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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 September 30, 2000
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)
5221 North O'Connor Boulevard, Suite 950
Irving, TX 75039
(Address of principal executive offices, including zip code)
(972) 402-4800
(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 September 30, 2000: 28,234,483
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<PAGE>
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 reported in the Company's Annual Report on Form 10-K filed on
March 28, 2000, those discussed in "Risk Factors" as reported in the Company's
Form S-4 filed October 16, 2000, as well as those risks discussed in this
Report, and in the Company's other United States Securities and Exchange
Commission filings.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page
-----------
<S> <C> <C>
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets at September 30, 2000 and December 31, 1999............................ 3
Condensed Consolidated Statements of Operations for the three and nine months ended
September 30, 2000 and October 2, 1999 ...................................................................... 4
Condensed Consolidated Statements of Cash Flows for the nine months ended September
30, 2000 and October 2, 1999................................................................................. 5
Notes to Condensed Consolidated Financial Statements......................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................ 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk................................................... 12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................................ 12
Item 6. Exhibits and Reports on Form 8-K............................................................................. 13
SIGNATURES................................................................................................... 13
</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>
September 30, December 31,
2000 1999
--------------------- -------------------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 3,101 $ 5,420
Accounts receivable, less allowance for
doubtful accounts of $2,613 on
September 30, 2000 and $1,659 on
December 31, 1999 12,743 12,799
Prepaid expenses and other 1,905 1,717
--------------------- -------------------
Total current assets 17,749 19,936
--------------------- -------------------
PROPERTY AND EQUIPMENT, at cost:
Network equipment 37,842 35,304
Office furniture and equipment 6,483 5,833
Leasehold improvements 859 793
--------------------- -------------------
45,184 41,930
Less - Accumulated depreciation and
amortization (38,084) (33,772)
--------------------- -------------------
Property and equipment, net 7,100 8,158
--------------------- -------------------
GOODWILL AND OTHER ASSETS, net 12,512 13,672
--------------------- -------------------
TOTAL ASSETS $ 37,361 $ 41,766
===================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 5,012 $ 7,781
Accrued liabilities 2,678 3,230
Current portion of long-term debt 4,443 7,689
--------------------- -------------------
Total current liabilities 12,133 18,700
LONG-TERM DEBT, net of current portion 2,518 2,513
--------------------- -------------------
TOTAL LIABILITIES 14,651 21,213
--------------------- -------------------
SHAREHOLDERS' EQUITY:
Convertible preferred stock, no par value -
Authorized -- 15,000,000 shares
Outstanding -- none -- --
Common stock, no par value --
Authorized -- 100,000,000 shares
Outstanding -- 28,234,483 shares at
September 30, 2000 and 27,530,170 shares
at December 31, 1999 121,875 119,519
Treasury stock, at cost (101) --
Receivable from issuance of common stock (93) (194)
Accumulated other comprehensive income 66 52
Accumulated deficit (99,037) (98,824)
--------------------- -------------------
Total shareholders' equity 22,710 20,553
--------------------- -------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 37,361 $ 41,766
===================== ===================
The accompanying notes are an integral part of these condensed consolidated financial statements.
</TABLE>
3
<PAGE>
DIGITAL GENERATION SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three and Nine Months Ended September 30, 2000 and October 2, 1999
(in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, October 2, September 30, October 2,
2000 1999 2000 1999
---------------------------------------- ----------------------------------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
REVENUES $ 13,779 $ 12,202 $ 40,028 $ 35,782
------------------ ----------------- ------------------ ----------------
COSTS AND EXPENSES:
Delivery and material costs 3,445 4,412 10,658 13,720
Customer operations 4,119 3,718 12,356 11,246
Sales and marketing 1,127 1,149 3,400 3,800
Research and development 797 756 2,431 2,048
General and administrative 1,712 1,650 5,767 4,259
Depreciation and amortization 1,673 2,280 4,857 7,204
------------------ ----------------- ------------------ ----------------
Total expenses 12,873 13,965 39,469 42,277
------------------ ----------------- ------------------ ----------------
INCOME (LOSS) FROM OPERATIONS 906 (1,763) 559 (6,495)
------------------ ----------------- ------------------ ----------------
OTHER INCOME (EXPENSE):
Interest income 17 152 113 305
Interest expense (184) (449) (885) (1,562)
------------------ ----------------- ------------------ ----------------
NET INCOME (LOSS) $ 739 $ (2,060) $ (213) $ (7,752)
================== ================= ================== ================
NET INCOME (LOSS) PER COMMON SHARE:
Basic $ 0.03 $ (0.08) $ (0.01) $ (0.29)
================== ================= ================== ================
Diluted $ 0.03 $ (0.08) $ (0.01) $ (0.29)
================== ================= ================== ================
WEIGHTED AVERAGE COMMON AND COMMON
SHARE EQUIVALENTS OUTSTANDING:
Basic 28,215 26,673 28,050 26,510
Diluted 29,531 26,673 28,050 26,510
The accompanying notes are an integral part of these condensed consolidated financial statements.
</TABLE>
4
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DIGITAL GENERATION SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2000 and October 2, 1999
(in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30, October 2,
2000 1999
----------------------------------------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (213) $ (7,752)
Adjustments to reconcile net loss to net cash provided by (used
in)
operating activities:
Depreciation and amortization of property and equipment 4,312 6,548
Amortization of goodwill and intangibles 540 578
Provision for doubtful accounts 970 206
Loss on retirement of property, plant and equipment 6 --
Changes in operating assets and liabilities --
Accounts receivable (914) (1,191)
Prepaid expenses and other assets 433 (1,711)
Accounts payable and accrued liabilities (3,321) 1,300
------------------- -------------------
Net cash provided by (used in) operating activities 1,813 (2,022)
------------------- -------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale of property, plant and equipment -- 75
Acquisition of property and equipment (1,688) (3,220)
------------------- -------------------
Net cash used in investing activities (1,688) (3,145)
------------------- -------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 2,356 1,374
Proceeds from line of credit 30,689 2,923
Payments on line of credit (28,812) (2,786)
Proceeds from issuance of long-term debt 3,000 1,500
Payments on long-term debt (9,690) (6,507)
------------------- -------------------
Net cash used in financing activities (2,457) (3,496)
------------------- -------------------
EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS 13 24
NET DECREASE IN CASH AND CASH EQUIVALENTS (2,319) (8,639)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 5,420 13,025
------------------- -------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,101 $ 4,386
=================== ===================
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 873 $ 1,868
Acquisition of property and equipment through $ 1,572 $ --
capital lease
Treasury stock purchased in exchange for $ 101 $ --
cancellation of note
The accompanying notes are an integral part of these condensed consolidated financial statements.
</TABLE>
5
<PAGE>
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The financial statements included herein have been prepared by Digital
Generation Systems, Inc. (the "Company") without audit, pursuant to the rules
and regulations of the Securities and Exchange Commission. Certain information
and 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
Annual Report on Form 10-K for the year ended December 31, 1999.
Effective for fiscal 2000, beginning January 1, the Company elected to adjust
its fiscal quarters so that each quarter ends on a calendar quarter. Quarters
end on March 31, June 30, and September 30. The Company's fiscal year will
continue to end on December 31.
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 of
operations and cash flows for the three and nine month periods ended September
30, 2000 and October 2, 1999. The results for the three and nine month periods
ended September 30, 2000 are not necessarily indicative of the results expected
for the full fiscal year.
Certain reclassifications were made to the 1999 condensed consolidated
financial statements to conform to the 2000 presentation.
2. DEBT TRANSACTIONS
On April 6, 2000, the Company entered into a long-term loan and security
agreement with Foothill Capital Corporation for a revolving credit facility
providing borrowings up to a maximum of $11 million. The credit facility is
secured primarily by accounts receivable and has a term of three years. The
amount available to the Company is based on eligible receivables less
outstanding letters of credit, as defined in the revolving credit facility
agreement. As of September 30, 2000, $1.9 million was outstanding under the
revolving credit facility and an additional $1.9 million was available for
borrowing.
3. INCOME TAXES
Net income for the three months ended September 30, 2000 will be offset by net
operating losses, therefore no tax expense has been provided for. SFAS 109
requires that the Company record a valuation allowance when it is more likely
than not that some portion or all of the deferred tax assets will not be
realized. The ultimate realization of deferred tax assets depends on the
Company's ability to generate sufficient taxable income in the future. The
Company has recognized a full valuation allowance for the amount of net deferred
tax assets as of September 30, 2000 and December 31, 1999.
6
<PAGE>
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
4. NET INCOME (LOSS) PER SHARE
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, October 2, September 30, October 2,
2000 1999 2000 1999
------------- ----------- ------------- ----------
<S> <C> <C> <C> <C>
Basic:
Net income (loss) $ 739 $ (2,060) $ (213) $ (7,752)
Weighted average shares
outstanding 28,215 26,673 28,050 26,510
------- -------- ------- --------
Income (loss) per share $ 0.03 $ (0.08) $(0.01) $ (0.29)
======= ======== ======= ========
Diluted:
Net income (loss) $ 739 $(2,060) $ (213) $(7,752)
Weighted average shares
outstanding 28,215 26,673 28,050 26,510
Add: Net effect of potential
dilutive shares 1,316 - - -
------- -------- ------- --------
Total 29,531 26,673 28,050 26,510
------- -------- ------- --------
Income (loss) per share $ 0.03 $ (0.08) $(0.01) $ (0.29)
======= ======== ======= ========
</TABLE>
Warrants to purchase 3,891,070 shares of common stock at a weighted average
exercise price of $3.57 were not included in the computation of diluted loss per
share for the three months ended October 2, 1999 and the nine months ended
September 30, 2000 and October 2, 1999, because the effect of these outstanding
warrants would be antidilutive. At September 30, 2000, 1,646,719 warrants, with
a weighted average exercise price of $3.38 had exercise prices below the average
market price of $5.85 for the three months ended September 30, 2000. Using the
treasury stock method for calculating the dilutive effect of stock warrants,
695,281 potential dilutive shares were included in the computation of diluted
income per share for the three months ended September 30, 2000.
At September 30, 2000 and October 2, 1999, options to purchase 3,259,098 and
4,355,209 shares of common stock at a weighted average exercise price of $4.81
and $4.32, respectively, were outstanding. At September 30, 2000, 2,691,663
options with a weighted average exercise price of $4.50 had exercise prices
below the average market price of $5.85 for the three months ended September
30, 2000. Using the treasury method for calculating the dilutive effect of
stock options, 621,153 potential dilutive shares were included in the
computation of diluted income per share for the three months ended September 30,
2000. For the three months ended October 2, 1999 and for the nine months ended
September 30, 2000 and October 2, 1999, no options were included in the
computation of diluted loss per share as their effect would be antidilutive.
During the nine months ended September 30, 2000, 704,313 shares of common
stock were issued pursuant to the exercise of options and warrants with proceeds
of $2,355,855.
7
<PAGE>
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
5. SEGMENT 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 September 30, 2000, 5% of the
Company's operating assets were located outside of the United States.
<TABLE>
<CAPTION>
For the Three Months Ended September 30, 2000
(In $000's)
--------------------------------------------------------------------------------
San Francisco New York Chicago Los Angeles Consolidated
--------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Revenue $ 5,723 $3,040 $4,279 $ 737 $13,779
Net income (loss) $(1,622) $ 531 $1,898 $ (68) $ 739
Total assets $23,898 $8,734 $3,466 $1,263 $37,361
</TABLE>
<TABLE>
<CAPTION>
For the Three Months Ended October 2, 1999
(In $000's)
--------------------------------------------------------------------------------
San Francisco New York Chicago Los Angeles Consolidated
--------------- ------------- ------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
Revenue $ 4,840 $2,808 $3,864 $ 690 $12,202
Net income (loss) $(5,034) $ 926 $1,788 $ 260 $(2,060)
Total assets $21,043 $9,850 $7,586 $1,384 $39,863
</TABLE>
<TABLE>
<CAPTION>
For the Nine Months Ended September 30, 2000
(In $000's)
--------------------------------------------------------------------------------
San Francisco New York Chicago Los Angeles Consolidated
--------------- -------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
Revenue $ 16,669 $9,270 $11,873 $2,216 $40,028
Net income (loss) $ (5,969) $1,282 $ 4,198 $ 276 $ (213)
</TABLE>
<TABLE>
<CAPTION>
For the Nine Months Ended October 2, 1999
(In $000's)
--------------------------------------------------------------------------------
San Francisco New York Chicago Los Angeles Consolidated
--------------- ------------- -------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Revenue $ 15,573 $8,710 $10,037 $1,462 $35,782
Net income (loss) $(10,206) $1,722 $ 1,010 $ (278) $(7,752)
</TABLE>
8
<PAGE>
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
6. OTHER
The Board of Directors of the Company has unanimously approved an Agreement
and Plan of Merger, dated as of July 7, 2000, which provides for the merger of
SG Nevada Merger Sub Inc., a wholly-owned subsidiary of the Company, with and
into StarGuide Digital Networks, Inc ("StarGuide"). In this merger, the holders
of StarGuide common stock will receive for each share of StarGuide common stock
approximately 1.6983 shares of Company common stock, and the holders of Company
common stock will continue to hold their shares. Upon consummation of the
merger, holders of StarGuide common stock will own approximately 59.25% of the
Company on a fully-diluted basis, and the holders of Company common stock prior
to the merger will own approximately 40.75% of the Company on a fully-diluted
basis. Final approval of the merger by the shareholders of the Company is
expected to be obtained at the annual meeting on November 21, 2000. StarGuide
will be the accounting acquirer for financial reporting purposes. The results
of operations of the combined company will not include DG Systems results of
operations prior to the merger.
7. NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This new
standard requires companies to record derivatives on the balance sheet as assets
or liabilities, measured at fair value. Under SFAS No. 133, gains or losses
resulting from changes in the values of derivatives are to be reported in the
statement of operations or as a component of other comprehensive income,
depending on the use of the derivatives and whether they qualify for hedge
accounting. The Company is required to adopt SFAS No. 133 in the first quarter
of 2001. To date, the Company has not engaged in any hedging activity and does
not expect adoption of this new standard to have a significant impact.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB
101), providing the staff's views in applying generally accepted accounting
principles to selected revenue recognition issues. For companies with fiscal
years that end on December 31, 2000, SAB 101 becomes effective for the fourth
quarter of fiscal year 2000. Any cumulative effect of the adoption of SAB 101
will be computed as of January 1, 2000. The Company believes that adopting SAB
101 will not have a material effect on the Company's financial position or
overall trends in results of operations.
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 various factors.
Revenues
Revenues were $13,779,000 for the three months ended September 30, 2000, a
13% increase from $12,202,000 for the three months ended October 2, 1999, and
revenues for the nine months ended September 30, 2000 were $40,028,000, a 12%
increase from $35,782,000 for the nine months ended October 2, 1999. Revenues
increased primarily due to increased volume as a result of greater acceptance of
the Company's video delivery and postproduction services and the expanded
network of Company equipment located in television stations.
9
<PAGE>
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Delivery and Material Costs
Delivery and material costs were $3,445,000 for the three months ended
September 30, 2000, a 22% decrease from $4,412,000 for the three months ended
October 2, 1999. Delivery and material costs were $10,658,000 for the nine
months ended September 30, 2000, a 22% decrease from $13,720,000 for the nine
months ended October 2, 1999. As a percentage of revenue, delivery and material
costs decreased to 25% from 36% for the three months ended September 30, 2000
and October 2, 1999, respectively, and decreased to 27% of revenues from 38% of
revenues in the nine months ended September 30, 2000 compared to the nine months
ended October 2, 1999. The decrease in costs in each period versus the same
period of the prior year is a result of the elimination of duplicate
telecommunication costs resulting from the Company's integration of the
Vancouver distribution Networking Operating Center ("NOC") into the San
Francisco NOC. Telecommunication costs were $1,072,000 and $2,090,000 for the
three months ended September 30, 2000 and October 2, 1999, respectively, and
$3,945,000 and $6,731,000 for the nine months ended September 30, 2000 and
October 2, 1999, respectively. Delivery and material costs include
telecommunication costs associated with online video and audio deliveries, video
and audio tapes along with the related packaging and shipping costs required
when physically duplicating and distributing a video or audio spot. In
addition, delivery and material costs include the direct material and fees paid
to other service providers in connection with postproduction services and other
services offered by the Company.
Customer Operations
Customer operations expenses were $4,119,000 and $3,718,000 for the quarters
ended September 30, 2000 and October 2, 1999, respectively, and $12,356,000 and
$11,246,000 for the nine months ended September 30, 2000 and October 2, 1999,
respectively. The increase in 2000 versus 1999 is primarily due to the
additional personnel necessary to respond to the greater volume of orders and
deliveries.
As a percentage of revenues, customer operations expense remained unchanged
at 30% for the three months ended September 30, 2000 and October 2, 1999 and 31%
for the nine months ended September 30, 2000 and October 2, 1999.
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, it will be required to continue to implement changes
that improve and increase the efficiency of its customer operations.
Sales and Marketing
Sales and marketing expenses were $1,127,000 for the three months ended
September 30, 2000, a 2% decrease from $1,149,000 for the three months ended
October 2, 1999, and decreased 11% to $3,400,000 from $3,800,000 for the nine
months ended September 30, 2000 and October 2, 1999, respectively. These
decreases in sales and marketing expense are the result of improved efficiency
of the Company's sales and marketing efforts, as well as the consolidation of
the Company's sales and marketing efforts among all of its locations. Sales and
marketing costs as a percentage of revenues decreased to 8% from 9% for the
three months ended September 30, 2000 and October 2, 1999, respectively, and
decreased to 8% of revenues from 11% of revenues in the nine months ended
September 30, 2000 compared to the nine months ended October 2, 1999, as a
result of these improved efficiencies and reorganization efforts.
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 and may fluctuate as a percentage of
revenue in future periods.
10
<PAGE>
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Research and Development
Research and development expenses increased 5% to $797,000 for the quarter
ended September 30, 2000 from $756,000 for the quarter ended October 2, 1999,
and increased 19% to $2,431,000 for the nine months ended September 30, 2000
from $2,048,000 for the nine months ended October 2, 1999. The increase in
research and development expense is primarily due to the capitalization of
certain salaries and benefits during the nine months ended October 2, 1999 for
personnel involved in developing software used to integrate the Company's San
Francisco NOC with that of its Vancouver subsidiary. As a percentage of
revenues, research and development expenses remained relatively unchanged at 6%
of revenues for the three and nine months ended September 30, 2000 and October
2, 1999.
The Company expects that additional research and development spending will
be necessary to remain competitive and that its future success will depend in
significant part upon the technological quality of its products and processes
relative to those of its competitors and its ability to develop both new and
enhanced products and services.
General and Administrative
General and administrative expenses increased 4% to $1,712,000 for the
quarter ended September 30, 2000 from $1,650,000 for the quarter ended October
2, 1999, and increased 35% to $5,767,000 from $4,259,000 for the nine months
ended September 30, 2000 and October 2, 1999, respectively. The increase is
primarily due to an increase in the allowance for doubtful accounts receivable.
General and administrative expenses have changed to 12% and 14% of revenues for
the quarter and nine months ended September 30, 2000 from 14% and 12% for the
quarter and nine months ended October 2, 1999.
Depreciation and Amortization
Depreciation and amortization expenses decreased 27% to $1,673,000 in the
three months ended September 30, 2000 from $2,280,000 in the three months ended
October 2, 1999, and decreased 32% to $4,857,000 in the nine months ended
September 30, 2000 from $7,204,000 in the nine months ended October 2, 1999.
The decrease is due to a higher percentage of fixed assets reaching or having
reached the end of their depreciable lives. However, the Company's total
investment in network equipment has increased from $35.3 million to $37.8
million at December 31, 1999 and September 30, 2000, respectively.
The Company recorded goodwill and intangibles amortization expense of
$179,000 and $540,000 for the quarter and nine months ended September 30, 2000,
and $191,000 and $578,000 for the quarter and nine months ended October 2, 1999.
Interest Income and Interest Expense
Interest income decreased 89% to $17,000 for the quarter ended September 30,
2000 from $152,000 for the quarter ended October 2, 1999, and decreased 63% to
$113,000 in the nine months ended September 30, 2000 from $305,000 for the nine
months ended October 2, 1999. This decrease is primarily the result of a
decreased level of cash and cash equivalents due primarily to the $9.7 million
of term debt the Company paid down during the first nine months of 2000.
Interest expense decreased 59% to $184,000 for the quarter ended September
30, 2000 from $449,000 for the quarter ended October 2, 1999, and decreased 43%
to $885,000 for the nine months ended September 30, 2000, from $1,562,000 in the
nine months ended October 2, 1999. The decrease is primarily the result of a
decrease in the Company's outstanding debt. Debt outstanding decreased to $7.0
million at September 30, 2000 from $14.1 million at October 2, 1999.
11
<PAGE>
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Liquidity and Capital Resources
Cash provided by operations was $1.8 million for the nine months ended
September 30, 2000 compared to cash used by operations of $2 million for the
nine months ended October 2, 1999. This increase of $3.8 million is
attributable to both increased revenues and the overall reduction in operating
expenses, particularly delivery and material costs.
The Company made capital additions of $1.7 million during the nine months
ended September 30, 2000 versus $3.2 million in the nine months ended October 2,
1999. The capital additions in both periods were a result of the Company's
continued expansion and improvement of its network. Principal payments on non-
revolving long-term debt were $9.7 million in the nine months ended September
30, 2000 versus $6.5 million in the nine months ended October 2, 1999.
The Company expects to continue to invest in the expansion and improvements
of its network. In particular, the Company is in the process of expanding its
infrastructure within the television broadcast industry that will require
additional DG Video Transmission Systems and Digital Video Playback Systems to
be built and installed in production studios and television stations.
Additionally, the Company is developing software for media asset management,
enhanced Internet media delivery and enhanced online access to its network.
At September 30, 2000, the Company's current sources of liquidity included
cash and cash equivalents of $3.1 million and $1.9 million of availability on
the revolving credit facility. 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 revolving
loan commitments, and other cash requirements through the foreseeable future.
On April 6, 2000, the Company entered into a long-term loan and security
agreement with Foothill Capital Corporation for a revolving credit facility
providing borrowings up to a maximum of $11 million. The credit facility is
secured primarily by accounts receivable and has a term of three years. The
amount available to the Company is based on eligible receivables less
outstanding letters of credit, as defined in the revolving credit facility
agreement. As of September 30, 2000, $1.9 million was outstanding under the
revolving credit facility and an additional $1.9 million was available for
borrowing.
On April 7, 2000, the Company entered into a long-term debt agreement to
refinance $3 million in outstanding loans and capital leases. The term of the
new agreement is two years and it expires in 2002.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has some operations in Canada and, therefore, is subject to the
risk that the Canadian dollar/US dollar exchange rates will adversely impact the
Company's results of operations. The Company believes this risk to be
immaterial to the Company's results of operations.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The Company is involved in routine litigation proceedings incidental to the
conduct of its business. The Company does not believe that any such proceedings
presently pending will have a material adverse effect on its financial condition
or results of operations.
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<PAGE>
DIGITAL GENERATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit Number Exhibit Title
-------------- -------------
27 /(1)/ Financial Data Schedule.
__________
/(1)/ Filed herewith
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: November 14, 2000 By /S/ OMAR A. CHOUCAIR
------------------------
Omar A. Choucair
Chief Financial Officer (Principal Financial
and Chief Accounting Officer)
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