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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K/A
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____________ TO
_____________.
COMMISSION FILE NUMBER: 0-27644
DIGITAL GENERATION SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 94-3140772
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
875 BATTERY STREET
SAN FRANCISCO, CALIFORNIA 94111
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(415) 276-6600
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
NOT APPLICABLE
(FORMER NAME, FORMER ADDRESS, FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting Common Stock held by
non-affiliates of the registrant, based upon the closing sale price of the
Common Stock on March 15, 1999, as reported on the NASDAQ National Market, was
approximately $99,501,540. Shares of Common Stock held by each officer and
director of the registrant and by each person who may be deemed to be an
affiliate have been excluded. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
As of March 15, 1999, the registrant had 26,533,744 shares of Common
Stock, without par value, outstanding.
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AMENDMENT NO. 1
The undersigned Registrant hereby amends Part III, to read in full as
follows:
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The current members of the Board of Directors, their ages as of March
31, 1999, their positions and offices held with the Company and certain
biographical information are set forth below.
<TABLE>
<CAPTION>
DIRECTORS AGE POSITIONS AND OFFICES HELD WITH THE COMPANY
- --------------------------- --- -----------------------------------------------------------
<S> <C> <C>
Scott K. Ginsburg 46 Chairman of the Board, Chief Executive Officer and Director
Henry W. Donaldson 53 President, Chief Operating Officer and Director
Richard H. Harris (1) 69 Vice Chairman of the Board and Director
Kevin R. Compton (2) 40 Director
Jeffrey M. Drazan (1) 40 Director
Lawrence D. Lenihan, Jr. 34 Director
Leonard S. Matthews (1)(2) 77 Director
</TABLE>
- ----------
(1) Member of Compensation Committee
(2) Member of Audit Committee
Scott K. Ginsburg joined the Company in December 1998 as Chief Executive
Officer and Chairman of the Board. He is also the Chairman and Chief Executive
Officer of Starguide Digital Networks and, most recently, served as Chief
Executive Officer and a director of Chancellor Media Corporation. Mr. Ginsburg
founded Evergreen Media Corporation in 1988 and was the co-founder of Statewide
Broadcasting, Inc. and H&G Communications, Inc. Mr. Ginsburg earned a B.A. from
George Washington University in 1974 and a J.D. from the George Washington
University Law Center in 1978.
Henry W. Donaldson joined the Company in March 1993, and served from
that date until December 1998 as the Company's President and Chief Executive
Officer and as a member of the Company's Board of Directors. He currently serves
as President and Chief Operating Officer and as a member of the Company's Board.
He was formerly President of the Data Communications Division of Rexel, Inc., a
provider of telecommunications and local area networking products and services,
from September 1989 through January 1993. Mr. Donaldson holds a B.A. in
Mathematics from Hamilton College.
Richard H. Harris has been a member of the Board of Directors of the
Company since July 1992. Since July 1992, Mr. Harris has been President and
Owner of Harris Classical Broadcasting, operating two FM audio stations in
Milwaukee, Wisconsin. From May 1984 to May 1986, Mr. Harris was Chairman of the
Radio Advertising Bureau. From June 1964 to April 1991, Mr. Harris held various
senior management positions with Westinghouse Broadcasting Company, including
Chairman of the Radio Group. Mr. Harris holds a B.A. in Communications and
Economics from the University of Denver and is a graduate of the Advanced
Management Program at Harvard University.
Kevin R. Compton has been a member of the Board of Directors of the
Company since March 1994. Mr. Compton has been a general partner of Kleiner
Perkins Caufield & Byers, a venture capital investment firm, since December
1990. Mr. Compton currently serves as a director of: Global Village
Communication, Inc., a networking hardware and software company, Citrix Systems,
a developer of server software, Corsair Communications, Inc., a developer of
hardware and software systems for the wireless telecommunications industry,
Verisign, a provider of digital authentication services, and on numerous
privately-held companies. Mr. Compton holds a B.S. in Business Administration
from the University of Missouri.
Jeffrey M. Drazan has been a member of the Board of Directors of the
Company since July 1992. Mr. Drazan has been a general partner of Sierra
Ventures, a venture capital investment firm, since 1985. Mr. Drazan
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currently serves as a director of FaxSav, Micromuse and Retix. Mr. Drazan holds
a B.S.E. in Engineering from Princeton and an M.B.A. from New York University.
Lawrence D. Lenihan, Jr. has been a member of the Board of Directors of
the Company since July 1997. Mr. Lenihan has been a managing member of the
General Partner for Pequot Private Equity Fund, L.P. since February 1997. He is
also a Principal at Dawson-Samberg Capital Management, Inc. and a Principal and
minority shareholder of Pequot Capital Management, Inc. Mr. Lenihan was a
Principal at Broadview Associates, LLC, prior to joining Dawson-Samberg. He
currently serves as a director of Direc-to-Phone and Sanctuary Woods Multimedia
Corporation. Mr. Lenihan holds a B.S.E.E. from Duke University and an M.B.A.
from the Wharton School.
Leonard S. Matthews has been a member of the Board of Directors of the
Company since April 1993. From May 1992 to the present, Mr. Matthews has been
Chairman of the Board of Next Century Media, an interactive television company.
From January 1979 to January 1989, Mr. Matthews was President and Chief
Executive Officer of the American Association of Advertising Agencies.
Previously, Mr. Matthews had been President of two of the world's leading
advertising agencies, Leo Burnett and Young & Rubicam. Mr. Matthews holds a B.S.
in Business Administration & Marketing from Northwestern University.
EXECUTIVE OFFICERS
For information with respect to executive officers of the Company, see
Item 4A of this Annual Report on Form 10-K.
COMPLIANCE WITH SECTION 16(a) OF THE
SECURITIES EXCHANGE ACT OF 1934
The members of the Board of Directors, the executive officers of the
Company and persons who hold more than 10% of the Company's outstanding Common
Stock are subject to the reporting requirements of Section 16(a) of the
Securities Exchange Act of 1934, as amended, which require them to file reports
with respect to their ownership of the Company's Common Stock and their
transactions in such Common Stock. Based upon (i) the copies of Section 16(a)
reports that the Company received from such persons for their 1998 fiscal year
transactions in the Common Stock and their Common Stock holdings and (ii) the
written representations received from one or more of such persons that no annual
Form 5 reports were required to be filed by them for the 1998 fiscal year, the
Company believes that all reporting requirements under Section 16(a) for such
fiscal year were met in a timely manner by its executive officers, Board members
and greater than ten-percent shareholders, except that Paul W. Emery, II filed a
Form 4 late and Kevin R. Compton filed a Form 5 late.
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ITEM 11. EXECUTIVE COMPENSATION
The following Summary Compensation Table sets forth the compensation
earned by the Company's Chief Executive Officer and the four other most highly
compensated executive officers who were serving as such at the end of 1998
(collectively, the "Named Officers"), each of whose aggregate compensation for
1998 exceeded $100,000 for services rendered in all capacities to the Company
and its subsidiaries for that fiscal year.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
----------
AWARDS
ANNUAL COMPENSATION NUMBER OF
----------------------------------------------- SECURITIES
OTHER ANNUAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY(1) BONUS COMPENSATION OPTIONS COMPENSATION(4)
- --------------------------- ---- ---------- ---------- ------------ ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
Scott K. Ginsburg(2) 1998 $ 1 $ 0 $ 39,607(3) 1,548,460 $ 0
Chairman of the Board 1997 $ -- $ -- $ -- -- $ --
and Chief Executive Officer 1996 $ -- $ -- $ -- -- $ --
Henry W. Donaldson 1998 $ 298,374 $ 50,000 $ 4,089(5) 350,000(6) $ 864
President and 1997 $ 225,000 $ 50,000 $ -- 80,000 $ 162
Chief Operating Officer 1996 $ 193,750 $ 50,000 $ -- -- $ 672
Paul W. Emery, II 1998 $ 186,647 $ 35,000 $ 0 150,000(7) $ 990
Vice President, Finance and 1997 $ -- $ -- $ -- -- $ --
Chief Financial Officer 1996 $ -- $ -- $ -- -- $ --
Robert H. Howard 1998 $ 149,241 $ 17,100 $ 0 -- $ 261
Vice President, Direct Sales 1997 $ 82,452 $ 26,667(8) $ -- 150,000 $ 8,919(9)
1996 $ -- $ -- $ -- $ --
Ernest V. Labbe 1998 $ 180,326 $ 30,000 $ 0 150,000 $ 528
Vice President, Operations 1997 $ -- $ -- $ -- -- $ --
1996 $ -- $ -- $ -- -- $ --
</TABLE>
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(1) Salary includes amounts deferred under the Company's 401(k) Plan.
(2) Mr. Ginsburg commenced employment on December 11, 1998.
(3) Represents various perquisites, including $30,000 for reimbursement of
expenses associated with Mr. Ginsburg's airplane.
(4) Includes taxable benefits from premiums for group term life insurance paid
by the Company.
(5) Represents automobile lease payments.
(6) Mr. Donaldson is unvested in 10,158 shares of the Company's Common Stock
purchased through restricted stock purchase agreements with an aggregate
value as of December 31, 1998 of $53,692 (net of consideration for the
shares paid by Mr. Donaldson) based on the closing price of $5.5625 for the
Company's Common Stock as reported on the Nasdaq National Market on such
date.
(7) Mr. Emery holds 50,000 shares of Common Stock purchased on December 9, 1998
pursuant to a restricted stock purchase agreement. All 50,000 shares were
unvested as of December 31, 1998 and have a fair market value of $278,125.
The shares vest as to 25% after one year and the balance in 36 equal monthly
installments thereafter.
(8) Represents sales commissions.
(9) Includes moving expenses of $8,631.
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The following table contains information concerning the stock option
grants made to each of the Named Officers for 1998. No stock appreciation rights
were granted to these individuals during such year.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS(1)
------------------------------------------------- POTENTIAL REALIZABLE
NUMBER OF % OF TOTAL VALUE AT ASSUMED
SECURITIES OPTIONS ANNUAL RATES OF STOCK
UNDERLYING GRANTED TO EXERCISE PRICE APPRECIATION
OPTIONS EMPLOYEES PRICE EXPIRATION FOR OPTION TERM(3)
NAME GRANTED IN 1998 PER SHARE DATE 5% 10%
---- ------- ------- --------- ---- -- ---
<S> <C> <C> <C> <C> <C> <C>
Scott K. Ginsburg 1,548,460(2) 55.2% $3.25 12/09/03 $1,390,386 $3,072,389
Henry W. Donaldson 30,081 1.1% $3.8125 04/29/05 $ 46,688 $ 108,802
169,919 6.1% $3.8125 04/29/05 $ 263,726 $ 614,594
32,043 1.1% $ 2.625 11/20/05 $ 34,242 $ 79,799
117,957 4.2% $ 2.625 11/20/05 $ 126,053 $ 293,758
Paul W. Emery, II 112,214 4.0% $ 2.75 01/12/05 $ 126,627 $ 292,763
37,786 1.3% $ 2.75 01/12/05 $ 42,302 $ 98,583
Robert H. Howard -- -- $ -- -- $ -- $ --
Ernest V. Labbe 112,214 4.0% $ 2.75 01/12/05 $ 125,627 $ 292,763
37,786 1.3% $ 2.75 01/12/05 $ 42,302 $ 98,583
</TABLE>
- ----------
(1) Each of the options listed in the table have a term of 7 years, subject to
earlier termination upon termination of employment. In the event of a merger
of the Company with or into another corporation or other legal, where vested
options have not been assumed or substituted by such successor corporation
or other entity, such options will be exercisable for a period of 15 days
from the date of notice thereof, and will terminate upon the expiration of
such period. The Company's 1992 Stock Option Plan provides that upon a
change in control, the unvested options granted to each of the Company's
executive officers will be subject to accelerated vesting to the extent of
50% of such unvested options. A change in control is defined as (i) a merger
or acquisition of the Company resulting in a 50% or greater change in the
total voting power of the Company immediately following such transaction, or
(ii) certain changes in the majority composition of the Company's Board of
Directors during a 24-month period, which changes are not initiated by the
Board of Directors.
(2) An entity affiliated with Mr. Ginsburg was granted the warrant on December
9, 1998 in consideration of Mr. Ginsburg's services. The warrant is not
exercisable for a minimum of one year and, thereafter, it becomes
exercisable over a 24-month period but only if the Common Stock achieves a
trading price of $10 per share or moreover a sustained period, and then half
the shares will vest, or achieves a price of $15 per share or more a
sustained period. The warrant will in any event become fully exercisable on
November 8, 2003. The warrants become fully exercisable upon a change in
control involving the Company. The warrants expire December 9, 2003.
(3) Potential gains are net of exercise price, but before taxes associated with
exercise. The 5% and 10% assumed annual rates of compounded stock price
appreciation are mandated by rules of the Securities and Exchange
Commission. There can be no assurance provided to any executive officer or
any other holder of the Company's securities that the actual stock price
appreciation over the 10-year option term will be at the assumed 5% and 10%
levels or at any other defined level. Unless the market price of the Common
Stock appreciates over the option term, no value will be realized from the
option grants made to the Named Officers.
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The following table sets forth information concerning option holdings as
of the end of the 1998 fiscal year with respect to each of the Named Officers.
No options were exercised by the Named Officers during the 1998 fiscal year. No
stock appreciation rights were outstanding at the end of that year.
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
AT FY-END AT FY-END(1)
--------- ------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Scott K. Ginsburg .... 0 1,548,460 0 $3,580,814
Henry W. Donaldson ... 163,590 428,910 $ 305,271 $ 931,760
Paul W. Emery, II..... 0 150,000 0 $ 421,875
Robert H. Howard ..... 59,373 90,627 $ 100,192 $ 152,933
Ernest V. Labbe ...... 0 150,000 0 $ 421,875
</TABLE>
(1) Based on the fair market value of the Company's Common Stock at year end,
$5.5625 per share, less the exercise price payable for such shares.
DIRECTOR COMPENSATION
Except for grants of stock options, directors of the Company generally
do not receive compensation for services provided as a director other than
reimbursement for documented reasonable expenses incurred in connection with
attendance at meetings of the Company's Board of Directors and the committees
thereof. The Company also does not pay compensation for committee participation
or special assignments of the Board of Directors.
Non-employee Board members are eligible for option grants pursuant to
the provisions of the Company's 1995 Director Option Plan. Under the 1995
Director Option Plan, each non-employee director of the Company will be
automatically granted an option to purchase 10,000 shares of the Company's
Common Stock (the "First Option") on the date on which the optionee first
becomes a non-employee director of the Company, and each non-employee director
will thereafter be granted an additional option to purchase 2,500 shares of the
Company's Common Stock (the "Subsequent Option") on the next anniversary. The
exercise price per share of all options granted under the 1995 Director Option
Plan shall be equal to the fair market value of a share of the Company's Common
Stock on the date of grant of the option. Shares subject to the First Option
vest over 36 months, and shares subject to the Subsequent Option shares vest
over 12 months beginning with the month following the second anniversary of its
date of grant. The terms of the options granted are ten years.
Directors who are also employees of the Company are eligible to receive
options for Common Stock directly under the 1992 Stock Option Plan and, if
officers of the Company, are also eligible to receive incentive cash bonus
awards and are eligible to participate in the 1996 Employee Stock Purchase Plan.
EMPLOYMENT CONTRACTS AND CHANGE IN CONTROL ARRANGEMENTS
None of the Company's executive officers have employment or severance
agreements with the Company, and their employment may be terminated at any time
at the discretion of the Board of Directors, except that Mr. Donaldson, the
Company's President and Chief Operating Officer, entered into an employment
agreement with the Company on November 20, 1998 that provides for a term of
employment through March 31, 2000. Pursuant to the employment agreement, Mr.
Donaldson's base salary was increased to $300,000. Pursuant to the employment
agreement, in January 1999, Mr. Donaldson was awarded an incentive bonus of
$50,000 based on the financial and operational performance of the Company during
1998, and is scheduled to receive a bonus of $75,000 for fiscal 1999 and has a
bonus potential for fiscal 2000 of $75,000 with a minimum of $50,000 guaranteed.
If, prior to March 31, 2000, the Company terminates Mr. Donaldson's employment
for any reason other than cause, then the
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Company shall pay Mr. Donaldson his base compensation through March 31, 2000,
Mr. Donaldson's stock options granted pursuant to the agreement shall become
fully exercisable, Mr. Donaldson shall be guaranteed a minimum bonus for 1999 of
$50,000 and a bonus for 2000 equal to one-quarter of the 1999 bonus, the Company
shall forgive any remaining indebtedness under a loan in the principal amount of
$175,000 incurred by Mr. Donaldson to purchase stock, and the Company shall
continue to provide certain perquisites and employee benefits through December
31, 2000. Provided Mr. Donaldson remains employed through March 31, 2000 or
through an earlier date determined by the Company, the agreement provides that
the Company will employ Mr. Donaldson as a part-time employee through March 31,
2001, but in any event for not less than one year from cessation of full-time
employment and Mr. Donaldson will make himself available for transition
assistance for up to forty (40) hours per month. During the period of part-time
employment, Mr. Donaldson will continue to be eligible for certain employee
benefits, including continued vesting of options and option shares.
Beginning in 1994, Mr. Donaldson purchased restricted stock from the
Company pursuant to four restricted stock purchase agreements. The Company has
the right to repurchase certain shares upon the termination of Mr. Donaldson's
employment with the Company prior to full vesting. Under the agreement dated
March 18, 1994 for 150,000 shares, the Company's right to repurchase lapses and
Mr. Donaldson vests in the shares in a series of 60 equal monthly installments
from March 15, 1993. Under the agreement dated December 5, 1994 for 50,000
shares, the Company's right to repurchase lapses and Mr. Donaldson vests in the
shares in a series of 48 equal monthly installments. Under the agreement dated
December 20, 1994 for 162,500 shares, the shares were fully vested at award.
Under the agreement dated March 14, 1995 for 250,000 shares, the Company's right
to repurchase lapses and Mr. Donaldson vests in the shares in a series of 48
equal monthly installments from September 29, 1994. In addition, in the event of
the acquisition of the Company by merger or sale of assets, the Company's right
to repurchase all such shares will terminate with respect to 50% of the unvested
shares on the date of acquisition of the Company. As of March 31, 1999, all of
such shares of the Company's Common Stock were fully vested and no longer
subject to the Company's right of repurchase.
Mr. Donaldson purchased all of the shares under the restricted stock
purchase agreements by delivery of four full recourse promissory notes in the
aggregate principal amount of $175,000. The promissory notes bear interest at
various annual interest rates ranging from 5% to 7.75% and become due and
payable at various dates from March 15, 1999 to March 14, 2000. Each promissory
note is secured by a pledge of the shares acquired with each such note. The
largest aggregate indebtedness during the fiscal year and the amount outstanding
on December 31, 1998 under all of the notes was $216,172.69.
On January 21, 1998, the Board of Directors awarded the right to
purchase 50,000 shares of the Company's Common Stock to Paul W. Emery II, the
Company's Chief Financial Officer, for a per share purchase price equal to
$3.875, the closing price of the Company's Common Stock on the Nasdaq National
Market on such date. The Board of Directors also approved the extension of a
loan to Mr. Emery in an amount equal to the aggregate purchase price for such
shares. The Company has the right to repurchase the shares of the Company's
Common Stock upon the termination of Mr. Emery's employment with the Company
prior to full vesting. The Company's right to repurchase lapses and Mr. Emery
vests in 25% of the shares on January 21, 1999 and in the balance in a series of
36 equal monthly installments thereafter. In addition, in the event of the
acquisition of the Company by merger or sale of assets, the Company's right to
repurchase such shares will terminate with respect to 50% of the unvested shares
on the date of the change of control of the Company. On December 9, 1998, Mr.
Emery entered into a Restricted Stock Purchase Agreement with the Company to
evidence his purchase of the shares and delivered his full recourse promissory
note in the amount of $193,750 in full payment for the shares. The note bears
interest at the rate of 4.52% per annum and is due on December 9, 2003. The
largest aggregate indebtedness under the note during the fiscal year and the
amount outstanding on December 31, 1998 was $193,750.
COMPENSATION COMMITTEE REPORT
The Compensation Committee of the Company's Board of Directors (the
"Compensation Committee" or the "Committee") reviews and approves the Company's
compensation policies. The following is the report of the Compensation Committee
describing the compensation policies applicable to the compensation of the
Company's Chief Executive Officer and other executive officers for the 1998
fiscal year.
For the 1998 fiscal year, the process utilized by the Committee in
determining executive officer compensation levels was based on the subjective
judgment of the Committee. Among the factors considered by the
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Committee were the recommendations of the CEO with respect to the compensation
of the Company's key executive officers. However, the Committee made the final
compensation decisions concerning such officers.
GENERAL COMPENSATION PHILOSOPHY. The Company's philosophy in setting its
compensation policies for executive officers is to maximize shareholder value
over time. The primary goal of the Company's executive compensation program is,
therefore, to closely align the interests of the executive officers with those
of the Company's shareholders. To achieve this goal, the Company attempts to (i)
offer compensation opportunities that attract and retain executives whose
abilities are critical to the long-term success of the Company, motivate
individuals to perform at their highest level and reward outstanding
achievement, (ii) maintain a portion of the executive total compensation at
risk, with payment of that portion tied to achievement of financial,
organizational and management performance goals, and (iii) encourage executives
to manage from the perspective of owners with an equity stake in the Company.
The Compensation Committee currently uses salary, incentive cash bonus awards
and long-term stock-based incentives to meet these goals.
BASE SALARY. The base salary component of total compensation is
primarily designed to attract, motivate, reward and retain highly skilled
executives and to compensate executives competitively within the industry and
the marketplace. In establishing base salaries of executive officers, the
Compensation Committee evaluates each executive's salary history, scope of
responsibility at the Company, prior experience, past performance for the
Company, expected contribution to the Company's future success and
recommendations from management. The Compensation Committee also takes into
account the salaries for similar positions at comparable companies in the
Company's industry, based on each individual Committee member's industry
experience, and the position of each executive officer's base pay relative to
the total compensation package, including cash incentives and long-term
incentives. In making its salary decisions, the Compensation Committee exercised
its discretion and judgment based upon these factors. No specific formula was
applied to determine the weight of each factor.
INCENTIVE CASH BONUSES. Each executive officer's annual bonus is based
on qualitative and quantitative factors and is intended to motivate and reward
executive officers by directly linking the amount of the bonus to performance
targets. In addition, incentive bonuses for executive officers are intended to
reflect the Compensation Committee's belief that the compensation of each
executive officer should be contingent upon the overall performance of the
Company. To carry out this philosophy, the Board of Directors reviews and
approves the financial goals for the fiscal year. The Compensation Committee
then evaluates the overall performance of the Company and approves performance
bonuses based on the extent to which the goals of the Board of Directors have
been achieved. The Company achieved record revenues in 1998 of $41.3 million,
and substantially reduced its EBITDA (Earnings before interest, tax,
depreciation and amortization) loss to ($204,000) for the year, both of which
were important milestones for the Company.
LONG-TERM INCENTIVE COMPENSATION. The Compensation Committee views stock
option grants as an important component of its long-term, performance-based
compensation philosophy. The Company provides long-term incentives to its Chief
Executive Officer and its other executive officers. During fiscal 1998, the
Board of Directors and/or the Compensation Committee, in their discretion, made
option grants to Messrs, Kozak, Labbe, Emery and Donaldson. The purpose of such
option grants is to attract and retain the best employee talent available and to
create a direct link between executive compensation and the long-term
performance of the Company. The Compensation Committee believes that stock
options directly motivate its executive officers to maximize long-term
shareholder value. The options also utilize vesting periods that encourage key
executives to continue in the employ of the Company. All options granted to
executive officers to date have been granted at the fair market value of the
Company's Common Stock on the date of grant. Accordingly, the option will
provide a return to the executive officer only if he or she remains in the
Company's employ, and then only if the market price of the Company's Common
Stock appreciates over the option term. The Board of Directors and/or the
Compensation Committee consider the grant of each option subjectively,
considering factors such as the individual performance of the executive officer
and the anticipated contribution of the executive officer to the attainment of
the Company's long-term strategic performance goals. Applying these principles,
a significant grant was made to Mr. Emery in connection with the commencement of
his employment. The grants made to Messrs. Donaldson and Labbe were made in
recognition of their years of service with the Company and to place a
significant portion of their total compensation at risk.
CEO COMPENSATION. Mr. Donaldson served as the Company's Chief Executive
Officer until December 13, 1998, when he became President and Chief Operating
Officer. Mr. Donaldson's compensation consists of base salary, an annual bonus
and stock options. On November 20, 1998, the Company and
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Mr. Donaldson entered into an employment agreement. Pursuant to the employment
agreement, Mr. Donaldson's base salary was increased to $300,000 and he was
awarded an incentive bonus of $50,000 based on the financial and operational
performance of the Company during 1998 and was granted an option to purchase
150,000 shares. In addition, Mr. Donaldson received stock option grants during
fiscal 1998 in the aggregate amount of 200,000 shares of Common Stock. The stock
option grants made to Mr. Donaldson were intended to reflect his years of
service with the Company and to place a significant portion of his total
compensation at risk, because the stock options will have no value unless there
is appreciation in the value of the Company's Common Stock over the term of the
stock options.
On December 13, 1998, Mr. Ginsburg was appointed the Chief Executive
Officer of the Company. At Mr. Ginsburg's request, his compensation consists of
base salary in the amount of $1 plus reimbursement of expenses, in keeping with
Mr. Ginsburg's goal of tying his compensation directly to stock performance. In
addition, an entity affiliated with Mr. Ginsburg received a warrant to purchase
up to 1,548,460 shares of the Common Stock of the Company in connection with the
commencement of his employment. The warrant was intended to induce Mr. Ginsburg
to join the Company as its new Chairman of the Board and Chief Executive Officer
and to place a significant portion of his total compensation at risk, because
the warrant does not become exercisable, and thus has no value, unless and until
the Company's Common Stock exceeds certain price thresholds.
TAX LIMITATION. Under the Federal tax laws, a publicly held company such
as the Company will not be allowed a federal income tax deduction for
compensation paid to certain executive officers to the extent that compensation
exceeds $1 million per officer in any year. To qualify for an exemption from the
$1 million deduction limitation, the shareholders have been asked to approve a
limitation under the Company's 1992 Stock Option Plan on the maximum number of
shares of Common Stock for which any one participant may be granted stock
options per calendar year. Because this limitation was adopted, any compensation
deemed paid to an executive officer when he or she exercises an outstanding
option under the 1992 Stock Option Plan with an exercise price equal to the fair
market value of the option shares on the grant date will qualify as
performance-based compensation that will not be subject to the $1 million
limitation. Since it is not expected that the cash compensation to be paid to
the Company's executive officers for the 1998 fiscal year will exceed the $1
million limit per officer, the Committee will defer any decision on whether to
limit the dollar amount of all other compensation payable to the Company's
executive officers to the $1 million cap.
Compensation Committee
Jeffrey M. Drazan
Richard H. Harris
Leonard S. Matthews
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The members of the Compensation Committee are Messrs. Drazan, Harris and
Matthews. None of these individuals was at any time during 1998, or at any other
time, an officer or employee of the Company.
No executive officer of the Company serves as a member of the board of
directors or compensation committee of any entity that has one or more executive
officers serving as a member of the Company's Board of Directors or Compensation
Committee.
8
<PAGE> 10
STOCK PERFORMANCE GRAPH
The graph set forth below compares the cumulative total shareholder
return on the Company's Common Stock between February 6, 1996 (the date the
Company's Common Stock commenced public trading) and December 31, 1998 with the
cumulative total return of (i) the Nasdaq Non-Financial Stocks Index and (ii)
the Nasdaq Computer and Data Processing Services Stocks Index, over the same
period. This graph assumes the investment of $100.00 on February 6, 1996 in the
Company's Common Stock, the Nasdaq Non-Financial Stocks Index and the Nasdaq
Computer and Data Processing Services Stocks Index, and assumes the reinvestment
of dividends, if any.
The comparisons shown in the graph below are based upon historical data.
The Company cautions that the stock price performance shown in the graph below
is not indicative of, nor intended to forecast, the potential future performance
of the Company's Common Stock. Information used in the graph was obtained from
the CRSP Total Return Index published by Nasdaq and SG Cowen, sources believed
to be reliable, but the Company is not responsible for any errors or omissions
in such information.
<TABLE>
<CAPTION>
2/6/96 12/31/96 12/31/97 12/31/98
<S> <C> <C> <C> <C>
Digital Generation Systems, $100 $76 $23 $66
Inc.
Nasdaq Non-Financial Stocks $100 $121 $142 $172
Index
Nasdaq Computer and Data $100 $125 $153 $220
Processing Services Stocks
Index
</TABLE>
9
<PAGE> 11
The Company effected its initial public offering of Common Stock on
February 6, 1996. For purposes of this presentation, the Company has assumed
that that the initial public offering price of $11.00 per share would have been
the closing price on February 5, 1996, the day prior to the commencement of
trading.
Notwithstanding anything to the contrary set forth in any of the
Company's previous or future filings under the Securities Act of 1933, as
amended, or the Securities Exchange Act of 1934, as amended, that might
incorporate this report or future filings made by the Company under those
statutes, the Compensation Committee Report and Stock Performance Graph shall
not be deemed filed with the Securities and Exchange Commission and shall not be
deemed incorporated by reference into any of those prior filings or into any
future filings made by the Company under those statutes.
10
<PAGE> 12
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of January 31, 1999, certain
information with respect to shares beneficially owned by (i) each person who is
known by the Company to be the beneficial owner of more than five percent of the
Company's outstanding shares of Common Stock, (ii) each of the Company's
directors and the executive officers named in the Summary Compensation Table and
(iii) all current directors and executive officers as a group. Beneficial
ownership has been determined in accordance with Rule 13d-3 under the Exchange
Act. Under this rule, certain shares may be deemed to be beneficially owned by
more than one person (if, for example, persons share the power to vote or the
power to dispose of the shares). In addition, shares are deemed to be
beneficially owned by a person if the person has the right to acquire shares
(for example, upon exercise of an option or warrant) within sixty (60) days of
the date as of which the information is provided; in computing the percentage
ownership of any person, the amount of shares is deemed to include the amount of
shares beneficially owned by such person (and only such person) by reason of
such acquisition rights. As a result, the percentage of outstanding shares of
any person as shown in the following table does not necessarily reflect the
person's actual voting power at any particular date.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED
AS OF JANUARY 31, 1999 (1) (2)
-------------------------------------
BENEFICIAL OWNER NUMBER OF SHARES PERCENTAGE OF CLASS
- ------------------------------------------ ---------------- -------------------
<S> <C> <C>
Entities and individuals affiliated with
Integral Capital Partners (3).................. 1,475,448 5.6%
2750 Sand Hill Road
Menlo Park, California 94025
Entities and individuals affiliated with
London Merchant Securities plc (4)............. 1,783,105 6.7%
Carlton House
33 Robert Adam Street
London W1M 5AH, England
Entities and individuals affiliated
Pequot Capital Management, Inc. (5) ........... 4,746,178 17.9%
354 Pequot Avenue
Southport, Connecticut 06490
Entities and individuals affiliated with
Technology Crossover Ventures (6).............. 2,785,659 10.5%
56 Main Street, Suite 210
Millburn, New Jersey 07041
Scott K. Ginsburg (7) ......................... 4,004,819 15.1%
Moon Doggie Family Partnership,
17340 Club Hill Drive, Dallas, Texas 75248
Henry W. Donaldson (8) ........................ 735,612 2.8%
Kevin R. Compton (9) .......................... 541,842 2.0%
Jeffrey M. Drazan (10) ........................ 1,329,257 5.0%
Richard H. Harris (11) ........................ 34,250 *
Lawrence D. Lenihan, Jr. (12) ................. 4,751,733 18.0%
Leonard S. Matthews (13) ...................... 44,859 *
Paul W. Emery, II (14) ........................ 93,750 *
Robert H. Howard (15) ......................... 71,873 *
Ernest V. Labbe (16) .......................... 44,250 *
All current directors and executive officers
as a group (10 persons) (7-16)................. 11,652,245 44.0%
</TABLE>
- ----------
* Less than 1% of the outstanding shares of Common Stock.
11
<PAGE> 13
(1) Except as indicated in the footnotes to this table and pursuant to
applicable community property laws, the persons named in the table have sole
voting and investment power with respect to all shares of Common Stock. To
the Company's knowledge, the entities named in the table have sole voting
and investment power with respect to all shares of Common Stock shown as
beneficially owned by them. Unless otherwise indicated, the business address
of each beneficial owner listed is 875 Battery Street, San Francisco,
California 94111.
(2) The number of shares of Common Stock deemed outstanding includes shares
issuable pursuant to stock options that may be exercised within sixty (60)
days after January 31, 1999.
(3) Includes 653,597 shares held in the name of Integral Capital Partners III,
L.P., 147,674 shares held in the name of Integral Capital Partners
International III, L.P., 670,751 shares held in the name of Integral Capital
Partners IV, L.P. and 3,426 shares held in the name of Integral Capital
Partners IV MS Side Fund, L.P. Integral Capital Management III, L.P. is the
sole general partner of Integral Capital Partners III, L.P. and the sole
investment general partner of Integral Capital Partners International III,
L.P. Integral Capital Management IV, LLC is the sole general partner of
Integral Capital Partners IV, L.P. ICP MS Management IV, LLC is the sole
general partner of Integral Capital Partners IV MS Side Fund, L.P. Integral
Capital Management III, L.P., Integral Capital Management IV, LLC and ICP MS
Management IV, LLC disclaim beneficial ownership of such shares except to
the extent of their pecuniary interests therein.
(4) Includes 560,824 shares held in the name of Lion Investments Limited and
1,222,281 shares held in the name of Westpool Investment Trust plc. Lion
Investments Limited and Westpool Investment Trust plc are wholly-owned
subsidiaries of London Merchant Securities plc.
(5) Includes 348,201 shares held in the name of Pequot Offshore Private Equity
Fund, Inc., 2,750,173 shares held in the name of Pequot Private Equity Fund,
L.P., 823,902 shares held in the name of Pequot International Fund, Inc. and
823,902 shares held in the name of Pequot Partners Fund, L.P. Pequot Capital
Management, Inc. is the investment advisor to Pequot Offshore Private Equity
Fund, Inc., Pequot Private Equity Fund, L.P., Pequot International Fund,
Inc. and Pequot Partners Fund, L.P. (the "Pequot Funds") and may be deemed
to beneficially own all of such shares. Pequot Capital Management, Inc.
acquired beneficial ownership of such shares from Dawson-Samberg Capital
Management, Inc., the former investment advisor to the Pequot Funds. On
January 1, 1999, Dawson-Samberg Capital Management, Inc. spun-off a portion
of its investment management business to Pequot Capital Management, Inc.,
including the beneficial ownership of all of such shares formerly held by
Dawson-Samberg Capital Management, Inc. Lawrence D. Lenihan, Jr., a member
of the Company's Board of Directors, is a principal and minority shareholder
of Pequot Capital Management, Inc. Mr. Lenihan disclaims beneficial
ownership of all shares held or beneficially owned by or through such
entity.
(6) Includes 875,890 shares held in the name of Technology Crossover Ventures,
L.P., 69,365 shares held in the name of Technology Crossover Ventures, C.V.,
28,599 shares held in the name of TCV II, V.O.F., 880,402 shares held in the
name of Technology Crossover Ventures II, L.P., 676,864 shares held in the
name of TCV II (Q), L.P., 120,118 shares held in the name of TCV II
Strategic Partners, L.P. and 134,421 shares held in the name of Technology
Crossover Ventures II, C.V. Technology Crossover Management, L.L.C. is the
sole general partner of Technology Crossover Ventures, L.P. and the sole
investment general partner of Technology Crossover Ventures, C.V. Technology
Crossover Management II, L.L.C. is the sole general partner of Technology
Crossover Ventures II, L.P., TCV II (Q), L.P. and TCV II Strategic Partners,
L.P. and the sole investment general partner of TCV II, V.O.F. and
Technology Crossover Ventures, C.V. Technology Crossover Management, L.L.C.
and Technology Crossover Management II, L.L.C. disclaim beneficial ownership
of such shares except to the extent of their pecuniary interests therein.
(7) Based on a filing with the Securities and Exchange Commission, dated
December 21, 1998, indicating beneficial ownership as of such date. Includes
2,920,134 shares held in the name of Moon Doggie Family Partnership, L.P.
Scott K. Ginsburg, the Company's Chairman of the Board and Chief Executive
Officer, is the sole general partner of Moon Doggie Family Partnership, L.P.
(8) Includes options exercisable into 239,787 shares of Common Stock.
(9) Based on a filing with the Securities and Exchange Commission, dated
February 16, 1999, indicating beneficial ownership as of such date. Includes
530,592 shares beneficially owned by affiliated entities of Kleiner,
Perkins, Caufield & Byers VI, L.P., of which Mr. Compton disclaims
beneficial ownership except to the
12
<PAGE> 14
extent of his pecuniary interest therein arising from his partnership
interests. Includes options exercisable into 11,250 shares of Common Stock.
(10) Includes 1,242,379 shares held in the name of Sierra Ventures IV and 53,085
shares held in the name of Sierra Ventures IV International. SV Associates
IV, L.P. is the sole general partner of each of Sierra Ventures IV and
Sierra Ventures IV International, and Mr. Drazan is a general partner of SV
Associates IV, L.P. Mr. Drazan disclaims beneficial ownership of all shares
held or beneficially owned by or through such entities except to the extent
of his pecuniary interest therein arising from general partnership
interests therein. Includes options exercisable into 31,250 shares of
Common Stock.
(11) Includes options exercisable into 11,250 shares of Common Stock.
(12) Includes 4,746,178 shares beneficially owned by affiliated entities of
Pequot Capital Management, Inc., of which Mr. Lenihan disclaims beneficial
ownership except as set forth above (see footnote 5) Includes options
exercisable into 5,555 shares of Common Stock.
(13) Includes options exercisable into 28,154 shares of Common Stock.
(14) Includes options exercisable into 43,750 shares of Common Stock.
(15) Includes options exercisable into 71,873 shares of Common Stock.
(16) Includes options exercisable into 43,750 shares of Common Stock.
13
<PAGE> 15
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On December 9, 1998, the Company issued 3,843,212 shares of Common Stock
to certain existing institutional and closely associated investors, 2,920,134 of
which were issued to an entity affiliated with Scott K. Ginsburg, the Company's
current Chairman of the Board and Chief Executive Officer, pursuant to the terms
of that certain Common Stock Subscription Agreement, dated September 29, 1998,
at a price per share of $2.7396, and 923,078 shares were issued to entities
affiliated with Integral Capital Partners, London Merchant Securities plc, and
Pequot Capital Management, Inc. pursuant to that certain Common Stock and
Warrant Subscription Agreement, dated December 9, 1998, at a price per share of
$3.25. The gross proceeds to the Company from the issuance of these additional
shares were approximately $11 million. In addition, the Company issued warrants
to purchase an aggregate of 1,921,607 shares of the Company's Common Stock to
such investors at an exercise price of $3.25 in connection with the private
placements of Common Stock. The warrants are not exercisable for a minimum of
one year and, thereafter, their exercisability is based on the performance of
the Company's Common Stock. The warrants expire in December 2001.
On December 9, 1998, the Company issued a warrant to purchase 1,548,460
shares of the Company's Common Stock at an exercise price of $3.25 to an entity
affiliated with Mr. Ginsburg in connection with Mr. Ginsburg's appointment as
the Company's Chairman of the Board and Chief Executive Officer. The warrant is
not exercisable for a minimum of one year and, thereafter, it becomes
exercisable over a 24-month period but only if the Common Stock achieves a
trading price of $10 per share or more over a sustained period, and then half
the shares will vest, or achieves a price of $15 per share or more over a
sustained period. The warrant will in any event become fully exercisable on
November 8, 2003. The warrants become fully exercisable upon a change in control
involving the Company. The warrants expire December 9, 2003.
On August 14, 1998, the Company issued 4,589,287 shares of Common Stock
to certain existing institutional and closely associated investors, including
Scott K. Ginsburg and entities affiliated with Integral Capital Partners, London
Merchant Securities plc, Pequot Capital Management, Inc., and Technology
Crossover Ventures, in a private placement transaction pursuant to the terms of
those certain Common Stock Subscription Agreements. These additional shares of
Common Stock were issued at $2.80 per share, and the total proceeds to the
Company, net of issuance costs, was approximately $12.7 million.
Effective August 12, 1998, all 4,950,495 outstanding shares of the
Company's Series A Convertible Preferred Stock, including shares held by
entities affiliated with Integral Capital Partners, Pequot Capital Management,
Inc., and Technology Crossover Ventures, were converted to Common Stock pursuant
to the terms of that certain Series A Preferred Stock Conversion Agreement. Each
holder of shares of the Company's Series A Convertible Preferred Stock received
1.1 shares of Common Stock for each share of Series A Convertible Preferred
Stock. The Board of Directors deemed this action necessary and appropriate in
order to assure conversion by these shareholders, who held certain preferred
stock rights which could have delayed the closing of the August 1998 private
placement transaction discussed above.
14
<PAGE> 16
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
DIGITAL GENERATION SYSTEMS, INC.
Dated: April 28, 1999 By: /s/ Scott K. Ginsburg
---------------------------------
Scott K. Ginsburg
Chairman of the Board and
Chief Executive Officer
In accordance with the requirements of the Securities Exchange Act of
1934, this Amendment was signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Scott K. Ginsburg
- ------------------------------ Chairman of the Board, Chief Executive April 28, 1999
Scott K. Ginsburg Officer and Director (Principal
Executive Officer)
*
- ------------------------------ President, Chief Operating Officer and April 28, 1999
Henry W. Donaldson Director
*
- ------------------------------ Chief Financial Officer April 28, 1999
Paul W. Emery, II (Principal Financial and Accounting
Officer)
*
- ------------------------------ Director April 28, 1999
Kevin R. Compton
*
- ------------------------------ Director April 28, 1999
Jeffrey M. Drazan
*
- ------------------------------ Director April 28, 1999
Richard H. Harris
*
- ------------------------------ Director April 28, 1999
Lawrence D. Lenihan, Jr.
*
- ------------------------------ Director April 28, 1999
Leonard S. Matthews
*By: /s/ Scott K. Ginsburg
Scott K. Ginsburg, Attorney-In-Fact
</TABLE>
15
