the future. In addition, the issuance of
such Preferred Stock may have the effect of delaying, deferring or preventing a
change of control of the Company without any further action by the shareholders
and may adversely affect the voting and other rights of the holders of the
Company's Common Stock. The provisions of such Preferred Stock could also have
the effect of limiting the price that investors might be willing to pay in the
future for shares of the Company's Common Stock. While the Company has no
present plans to issue shares of Preferred Stock, there can be no assurance that
such shares of Preferred Stock will not be issued in the future in accordance
with the terms and conditions that the Board of Directors deems to be in the
best interests of the Company and its shareholders.
Registration Rights. In connection with the sale of shares of the
Company's Common Stock which occurred on August 14, 1998 as described further in
"Part II. Item 5. Other Information - Nasdaq National Market Listing
Qualifications", the Company has agreed to file a registration statement with
the SEC for the purposes of registering the re-sale of such shares and to list
such shares on the Nasdaq National Market. The Company presently intends to
begin such registration process within 60 days of the closing of the sale of
the shares of its Common Stock and has granted demand registration rights
exercisable no earlier than 60 days from the closing of the sale of such shares.
In addition, certain other holders of the Company's Common Stock including
former holders of the Company's Series A Preferred, previously have been granted
similar demand and piggy-back registration rights. Following the successful
completion of such registration and listing processes, such additional shares of
the Company's Common Stock will be freely tradable in the public market, subject
to volume limitations applicable to affiliates of the Company. Sales of a
substantial number of additional shares in the public market could adversely
affect the market price of the Company's Common Stock and could impair the
Company's future ability to raise capital through the sale of its equity
securities.
Dependence on Emerging Markets. The market for the electronic delivery of
digital audio and video transmissions by advertisers, advertising agencies,
production studios, and video and music distributors to radio and television
stations, is relatively new and alternative technologies are rapidly evolving.
The Company's marketing task requires it to overcome buyer inertia related to
the diffuse and relatively low level decision making regarding an agency's
choice of delivery services 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
maintaining compliance with industry standards, with the Company's existing
network. Work in TV station system interface includes implementation of various
system control protocols and improvements of the 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
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meet the Company's future delivery commitments and broadcast quality
requirements and to do so on a cost-effective basis. See "Dependence on Certain
Suppliers."
The introduction of products embodying new technologies can render existing
products obsolete or unmarketable. There can be no assurance that the Company
will be successful in identifying, developing, contracting for the manufacture
of, and marketing product enhancements or new products that respond to
technological change, that the Company will not experience difficulties that
could delay or prevent the successful development, introduction and marketing of
these products, or that its new products and product enhancements will
adequately meet the requirements of the marketplace and achieve market
acceptance. Delays in the commencement of commercial availability of new
products and services and enhancements to existing products and services may
result in customer dissatisfaction and delay or loss of revenue. If the Company
is unable, for other reasons, to develop and introduce new products and services
or enhancements of existing products and services in a timely manner or if new
versions of existing products do not achieve a significant degree of market
acceptance, there could be a material adverse effect on the Company's business,
financial condition and results of operations.
Dependence on Radio Advertising. 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 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
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Company competes with a variety of dub and ship houses and production studios
that have traditionally distributed taped advertising spots via physical
delivery. Although such dub and ship houses and production studios do not
currently offer electronic delivery, they have long-standing ties to local
distributors that will be difficult for the Company to replace. Some of these
dub and ship houses and production studios have greater financial, distribution
and marketing resources and have achieved a higher level of brand recognition
than the Company. Digital Courier International Corporation ("DCI") has deployed
a system to electronically deliver audio content in Canada and the United
States. 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 addition, the Company has learned that
DCI was recently placed in receivership and potentially could be sold. If DCI
were to be sold to one of the Company's current competitors, or a company with
greater resources desiring entry to this market, it could adversely impact the
Company's ability to compete in the market for the delivery of audio content as
well as the other markets served by the Company.
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 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.
18
<PAGE> 19
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.
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. The Company has done a
preliminary assessment of the components and applications of its Network and has
determined that a number of these components are year 2000 compliant. The
Company has begun taking the steps it believes are necessary to make the
remainder of the network and related applications as well as the other systems
utilized by the Company year 2000 compliant. Although the Company currently
does not anticipate that the resource requirements or expenses related to these
procedures will have a material affect on its operating results or financial
position, there can be no assurance that such steps will be successful. In
addition, although the Company has direct programming control over its Network
applications and believes 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 effect on the Company's
business, financial condition and results of operations.
Potential Fluctuations in Quarterly Results; Seasonality. The Company's
quarterly operating results have in the past and may in the future vary
significantly depending on factors such as the volume of advertising in response
to seasonal buying patterns, the timing of new product and service
introductions, increased competition, the timing of the Company's promotional
efforts, general economic factors, and other factors. For example, the Company
has historically experienced lower sales in the first quarter and higher sales
in the fourth quarter, due to increased customer advertising volumes for the
Christmas selling season. As a result, the Company believes that period to
period comparisons of its results of operations are not necessarily meaningful
and should not be relied upon as an indication of future performance. In any
period, the Company's revenues and delivery costs are subject to variation based
on changes in the volume and mix of deliveries performed during the period. In
particular, the Company's operating results have historically been significantly
influenced by the volume of deliveries ordered by television stations during the
"Sweeps" rating periods that currently take place in February, May, August and
November. The increased volume of these deliveries during such periods and the
Company's pricing for "Sweeps" advertisements have historically increased the
total revenues and revenues per delivery of the Company and tended to reduce
delivery costs as a percentage of revenues. The Company's expense levels are
based, in part, on its expectations of future sales levels. If sales levels are
below expectations, operating results are likely to be materially adversely
affected. In addition, the Company has historically operated with little or no
backlog. The absence of backlog increases the difficulty of predicting sales and
operating results. Fluctuations in sales due to seasonality may become more
pronounced as the growth rate of the Company's sales slows. Due to the unique
nature of the Company's products and services, the Company believes that it will
incur significant expenses for sales and marketing, including advertising, to
educate potential customers about such products and services.
Dependence on Key Personnel. The Company's success depends to a significant
degree upon the continuing contributions of, and on its ability to attract and
retain, qualified management, sales, operations, marketing and technical
personnel. The competition for qualified personnel, particularly engineering
staff, is intense and the loss of any of such persons, as well as the failure to
recruit additional key personnel in a timely manner, could adversely affect the
Company. There can be no assurance that the Company will be able to continue to
attract and retain qualified management, sales and technical personnel for the
development of its business. The Company generally has not entered into
employment or noncompetition agreements with any of its employees. The Company
does not maintain key man life insurance on the lives of any of its key
personnel. The Company's failure to attract and retain key personnel could have
a material adverse effect on its business, operating results and financial
condition.
Dependence on Certain Suppliers. The Company relies on certain single or
limited-source suppliers for certain integral components used for the assembly
of the Company's 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
19
<PAGE> 20
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.
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.
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<PAGE> 21
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
21
<PAGE> 22
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.
Possible Volatility of Share Price. The trading prices of the Company's
Common Stock may be subject to wide fluctuations in response to a number of
factors, including variations in operating results, changes in earnings
estimates by securities analysts, announcements of extraordinary events such as
litigation or acquisitions, announcements of technological innovations or new
products or services by the Company or its competitors, as well as general
economic, political and market conditions. In addition, stock markets have
experienced extreme price and volume trading volatility in recent years. This
volatility has had a substantial effect on the market prices of the securities
of many high technology companies for reasons frequently unrelated to the
operating performance of specific companies. These broad market fluctuations may
adversely affect the market price of the Company's Common Stock.
22
<PAGE> 23
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time the Company has been, or may become, involved in
litigation proceedings incidental to the conduct of its business. The Company
does not believe that any such proceedings presently pending will have a
material adverse affect on the Company's financial position or its results of
operations.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The 1998 Annual Meeting of Shareholders of the Company was held on April
29, 1998 (the "Annual Meeting"). The following matters were voted upon at the
Annual Meeting: (i) the election of the Board of Directors of Kevin R. Compton,
Henry W. Donaldson, Jeffrey M. Drazan, Richard H. Harris, and Leonard S.
Matthews; (ii) the election of Board of Director Lawrence D. Lenihan, Jr.; (iii)
amendment of the Company's 1992 Stock Option Plan to increase by 500,000 the
authorized number of options under the plan; (iv) amendment of the Company's
Articles of Incorporation by increasing the authorized number of shares of the
Company's Common Stock to 40,000,000 shares from 30,000,000 and increasing the
authorized number of the Company's Preferred Shares to 15,000,000 shares from
5,000,000; and (v) ratification of the appointment of Arthur Andersen, LLP, as
independent auditors of the Registrant for the fiscal year ending December 31,
1998. The results of the vote were as follows:
<TABLE>
<CAPTION>
VOTES
AGAINST/ BROKER
MATTER VOTES FOR WITHHELD ABSTENTIONS NON-VOTES
------ ---------- -------- ----------- ---------
<S> <C> <C> <C> <C>
1. Elect Directors
Kevin R. Compton 9,977,101 442,331 0 0
Henry W. Donaldson 9,906,360 515,072 0 0
Jeffrey M. Drazan 9,977,301 442,131 0 0
Richard H. Harris 9,945,601 473,831 0 0
Leonard S. Matthews 9,977,101 442,331 0 0
2. Elect Director Lawrence D. Lenihan 3,609,374 0 0 0
3. Amend the Company's 1992 Stock Option
Plan 13,165,138 813,490 21,129 29,049
4. Amend the Company's Articles of
Incorporation 9,242,447 803,559 5,904 3,976,896
5. Ratify the Appointment of
Arthur Andersen, LLP 14,001,890 17,462 9,454 0
</TABLE>
ITEM 5. OTHER INFORMATION
NASDAQ NATIONAL MARKET LISTING QUALIFICATIONS
On May 20, 1998, the Company received notice from the Nasdaq Stock
Market, Inc. ("Nasdaq") that, on the basis of its report on Form 10- Q for the
quarter ending March 31, 1998, the Company's net tangible assets fell below the
level required for continued inclusion of the Company's common stock on the
Nasdaq National Market System ("NNM"). On June 26, 1998, the Company announced
it had received notification from Nasdaq of Nasdaq's intention to delist its
securities from the NNM. Nasdaq had taken the position, in its interpretation
of its policies, that the Company did not meet the minimum capitalization
requirements for continued listing on the NNM and the Company filed a request
for a hearing.
On August 5, 1998, the Company announced that it had received
subscriptions from certain of its investors and affiliates of its current and
other institutional investors to purchase approximately 3.9 million shares of
the Company's Common Stock for nearly $11 million in a private placement
transaction of registrable common stock (the "private placement"). On August
7, 1998, the Company appeared before a Nasdaq Listing Qualifications Panel (the
"Panel") to disclose its intent to raise additional capital and to convert its
outstanding Preferred Stock in order to meet and sustain long-term compliance
with Nasdaq's computational requirements for continued listing on the NNM. The
Company discussed with the Panel its plan to close the Private Placement for
approximately 4.6 million shares of the Company's Common Stock, compared to the
3.9 million level subscribed at August 5, at $2.80 per share, and to issue to
all holders of the Company's Series A Preferred Stock ("Preferred Stock") who
agreed immediately to convert their shares of Preferred Stock into Common Stock
at the applicable one-to-one ratio, with one additional share of Common Stock
for every ten shares of Preferred Stock so converted.
On August 12, 1998, Nasdaq notified the Company in writing that the
hearing Panel was of the opinion that the Company's plans would enable the
Company to maintain long-term compliance with the requirements for continued
listing on the NNM. On August 14, the Company announced that it had closed the
private placement, thereby raising approximately $12.9 million, and that all
holders of the Company's Preferred Stock had accepted the conversion. The
Company has agreed to use its diligent efforts to file a registration statement
with the Securities and Exchange Commission on Form S-3 within sixty days of
August 14, 1998 with respect to the shares purchased in the private placement.
The Company has also agreed to enter into a registration rights agreement with
the purchasers of the shares issued in the private placement granting demand
registration rights exercisable no earlier than that same date.
DEADLINE FOR RECEIPT OF SHAREHOLDER PROPOSALS FOR 1999 ANNUAL MEETING
Shareholders are entitled to present proposals for action at forthcoming
shareholder meetings of the Company if they comply with the requirements of the
appropriate proxy rules promulgated by the Securities and Exchange Commission.
According to the Securities and Exchange Commission rules, proposals of
shareholders of the Company intended to be presented for consideration at the
Company's 1999 Annual Meeting of Shareholders must be received at the Company's
principal executive offices not less than 120 calendar days before the date on
which the Company's proxy statement is released to shareholders in connection
with the previous year's annual meeting. Therefore, as the Company mailed proxy
statements to shareholders on April 3, 1998 in connection with its 1998 Annual
Meeting of Shareholders, the deadline for shareholders to submit proposals to
be presented for consideration at the Company's 1999 Annual Meeting of
Shareholders is December 28, 1998, in order that they may be included in the
proxy statement and form of proxy related to that meeting.
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<PAGE> 24
The proxy card used in connection with the Company's 1998 Annual Meeting of
Shareholders granted the proxy holders discretionary authority to vote on any
matter properly raised at the 1998 Annual Meeting of Shareholders and the
Company presently intends to use a similar form of proxy card for its 1999
Annual Meeting of Shareholders. If a shareholder intends to submit a proposal at
the Company's 1999 Annual Meeting which is not eligible for inclusion in the
proxy statement and form of proxy relating to that shareholder meeting, a new
rule recently established by the Securities and Exchange Commission requires
that such proposals must be received by the Company no later than February 17,
1999. If such a shareholder fails to comply with the foregoing notice provision
for proposals not included in the proxy statement and related form of proxy, the
proxy holders will be allowed to use their discretionary voting authority if
such a proposal is properly raised at the Company's 1999 Annual Meeting of
Shareholders.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
--------- -------------
<S> <C>
3.1(d) Restated Articles of Incorporation of registrant.
3.2(b) Bylaws of registrant, as amended to date.
3.3(a) Certificate of Amendment of the Articles of Incorporation
filed with California Secretary of State on July 3, 1998.
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.
10.6(b) Amendment to Warrant Agreement between the Company and
Comdisco, Inc., dated January 31, 1996.
10.7.1(c) Corporate Service Plan Agreement between the Company and MCI
Telecommunications Corporation, dated March 23, 1994.
10.7.2(c) First Amendment to Corporate Service Plan Agreement between
the Company and MCI Telecommunications Corporation, dated
November 2, 1995.
10.8(b) Master Lease Agreement between the Company and Comdisco,
Inc., dated October 20, 1994, and Exhibits thereto.
10.9(b) Loan and Security Agreement between the Company and
Comdisco, Inc., dated October 20, 1994, and Exhibits
thereto.
10.10(b) Master Equipment Lease between the Company and Phoenix
Leasing, Inc., dated January 7, 1993.
10.15(c) Audio Server Network Prototype Vendor Agreement and
Satellite Vendor Agreement between the Company and ABC Radio
Networks, dated December 15, 1995.
10.17(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.
</TABLE>
24
<PAGE> 25
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
--------- -------------
<S> <C>
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(k) 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.
10.29(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(g) 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(g) 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.
10.33(a) Common Stock Subscription Agreement for private placement of
Company's common stock at $2.80 per share.
21.1(g) Subsidiaries of the Registrant.
27(a) Financial Data Schedule.
</TABLE>
- ---------------
(a) Filed herewith.
(b) Incorporated by reference to the exhibit bearing the same number filed with
registrant's Registration Statement on Form S-1 (Registration No. 33-80203).
(c) Incorporated by reference to the exhibit bearing the same number filed with
registrant's Registration Statement on Form S-1 (Registration No. 33-80203).
The registrant has received confidential treatment with respect to certain
portions of this exhibit. Such portions have been omitted from this exhibit
and have been filed separately with the Securities and Exchange Commission.
(d) Incorporated by reference to the exhibit bearing the same number filed with
registrant's Quarterly Report on Form 10-Q filed May 3, 1996, as amended.
(e) Incorporated by reference to the exhibit bearing the same number filed with
registrant's Quarterly report on Form 10-Q filed November 13, 1996.
(f) Incorporated by reference to the exhibit bearing the same number 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 31, 1998.
(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.
25
<PAGE> 26
(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.
(k) Incorporated by reference to the exhibit bearing the same title filed with
registrant's Quarterly Report on Form 10-Q filed May 15, 1998.
(b) Reports on Form 8-K.
Not applicable.
26
<PAGE> 27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DIGITAL GENERATION SYSTEMS, INC.
Dated: August 14, 1998 By: /s/ PAUL W. EMERY, II
------------------------------------
Paul W. Emery, II
Vice President & Chief Financial
Officer
(Principal Financial and
Chief Accounting Officer)
27
<PAGE> 1
EXHIBIT 3.3
CERTIFICATE OF AMENDMENT
OF
THE ARTICLES OF INCORPORATION
OF
DIGITAL GENERATION SYSTEMS, INC.
Henry W. Donaldson and John B. Goodrich hereby certify as follows:
1. They are the duly elected, qualified and acting President and the
Secretary, respectively, of Digital Generation Systems, Inc., a
California corporation (the "Corporation").
2. Article III(A) of the Articles of Incorporation of the Corporation (the
"Articles of Incorporation") is hereby amended to read as follows:
"(A) Classes of Stock. The Company is authorized to issue
55,000,000 shares of its capital stock, which are divided into
two classes designated "Common Stock" and "Preferred Stock,"
respectively. The Company is authorized to issue 40,000,000
shares of Common Stock and 15,000,000 of Preferred Stock."
3. The foregoing amendment of the Articles of Incorporation has been duly
approved by the Board of Directors of the Corporation.
4. The foregoing amendment of Articles of Incorporation has been duly
approved by the required vote of shareholders in accordance with
Section 902 and 903 of the General Corporation Law of California. The
total number of outstanding shares of Common Stock of the Corporation
entitled to vote with respect to the foregoing amendment of the
Articles of Incorporation was 12,210,625 shares, and the total number
of outstanding shares of Series A Convertible Preferred Stock of the
Corporation entitled to vote with respect to the foregoing amendment to
the Articles of Incorporation was 4,950,495 shares. The number of
shares of Common Stock of the Corporation and the number of shares of
Series A Convertible Preferred Stock of the Corporation voting in the
favor of the foregoing amendment to the Articles of Incorporation
equaled or exceeded the vote required. The percentage vote required to
approve the foregoing amendment to the Articles of Incorporation was a
majority of the outstanding shares of Common Stock of the Corporation,
voting as a separate class and a majority of the outstanding shares of
Series A Convertible Preferred Stock, voting as a separate class in
accordance with Section 903(a)(1) of the General Corporation Law of
California, and a majority of the outstanding shares of Common Stock of
the Corporation and Series A Convertible Preferred Stock of the
Corporation, voting together as a single class in accordance with
Section 902(a) of the General Corporation Law of California and the
applicable provisions of the Articles of Incorporation.
<PAGE> 2
We further declare under penalty of perjury under the laws of the State
of California that the matters set forth in this certificate are true and
correct of our own knowledge.
San Francisco, California /s/ HENRY W. DONALDSON
July 29, 1998 -----------------------------------------
Henry W. Donaldson
President
Palo Alto, California /s/ JOHN B. GOODRICH
July 30, 1998 -----------------------------------------
John B. Goodrich
Secretary
-2-
<PAGE> 1
EXHIBIT 10.33
DIGITAL GENERATION SYSTEMS, INC.
COMMON STOCK SUBSCRIPTION AGREEMENT
The undersigned ("Subscriber") hereby offers to purchase
________________________ shares of the Common Stock (the "Shares") of Digital
Generation Systems, Inc., a California corporation (the "Company") at a price of
$2.80 per share, and is herewith delivering payment for such Shares by check or
wire transfer payable to the Company.
1. Subscriber, by offering to purchase the Shares, (a) hereby represents
and warrants to the Company that all information provided by Subscriber
herewith is true and correct and (b) hereby represents and warrants to
the Company as follows:
a. Investment. Subscriber is acquiring the Shares for
investment for Subscriber's own account, not as a nominee or
agent, and not with the view to, or for resale in connection
with, any distribution thereof in violation of applicable
securities laws. Subscriber understands that such Shares have not
been, and will not be, registered under the Securities Act of
1933, as amended, (the "Securities Act") by reason of a specific
exemption from the registration provisions of the Securities Act
which depends upon, among other things, the bona fide nature of
the investment intent and the accuracy of such Subscriber's
representations as expressed herein.
b. Rule 144. Subscriber acknowledges that the Shares must be
held indefinitely unless subsequently registered under the
Securities Act or an exemption from such registration is
available. Subscriber is aware of the provisions of Rule 144
promulgated under the Securities Act which permit limited resale
of shares purchased in a private placement subject to the
satisfaction of certain conditions, including, among other
things, except as otherwise permitted under Rule 144(k), if
applicable, (i) the availability of certain current public
information about the Company, (ii) the resale occurring not less
than one year after a party has purchased and fully paid for the
shares to be sold, (iii) the sale being effected through a
"broker's transaction" or in transactions directly with a "market
maker" (as provided by Rule 144(f)) and (iv) the number of shares
being sold during any three-month period not exceeding specified
limitations.
c. Legends. Subscriber agrees that each certificate or other
document evidencing any of the Shares shall be endorsed with the
legend set forth below. Subscriber agrees not to transfer the
Shares represented by any such certificate without complying with
the restrictions on transfer described in the legend endorsed on
such certificate.
THE SECURITIES REPRESENTED BY THIS INSTRUMENT HAVE NOT BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR
QUALIFIED UNDER APPLICABLE STATE SECURITIES LAWS. THE SECURITIES
MAY NOT BE SOLD, TRANSFERRED, OR ASSIGNED IN THE ABSENCE OF SUCH
REGISTRATION OR QUALIFICATION, WITHOUT AN OPINION OF COUNSEL FOR
THE HOLDER, CONCURRED IN BY COUNSEL FOR THE COMPANY, STATING
<PAGE> 2
THAT SUCH SALE, TRANSFER, OR ASSIGNMENT IS EXEMPT FROM THE
REGISTRATION REQUIREMENTS OF SAID ACT. THIS CERTIFICATE MUST BE
SURRENDERED TO THE CORPORATION OR ITS TRANSFER AGENT AS A
CONDITION PRECEDENT TO THE TRANSFER OF ANY INTEREST IN THE
SECURITIES REPRESENTED BY THIS CERTIFICATE.
d. Access to Data. Subscriber has requested and received from
the Company all the information Subscriber considers necessary or
appropriate for deciding whether to purchase the Shares.
Subscriber has had an opportunity to ask questions of and receive
answers from management of the Company concerning the Company,
the Company's business and financial affairs and the Subscriber's
purchase of Shares hereunder. Subscriber has had such questions
answered to Subscriber's satisfaction. Subscriber understands
that any information contained in any written documentation or
made by management during discussions with the Company were
intended to describe the aspects of the Company's business and
prospects which the Company believes to be material, but such
information does not necessarily provide a thorough exhaustive
description. Subscriber acknowledges that any estimates or
projections as to events that may occur in the future were based
upon the best judgment of the Company's management at the time
such estimates or projections were made and that whether or not
such estimates or projections will depend upon the Company's
achieving its overall business objectives, including the
availability of funds resulting from the sale of the Shares.
Subscriber acknowledges there is no assurance that any
projections will be attained.
e. Preexisting Personal or Business Relationship. Subscriber
either has a preexisting personal or business relationship with
the Company or any of its officers, directors or controlling
persons or, by reason of Subscriber's business or financial
experience, could be reasonably assumed to have the capacity to
protect Subscriber's own interests in connection with the
purchase of the Shares.
f. Authorization. This agreement, upon acceptance by the
Company, will constitute a valid and legally binding obligation
of Subscriber, enforceable in accordance with its terms.
g. Brokers or Finders. There are no arrangements or claims
for brokerage or finders' fees or agents' commissions or any
similar charges in connection with this agreement or any
transaction contemplated hereby based on any arrangement or
agreement known to Subscriber.
h. No Reliance on Third Parties. In purchasing the Shares,
Subscriber is not relying upon any representation or assurance
from any person.
i. Risk of Investment. Subscriber understands the risks
inherent in new ventures and the risks associated with unproven
technologies such as those of the Company, and Subscriber has
experience in investing in such ventures. Subscriber can bear the
entire loss of his investment in the Company.
j. No Legal Tax or Investment Advice. Subscriber understands
that nothing in this Agreement or any other materials presented
to Subscriber or information provided by the Company's management
in connection with the purchase and sale of the Shares
constitutes
2
<PAGE> 3
legal, tax, or investment advice. Subscriber has consulted such
legal, tax, and investment advisors as it, in its sole
discretion, has deemed necessary or appropriate in connection
with its purchase of the Shares.
2. Address. Subscriber's address listed below is true and correct.
3. Subscriber understands that the final number of Shares which may be
purchased by Subscriber will be determined by the Company and that this
offer to purchase Shares is subject to acceptance, in whole or in part,
by the Company. Funds not accepted for the purchase of Shares will be
refunded.
4. Subject to acceptance by the Company of Subscriber's offer to purchase
Shares hereunder and upon receipt of Subscriber's payments, the Company
will cause a stock certificate representing the Shares purchased by
Subscriber to be prepared, and the Company will cause such stock
certificate to be transmitted to the Subscriber at the address shown
below.
5. By accepting below, the Company undertakes, within 60 days of the
closing of the round in which the Shares are purchased, to use its
diligent efforts to prepare and file a registration statement with the
Securities and Exchange Commission on Form S-3 registering the shares
under the Securities Act of 1933, as amended, and hereby represents,
warrants, covenants and agrees as to the matters set forth on Annex I
attached hereto.
IN WITNESS WHEREOF, Subscriber hereby executes this Agreement as of
_____________, 1998.
_________________________________________
Signature
_________________________________________
Print Name
Address:_________________________________
_________________________________________
_________________________________________
(Do not write below this line.)
Accepted as to ________ Shares as of ____________, 1998.
Digital Generation Systems, Inc.
By: ____________________________________
Henry Donaldson, President
3
<PAGE> 4
ANNEX I TO SUBSCRIPTION AGREEMENT
1. By executing the attached Subscription Agreement (the "Agreement"),
the Company hereby represents and warrants to Subscriber that: (a) the Shares
have been duly authorized and, when issued, will be duly and validly issued,
fully paid and non-assessable; (b) the Company has registered its Common Stock
pursuant to Section 12 of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), and the Common Stock is listed and traded on the NASDAQ
National Market and the Company has timely filed all material required to be
filed pursuant to all reporting obligations under either Section 13(a) or 15(d)
of the Exchange Act for a period of at least twelve (12) months immediately
preceding the offer or sale of the Shares; (c) the Company has legally available
sufficient authorized and unissued Common Stock as may be reasonably necessary
to effect the sale and issuance of the Shares; (d) the Agreement has been duly
and validly authorized by the Company and, when executed and delivered by the
Company, will be the valid and binding agreement of the Company enforceable in
accordance with its terms; (e) the execution and delivery of the Agreement by
the Company, the issuance of the Shares, and the consummation by the Company of
the other transactions contemplated by the Agreement, do not and will not
conflict with or result in a breach by the Company of any of the terms or
provisions of, or constitute a default under, the articles of incorporation or
by-laws of the Company, or any material agreement or instrument to which the
Company is a party or by which it or any of its properties or assets are bound,
or any material existing applicable law, rule, or regulation or any applicable
decree, judgment, or order of any court or other governmental body having
jurisdiction over the Company or any of its properties or assets, except such
conflict, breach or default which would not have a material adverse effect on
the transactions contemplated herein; and (f) no authorization, approval or
consent of any court, governmental body, regulatory agency, self-regulatory
organization, or stock exchange or market or the stockholders of the Company is
required to be obtained by the Company for the issuance and sale of the Shares
to Subscriber as contemplated by the Agreement, except such authorizations,
approvals and consents that have been obtained.
2. By accepting Subscriber's offer to purchase the Shares, the Company hereby
agrees to enter into a separate registration rights agreement with Subscriber
(and any other purchasers of common stock of the Company in the same round in
which the Shares are purchased) granting Subscriber the demand registration
rights contained in Section 1.3 of the Amendment and Restatement No. 5 to Rights
Agreement entered into as of July 14, 1997 by and among the Company and certain
of its securityholders, which rights shall apply to the registration statement
on Form S-3 referred to in Section 5 of the Agreement. The demand registration
rights so granted will be exercisable no earlier than sixty (60) days following
the closing of the round in which the Shares are purchased. Nothing in this
Section 2 is intended to limit the Company's obligations under section 5 of the
Agreement to file the Form S-3. Notwithstanding anything herein to the contrary,
the Form S-3 shall be maintained effective by the Company until the earlier of
(i) the date as to which Subscriber may sell all of the Shares without
registration in a single transaction pursuant to Rule 144(k) or (ii) the date on
which Subscriber has sold all of the Shares to the public.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 4,188
<SECURITIES> 0
<RECEIVABLES> 9,351
<ALLOWANCES> (668)
<INVENTORY> 327
<CURRENT-ASSETS> 13,428
<PP&E> 34,749
<DEPRECIATION> (21,357)
<TOTAL-ASSETS> 51,908
<CURRENT-LIABILITIES> 16,571
<BONDS> 12,025
31,561
0
<COMMON> 57,208
<OTHER-SE> (65,457)
<TOTAL-LIABILITY-AND-EQUITY> 51,908
<SALES> 0
<TOTAL-REVENUES> 19,971
<CGS> 0
<TOTAL-COSTS> 25,900
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 83
<INTEREST-EXPENSE> 1,407
<INCOME-PRETAX> (7,222)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,222)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,222)
<EPS-PRIMARY> (0.59)<F1>
<EPS-DILUTED> (0.59)
<FN>
<F1> FOR PURPOSES OF THIS EXHIBIT, PRIMARY MEANS BASIC.
</FN>
</TABLE>
