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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED APRIL 3, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO _______________.
COMMISSION FILE NUMBER: 0-27644
DIGITAL GENERATION SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 94-3140772
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
875 BATTERY STREET
SAN FRANCISCO, CALIFORNIA 94111
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(415) 276-6600
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
NOT APPLICABLE
(FORMER NAME, FORMER ADDRESS, FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT
WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] NO [ ]
NUMBER OF SHARES OF REGISTRANT'S COMMON STOCK, WITHOUT PAR VALUE, OUTSTANDING AS
OF APRIL 30, 1999: 26,593,447
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DIGITAL GENERATION SYSTEMS, INC.
The discussion in this Report contains forward-looking statements that involve
risks and uncertainties. The statements contained in this Report that are not
purely historical are forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. Words such as "anticipates," "believes,"
"plans," "expects," "future," "intends," and similar expressions are used to
identify forward-looking statements. All forward-looking statements included in
this document are based on information available to the Company on the date
hereof, and we assume no obligation to update any such forward-looking
statements. The Company's actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including, but not limited to, those discussed in "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Certain Business
Considerations" as well as those discussed in this section and elsewhere in this
Report, and the risks discussed in the Company's other United States Securities
and Exchange Commission filings.
TABLE OF CONTENTS
<TABLE>
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Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements ........................................................................... 3
Condensed Consolidated Balance Sheets at April 3, 1999 and December 31, 1998 ................... 3
Condensed Consolidated Statements of Operations for the quarter ended April 3, 1999 and
March 31, 1998 ................................................................................. 4
Condensed Consolidated Statements of Cash Flows for the quarter ended April 3, 1999 and
March 31, 1998 ................................................................................. 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 .............................................................................. 24
Item 2. Changes in Securities .......................................................................... 24
Item 3. Defaults upon Senior Securities ................................................................ 24
Item 4. Submission of Matters to a Vote of Security Holders ............................................ 24
Item 5. Other Information .............................................................................. 24
Item 6. Exhibits and Reports on Form 8-K ............................................................... 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)
<TABLE>
<CAPTION>
APRIL 3, DECEMBER 31,
1999 1998
--------- ------------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 8,240 $ 13,025
Accounts receivable, less allowance for doubtful accounts
of $1,818 in 1999 and $1,895 in 1998 9,299 9,995
Prepaid expenses and other 1,026 933
--------- ---------
Total current assets 18,565 23,953
--------- ---------
PROPERTY AND EQUIPMENT, at cost:
Network equipment 34,055 33,211
Office furniture and equipment 3,949 3,730
Leasehold improvements 563 542
--------- ---------
38,567 37,483
Less - Accumulated depreciation and amortization (28,009) (25,738)
--------- ---------
Property and equipment, net 10,558 11,745
--------- ---------
GOODWILL AND OTHER ASSETS, net 14,030 14,094
--------- ---------
TOTAL ASSETS $ 43,153 $ 49,792
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 3,815 $ 3,035
Accrued liabilities 2,849 4,081
Line of credit -- 1,433
Current portion of long-term debt 8,095 8,226
--------- ---------
Total current liabilities 14,759 16,775
LONG-TERM DEBT, net of current portion 6,672 9,307
SHAREHOLDERS' EQUITY:
Convertible preferred stock, no par value --
Authorized -- 15,000,000
Outstanding -- none at April 3, 1999 and
none at December 31, 1998 -- --
Common stock, no par value --
Authorized -- 40,000,000 shares
Outstanding - 26,534,193 shares at April 3, 1999
and 26,239,520 shares at December 31, 1998 115,148 114,131
Receivable from issuance of common stock (369) (369)
Accumulated other comprehensive income (5) 9
Accumulated deficit (93,052) (90,061)
--------- ---------
Total shareholders' equity 21,722 23,710
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 43,153 $ 49,792
========= =========
</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 QUARTER ENDED APRIL 3, 1999 AND MARCH 31, 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------
APRIL 3, MARCH 31,
1999 1998
-------- --------
(Unaudited)
<S> <C> <C>
REVENUES $ 11,460 $ 9,874
-------- --------
COSTS AND EXPENSES:
Delivery and material costs 4,539 3,746
Customer operations 3,557 3,575
Sales and marketing 1,237 1,264
Research and development 612 588
General and administrative 1,507 1,029
Depreciation and amortization 2,464 2,833
-------- --------
Total expenses 13,916 13,035
LOSS FROM OPERATIONS (2,456) (3,161)
OTHER INCOME (EXPENSE):
Interest income 95 69
Interest expense (604) (711)
Gain (loss) from foreign exchange (26) --
-------- --------
NET LOSS $ (2,991) $ (3,803)
======== ========
BASIC AND DILUTED NET LOSS PER COMMON SHARE
$ (0.11) $ (0.31)
======== ========
WEIGHTED AVERAGE COMMON SHARES 26,462 12,176
======== ========
</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 QUARTER ENDED APRIL 3, 1999 AND MARCH 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------------
APRIL 3, MARCH 31,
1999 1998
-------- --------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $ (2,991) $ (3,803)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization of property and equipment 2,269 2,506
Amortization of goodwill and intangibles 195 327
Foreign currency translation adjustment (14) --
Provision for doubtful accounts (77) 38
Changes in operating assets and liabilities --
Accounts receivable 662 (407)
Prepaid expenses and other assets (93) (218)
Accounts payable and accrued liabilities (441) (342)
-------- --------
Net cash used in operating activities (490) (1,899)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of short-term investments -- (1,011)
Acquisition of property and equipment (1,104) (603)
-------- --------
Net cash provided by (used in) investing activities (1,104) (1,614)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 1,017 83
Proceeds from line of credit -- 3,201
Payments on line of credit (1,433) (3,969)
Proceeds from issuance of long-term debt -- 1,890
Payments on long-term debt (2,713) (1,942)
-------- --------
Net cash provided by (used in) financing activities (3,129) (737)
-------- --------
EFFECT OF EXCHANGE RATE CHANGES (62) --
NET DECREASE IN CASH AND CASH EQUIVALENTS (4,785) (4,250)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 13,025 7,833
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 8,240 $ 3,583
======== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 1,066 $ 714
</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, 1998.
Effective for fiscal year 1999, beginning January 1, the Company elected
to adjust its fiscal quarters so that each quarter is thirteen weeks in length
and ends on the Saturday nearest to March 31, June 30, and September 30.
Therefore, the first fiscal quarter of 1999 ended on April 3, 1999, second
quarter will end on July 7, 1999 and third quarter will end on October 2, 1999.
Fiscal fourth quarter will continue to end on December 31, 1999.
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 month period ended April 3, 1999. The results for the three month period
ended April 3, 1999 are not necessarily indicative of the results expected for
the full fiscal year.
2. CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Cash and cash equivalents consist of liquid investments with original
maturities of three months or less. As of April 3, 1999 and December 31, 1998,
cash and cash equivalents consists principally of U.S. Treasury Bills and
various money market accounts; as a result, purchase cost approximates the fair
market value.
3. ACQUISITION
DCI
On September 25, 1998, the Company acquired substantially all of the
property and assets, including all accounts receivable, inventories, contracts,
equipment, real property leases and other related assets of Digital Courier
International, Inc. ("DCI"). DCI is in the business of supplying electronic
distribution and communications services for the radio broadcast industry in the
United States and Canada.
The Company paid $13.5 million in Canadian dollars (approximately US $9.06
million) for DCI. The DCI acquisition was accounted for as a purchase. The
excess of purchase price and acquisition costs over the fair value of assets
acquired of approximately $6.2 million has been included in Goodwill and Other
Assets in the accompanying consolidated balance sheet as of April 3, 1999,
and is being amortized over a twenty year period. The operating results of DCI
have been included in the consolidated results and balances of the Company from
the date of the closing of the transaction, September 25, 1998. Amortization
expense of $84,000 is included in the consolidated statements of operations for
the period ended April 3, 1999.
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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 on the basis that the acquisition of DCI had occurred
at the beginning of the fiscal 1998:
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------
APRIL 3, MARCH 31,
1999 1998
-------- ---------
(in thousands, except per share data)
<S> <C> <C>
Revenues .................................. $ 11,460 $ 10,607
Net Loss .................................. $ (2,991) $(6,062)
Basic and Diluted Net Loss Per Common Share $ (0.11) $ (0.50)
Number of Shares used in Computation ...... 26,462 12,176
</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 DCI been consummated at the beginning of fiscal 1998, nor of
future operations of the combined companies under the ownership and management
of the Company.
4. SEGMENT INFORMATION:
In 1998, the Company adopted Statement of Financial Accounting Standard No.
131, "Disclosures about Segments of an Enterprise and Related Information." The
Company operates predominantly in one industry segment: digital and physical
distribution and post-production services for audio and video content, and its
operations are managed primarily by geographic areas. The Company has defined
its reportable segments based on these geographic areas.
The information in the following tables is derived directly from the
segments' internal financial reporting used for corporate management purposes.
The expenses, assets and liabilities attributable to corporate activity are not
allocated to the operating segments. As of April 3, 1999, 21% of operating
assets are located outside of the United States. The balance sheet information
for the Company's Los Angeles segment is maintained as part of the Chicago
segment and is impractical to break out separately.
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DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED APRIL 3, 1999
------------------------------------------------------------------------------------------------
IN $000'S
ADJUSTMENTS &
SAN FRANCISCO NEW YORK CHICAGO LOS ANGELES VANCOUVER ELIMINATIONS CONSOLIDATED
------------- -------- ------- ----------- --------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Operating revenue $ 5,643 $ 2,940 $ 3,048 $ 240 $ 1,136 $ (1,547) $ 11,460
EBITDA* (320) 595 307 (290) (284) -- 8
Operating income (loss) (1,777) 440 (266) (366) (488) -- (2,456)
Net loss $ (2,214) $ 440 $ (325) $ (366) $ (526) -- $ (2,991)
At April 3, 1999
Identifiable assets 54,879 10,222 7,239 -- 9,060 (38,247) 43,153
Total assets $ 54,879 $ 10,222 $ 7,239 $ -- $ 9,060 $(38,247) $ 43,153
</TABLE>
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED MARCH 31, 1998
------------------------------------------------------------------------------------------------
IN $000'S
ADJUSTMENTS &
SAN FRANCISCO NEW YORK CHICAGO LOS ANGELES VANCOUVER ELIMINATIONS CONSOLIDATED
------------- -------- ------- ----------- --------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Operating revenue $ 4,212 $ 2,541 $ 3,221 $ 674 $ -- $ (774) $ 9,874
EBITDA* (1,026) 466 191 41 -- -- (328)
Operating income (loss) (2,852) 310 (584) (35) -- -- (3,161)
Net loss $ (3,364) $ 310 $ (714) $ (35) $ -- $ -- $ (3,803)
At March 31, 1998
Identifiable assets 47,128 10,428 27,376 -- -- (29,117) 55,815
Total assets $ 47,128 $ 10,428 $ 27,376 $ -- $ -- $(29,117) $ 55,815
</TABLE>
*Earnings before interest, taxes, depreciation and amortization.
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 quarter should not be relied on as indicative of
results for any future period.
STATEMENTS OF OPERATIONS:
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------
APRIL 3, MARCH 31,
1999 1998
-------- ---------
<S> <C> <C>
Revenues ........................................ 100.0% 100.0%
Costs and Expenses:
Delivery and material costs .................. 39.6 37.9
Customer operations .......................... 31.0 36.2
Sales and marketing .......................... 10.8 12.8
Research and development ..................... 5.3 6.0
General and administrative ................... 13.2 10.4
Depreciation and amortization ................ 21.5 28.7
----- -----
Total expenses ............................ 121.4 132.0
----- -----
Loss from operations ............................. (21.4) (32.0)
Other income (expense):
Interest income .............................. 0.8 0.7
Interest expense ............................. (5.3) (7.2)
Gain/(loss) from foreign transactions ........ (0.2) --
----- -----
Net loss ......................................... (26.1)% (38.5)%
===== =====
</TABLE>
Revenues
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------
APRIL 3, MARCH 31,
1999 1998
-------- ---------
(in thousands)
<S> <C> <C>
Audio Distribution $ 5,853 $ 3,647
Video Distribution 3,937 3,230
Postproduction Services & Other Services 1,670 2,997
------- -------
Total Revenues $11,460 $ 9,874
======= =======
</TABLE>
Revenues were $11,460,000 for the quarter ended April 3, 1999, a 16%
increase over $9,874,000 for the quarter ended March 31, 1998,. The increase was
due primarily to an increase of 59% in the combined volume of audio and video
deliveries. Of the total increase in deliveries in 1999, there was a 238%
increase in orders delivered through the DG Systems Network Operating Centers
("NOCs") in San Francisco and Vancouver. The Company believes that the increase
in delivery volumes is due to a number of factors, including the
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<PAGE> 10
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
September 1998 acquisition of DCI.
Average revenue per audio delivery increased approximately 13% for the
quarter ended April 3, 1999, from the quarter ended March 31, 1998. This
increase is due primarily to a more uniform pricing structure that has been
established among all of its locations as well as a slight increase over the
prior year in the percentage of customers using the company's Priority and
Express services which guarantee delivery of spots within and one and four
hours, respectively.
Average revenue per video delivery decreased approximately 5% for the
quarter ended April 3, 1999 from the quarter ended March 31, 1998. The decrease
in average revenue per video delivery is due to a lower demand among many of its
video customers who do not require as many of the value added services that the
Company offers, as they did in the prior year.
Delivery and Material Costs
<TABLE>
<CAPTION>
QUARTER ENDED,
---------------------
APRIL 3, MARCH 31
1999 1998
-------- --------
(in thousands)
<S> <C> <C>
Audio Distribution $2,023 $ 833
Video Distribution 1,787 1,513
Postproduction Services & Other Services 729 1,400
------ ------
Total Delivery and Material Costs $4,539 $3,746
====== ======
</TABLE>
Delivery and material costs for the quarter ended April 3, 1999 were
$4,539,000 a 21% increase from $3,746,000 for the quarter ended March 31, 1998.
The increase in costs is primarily due to the increased delivery volume, as well
as a result of the acquisition of DCI. The increased costs include both fees
paid to other service providers for charges incurred by the Company for the
receipt, transmission and delivery of information via the Company's distribution
NOCs. Delivery and materials costs also include costs for video and audio tapes
and the related packaging and shipping costs required when physically
duplicating and distributing a video or audio spot. In addition, delivery and
materials costs include the direct materials and fees paid to other service
providers in connection with postproduction services and other services offered
by the Company.
Audio distribution delivery and material costs as a percentage of audio
delivery revenues increased to approximately 35% from 23% in the quarter ended
April 3, 1999, from March 31, 1998, respectively. This increase is primarily due
to the costs that the Company has incurred in its efforts to integrate its
network with that of DCI, which it acquired in September 1998.
Video distribution delivery and material costs as a percentage of video
revenues decreased to approximately 45% from 47% in the quarter ended April 3,
1999 from March 31, 1998, respectively. This
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decrease is due to enhancements to its video delivery system that have allowed
the Company to achieve a higher maximum capacity of video deliveries that can be
sent through its network.
Total delivery and material costs as a percentage of revenues increased
to 40% from 38% for the quarter ended April 3, 1999, and March 31, 1998,
respectively.
Delivery and material costs related to the other services provided by the
Company were 44% and 47% of their associated revenues for the quarter ended
April 3, 1999 and March 31, 1998, 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 expects that delivery costs will increase in absolute dollars
and may fluctuate as a percentage of revenues in future periods, influenced
principally by volumes, average sales price and scale economies as video
deliveries increase in volume. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations ---", "Certain Business
Considerations ---Uncertainties Relating to Integration of Operations,"
"---Ability to Manage Growth," "---Dependence on Certain Suppliers" and
"---Potential Fluctuations in Quarterly Results; Seasonality."
Customer Operations
Customer operations expenses for the quarter ended April 3, 1999 were
$3,557,000 a decrease of less than 1% from $3,575,000 for the quarter ended
March 31, 1998.
Customer operations expenses as a percentage of revenues decreased to 31%
from 36% in the quarter ended April 3, 1999 and March 31, 1998, respectively.
This decrease is primarily due to process improvements in orders processed
through the Company's NOC, which serves as the primary support for the digital
network. The Company continually attempts to improve process flows in an effort
to gain scale efficiencies.
The Company expects that customer operations expenses will increase in
absolute dollars and may fluctuate as a percentage of revenues in future
periods. Moreover, the Company believes that in order to compete effectively and
manage future growth, the Company will be required to continue to implement
changes that improve and increase the efficiency of its customer operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations ---", "Certain Business Considerations --Ability to Maintain and
Improve Service Quality" and "-- Ability to Manage Growth."
Sales and Marketing
Sales and marketing expenses were $1,237,000 for the quarter ended April
3, 1999, a 2% decrease from $1,264,000 for the quarter ended March 31, 1998. The
decrease in sales and marketing expenses is due primarily to the consolidation
of the Company's sales and marketing efforts among all of its locations. In
addition, sales and marketing expense as a percentage of revenues was reduced to
11% of revenues for the quarter ended April 3, 1999 from 13% of revenues for the
quarter ended March 31, 1998.
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. The Company expects that sales and marketing
expenses will increase in absolute dollars in future periods and may fluctuate
as a percentage of revenue in future periods. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations ---", "Certain
Business Considerations---Dependence on Emerging Markets."
Research and Development
Research and development expenses increased 4% to $612,000 for the
quarter ended April 3, 1999 from $588,000 for the quarter ended March 31, 1998.
The increase reflects the costs incurred for various Year 2000 issues, as well
the addition of key personnel to address the future delivery capacity of the
Company's network beyond the Year 2000.
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
11
<PAGE> 12
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 for the quarter ended April 3, 1999
were $1,507,000 a 47% increase from $1,029,000 for the quarter ended March 31,
1998. The increase is primarily due to the costs incurred to consolidate and
upgrade the Company's order entry, billing, and financial reporting systems and
the increase in staff as a result of the acquisition of DCI. General and
administrative expenses have increased to 13% of revenues for the quarter ended
April 3, 1999 from 10% for the quarter ended March 31, 1998.
Depreciation and Amortization
Depreciation and amortization expenses decreased 13% to $2,464,000 for
the quarter ended April 3, 1999 from $2,833,000 for the quarter ended March 31,
1998. The Company acquired the bulk of its assets prior to December 31, 1996;
therefore, beginning in fiscal year 1998, there has been a higher percentage of
fixed assets which are reaching or have already reached the end of their
depreciable life. The decline of depreciation expense in the first quarter of
1999 reflects this. As of April 3, 1999, the Company's total investment in
network equipment has increased 10% to $34.1 million, from $30.9 million at
March 31, 1998.
The Company recorded amortization expense of $195,000 for the quarter
ended April 3, 1999, and $327,000 for the quarter ended March 31, 1998. The
increase in amortization expense from the acquisition of DCI in September 1998
was offset by the reduction in amortization expense due to the write down of the
Mediatech subsidiary's net assets in the quarter ended September 30, 1998.
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 ("DVPSs") to be built
and installed in production studios and television stations. The Company expects
depreciation and amortization to fluctuate in proportion to this growth.
However, there can be no assurance that the Company will make such investments
or that such investments will result in future revenue growth. See "Management's
Discussion and Analysis of Financial Position and Results of Operations ---",
"Certain Business Considerations -- Future Capital Needs; Uncertainty of
Additional Funding."
Interest Income and Interest Expense
Interest income increased 38% to $95,000 for the quarter ended April 3,
1999 from $69,000 in the quarter ended March 31, 1998. This increase is
primarily the result of an increased level of cash and cash equivalents and
short term investments in the first quarter of 1999 over the first quarter of
1998. The Company's initial public offering was completed in February 1996 and
since that time the offering's proceeds have been used to fund much of 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
used in the Company's operations.
Interest expense decreased 15% to $604,000 in the quarter ended April 3,
1999 from $711,000 in the quarter ended March 31, 1998. The decrease is due
primarily to a decrease in the Company's outstanding debt, particularly its
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 decreased to $ 11.1 million
at April 3, 1999 from $14.1 million at March 31, 1998. The Company expects that
interest expense will fluctuate in the future based on the levels of borrowing.
Liquidity and Capital Resources
Net cash used in operating activities decreased to $490,000 in the
quarter ended April 3, 1999 from $1.9 million in the quarter ended March 31,
1998.
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The Company made capital additions of $1.1 million during the quarter
ended April 3. The capital additions in both periods were a result of the
Company's continued expansion of its network. Principal payments on long-term
debt were $2,740,000 in the quarter ended April 3, 1999 versus $1,942,000 in the
quarter ended March 31, 1998.
At April 3, 1999, the Company's current sources of liquidity included
cash and cash equivalents of $8.2 million. Based on management's current plans
and forecasts, the Company believes that its existing sources of liquidity will
satisfy the Company's projected working capital, capital lease and term loan
commitments and other cash requirements through fourth quarter 1999.
CERTAIN BUSINESS CONSIDERATIONS
The Company's business is subject to the following risks in addition to
those described elsewhere in this Report.
History of Losses; Future Operating Results Uncertain. DG Systems was
founded in 1991 and has been unprofitable since its inception. The Company
expects to continue to generate net losses for much of the next twelve months.
As of April 3, 1999, the accumulated deficit was $93.1 million. Although the
Company has recently experienced growth, a significant portion of such growth is
due to acquisitions. In addition, such growth rates may not be sustainable and
such growth rates should not be used as an indication of future sales growth, if
any, or as an indication of future operating results. The Company's future
success also depends in part on continued reductions in delivery and service
costs, particularly its ability to continue to automate order processing and to
reduce telecommunications costs. High fixed costs of the company's satellite
delivery system and high depreciation expense related to its network equipment
contribute heavily to its losses. As a result of the foregoing factors, there
can be no assurance that the Company's sales will grow or that the Company's
sales will be sustained in future periods. In addition, there can be no
assurance that the Company will be able to reduce delivery and service costs, or
that it 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 NOC in
San Francisco, and in populating television stations with the units necessary
for the receipt of electronically delivered video advertising content. However
the Company cannot assure that the placement of these units will cause this
service to achieve adequate market acceptance among customers that require video
advertising content delivery. The Company's inability to place units in an
adequate number of stations or its inability to capture market share among
content delivery customers which may be the result of price competition, new
product introductions from competitors or otherwise, would seriously harm 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 continue to enhance
ancillary services that typically are provided by dub and ship houses. These
ancillary services include physical archiving, closed captioning, modification
of slates and format conversions. Such services will need to be provided on a
localized basis in each of the major cities in which the Company provide
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, it cannot assure that it will be able to
successfully contract for and provide these services in each or any major
metropolitan area or that it will be able to provide competitive video
distribution services in other U.S. markets. Also, although the Company is
taking the steps required to achieve the network capacity and scalability
necessary to deliver video content reliably and cost effectively as video
advertising delivery volume grows, the Company cannot assure that it will
achieve such goals and its failure to do so may seriously harm its business,
operating results and financial position. In addition, the Company may be unable
to retain current audio delivery customers or attract future audio delivery
customers who may ultimately demand delivery of both media content unless it can
successfully continue to develop and provide video transmission services. The
failure to retain such customers could seriously harm its results of operations
and financial condition.
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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 our control, 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, claims by stations for lost
air-time may nevertheless be asserted in these circumstances and dissatisfied
advertisers may refuse to make further deliveries through DG Systems in the
event of a significant occurrence of lost deliveries, which would seriously harm
its business, financial condition and results of operations. Although the
Company maintains insurance against business interruption, such insurance may
not be adequate to protect it from significant loss in these circumstances or
from the effects of a major catastrophe (such as an earthquake or other natural
disaster) which could result in a prolonged interruption of its business. In
particular, one of its NOCs 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 NOC. 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 and satellite service
providers; and
- - The inability to maintain our installed base of RSTs, RPTs, CWs, VRTSs
and DVPS units that comprise its distribution network.
Failure to make timely deliveries for whatever reason could result in
dissatisfied advertisers refusing to make further deliveries through DG Systems
which would seriously harm its business, financial condition and results of
operations.
Dependence on Technological Developments. The market for the distribution
of digital audio and video transmissions is characterized by rapidly changing
technology. The Company's success will depend, in part, on the technological
quality of its products and processes relative to those of its competitors and
its ability to develop and introduce new and enhanced products and services at
competitive prices and in a timely and cost-effective fashion. Its development
efforts have been focused on:
- - Satellite transmission technology;
- - Video compression technology;
- - TV station systems interfaces;
- - Reliability and throughput enhancements to the network; and
- - Increasing its percentage of on-line deliveries.
The growth of its electronic video delivery services also depends on its
ability to obtain reliable and cost-effective satellite delivery capability.
Development efforts in satellite transmission technology are oriented to
development and deployment of software to lower transmission costs and increase
delivery reliability. Development efforts in video compression technology are
directed toward integration of emerging broadcast quality compression systems
within its existing network, thereby continuing to improve picture quality while
maintaining compliance with industry standards. TV station system interface
implementation includes various system control protocols and improvements of the
system throughput and reliability. The Company has an agreement with Hughes
Network Systems, Inc. ("Hughes") which gives us access to Hughes' satellite
capacity for electronic delivery of digital audio and video transmissions by
that media. The Company has developed and incorporated the software designed to
enable the current DVPSs to receive digital satellite transmissions over the
Hughes satellite system. However, the Hughes satellite system may not have the
capacity to meet its future delivery commitments and broadcast quality
requirements on a cost-effective basis, if at all. See "Dependence on Certain
Suppliers."
The introduction of new products can render existing products obsolete or
unmarketable. The Company
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may not be successful in identifying, developing, contracting for the
manufacture of, and marketing product enhancements or new products that respond
to technological change. In addition, the Company may experience difficulties
that could delay or prevent the successful development, introduction and
marketing of any new products or product enhancements, and these products may
not adequately meet the requirements of the marketplace and achieve market
acceptance. Delays in the introduction of new products and services or
enhancements to existing products and services may result in customer
dissatisfaction and delay or loss of revenue. The inability to develop and
introduce new products and services or enhancements of existing products and
services in a timely manner or with a significant degree of market acceptance
could seriously harm its business, financial condition and results of
operations.
Ability to Manage Growth. The Company have recently experienced a period of
rapid growth that has resulted in new and increased responsibilities for
management personnel and that has placed and continues to place a significant
strain on its operating, management and financial systems and resources. To
accommodate this recent growth and to compete effectively and manage future
growth, if any, it must continue to implement and improve its operational,
financial and management information systems, procedures and controls on a
timely basis and to expand, train, motivate and manage its work force. In
particular, the Company believes that to achieve these objectives it must
complete the following:
- Automation of the customer order entry process;
- Integration of the delivery fulfillment process into the customer
billing system; and
- Combination of these systems with those of its wholly-owned
subsidiaries, PDR Productions, Inc. ("PDR"), Starcom Mediatech,
Inc. ("Mediatech") and DCI.
Its personnel, systems, procedures and controls may not be adequate to support
its existing and future operations. Any failure to implement and improve its
operational, financial and management systems or to expand, train, motivate or
manage its employees could seriously harm its business, financial condition and
results of operations.
Future Capital Needs; Uncertainty of Additional Funding. The Company
intends to continue making capital expenditures to produce and install RSTs,
RPTs, CWs, VRTSs, and DVPS units and to introduce additional services. In
addition, it 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,
it anticipates that 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 until the fourth quarter of 1999.
However, the Company cannot assure that it will not require additional capital
sooner than currently anticipated or that any such additional funds will be
adequate to fund its capital needs, which capital needs depend upon numerous
factors, including:
- The progress of its product development activities;
- The cost of increasing its sales and marketing activities; and
- The amount of revenues generated from operations.
None of the foregoing factors 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 pursues one or more such acquisitions. Furthermore,
it can not assure that either additional financing will be available to it, or
if it is available, that such additional financing will be available on
acceptable terms. The Company's inability to obtain financing for such
acquisitions on acceptable terms may prevent it from completing advantageous
acquisitions and consequently could seriously harm its prospects and future
rates of growth. Its inability to obtain additional funding for continuing
operations or an acquisition would seriously harm its business, financial
condition and results of operations. Consequently, it could be required:
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- To significantly reduce or suspend its operations;
- To seek a merger partner; or
- To sell additional securities on terms that are highly dilutive to
its existing investors.
Dependence on Emerging Markets. The market for the electronic delivery of
digital audio and video transmissions by advertisers, advertising agencies,
production studios, and video and music distributors to radio and 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 such market grows at all. If the market fails to grow, or grows more
slowly than anticipated, our business, operating results and financial condition
would be seriously harmed. Even if the market does grow, it cannot assure that
its 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, it cannot assure that it will be able to conform its products to
such standards in a timely fashion, or that it will be able to conform its
products to such standards 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. However, it cannot assure that
it will be successful in developing such services, or in obtaining new customers
for such services. See "Dependence on New Product Introductions." Furthermore,
it cannot assure that it 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 its
network, including its field receiving equipment and rooftop satellite antennae.
The Company's marketing efforts to date with regard to its 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. The
Company cannot assure that it has correctly identified such markets or that its
planned products and services will address the needs of such markets.
Furthermore, it cannot assure that its 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 its products and services will require it
to overcome significant market development hurdles, many of which may not
currently be foreseen.
Uncertainties Relating to Integration of Operations. The Company effected
the recent acquisitions of PDR, Mediatech, and DCI, 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, Mediatech or DCI with DG Systems. Achieving the anticipated benefits of
these acquisitions will depend in part upon whether the integration of the
organizations and businesses of PDR, Mediatech and DCI with those of DG Systems
is achieved in an efficient, effective and timely manner. However, the Company
cannot assure that such integration will occur. The successful integration and
expansion of its business following its acquisition of PDR, Mediatech and DCI
requires communication and cooperation among the senior executives and key
technical personnel of DG Systems, PDR, Mediatech and DCI. Given the inherent
difficulties involved in completing a business combination, the Company cannot
assure 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 its business. The failure to effectively accomplish
the integration of the operations of PDR, Mediatech and DCI with those of DG
Systems could seriously harm its results of operations and financial condition.
In addition, the Company cannot assure that all of its current and potential
customers will favorably view its services as offered through PDR, Mediatech and
DCI or that it will realize any of the other anticipated benefits of the
acquisitions. Moreover, as a result of these acquisitions, certain of its
customers may perceive PDR, Mediatech or DCI to be a competitor, and this could
affect such customers' willingness to do business with the Company in the
future. The loss of significant customers would seriously harm its results of
operations and financial condition.
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Dependence on Radio Advertising. Prior to its acquisitions of PDR and
Mediatech, its 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. The
Company expects the delivery of such services to continue to account for a
significant portion of its revenues for some time. A decline in demand for, or
average selling prices of, its radio advertising delivery services for any of
the following reasons, or otherwise, would seriously harm its business,
financial condition and results of operations:
- Competition from new advertising media;
- New product introductions or price competition from competitors;
- A shift in purchases by customers away from its premium services,
such as DG Priority or Rush and DG Express or Same Day; and
- A change in the technology used to deliver such services.
Additionally, the Company is dependent on its relationship with 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 its equipment in any way, it could
seriously harm its business, financial condition and results of operations.
Competition. The Company currently competes in the market for the
distribution of audio advertising spots to radio stations and the distribution
of video advertising spots to television stations. The principal competitive
factors affecting these markets are ease of use, price, timeliness and accuracy
of delivery. The 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 us 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
it has. In September 1998, the Company acquired substantially all of the assets
of DCI, a supplier of electronic distribution and communications services for
the radio broadcast industry in the United States and Canada. This acquisition
has resulted in:
- Expansion of its customer base;
- An increase in the number of radio stations included in its
network; and
- An improvement in its ability to provide a point to point delivery
service between the radio stations and groups.
The Company believes that it offers the only nationwide electronic delivery
option for audio spot distribution. In the market for the distribution of video
content to television stations, it encounters competition from numerous large
and small dub and ship houses and production studios, certain of which currently
function as marketing partners with DG Systems in the audio distribution market.
To the extent that it is successful in entering new markets, such as the
delivery of other forms of content to radio and television stations, the Company
would expect to face competition from companies in related communications
markets and/or package delivery markets. Some of these companies in related
markets could offer products and services with functionality similar or superior
to that offered by its products and services. Telecommunications providers such
as AT&T, MCI Worldcom 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.
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Many of its 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 DG Systems. The
Company may not be able to compete successfully against current and future
competitors based on these and other factors. It expects that an increasingly
competitive environment will result in price reductions that could result in
lower profits and loss of market share, all of which would seriously harm its
business, financial condition and results of operations. 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 its 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. Accordingly, it may not be able to compete successfully with new or
existing competitors, and the effects of such competition could seriously harm
its business, financial condition and results of operations.
Other Risks Associated with Nasdaq National Market Listing Qualification.
The holders of the registered Common Stock of DG Systems currently enjoy a
substantial benefit in terms of liquidity by having such Common Stock listed on
the Nasdaq National Market trading system. This benefit would be lost if the
Company were to be delisted from the Nasdaq National Market. On November 25,
1998, the Company received notice from the Nasdaq Stock Market, Inc. ("Nasdaq")
that, on the basis of its Quarterly Report on Form 10-Q for the quarter ending
September 30, 1998, its net tangible assets had fallen below the level required
for continued inclusion of its Common Stock on the Nasdaq National Market
trading system. On December 10, 1998, it submitted information to Nasdaq that it
had raised approximately $11 million and, therefore, believed that it was once
again in compliance with all of the requirements for continued listing on the
Nasdaq National Market.
Nasdaq subsequently requested additional information regarding its August
1998 and December 1998 financing activities as well as its acquisition of
substantially all of the assets of DCI in order to ascertain its compliance with
applicable corporate governance rules. On December 17, 1998, the Company
submitted additional information to Nasdaq in response to this request. While
the Company believes it is currently in compliance with Nasdaq's continued
listing requirements and corporate governance rules, it cannot assure that
Nasdaq will make such a finding or that it will be able to continue to have its
Common Stock listed on the Nasdaq National Market or similar public securities
exchange.
Year 2000 Readiness Disclosure. 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 nine months, 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 the Year 2000 coding problem. To
identify potential issues, the Company utilized a third party consulting firm to
assess the Year 2000 risk regarding the level of dependence and the exposure of
various internal and external systems and related applications upon which the
Company may be dependent. With the completion of this third party assessment the
Company has developed a formal project plan.
The Company has completed 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 a formal comprehensive project plan in
place and is currently 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. The Company's project plan
consists of five major phases: Awareness, Assessment, Detailed Analysis and
Preliminary Testing, System Conversion and Testing, and Implementation. The
above mentioned phases include education, a complete company wide inventory
assessment, testing and correction of all non-compliant systems. Each piece of
equipment or system will go through all five phases and will be completed at
different times throughout the year. The Company's goal is to reach total Year
2000 compliance of all systems and equipment, technical and non-technical, by
November 1999. The Company's strategy also includes development of contingency
plans to address potential disruption of operations arising from the Year 2000
problem. The Company is in the development stage of contingency planning and, at
this time, has not completed its contingency plan.
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Awareness: The Company believes that awareness of the Year 2000 problem is
critical to its business and employees. Therefore, the Company has chosen
several means of communicating the Year 2000 problem to each sector of its
business. These shall include, but are not limited to, executive staff meetings,
team meetings, E-mail notices, Website updates, and communication by US Mail to
customers and vendors.
Assessment: The Company is assessing all systems including hardware,
application software and firmware. A complete company-wide inventory assessment
is nearing completion and is necessary to determine any potential Year 2000
issues. The Company is currently reviewing each vendor's Year 2000 project plan
and status. Each vendor has or will receive a compliance letter and
questionnaire to allow the Company to gauge the vendor's compliance level.
Non-Information Technology equipment such as elevators, security systems, and
electric power, have been placed into the Service Provider category and each
area is being monitored closely to ensure that no disruption in services will
occur. Mission critical suppliers have been identified and contingency plans are
being developed.
Detailed Analysis & Preliminary Testing: The Company has completed
preliminary testing and analysis on most mission critical systems. Remote
testing of offsite systems hardware is scheduled to begin in April. All offsite
systems are expected to be Year 2000 compliant by the third quarter of 1999. The
Company's financial systems are currently being upgraded. A detailed analysis
and preliminary testing of each remaining system is scheduled and/or is
currently in progress.
System Conversion & Testing: The Company's network includes RPTs, CWs and
DVPS strategically placed across the country in broadcasting stations. The
Company has direct network control over its applications and has included
detailed testing and correction of all source code and associated data elements.
Each unit will be remotely tested and any necessary corrections or modifications
will be made. Internally, the Company utilizes many third party application
software programs as well as programs developed in-house. Upgrades and
modifications will be tested and implemented as needed.
Implementation: The Company will implement new or upgraded software as
needed to assure its continuation of business with little or no risk of
disruption from Year 2000. All systems compliance information will be documented
and a contingency plan for each system or service is scheduled to be in place by
November of 1999.
Risks: Although the Company has direct programming control over its network
applications, 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 is also dependent upon other third
parties, in particular its telephone and satellite transmission suppliers, in
order to provide its electronic distribution services. The Company is in the
process of obtaining relevant information from these suppliers in order to
increase awareness of potential issues. If such vendors' systems are not Year
2000 compliant, it could have a material adverse affect on the Company's
operations. At this time, the Company has not fully quantified the potential
impact of third party vendor year 2000 issues.
The Company believes that the purchasing pattern of its current and
potential customers may be affected by the Year 2000 problem 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
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foregoing could result in a loss of revenues which would have a material adverse
effect on the Company's business, financial condition and results of operations.
At this time, the Company is developing detailed contingency plans for the
possibility of significant disruption due to Year 2000 issues. Preliminary
discussions have been held but completion of the development of such a
contingency plan will be dependent upon the findings and resulting actions taken
based on the risk assessment studies discussed above.
Costs: The Company currently does not anticipate that the direct resource
requirements or expenses of the Company related to resolving Year 2000 issues
will have a significant adverse effect on its operating results or financial
position. To date, the Company has incurred approximately $800,000 in Year 2000
readiness related expenses, and estimates that total Year 2000 related expenses
will be approximately $2 million.
The foregoing assessment is based on information currently available to the
Company. The Company can provide no assurance that applications and equipment
that the Company believes to be Year 2000 compliant will not experience
problems. Failure by the Company or third parties on which it relies to resolve
Year 2000 problems could have a material adverse effect on the Company's 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:
- Volume of advertising in response to seasonal buying patterns;
- Timing of introductions of new products and services;
- Increased competition;
- Timing of its promotional efforts; and
- General economic 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, it 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 its
future performance. In any single period, its revenues and delivery costs are
subject to variation based on changes in the volume and mix of deliveries
performed during such period. In particular, its 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 its relatively higher prices for "Sweeps"
advertisements have historically increased the total revenues and revenues per
delivery and tended to reduce relative delivery costs. Its 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 seriously harmed. 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
its sales growth rate slows. Due to the unique nature of its products and
services, it 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 Company has employment agreements with certain of its key
executives. In general, the agreements provide for base salaries, bonuses,
option grants based on certain performance criteria, and terminations payments.
It does not maintain key man life insurance on the lives of any of its key
personnel. The competition for qualified personnel, particularly engineering
staff, is intense, and it is possible that it may not be able to continue to
attract and retain qualified management, sales and technical personnel for the
development of its business. If the Company is unable to attract, hire and
retain qualified personnel in the future, the success of its business could be
impaired, and this could seriously harm its business, operating results and
financial condition.
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Dependence on Certain Suppliers. The Company relies on certain single or
limited-source suppliers for integral components used for the assembly of its
audio and video units. Although these 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 DG Systems, it would delay its deployment of
audio and video units. This would have the effect of depressing its business
until it was able to establish sufficient component supply through an
alternative source. The Company believes that there are currently alternative
component manufacturers that could supply the components required to produce its
products, but it 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 it purchases its
components on a purchase order basis. The Company has experienced component
shortages in the past, and material component shortages or production or
delivery delays may occur in the future. The inability to continue 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 seriously harm its
business, financial condition and results of operations.
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' satellite system entails a number of significant risks. Its business,
results of operations and financial condition would be seriously harmed if
Hughes were unable for any reason to continue to meet its delivery commitments
on a cost-effective basis or if any transmissions failed to satisfy its quality
requirements. In the event that the Company was unable to continue to use
Hughes' satellite capacity, it would have to identify, qualify and transition
deliveries to an acceptable alternative satellite transmission vendor. Such an
alternative satellite transmission vendor may not be available in a position to
satisfy its delivery requirements on a timely and cost-effective basis, if at
all. In the event that such an alternative satellite transmission vendor were
available, the identification, qualification and transition process could take
up to nine months or longer.
The Company obtains its local access telephone transmission services
through Teleport Communications Group. It obtains its long distance telephone
access through an exclusive contract with MCI Worldcom, which 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 seriously
harm its business, results of operations and financial condition.
Dependence on New Product Introductions. The Company's future growth
depends on the successful and timely introduction of new products and services
in markets that do not currently exist or are just emerging. Its goal is 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. The Company may not be able to successfully complete
development of such products and services. Even if any such development is
completed, it may not be able to introduce these products and services and these
products may not realize market acceptance or meet the technical or other
requirements of potential customers. The failure to successfully develop and
introduce new products and services could seriously harm its business, financial
condition and results of operations.
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. It relies on a
combination of trade secret, copyright and trademark laws and nondisclosure and
other arrangements to protect its proprietary rights. We do not have any patents
or patent applications pending. We generally enter into confidentiality or
license agreements with its employees, distributors and customers, and limit
access to and distribution of its software, documentation and other proprietary
information. Despite its efforts to protect its proprietary rights, unauthorized
parties may attempt to copy or obtain and use information that it regards as
proprietary. The steps that it has taken to protect its proprietary information
may not 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 its
proprietary rights to the same extent as do the
21
<PAGE> 22
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, it may still receive future
communications from third parties asserting that it is infringing, or may be
infringing, 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. If such claims are successful, the Company may not be able to obtain
any licenses necessary for the operation of its business or, if obtainable, such
licenses may not obtainable on commercially reasonable terms. In the event of a
successful claim of infringement and its failure or inability to license the
infringed or similar proprietary information, its business, financial condition
and results of operations could be seriously harmed.
Concentration of Stock Ownership; Antitakeover Provisions. The present
executive officers and directors of DG Systems and its respective affiliates own
approximately 46% of its Common Stock. As a result, these shareholders will be
able to control or significantly influence all matters requiring shareholder
approval, including the election of directors and the approval of significant
corporate transactions. Such concentration of ownership may have the effect of
delaying or preventing a change in control of DG Systems. Furthermore, certain
provisions of its 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 DG Systems.
Preferential Rights of Preferred Stock . DG Systems presently has
15,000,000 shares of Preferred Stock authorized. On August 12, 1998, the holders
of 4,950,495 shares of Series A Convertible Preferred Stock, constituting all of
the outstanding shares of the Series A Convertible Preferred Stock, elected to
convert such shares into shares of its Common Stock. Accordingly, pursuant to
its Articles of Incorporation, the 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 shares of any such series and to determine the
rights, preferences, privileges and restrictions granted to or imposed upon, any
such series.
Registration Rights. In connection with the August and December 1998
private placements of shares of its Common Stock, as further described in
"Market for Registrant's Common Stock and Related Shareholder Matters," the
Company agreed to prepare and file a Registration Statement on Form S-3 (the
"Registration Statement"), with the Security and Exchange Commission for the
purposes of registering the resale of such shares and to list such shares on the
Nasdaq National Market. Certain other holders of its Common Stock, including
former holders of its Series A Convertible Preferred Stock, previously have been
granted demand and piggy-back registration rights, such that such holders were
entitled to include their shares in this registration process and any such
subsequent registration process. The Registration Statement, effective as of
February 12, 1999, registered 15,214,220 shares of its Common Stock. The Company
has agreed to use commercially reasonable efforts to keep the Registration
Statement effective for the lesser of until the date as to which all such shares
of Common Stock may be sold by the holders thereof without registration in a
single transaction pursuant to Rule 144(k) under the Act or until all such
shares have been sold. In addition, in connection with the December 9, 1998
issuance of warrants to purchase its Common Stock, as further described in
"Market for Registrant's Common Stock and Related Shareholder Matters," the
Company granted the holders of such warrants demand registration rights with
respect to the shares of Common Stock issuable upon exercise of such warrants.
Following the completion of such registration on Form S-3, the additional
15,214,220,shares of DG Systems' Common Stock registered thereunder became
freely tradable in the public market, subject to volume limitations applicable
to affiliates of DG Systems. Sales of a substantial number of additional shares
in the public market could seriously harm the market price of DG System's Common
Stock and could impair its future ability to raise capital through the sale of
its equity securities.
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 require us to incur substantial costs and
expend significant managerial resources to obtain any necessary regulatory
approvals and to 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 its products and services to be redesigned,
22
<PAGE> 23
causing product and service delivery delays that could seriously harm its
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. However, the Company cannot assure that its products and services
will achieve market acceptance in foreign countries. Its inability to
successfully establish and expand its international operations may also limit
its ability to obtain significant international revenues and could seriously
harm its business, operating results and financial condition. 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, its
business, operating results and financial condition could be seriously harmed 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 its 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 DG Systems or its competitors; and
- 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 its Common
Stock.
23
<PAGE> 24
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On February 6, 1999, City National Bank filed a lawsuit against
Starcom Television Services, Inc. ("Starcom Television"), a predecessor in
interest of the Company's Mediatech subsidiary, Gary J. Worth, a former officer
of Starcom Television, and certain other parties in Superior Court of
California for the County of Los Angeles. The lawsuit alleges causes of action
for breaches of a certain September 1993 Assumption Agreement whereby Starcom
Television allegedly agreed to assume certain monetary obligations of Program
Entertainment Group, Inc. to City National Bank. City National Bank is seeking
monetary damages plus interest and recovery of certain collateral. These claims
arose prior to the Company's acquisition of Mediatech. The Company believes it
has several material defenses to these claims as well as claims for indemnity
against certain of the co-defendants and other third parties. In the event that
the Company's defenses are unsuccessful, the Company may be required to pay
damages and deliver collateral to City National Bank, and such a judgement
could seriously harm the Company's business, financial condition and results of
operations.
In addition, the Company may from time to time become involved in
litigation proceedings incidental to the conduct of its business. Other than as
set forth above, the Company does not believe that any such proceedings
presently pending will have a material adverse effect on the Company's
financial condition or results of operations.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
As mentioned in the Notes to the Consolidated Financial Statements, effective
for fiscal year 1999, beginning January 1, the Company elected to adjust its
fiscal quarters so that each quarter is thirteen weeks in length and ends on the
Saturday nearest to March 31, June 30, and September 30. Therefore, the first
fiscal quarter of 1999 ended on April 3, 1999, second quarter will end on July
7, 1999 and third quarter will end on October 2, 1999. Fiscal fourth quarter
will continue to end on December 31, 1999.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT NUMBER EXHIBIT TITLE
-------------- -------------
<S> <C>
3.1.1(d) Restated Articles of Incorporation of registrant.
3.1.2(h) Certificate of Determination of Rights of Series A
Convertible Preferred Stock of Digital Generation
Systems, Inc., filed by the Secretary of State of the
State of California on July 16, 1997.
3.2(b) Bylaws of registrant, as amended to date.
4.1(b) Form of Lock-Up Agreement.
4.2(b) Form of Common Stock Certificate.
10.1(b) 1992 Stock Option Plan (as amended) and forms of
Incentive Stock Option Agreement and Non-statutory
Stock Option Agreement.
10.2(b) Form of Directors' and Officers' Indemnification
Agreement.
10.3(b) 1995 Director Option Plan and form of Incentive Stock
Option Agreement thereto.
10.4(b) Form of Restricted Stock Agreement.
10.5.1(c) Content Delivery Agreement between the Company and
Hughes Network Systems, Inc., dated November 28, 1995.
10.5.2(c) Equipment Reseller Agreement between the Company and
Hughes Network Systems, Inc., dated November 28, 1995.
10.6(b) Amendment to Warrant Agreement between the Company and
Comdisco, Inc., dated January 31, 1996.
10.7(j) Special Customer Agreement between the Company and MCI
Telecommunications Corporation, dated May 5, 1997.
</TABLE>
24
<PAGE> 25
<TABLE>
<CAPTION>
EXHIBIT NUMBER EXHIBIT TITLE
-------------- -------------
<S> <C>
10.8(b) Master Lease Agreement between the Company and
Comdisco, Inc., dated October 20, 1994, and Exhibits
thereto.
10.9(b) Loan and Security Agreement between the Company and
Comdisco, Inc., dated October 20, 1994, and Exhibits
thereto.
10.10(b) Master Equipment Lease between the Company and Phoenix
Leasing, Inc., dated January 7, 1993.
10.15(c) Audio Server Network Prototype Vendor Agreement and
Satellite Vendor Agreement between the Company and ABC
Radio Networks, dated December 15, 1995.
10.17(b) Promissory Note between the Company and Henry W.
Donaldson, dated March 18, 1994, December 5, 1994,
December 5, 1994, and March 14, 1995.
10.18(b) Warrant Agreement to purchase Series B Preferred Stock
between the Company and Comdisco, Inc., dated as of
October 20, 1994.
10.19(b) Warrant Agreement to purchase Series C Preferred Stock
between the Company and Comdisco, Inc., dated as of
June 13, 1995.
10.20(b) Warrant Agreement to purchase Series D Preferred Stock
between the Company and Comdisco, Inc., dated as of
January 11, 1996.
10.22(d) Agreement of Sublease for 9,434 rentable square feet at
855 Battery Street, San Francisco, California between
the Company and T.Y. Lin International dated September
8, 1995 and exhibits thereto.
10.23(d) Agreement of Sublease for 5,613 rentable square feet at
855 Battery Street, San Francisco, California between
the Company and Law/Crandall, Inc. dated September 29,
1995 and exhibits thereto.
10.24(e) Digital Generation Systems, Inc. Supplemental Stock
Option Plan.
10.25(e) Stock Purchase Agreement by and among Digital
Generation Systems, Inc. and PDR Productions, Inc. and
Pat DeRosa dated as of October 15, 1996 and exhibits
thereto.
10.26(f) Amendment to Stock Purchase Agreement dated November 8,
1996, among Digital Generation Systems, Inc., and Pat
DeRosa.
10.27(h) Loan Agreement dated as of January 28, 1997 between
Digital Generation Systems, Inc. as Borrower, and
Venture Lending and Leasing, Inc. as Lender and
exhibits thereto.
10.28(I) Stock Purchase Agreement, dated as of July 18, 1997, by
and between Digital Generation Systems, Inc., a
California corporation, IndeNet, Inc., a Delaware
Corporation, and exhibits thereto.
10.29(I) Preferred Stock Purchase Agreement, dated as of July
14, 1997, by and among Digital Generation Systems, Inc.
and the parties listed on the Schedule of Purchasers
attached, as Exhibit A thereto.
10.30(I) Amendment to Preferred Stock Purchase Agreement, dated
as of July 23, 1997, by and among Digital Generation
Systems, Inc. and the purchasers listed on the Exhibit
A thereto.
10.31(k) 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(q) 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(l) Common Stock Subscription Agreement for private
placement of Company's Common Stock at $2.80 per share.
10.34(m) Sale and Purchase Agreement, dated September 10, 1998,
by and between Grant Thornton Limited, in its capacity
as Receiver-Manager of Digital Courier International
Corporation and Digital Courier International, Inc. and
Digital Generation Systems, Inc. and exhibits thereto.
10.35(n) Series A Preferred Stock Conversion Agreement dated as
of August 12, 1998.
10.36(p) Amendment and Restatement No. 5 of the Registration
Rights Agreement, dated July 14, 1997, by and among the
Registrant and certain of its securityholders.
10.37(p) Amended and Restated Registration Rights Agreement,
dated December 9, 1998, by and among the Registrant and
certain of its securityholders
10.38(p) Registration Rights Agreement, dated December 9, 1998,
by and among the Registrant and certain of its
securityholders.
10.39(q) Common Stock and Warrant Purchase Agreement dated
December 9, 1998 by and among the registrant and
investors listed in Schedule A thereto.
</TABLE>
25
<PAGE> 26
<TABLE>
<CAPTION>
EXHIBIT NUMBER EXHIBIT TITLE
-------------- -------------
<S> <C>
10.40(q) Common Stock Subscription Agreement dated December 9,
1998 by and among the Registrant and Scott Ginsburg.
10.41(q) Warrant Purchase Agreement dated December 9, 1998 by
and among the Registrant and Scott Ginsburg.
10.42(q) Warrant No. 1 to Purchase Common Stock dated December
9, 1998 by and among Registrant and Scott K. Ginsburg.
10.43(q) Warrant No. 2 to Purchase Common Stock dated December
9, 1998 by and among Registrant and Scott K. Ginsburg
27(q) Financial Data Schedule.
</TABLE>
- ----------------
(a) Filed herewith.
(b) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Registration Statement on Form S-1 (Registration No.
33-80203).
(c) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Registration Statement on Form S-1 (Registration No.
33-80203). The registrant has received confidential treatment with
respect to certain portions of this exhibit. Such portions have been
omitted from this exhibit and have been filed separately with the
Securities and Exchange Commission.
(d) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Quarterly Report on Form 10-Q filed May 3, 1996, as
amended.
(e) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Quarterly report on Form 10-Q filed November 13, 1996.
(f) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Current Report on Form 8-K/A filed January 21, 1997.
(g) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Annual Report on Form 10-K filed March 18, 1997.
(h) Incorporated by reference to the exhibit bearing the same number filed
with registrant's quarterly report on Form 10-Q filed May 15, 1997.
(i) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Form 8-K filed August 1, 1997.
(j) Incorporated by reference to the exhibit bearing the same 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 number filed
with registrant's Annual Report on Form 10-K filed March 31, 1998.
(l) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Quarterly report on Form 10-Q filed May 15, 1998.
(m) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Quarterly report on Form 10-Q filed August 14, 1998.
(n) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Current Report on Form 8-K filed October 13, 1998.
(o) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Quarterly report on
26
<PAGE> 27
Form 10-Q filed November 16, 1998.
(p) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Registration Report on Form S-3 filed on December 31,
1998.
(q) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Registration Report on Form 10-K filed on March 31,
1999.
(b) REPORTS ON FORM 8-K.
Not Applicable.
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: May 18, 1998 BY: /S/ PAUL W. EMERY, II
--------------------------------
PAUL W. EMERY, II
VICE PRESIDENT & CHIEF FINANCIAL
OFFICER (PRINCIPAL FINANCIAL AND
CHIEF ACCOUNTING OFFICER)
27
<PAGE> 28
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NUMBER EXHIBIT TITLE
-------------- -------------
<S> <C>
3.1.1(d) Restated Articles of Incorporation of registrant.
3.1.2(h) Certificate of Determination of Rights of Series A
Convertible Preferred Stock of Digital Generation
Systems, Inc., filed by the Secretary of State of the
State of California on July 16, 1997.
3.2(b) Bylaws of registrant, as amended to date.
4.1(b) Form of Lock-Up Agreement.
4.2(b) Form of Common Stock Certificate.
10.1(b) 1992 Stock Option Plan (as amended) and forms of
Incentive Stock Option Agreement and Non-statutory
Stock Option Agreement.
10.2(b) Form of Directors' and Officers' Indemnification
Agreement.
10.3(b) 1995 Director Option Plan and form of Incentive Stock
Option Agreement thereto.
10.4(b) Form of Restricted Stock Agreement.
10.5.1(c) Content Delivery Agreement between the Company and
Hughes Network Systems, Inc., dated November 28, 1995.
10.5.2(c) Equipment Reseller Agreement between the Company and
Hughes Network Systems, Inc., dated November 28, 1995.
10.6(b) Amendment to Warrant Agreement between the Company and
Comdisco, Inc., dated January 31, 1996.
10.7(j) Special Customer Agreement between the Company and MCI
Telecommunications Corporation, dated May 5, 1997.
10.8(b) Master Lease Agreement between the Company and
Comdisco, Inc., dated October 20, 1994, and Exhibits
thereto.
10.9(b) Loan and Security Agreement between the Company and
Comdisco, Inc., dated October 20, 1994, and Exhibits
thereto.
10.10(b) Master Equipment Lease between the Company and Phoenix
Leasing, Inc., dated January 7, 1993.
10.15(c) Audio Server Network Prototype Vendor Agreement and
Satellite Vendor Agreement between the Company and ABC
Radio Networks, dated December 15, 1995.
10.17(b) Promissory Note between the Company and Henry W.
Donaldson, dated March 18, 1994, December 5, 1994,
December 5, 1994, and March 14, 1995.
10.18(b) Warrant Agreement to purchase Series B Preferred Stock
between the Company and Comdisco, Inc., dated as of
October 20, 1994.
10.19(b) Warrant Agreement to purchase Series C Preferred Stock
between the Company and Comdisco, Inc., dated as of
June 13, 1995.
10.20(b) Warrant Agreement to purchase Series D Preferred Stock
between the Company and Comdisco, Inc., dated as of
January 11, 1996.
10.22(d) Agreement of Sublease for 9,434 rentable square feet at
855 Battery Street, San Francisco, California between
the Company and T.Y. Lin International dated September
8, 1995 and exhibits thereto.
10.23(d) Agreement of Sublease for 5,613 rentable square feet at
855 Battery Street, San Francisco, California between
the Company and Law/Crandall, Inc. dated September 29,
1995 and exhibits thereto.
10.24(e) Digital Generation Systems, Inc. Supplemental Stock
Option Plan.
10.25(e) Stock Purchase Agreement by and among Digital
Generation Systems, Inc. and PDR Productions, Inc. and
Pat DeRosa dated as of October 15, 1996 and exhibits
thereto.
10.26(f) Amendment to Stock Purchase Agreement dated November 8,
1996, among Digital Generation Systems, Inc., and Pat
DeRosa.
10.27(h) Loan Agreement dated as of January 28, 1997 between
Digital Generation Systems, Inc. as Borrower, and
Venture Lending and Leasing, Inc. as Lender and
exhibits thereto.
10.28(I) Stock Purchase Agreement, dated as of July 18, 1997, by
and between Digital Generation Systems, Inc., a
California corporation, IndeNet, Inc., a Delaware
Corporation, and exhibits thereto.
10.29(I) Preferred Stock Purchase Agreement, dated as of July
14, 1997, by and among Digital Generation Systems, Inc.
and the parties listed on the Schedule of Purchasers
attached, as Exhibit A thereto.
10.30(I) Amendment to Preferred Stock Purchase Agreement, dated
as of July 23, 1997, by and among Digital Generation
Systems, Inc. and the purchasers listed on the Exhibit
A thereto.
10.31(k) 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(q) 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(l) Common Stock Subscription Agreement for private
placement of Company's Common Stock at $2.80 per share.
10.34(m) Sale and Purchase Agreement, dated September 10, 1998,
by and between Grant Thornton Limited, in its capacity
as Receiver-Manager of Digital Courier International
Corporation and Digital Courier International, Inc. and
Digital Generation Systems, Inc. and exhibits thereto.
10.35(n) Series A Preferred Stock Conversion Agreement dated as
of August 12, 1998.
10.36(p) Amendment and Restatement No. 5 of the Registration
Rights Agreement, dated July 14, 1997, by and among the
Registrant and certain of its securityholders.
10.37(p) Amended and Restated Registration Rights Agreement,
dated December 9, 1998, by and among the Registrant and
certain of its securityholders
10.38(p) Registration Rights Agreement, dated December 9, 1998,
by and among the Registrant and certain of its
securityholders.
10.39(q) Common Stock and Warrant Purchase Agreement dated
December 9, 1998 by and among the registrant and
investors listed in Schedule A thereto.
</TABLE>
28
<PAGE> 29
<TABLE>
<CAPTION>
EXHIBIT NUMBER EXHIBIT TITLE
-------------- -------------
<S> <C>
10.40(q) Common Stock Subscription Agreement dated December 9,
1998 by and among the Registrant and Scott Ginsburg.
10.41(q) Warrant Purchase Agreement dated December 9, 1998 by
and among the Registrant and Scott Ginsburg.
10.42(q) Warrant No. 1 to Purchase Common Stock dated December
9, 1998 by and among Registrant and Scott K. Ginsburg.
10.43(q) Warrant No. 2 to Purchase Common Stock dated December
9, 1998 by and among Registrant and Scott K. Ginsburg
27(q) Financial Data Schedule.
</TABLE>
- ----------------
(a) Filed herewith.
(b) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Registration Statement on Form S-1 (Registration No.
33-80203).
(c) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Registration Statement on Form S-1 (Registration No.
33-80203). The registrant has received confidential treatment with
respect to certain portions of this exhibit. Such portions have been
omitted from this exhibit and have been filed separately with the
Securities and Exchange Commission.
(d) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Quarterly Report on Form 10-Q filed May 3, 1996, as
amended.
(e) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Quarterly report on Form 10-Q filed November 13, 1996.
(f) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Current Report on Form 8-K/A filed January 21, 1997.
(g) Incorporated by reference to the exhibit bearing the same number filed
with registrant's Annual Report on Form 10-K filed March 18, 1997.
(h) Incorporated by reference to the exhibit bearing the same number filed
with registrant's quarterly report on Form 10-Q filed May 15, 1997.
(i) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Form 8-K filed August 1, 1997.
(j) Incorporated by reference to the exhibit bearing the same 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 number filed
with registrant's Annual Report on Form 10-K filed March 31, 1998.
(l) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Quarterly report on Form 10-Q filed May 15, 1998.
(m) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Quarterly report on Form 10-Q filed August 14, 1998.
(n) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Current Report on Form 8-K filed October 13, 1998.
(o) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Quarterly report on Form 10-Q filed November 16, 1998.
(p) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Registration Report on Form S-3 filed on December 31,
1998.
(q) Incorporated by reference to the exhibit bearing the same title filed
with registrant's Registration Report on Form 10-K filed on March 31,
1999.
29
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> APR-03-1999
<CASH> 8,240
<SECURITIES> 0
<RECEIVABLES> 9,299
<ALLOWANCES> (1,818)
<INVENTORY> 396
<CURRENT-ASSETS> 18,565
<PP&E> 38,567
<DEPRECIATION> (28,009)
<TOTAL-ASSETS> 43,153
<CURRENT-LIABILITIES> 14,759
<BONDS> 6,672
0
0
<COMMON> 115,148
<OTHER-SE> (93,426)
<TOTAL-LIABILITY-AND-EQUITY> 43,153
<SALES> 0
<TOTAL-REVENUES> 11,460
<CGS> 0
<TOTAL-COSTS> 13,916
<OTHER-EXPENSES> 0
<LOSS-PROVISION> (77)
<INTEREST-EXPENSE> 604
<INCOME-PRETAX> (2,991)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,991)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,991)
<EPS-PRIMARY> 0.11<F1>
<EPS-DILUTED> 0.11
<FN>
<F1>FOR PURPOSES OF THIS EXHIBIT, PRIMARY MEANS BASIC.
</FN>
</TABLE>
