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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For The Fiscal Year Ended December 31, 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 [ ]
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, 2000, as reported on the Nasdaq National Market, was approximately
$108,782,282. 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, 2000, the registrant had 27,942,182 shares of Common Stock,
without par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
The registrant has incorporated by reference into Part III of this Form 10-K
portions of its definitive Proxy Statement for its Annual Meeting of
Shareholders to be filed within 120 days after the end of the fiscal year, (the
"Proxy Statement") and to be held on the date set forth in such Proxy Statement.
Except with respect to information specifically incorporated by reference into
this Form 10-K, the Proxy Statement is not deemed to be filed as a part hereof.
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 elsewhere in this Report, and the
risks discussed in the Company's other United States Securities and Exchange
Commission filings.
TABLE OF CONTENTS
PART I
ITEM 1. BUSINESS....................................................................... 1
Industry Background............................................................ 1
The Company.................................................................... 2
Products and Services.......................................................... 3
The DG Systems Network......................................................... 4
Markets and Customers.......................................................... 5
Sales, Marketing and Customer Service.......................................... 6
Competition.................................................................... 7
Intellectual Property and Proprietary Rights................................... 8
Employees...................................................................... 9
ITEM 2. PROPERTIES..................................................................... 9
ITEM 3. LEGAL PROCEEDINGS.............................................................. 9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................ 10
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT........................................... 10
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.......... 11
ITEM 6. SELECTED FINANCIAL DATA........................................................ 12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS..................................................................... 13
Overview....................................................................... 13
Results of Operations.......................................................... 14
Liquidity and Capital Resources................................................ 16
Certain Business Considerations................................................ 17
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..................... 25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA..................................... 25
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISLOSURE...................................................................... 25
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............................. 26
ITEM 11. EXECUTIVE COMPENSATION......................................................... 26
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................. 26
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................. 26
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K................ 27
EXHIBITS AND REPORTS ON FORM 8-K............................................................. 27
SIGNATURES................................................................................... 31
DIGITAL GENERATION SYSTEMS, INC.
PART I
ITEM 1. BUSINESS
Digital Generation Systems, Inc. ("DG Systems", "DG" or the "Company")
operates a nationwide, value-added digital network which links hundreds of
advertisers and advertising agencies with more than 7,500 radio and 700
television stations across the United States and Canada. The Company's fault-
tolerant Network Operation Center located in San Francisco delivers audio,
video, image and data content that comprise transactions between the advertising
and broadcast industries.
As a result of its September 1998 acquisition of Digital Courier
International, Inc., ("DCI"), a provider of electronic distribution and
communications services for the radio broadcast industry, the Company is now the
most significant provider of audio spot advertising to radio stations, enjoying
a market share in excess of 50%. In late 1996, the Company entered the market
for the electronic distribution of digital video spots to television stations,
cable systems and networks. DG Systems generates its revenues principally from
advertising agencies, advertisers, tape duplication vendors and dealers,
syndicated programmers and music companies that principally service these
markets. The Company believes that its digital network enables rapid, cost-
effective and reliable transmission of audio and video broadcast content, and
provides higher levels of quality, control and flexibility than physical
distribution methods currently available. In July 1997, the Company purchased
Starcom Mediatech, Inc. ("Mediatech"), a provider of broadcast video and audio
duplication, syndicated program distribution and corporate media duplication
services, with facilities in Chicago, Los Angeles and New York, augmenting its
November 1996 acquisition of PDR Productions, Inc. ("PDR"), a New York City-
based broadcast production services company. As a result of these acquisitions
the Company also has become a leading provider of video advertising distribution
and is rapidly adding new customers to its digital audio and video network. The
Company offers a complete range of post production services, including editing,
duplication, color control, close captioning, content review, quality assurance,
electronic archiving and format conversions, all of which allow one-stop
shopping in the critical advertising markets of New York City, Chicago, and Los
Angeles.
Industry Background
While many radio and television broadcasters now embrace digital technology
for much of their production processes and in-station media management, current
methods for the distribution of audio and video advertising content are based
primarily on the manual duplication and physical delivery of analog tapes.
According to industry sources, there are approximately 10,000 commercial radio
and 1,100 commercial television stations in the United States. These stations
generate revenue principally by selling airtime to advertisers. Advertising is
most frequently produced under the direction of advertising agencies for large
national or regional advertisers, or by station personnel for advertisers that
are local in nature. Advertising is characterized as "network" or "spot",
depending on how it is bought and distributed. Network advertising typically is
delivered to stations as part of a "network feed" (bundled with network
programming), while spot advertising is delivered to stations independently of
other programming content.
Spot advertising airtime typically is purchased by advertising agencies or
media buying firms on behalf of advertisers. Advertisers and their agencies
select individual stations or groups of stations to support marketing
objectives, which usually are based on the stations' geographic and other
demographic characteristics. The actual commercials or "spots" typically are
produced at a digital production studio and recorded on digital tape. Variations
of the spot intended for specific demographic groups also are produced at this
time. The spots undergo a review of quality and content before being cleared for
distribution to broadcast stations. Tapes containing the spot and its variations
are then duplicated on analog tape, packaged, labeled and shipped to the radio
and television stations and cable head-ends specified by the advertiser or its
agency.
The predominant method for distributing spot advertisements to radio and
television stations traditionally has been the physical delivery of analog audio
or videotapes. The Company estimates that approximately 30% of radio spots and
more than 90% of video spots are delivered by air express services. Many
companies, commonly known as "dub and ship houses", are in the business of
duplicating audio and video tapes, assembling them according to agency-specified
bills of material and packing them for air express delivery. The Company
estimates that it has transitioned approximately 60% of the market for audio
spot deliveries and approximately 10% of video spot deliveries, to digital
distribution. The Company estimates the market sizes for the audio distribution
market to be approximately $40 million and approximately $150 million for the
video distribution market.
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The Company
DG Systems is a leading provider of electronic and physical distribution and
ancillary post-production services for audio and video content to advertising
agencies, production studios and broadcast stations throughout the United
States. The Company, a California corporation, was incorporated in 1991. The
Company has developed a digital network currently serving over 7,500 radio and
725 television stations that is controlled through the Company's San Francisco
Network Operating Center ("NOC"). This network enables the rapid, cost-effective
and reliable electronic transmission of audio and video spots and other content
and provides a high level of quality, accountability and flexibility to both
advertisers and broadcasters. With DG Systems' network, transmissions are
automatically routed to stations through a computerized on-line transaction and
delivery system and arrive at stations in as little as one hour after an order
is received. Typically associated traffic (text) instructions are simultaneously
transmitted by facsimile to minimize station handling and scheduling errors.
Shortly after a spot is delivered to a station, the Company sends the customer a
confirmation specifying the time of delivery. Additionally, the Company's
digital network delivers close to "master" quality audio or video to broadcast
stations, which is equal to or superior to that currently delivered on analog
tape.
DG Systems generates its revenues from advertising agencies as well as from
production studios and dub and ship houses that consolidate and forward the
deliveries to broadcast stations. The Company has historically operated and
currently operates without substantial backlog. The Company receives
distribution orders with specific bills of material, routing and timing
instructions provided by the customer. These orders are entered into the
Company's computer system either by the customer (through an internet-based
order-entry system) or by DG Systems and are scheduled for electronic delivery
if a station is on the Company's network, or are scheduled for physical delivery
via the Company's various dub and ship facilities if a destination station is
not on the network.
Audio content is received electronically at the Company's NOC from Record Send
Terminals ("RSTs") and, in the case of Digital Courier's network, Client
Workstations ("CWs"), that are owned by the Company and deployed primarily in
production studios. Audio can also be received using the Company's "iAudio"
internet audio collection system. When audio spots are received, Company
personnel quality-assure the audio content and then initiate the electronic
transaction to transmit various combinations of audio to designated radio
stations. Audio transmissions are delivered over standard telephone or ISDN
lines to servers that the Company has placed in each radio station. The audio
spots are thereafter available to the station on demand.
Video content is received electronically at the Company's San Francisco NOC
primarily from DG Video Record Transmission Systems ("VRTSs") that are owned by
the Company and deployed in production video studios. Video content also can be
received at the Company's San Francisco NOC through airfreight carriers or
through high-speed communication lines from collection points in locations where
VRTSs are not available. When video spots are received, Company personnel
quality-assure the spots and release the video to the NOC, where it is combined
with the customer's electronic transaction to transmit the various combinations
of video to designated television stations. Video transmissions are sent via a
high-speed frame relay link to the digital satellite uplink facility over which
they are then delivered directly to servers that the Company has placed in
television stations and cable interconnects.
Audio and video transmissions are received at designated radio and television
stations on DG-owned servers, called Receive Playback Terminals ("RPTs"), Client
Workstations ("CWs") and ADvantage Digital Video Playback Systems ("DVPS"). The
servers enable stations to receive and play back material delivered through the
Company's digital distribution network. The units are owned by the Company and
typically are installed in the "master control" or production area of the
stations. Upon receipt, station personnel generally review the content and
transfer the spot to a standardized internal station format for subsequent
broadcast. Through its NOC, the Company monitors the spots stored in each RPT,
CW, or DVPS and ensures that space is always available for new transmissions.
The Company can quickly transmit audio or video at the request of a station or
in response to the request of a customer who wishes to alter an existing order,
enabling responsiveness not possible in a physical tape distribution system.
DG Systems currently offers four primary levels of digital audio distribution
services and three levels of video distribution services from its NOC to
broadcast advertisers distributing content to broadcast stations: DG Priority, a
service which guarantees arrival of the first audio spot on an order within one
hour (available for audio only); DG Express, which guarantees arrival within
four hours; DG Standard, which guarantees arrival by noon the next day; and DG
Economy, which
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guarantees arrival by noon on the second day. The Company also offers a set of
premium services enabling advertisers to distribute audio or video spots
provided after normal business hours and, therefore, after overnight parcel
delivery service is no longer available.
In addition to its standard services, the Company has developed unique
products to service four vertical markets with particular time-sensitive
delivery needs. "Sweeps" delivery is a specialized service for television
stations that wish to advertise on radio with either topical or cooperative
content to stimulate viewership during the periods of ratings measurements
conducted by the A.C. Nielsen Company. The Company also offers delivery of
advertising for daily newspapers seeking to expand their readership based on a
dissemination of breaking news during the morning rush hour. The Company
distributes first release music singles and uses unique software functionality
to insure that the singles are released throughout the country to all stations
simultaneously thereby eliminating concerns of favoritism or premature release.
Finally, the Company delivers political advertising during election campaigns,
providing a rapid response mechanism for candidates and issue groups.
The Company also provides audio and video duplication services, syndicated
programming distribution services, and a host of other ancillary post production
services through its nationwide facilities in New York, Chicago, Louisville and
Los Angeles.
Products and Services
The Company's mission is to become the leading provider of electronic value-
added transaction services to the advertising and broadcast industries.
Audio Advertising Distribution. Prior to the Company's acquisitions of PDR and
Mediatech, substantially all of the Company's revenues were derived from the
delivery of radio advertising from advertising agencies, production studios and
dub-and-ship houses to radio stations in the United States. In 1998, the Company
acquired DCI, and has integrated DCI's network with the Company's existing
network to form a single, comprehensive network servicing over 7,500 stations
throughout Canada and the United States. Audio services are expected to continue
to account for a significant share of the Company's revenues for some time. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Certain Business Considerations -- Dependence on Radio
Advertising." The Company also derives revenue from its offering of audio
distribution services in the four vertical markets: sweeps; local/regional
newspapers; music releases; and political advertising. The Company provides
two-way audio transmission services to radio stations within markets, regions
and co-owned groups, facilitating the sharing of programming and commercial
content. The Company also derives limited revenue today through its studio
services, which enable production studios to directly exchange audio files with
each other without the intervention of Company personnel.
Postproduction Services. The Company's acquisitions of PDR and Mediatech have
enabled it to provide digital delivery to a larger base of customers and to
provide postproduction services in the three major advertising markets (New
York, Los Angeles and Chicago) for a "one-stop shopping solution." The Company
continues to focus on value-added postproduction services to complement the
Company's digital delivery product. Such services include leading edge digital
editing, digital closed captioning, Internet-based encoding, and CD-ROM
mastering and duplication.
Video Advertising Distribution. The Company believes that the delivery of
television advertising is characterized by many of the same challenges facing
radio advertisers. The Company introduced its video distribution services in
1996. To date the Company has deployed a video distribution network consisting
of over 725 television stations and cable interconnects which currently are on-
line and receive video content through the Company's network. The Company is
actively marketing and selling its video services to agencies, advertisers and
dealers. As many of the Company's radio advertising customers also are active
television advertisers, its current customers who already utilize the Company's
audio spot distribution services are candidates for or already are utilizing its
video services. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Certain Business Considerations - Dependence on
Video Advertising Delivery Service Deployment", and "- Dependence on
Technological Developments" and " - Competition."
Syndicated Program Distribution. The Company also generates revenue by
distributing syndicated programming. This service primarily consists of
integrating commercials into syndicated programs and either uplinking the
completed programs
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via satellites for distribution to stations nationwide and in Canada or the
physical duplication and shipping of shows to stations that do not receive a
satellite feed.
Corporate Duplication. The Company also generates revenues from the
duplication of corporate content. This service primarily consists of large
quantity duplication of training, corporate or product information tapes on non-
broadcast quality tape stock, such as VHS.
Music Distribution. The Company also derives revenues from its "first release
music deliveries," in which it offers music labels the capability to
electronically distribute first-release music singles simultaneously to selected
radio stations.
The Company's future growth depends on its successful and timely introduction
of new products and services, often in markets that do not currently exist or
are just emerging. The Company currently is undertaking efforts to develop new
products and services. There can be no assurance, however, that the Company will
successfully complete such development or that, if such development is
completed, the Company's introduction of these products and services will
realize market acceptance or will meet the technical or other requirements of
potential customers. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Certain Business Considerations -
Dependence on Emerging Markets."
The DG Systems Network
DG Systems has developed a sophisticated, highly scaleable network
communication system to provide network transaction services to the advertising
and broadcast industries. Today this system supports two-way communication
between advertisers, agencies, production studios and stations via standard
telephone lines, ISDN lines, digital data satellite frame relay connections and
the Internet. The Company intends to continue employing state-of-the-art
communications capabilities, such as XDSL and cable modems, as they become
widely available and economically feasible. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Certain Business
Considerations - Ability to Manage Growth" and " - Future Capital Needs;
Uncertainty of Additional Funding."
The Company's network consists of the following: (i) Record Send Terminals and
Client Workstations (audio) and Video Record and Transmission Systems (video)
owned by the Company and installed primarily at production studios; (ii) NOC at
the Company's headquarters used to assemble, process, route and store digital
content; and (iii) ADvantage Receive Playback Terminals and Client Workstations
(audio) and ADvantage Digital Video Playback Systems (video) owned by the
Company and installed at broadcast stations, cable interconnects and broadcast
and cable networks.
Record Send Terminal and Client Workstation. Both the RST and CW are PC-based
audio encoder and communications servers with a full screen monitor and
keyboard. The RST accepts audio in either analog or digital format and encodes
the audio using an efficient algorithm for transmissions to the Company's NOC in
San Francisco.
Video Record Transmission System. The VRTS is a video encoder and
communications server with a full screen monitor and keyboard. The VRTS accepts
video in either analog or digital format and encodes the video using a standard
MPEG-2 compression algorithm for transmissions to the Company's Network
Operating Center in San Francisco.
Network Operating Centers. DG Systems has developed a fault-tolerant
client/server on-line transaction system based on relational databases and UNIX
servers from Sun Microsystems. The Company has developed software applications
incorporating critical operational capabilities such as transaction management,
communication facility monitoring, system security, intelligent network routing
and customer service databases. The major system components include (i) a
transaction scheduling, monitoring and management system, (ii) a media
collection, processing and delivery system which is designed to handle audio,
video, image and data organizing the delivery content by destination address,
and routing those deliveries by the most cost-effective route, and (iii) a high-
capacity media storage and archive system that indexes and archives every media
file delivered by the Company.
ADvantage Receive Playback Terminal. The RPT is a rack-mountable, PC-based
communication server and media decoder that enables radio stations to receive
and play back audio content delivered through the Company's digital distribution
network. The RPT communicates with the Company's network to exchange media and
transactional information,
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and allows users to play back broadcast quality audio on demand. RPT software
consists of extensive remote capabilities such as system diagnostics, storage
management and remote software upgrade as well as enhanced security features
such as user authentication, network access security protocol and media content
encryption to prevent unauthorized access.
ADvantage Digital Video Playback System. The DVPS is a rack-mountable, PC-
based communication server and video decoder that enables television stations
and cable systems to receive and play back advertisements delivered through the
Company's digital distribution network. The DVPS communicates with the Company's
network to exchange media and transactional information, and allows users to
play broadcast quality video on demand. The DVPS includes a fully integrated
monitor and keyboard and has the disk capacity to store up to 250 30-second
spots. DVPS software consists of extensive remote capabilities such as system
diagnostics, storage management and remote software upgrades as well as enhanced
security features such as user authentication, network access security protocol
and media content encryption to prevent unauthorized access.
Hughes DirecPC Satellite Interface. The Company has a joint development and
deployment agreement with Hughes Network Systems, Inc. for satellite delivery to
its network of stations. The Company has developed an electronic interface
between its NOC in San Francisco and the Hughes satellite uplink facility. The
Company also has integrated the Hughes DirecPC satellite technology into its
DVPSs to permit the receipt of media content from satellite as well as from
terrestrial connections.
Client Workstation. The CW is a rack-mountable or desktop, PC-based
communication server and media encoder/decoder that enables radio stations to
receive, play back, record and send audio content delivered through the
Company's digital distribution network. The CW communicates with the Company's
network to exchange media and transactional information, and allows users to
record, store and play back broadcast quality audio on demand. CW software
consists of extensive remote capabilities such as system diagnostics, storage
management and remote software upgrade as well as enhanced security features
such as user authentication and a network access security protocol to prevent
unauthorized usage of the network.
DG's extensive network of digital audio receive playback terminals and video
playback systems strategically placed across the country in broadcast stations,
its record send terminals, customer workstations and video record transmission
systems, coupled with unique encoding, compression and complex communications
software, connected via its NOC described above, and an established customer
base, create important barriers to entry for potential competitors. The
transmission of content is controlled by a very comprehensive transaction
scheduling, routing, monitoring and delivery management system that the Company
believes would be very difficult to replicate. Additionally, DG's audio and
video capabilities now are complemented with facilities in New York City,
Chicago, Louisville, and Los Angeles to handle customers' other production
services needs. The Company believes that no single competitor today offers DG's
audio, video, and production services capabilities that are deliverable locally
and nationally via several strategic locations.
Markets and Customers
A large portion of the Company's current revenue is derived from the delivery
of spot radio and television advertising to broadcast stations, cable systems
and networks. The Company derives revenue from advertising agencies directly and
from its marketing partners, which are typically dub and ship houses that have
signed agreements with the Company to consolidate and forward the deliveries of
their advertising agency customers to broadcast stations, cable systems and
networks via the Company's electronic delivery service in exchange for price
discounts from the Company. The advertisements distributed by the Company are
representative of the five leading national advertising categories of
automotive, retail, business and consumer services, food and related products
including soft drinks, and entertainment. The volume of advertising from these
segments is subject to substantial seasonal and cyclical variations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Certain Business Considerations - Potential Fluctuations in
Quarterly Results; Seasonality." Through its acquisition of the assets of DCI,
the Company has also acquired an additional revenue stream from radio stations
by providing distribution between radio stations and radio groups.
In addition to its core distribution services, DG Systems has identified
vertical-market applications for services where same day delivery is used to
promote time-sensitive content. These applications include:
5
Sweeps Promotions. The A.C. Nielsen ratings periods take place during the
broadcast months of February, May, September, and November. The Company's
services allow local television stations, their affiliated networks and
syndicators, whose own advertising rates are based on their Nielsen ratings, to
promote viewership of their programs during ratings periods.
Station to Station Distribution. Many radio stations produce and distribute
commercials and short-form programming to other stations for airplay on the same
day, and the Company's network has proven efficient in delivering this content,
replacing ground deliveries and couriers. In addition, consolidation in radio
ownership has resulted in many of the new radio mega-groups developing
facilities for central audio production. The Company's delivery system is used
to distribute this production to the group's co-owned stations.
Political Campaigns. Radio and television can provide a rapid response
mechanism for candidates and issue groups. The Company offers a same-day service
for the facilitation of such advertising during political campaigns. In 1998, an
election year, the Company delivered 25,000 campaign advertisements,
representing over 300 candidates and propositions.
The Company also offers the following services:
Postproduction Services. Advertising agencies, advertisers, corporations, and
public relations firms often require additional services to be performed before
a produced element is distributed for broadcast purposes. In addition to the
Company's traditional postproduction services - closed captioning, commercial
tagging, international standards conversions, and duplication - the Company has
developed and introduced digital solutions in the postproduction environment.
The new digital services enforce the Company's focus on a fully digital
production and distribution environment.
Syndication Programming Distribution. Syndicators distribute long form video
programming inclusive of advertising to local television stations and cable
operators. The Company offers numerous postproduction services to prepare this
content for broadcast and distributes it across the country and around the
world. Distribution services include both satellite uplink and physical
duplication and shipping to those stations which do not or cannot receive the
content via satellite.
Corporate Duplication. Corporations and other entities develop training,
management communications and other general information programs for internal
and external distribution for various purposes. The Company provides high volume
duplication of such content on non-broadcast quality tape stock, typically VHS.
Sales, Marketing and Customer Service
Brand Strategy. The Company's brand strategy is to position itself as the
standard transaction method for the radio, television, cable, and network
broadcast industries. The Company focuses its marketing messages and programs at
multiple segments within the advertising and broadcast industries. Each of the
segments interacts with the Company for a different reason. Agencies purchase
services from the Company on behalf of their advertisers. Production studios
facilitate the transmission of audio and video to the Company's NOC. Production
studios and dub and ship houses resell delivery services to agencies. Stations
join the network to receive the content from their customers, the agencies and
advertisers. A key strategy to providing a consistent brand theme at all levels
is developing "DG" as a brand identity across these various product and services
offerings.
Internet/E-Commerce Strategy. The Company introduced its first Internet-based
services called DG On-line in 1998 to facilitate the electronic remote entry of
work orders and to provide on line tracking of order status by its customers. In
1999, the Company estimates that 30% of its orders were entered electronically
via the Internet, versus approximately 11% during 1998. In addition, the
Company also offers its "iAudio" Internet audio collection system service which
allows audio content to be received from clients via the Internet.
Sales. The Company employs a direct sales force that calls on various
departments at advertising agencies to communicate the capabilities and
comparative advantages of the Company's electronic distribution system and
related products and services. In addition, the Company's sales force calls on
corporate advertisers who are in a position to either direct or influence
agencies in directing deliveries to the Company. A separate staff sells to and
services audio and video dealers, who resale the Company's distribution
services. Lastly, an insider sales staff represents the Company's services to
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radio stations. The Company currently has field sales offices in New York, Los
Angeles and Chicago, as well as sales personnel in its San Francisco
headquarters. The Company's sales force includes field sales, inside sales, and
telemarketing.
Marketing. The Company's marketing programs are directed toward demand
stimulation with an emphasis on popularizing the benefits of digital delivery,
including fast turnaround (same day services), increased flexibility, higher
quality, problem recovery, and greater reliability and accountability. These
marketing programs include direct mail and telemarketing campaigns, newsletters,
collateral material (including brochures, data sheets, etc.), application
stories, and corporate briefings in major U.S. cities. The Company also engages
in public relations activities including trade show participation, the
stimulation of articles in the trade and business press, press tours and
advertising in advertising and broadcast oriented trade publications.
The Company also markets to broadcast stations to arrange for the placement of
its RPTs and DVPSs for the receipt only of audio and video advertisements, or
Client Workstations, which provide the ability to both receive and to originate
distribution of audio to other radio stations. There is currently no charge for
a station to receive an advertisement. For radio stations or groups that
subscribe to network distribution services utilizing the Client Workstation, the
station signs a month-to-month, one-year, or two-year term of service.
The Company believes that in combination with its acquisition of the assets of
DCI, its combined network provides digital distribution coverage for more than
90% of commercial radio stations and distribution traffic in the United States
and Canada. The Company is focusing on the most significant 750 television
stations as rated by A.C. Nielsen, along with the major cable interconnects and
cable and broadcast networks.
Customer Service. The Company's approach to customer service is based on a
distributed model designed to provide focused support from key market centered
offices, located in Los Angeles, San Francisco, Chicago and New York. Clients
work with specific, assigned account coordinators to place production service
and distribution orders. National distribution orders are electronically routed
to the San Francisco NOC for electronic distribution or, for offline
destinations, to the Company's national duplication center in Louisville,
Kentucky. The Company's distributed service approach provides direct support in
the key market cities enabling the Company to develop closer relationships with
clients as well as the ability to support client needs for local production
services. The Company also maintains a customer service team dedicated to
supporting the needs of radio, television, and network stations. This support is
available 7 days a week, 24 hours a day, to respond to station requests for
information, traffic instructions or additional media. Providing direct support
alleviates the need for client traffic departments to deal with individual
stations or the challenges of staffing for off-hours support. The Company's
customer service operation centers are linked to the Company's order management
and media storage systems, and national distribution network. These resources
enable the Company to manage the distribution of client orders to the
fulfillment location best suited to meet critical customer requirements as well
as providing order status and fulfillment confirmation. This distributed model
also provides the Company with significant redundancy and re-route capability,
enabling the Company to meet customer needs when weather or other conditions
prevent deliveries using traditional courier services.
Work orders entered by customers into the CW are shipped automatically through
the NOC to their destinations with minimal human intervention. No monitoring is
done of the spots, unless the Company is asked to review a spot by a client.
These capabilities enable the Company's customers to move to an e-commerce
business model as the service is developed more fully.
Competition
The market for the distribution of advertising and other content to radio and
television stations and cable systems is highly competitive. The Company
currently competes in the market for the distribution of audio and video
advertising spots to broadcast stations, cable systems and networks. The
principal competitive factors affecting this market are ease of use, price,
timeliness and accuracy of delivery.
The Company competes with a variety of dub and ship houses and production
studios that have traditionally distributed taped advertising spots via physical
delivery. As local distributors, these entities have long-standing ties with
advertising agencies that are often difficult for the Company to replace. In
addition, these dub and ship houses and production studios
7
often provide an array of ancillary video services, including archival storage
and retrieval, closed captioning and format conversions, enabling them to
deliver to their advertiser and agency customers a full range of customizable,
media postproduction, preparation, distribution and trafficking services. The
Company's acquisitions of Mediatech and PDR enable the Company to provide
similar services in the three largest domestic advertising markets: New York,
Los Angeles and Chicago. The Company plans to continue pursuing potential dub
and ship house partners where such partnerships make strategic sense.
With the acquisition of DCI, the Company has the only widely deployed
electronic system for the delivery of audio advertisements; consequently, it
competes largely with physical tape duplication and shipping for audio
advertising distribution.
In the video marketplace, the Company also competes with dub and ship houses
across the country but additionally with a satellite-based real-time video
distribution network operated by Vyvx, an operating division of the Williams
Communications Group. This network differs from that of the Company in several
ways, including limited error checking, lack of digital video as the standard
output to the station and lack of a station server to support presentation of
video-on-demand to the station. The Company has been able to successfully
convince a number of customers of the relative benefits of its system. The
Company also anticipates that certain common and/or value-added
telecommunications carriers may develop and deploy high bandwidth network
services targeted at the advertising and broadcast industries, although none has
at this point entered the market for spot distribution.
To the extent that the Company is successful in entering new markets, such as
delivery of other content to radio and television stations or delivery of data
concerning the actual airtime and audience ratings of commercials, it expects to
face competition from companies in related communications markets and/or package
delivery markets which offer products and services with functionality similar to
that offered by the Company's products and services. Telecommunications
providers such as AT&T, MCI, and Regional Bell Operating Companies could enter
the market as competitors with significantly lower telecommunications
transportation costs. The Company also could face competition from entities with
package delivery expertise such as Federal Express, United Parcel Service, DHL
or Airborne if any such companies enter the electronic data delivery market.
Radio Networks such as ABC or Westwood One also could become competitors by
selling and transmitting advertisements separately from their network content
programming.
Many of the Company's current and potential competitors in the markets for
audio and video distribution have substantially greater financial, technical,
marketing and other resources than the Company. The Company expects that an
increasingly competitive environment may result in price reductions that could
result in reduced unit profit margins and loss of market share, all of which
would have a material adverse effect on the Company's business, results of
operations and financial condition. Moreover, the markets for the distribution
of audio and video content have become increasingly concentrated in recent years
as a result of acquisitions, which are likely to permit many of the Company's
competitors to devote significantly greater resources to the development and
marketing of new services. There can be no assurance that the Company will be
able to compete successfully with new or existing competitors or that
competitive pressures faced by the Company will not materially and adversely
affect its business, operating results and financial condition. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations Certain Business Considerations - Competition."
The Company believes it has the broadest coverage in broadcast radio and the
largest market share.
Intellectual Property and Proprietary Rights
The Company primarily relies upon a combination of copyright, trademark and
trade secret laws and license agreements to establish and protect proprietary
rights in its technologies. The source code for the Company's software is
protected both as a trade secret and as an unpublished copyrighted work. Despite
these precautions, it may be possible for a third party to copy or otherwise
obtain and use the Company's hardware, software or technology without
authorization or to develop similar technology independently. In addition,
effective copyright and trade secret protection may be unavailable or limited in
certain foreign countries.
Because the Company's business is characterized by rapid technological change,
the Company believes that factors such as the technological and creative skills
of its personnel, new computer hardware, software and telecommunications
8
developments, frequent hardware and software enhancements, name recognition, and
reliable customer service and support are more important to establishing and
maintaining a leadership position than the various legal protections of its
technology.
The Company believes that its software, trademarks and other proprietary
rights do not infringe the proprietary rights of third parties. There can be no
assurance, however, that third parties will not assert such infringement by the
Company with respect to current or future software, hardware or services. Any
such claims, with or without merit, could be time-consuming, result in costly
litigation, cause software release delays or might require the Company to enter
into royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to the Company.
Employees
As of December 31, 1999, the Company had a total of 341 employees, including
26 in research and development, 34 in sales and marketing, 239 in operations and
manufacturing, and 42 in finance and administration. Of these employees, 315
were located in the United States and 26 were located in Canada. None of the
Company's employees are represented by a collective bargaining agreement, and
the Company has not experienced a work stoppage. The Company considers its
relations with its employees to be good.
The Company's business and prospects depend in significant part upon the
continued service of its key management, sales and marketing and administrative
personnel. The Company does not generally have employment agreements with its
key personnel. The loss of key management or technical personnel could
materially adversely affect the Company's business, operating results and
financial condition. The Company believes that its prospects depend in large
part upon its ability to attract and retain highly-skilled managerial, sales and
marketing and administrative personnel. Competition for such personnel is
intense, and there can be no assurance that the Company will be successful in
attracting and retaining such personnel. Failure to attract and retain key
personnel could have a material adverse effect on the Company's business,
operating results and financial condition. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations Certain Business
Considerations - Dependence on Key Personnel."
ITEM 2. PROPERTIES
The Company's headquarters are located at leased office space located at 875
Battery Street in San Francisco, California. The Company's lease is for 19,000
square feet and expires in June 2001. In order to sustain uninterrupted network
integrity, the Company has an agreement for non-interruptible access to
emergency power and the Company has arranged for alternative fiber optic routes
to maintain its fiber connection between its computers and its long distance
carrier. However, there can be no assurance that a catastrophic earthquake or
other natural disaster could not interrupt the company's operations. The Company
maintains a lease, set to expire in 2001, for a 5,000 square foot facility which
is used for assembly of its field equipment and for offsite storage. In
addition, the Company leases approximately 3,000 square feet in Louisville,
Kentucky for its dub and ship facility which expires in 2002; approximately
22,000 square feet in New York City which is occupied by DG East (formerly PDR)
and expires in 2006; approximately 13,000 square feet in Los Angeles occupied by
DG West (formerly Mediatech) which expires in 2006; 25,000 square feet in
Chicago, which is occupied by DG Central (formerly Mediatech) on a month to
month rental agreement, pending finalization of a long-term lease; 9,000 square
feet occupied by DG North (formerly DCI) in Burnaby, British Columbia
(Vancouver, Canada) on a month to month rental agreement; and 10,000 square feet
in Dallas which expires in August 2001. The Company believes that these
facilities and offices are adequate to meet its requirements for the foreseeable
future.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject, from time to time, to various legal proceedings and
claims, either asserted or unasserted, which arise in the ordinary course of
business. While the outcome of these claims cannot be predicted with certainty,
management does not believe that the outcome of any of these legal matters
asserted to date will have a material effect on the Company's consolidated
financial condition or results of operations.
9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matters to a vote of security holders during
the fourth quarter of the fiscal year ended December 31, 1999.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers and directors of the Company and their ages as of
December 31, 1999 are as follows:
Name Age Title(s)
- ----------------------------------- ------ -------------------------------------------------------
Scott K. Ginsburg (2) 47 Chairman of the Board
Matthew E. Devine 51 Chief Executive Officer and Director
Omar Choucair 37 Chief Financial Officer
Lawrence D. Lenihan, Jr (1) (2) 35 Director
Michael G. Linnert (1) 29 Director
David M. Kantor (1) (2) 43 Director
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
Scott K. Ginsburg joined the Company in December 1998 as Chief Executive
Officer and Chairman of the Board. In July 1999, Matthew E. Devine assumed the
responsibilities of Chief Executive Officer, but Mr. Ginsburg remains the
Company's Chairman. He is also the Chairman of Starguide Digital Networks and,
most recently, served as Chief Executive Officer and Director of Chancellor
Media Corporation (now AMFM 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.
Matthew E. Devine joined the Company in July 1999 as Chief Executive Officer
and Director. Prior to joining the Company, Mr. Devine served as Chief
Financial Officer of Chancellor Media Corporation (now AMFM Corporation) and
served as Chief Financial Officer, Executive Vice President, Treasurer,
Secretary and Director for Evergreen Media Corporation. Between 1975 and 1988,
Mr. Devine served in various finance positions at AMR Corporation, parent
company to American Airlines.
Omar A. Choucair joined the Company as Chief Financial Officer in July 1999.
Prior to joining the Company, Mr. Choucair served as Vice President of Finance
for Chancellor Media (now AMFM Corporation), and served as Vice President of
Finance for Evergreen Media before it was acquired by Chancellor Media in 1997.
Prior to entering the media industry, Mr. Choucair was a Senior Manager at KPMG
LLP, where he specialized in media and telecommunications clients. Mr. Choucair
received a B.B.A. from Baylor University and is a Certified Public Accountant.
Lawrence D. Lenihan, Jr. has been a member of the Board of Directors of the
Company since July 1997. Mr. Lenihan is a Managing Director of Pequot Capital
Management, Inc. He joined the predecessor to this firm, Dawson-Samberg Capital
Management, in 1996. He is also a Managing Member of the General Partner of
Pequot Private Equity Fund II, L.P. Prior to joining Pequot, Mr. Lenihan was a
principal at Broadview Associates, LLC, from 1993 to 1996. Prior to joining
Broadview, Mr. Lenihan held several positions at IBM, most recently as the
leader of an interactive multimedia software product business. Mr. Lenihan
graduated from Duke University with a B.S. in Electrical Engineering and he
holds an M.B.A. from the Wharton School of Business at the University of
Pennsylvania. He currently serves as director of several public and private
companies including SkyOnline, Interpacket Group Inc, Performaworks, FlexiGift,
Inc., and Mediaplex, Inc.
Michael G. Linnert has been a member of the Board of Directors of the Company
since July 1999. Mr. Linnert is a General Partner with Technology Crossover
Ventures, a venture capital firm, which specializes in emerging Internet and
communications companies. He currently serves as a board member of
petopia.com. Prior to joining Technology Crossover Ventures, Mr. Linnert was
a member of the investment banking division at Goldman, Sachs & Co. Mr. Linnert
holds a B.S.E.E. from the University of Notre Dame and an MBA from Stanford
Graduate School of Business.
10
David M. Kantor has been a member of the Board of Directors of the Company
since August 1999. Mr. Kantor is Senior Vice President for Network Operations of
AMFM, Inc. (formerly Chancellor Media Corporation) and manages AMFM Radio
Networks. Prior to joining AMFM, he was President of ABC Radio Network, having
previously served as Executive Vice President. Prior to joining ABC Radio
Network, he held executive positions with Cox Cable and Satellite Music Network.
Mr. Kantor holds a B.S. from the University of Massachusetts and an MBA from
Harvard Business School.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
The Common Stock of the Company has been traded on the Nasdaq National Market
under the symbol DGIT since the Company's initial public offering on February 6,
1996. Prior to that time there was no public market for the Company's Common
Stock or other securities.
The following table sets forth the high and low closing sales prices of our
Common Stock from January 1, 1998 to December 31, 1999. Such prices represent
prices between dealers, do no include retail mark-ups, mark-downs or commissions
and may not represent actual transactions.
Fiscal Year Ended 1999 Fiscal Year Ended 1998
------------------------------------ ------------------------------------
High Low High Low
----------------- ----------------- ----------------- -----------------
First Quarter......... $8.13 $3.63 $5.13 $1.56
Second Quarter........ 9.00 4.13 4.38 3.25
Third Quarter......... 6.13 3.38 4.19 2.38
Fourth Quarter........ 7.56 3.25 5.75 2.25
As of December 31, 1999, the Company had issued and outstanding 27,530,170
shares of its Common Stock. As of March 15, 2000, the Company had issued and
outstanding 27,942,184 shares of its Common Stock held by 110 shareholders of
record. The Company estimates that there are approximately 4,037 beneficial
shareholders.
In December 1999, the Company's Board of Directors authorized the sale and
issuance of Common Stock in a private placement transaction. The Company issued
725,199 common shares to current institutional investors and members of
management at a price of $5.17 per share, or an aggregate of $3,750,000. The
offers and sales of the Common Stock and warrants to purchase Common Stock were
exempt from the registration requirements of the Securities Act of 1933, as
amended (the "Act"), pursuant to Section 4(2) thereof. The Company relied on the
following criteria to make such exemption available: the number of offerees, the
size and manner of the offering, the sophistication of the offerees and the
availability of material information.
The Company has never declared or paid cash dividends on its capital stock.
The Company currently expects to retain its future earnings for use in the
operation and expansion of its business and does not anticipate paying any cash
dividends in the foreseeable future.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations ---Certain Business Considerations Concentration of Stock
Ownership", "---Preferential Rights of Outstanding Preferred Stock" and "---
Possible Volatility of Share Price."
11
ITEM 6. SELECTED FINANCIAL DATA
Statements of Operations:
Years Ended December 31,
-------------------------------------------------------
1995 1996 1997 1998 1999
--------- --------- ---------- ---------- ---------
(in thousands, except per share data)
Revenues........................................... $ 5,144 $10,523 $ 29,175 $ 41,270 $48,724
------- ------- -------- -------- -------
Costs and expenses:
Delivery and material costs.................. 1,810 3,084 11,334 14,630 17,857
Customer operations.......................... 2,974 4,164 11,388 14,780 15,138
Sales and marketing.......................... 3,406 3,998 4,417 4,970 4,818
Research and development..................... 1,590 2,092 2,473 2,780 2,577
General and administrative................... 1,380 1,677 3,169 4,314 6,552
Write down of goodwill and fixed assets (1) -- -- -- 17,006 --
Non-recurring charges........................ -- -- -- -- 370
Depreciation and amortization................ 2,345 4,331 9,306 10,266 8,591
------- ------- -------- -------- -------
Total expenses.......................... 13,505 19,346 42,087 68,746 55,903
------- ------- -------- -------- -------
Loss from operations............................... (8,361) (8,823) (12,912) (27,476) (7,179)
------- ------- -------- -------- -------
Other income (expense):
Interest income and other, net............... 417 1,422 744 253 319
Interest expense............................. (836) (1,726) (2,607) (3,014) (1,903)
------- ------- -------- -------- -------
Net Loss........................................... $(8,780) $(9,127) $(14,775) $(30,237) $(8,763)
======= ======= ======== ======== =======
Basic and diluted net loss per common share (2) $(9.78) $(.87) $(2.52) $(1.97) $(0.33)
======= ======= ======== ======== =======
Weighted average common shares..................... 898 10,488 11,893 16,272 26,653
======= ======= ======== ======== =======
(1) See Note 3 of Notes to Consolidated Financial Statements
(2) See Note 11 of Notes to Consolidated Financial Statements
Balance Sheet Data:
December 31,
------------------------------------------------------------------------
1995 1996 1997 1998 1999
------------ ----------- --------------- ------------- -------------
(in thousands)
Cash, cash equivalents and short-term investments... $ 6,205 $20,597 $ 8,820 $13,025 $ 5,420
Working capital..................................... 4,651 14,200 (879) 7,178 1,236
Property and equipment, net......................... 5,772 12,630 17,566 11,745 8,158
Total assets........................................ 14,459 45,248 60,697 49,792 41,766
Long-term debt, net of current portion.............. 4,540 8,495 11,847 9,307 2,513
Shareholders' equity................................ 6,373 26,839 30,449 23,710 20,553
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
The Company was incorporated in 1991. Through 1993, the Company was a
development-stage company, principally engaged in developing its network,
marketing its services to radio stations and advertising agencies, and producing
and deploying terminals for use at advertising agencies, production studios and
radio stations. In 1994, the Company first generated significant operating
revenues from the delivery of audio commercials and the related text traffic
instructions to radio stations through a nationwide network established by the
Company. The Company has invested heavily in the development of its digital
audio network which was nearly complete by the end of 1996. It was at that time
that the Company began to promote its digital video technology service revenues
from which have grown every year since that time. As the Company's audio and
video network coverage has expanded to include an increasing number of radio and
television stations, the number of deliveries ordered by customers has
increased. At the same time, the number of deliveries performed via electronic
delivery has increased relative to the number performed by physical delivery
through the Company's dub and ship facility in Louisville, Kentucky.
The Company defines a delivery as the transmission, electronic or physical, of
a piece or pieces of audio or video content, generally a commercial ("spot") or
a set of commercials ("tied spots") to a destination, generally a radio or
television station, based on a single order from a customer. Each order usually
calls for the delivery of the same spot or spots to multiple destinations,
resulting in multiple deliveries. The revenue earned per delivery is dependent
upon the type of service ordered, generally defined by the time interval between
submission and delivery (Priority, Express, Standard or Economy), the channel
from which the order is received (directly from an advertiser or advertising
agency or through a dub and ship house), and the quantity of audio or video
being delivered (a single spot or multiple tied spots). DG Systems derives
revenue from advertising agencies, as well as production studios and dub and
ship houses that consolidate and forward deliveries for their agency customers.
Because the revenue earned for the delivery of the first spot is significantly
greater than the revenue earned for a tied spot and because the Company's per
spot electronic transmission cost is relatively constant regardless of volume,
electronic deliveries that comprise a single spot are generally more profitable
than deliveries which include tied spots. The Company recognizes revenue for
each order on the date the content is received by the customer.
The Company assembles, owns and maintains Receive Playback Terminals ("RPTs"),
which are located in radio stations; Record Send Terminals ("RSTs"), which are
located in advertising agencies and production studios; Client Workstations
("CWs") which are located in both radio stations and dealer locations; Video
Record Transmission Systems ("VRTSs"), which are located primarily in production
studios; and Digital Video Playback Systems ("DVPSs"), which are located in
television stations. The capital required to build the network has been obtained
through various stock offerings to investors, primarily venture capital firms,
leasing agreements, and the Company's initial public offering, which was
completed in February 1996.
In November 1996, the Company acquired 100% of the capital stock of PDR
Productions, Inc. ("PDR"), a New York City based media duplication and
distribution company. PDR's primary operations are services typical of the
traditional dub and ship house, including the physical duplication and
distribution of video content on a wide range of tape formats and performance of
a variety of audio and video editing services. The acquisition was accounted for
as a purchase and the operating results of PDR have been included in the
consolidated results of the Company from the date of the closing of the
transaction, November 8, 1996.
In July 1997, the Company acquired 100% of the capital stock of Starcom
Mediatech, Inc. ("Mediatech"), a wholly owned subsidiary of IndeNet, Inc.
("IndeNet") with operating facilities in Chicago, Los Angeles, New York and
Louisville. Mediatech's primary operations, similar to those of PDR, are also
services typical of a traditional dub and ship house. Although Mediatech's
revenues are generated primarily from the duplication and distribution of short
form content, consistent with those of DG Systems prior to this acquisition,
Mediatech's revenues also include a significant portion generated from the
distribution of long form syndicated programming of both live and previously
broadcast television shows. Such services include integrating commercials into
syndicated programs and uplinking the completed programs to satellites as well
as the physical duplication and distribution of such programs to those stations
which do not receive a satellite feed.
13
The acquisition was accounted for as a purchase and the operating results of
Mediatech have been included in the consolidated results of the Company from the
date of the closing of the transaction, July 18, 1997.
In September 1998, the Company acquired the assets of Digital Courier
International, Inc. ("DCI"), which has provided the Company with a Canadian
network for the delivery of radio advertisements, and two-way sending capability
in the US and Canadian market. In late 1998, the Company commenced plans to
integrate the acquired DCI assets with the Company's network with the
expectation of higher operating efficiencies. The acquisition was accounted for
as a purchase and the operating results and balance sheet 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.
The Company acquired PDR, Mediatech and DCI with the expectation that the
acquisitions would result in enhanced efficiencies for the combined company,
including those resulting from the capability of providing digital delivery to
new customers and the capability of providing ancillary services to new and
existing customers in the markets served by PDR, Mediatech and DCI. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations ---Certain Business Considerations --- Uncertainties Relating to
Integration of Operations" and "--Dependence on Video Advertising Service
Deployment."
Results of Operations
Revenues
Revenues increased from $29,175,000 to $41,270,000 to $48,724,000 for the
years ended December 31, 1997, 1998 and 1999, respectively.
Revenues increased in 1998 primarily due to the acquisitions of Mediatech in
1997 and DCI in 1998. In addition, the increase is due to certain other
factors, including increased volume resulting from greater acceptance of the
services offered by the Company and increased availability of an expanded
network of Company equipment located in radio and television stations, as well
as general price increases. The increase from 1998 to 1999 is due in part to
including the results of operations of DCI for an entire year, as well as
continued volume and price increases.
Delivery and Material Costs
Delivery and material costs were $11,334,000, $14,630,000 and $17,857,000 in
1997, 1998 and 1999, respectively. The increase in costs in each period versus
the same period of the prior year is primarily due to the increased delivery
volume, as well as the acquisition of DCI and Mediatech. These costs include
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
Networking Operating Center ("NOC"), costs for video and audio tapes, packaging
and shipping costs required when physically duplicating and distributing a video
or audio spot, and direct material and fees paid to other service providers in
connection with postproduction services and other services offered by the
Company.
Delivery and material costs as a percentage of revenues decreased from 39% in
1997 to 35% in 1998 and increased to 37% in 1999. The decrease from 1997 to 1998
is due principally to the improvements in electronic costs of delivery for audio
and video distribution as volumes have increased. In 1999, the increase in
delivery and materials costs as a percentage or revenues over 1998 is due
primarily to increased volumes.
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."
14
Customer Operations
Customer operations expenses were $11,388,000, $14,780,000 and 15,138,000 in
1997, 1998 and 1999, respectively. The increase in 1998 versus 1997 is due
primarily to increased costs incurred to support the greater volume of
deliveries processed through the Company's San Francisco NOC as well as the
consolidation of the costs of the former Mediatech and DCI operations. The
increase in 1999 versus 1998 is the result of including a full year of costs in
1999 of the former DCI operations and the addition of the personnel necessary to
respond to the greater volume of orders and deliveries.
Customer operations expenses as a percentage of revenues has decreased from
39% to 36% to 31% in 1997, 1998 and 1999, respectively. These decreases are
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 $4,417,000, $4,970,000 and $4,818,000 in
1997, 1998 and 1999, respectively. The increase in 1998 versus 1997 is due
primarily to growth in marketing program costs to increase customer awareness of
the Company's services. In addition, sales and marketing expenses increased due
to the acquisition of DCI. The decrease in 1999 versus 1998 is due primarily
to the consolidation of the Company's sales and marketing efforts among all of
its locations. Sales and marketing costs as a percentage of revenue has
decreased from 15% to 12% to 10% of revenues for 1997, 1998 and 1999,
respectively, due to greater economies of scale.
The Company expects to continue to expand sales and marketing programs
designed to introduce the Company's existing and future 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 were $2,473,000, $2,780,000 and $2,577,000
in 1997, 1998 and 1999, respectively. The increase in 1998 versus 1997 is
primarily due to the hiring of additional engineers to develop and enhance the
Company's digital services. Research and development expenses in 1998 also
increased due to the additional research and development expenses incurred as a
result of its acquisition of DCI. The decrease in expenses in 1999 versus 1998
is due primarily to the capitalization of certain salaries and benefits related
to internally generated software and the consolidation of the Company's research
and development efforts amount all of its locations. As a percent of revenues,
research and development expenses have decreased from 8% in 1997 to 7% in 1998
to 5% in 1999.
The Company expects that increased research and development expenses will be
necessary to remain competitive and that its future success will depend in part
upon the technological quality of its products and processes relative to those
of its competitors and its ability both to develop new and enhanced products and
services. The Company's research and development expenses may increase
substantially in absolute dollars and may fluctuate as a percentage of revenues
in future periods.
General and Administrative
General and administrative expenses consist primarily of personnel, consulting
fees, and related overhead costs for finance and general management of the
Company. General and administrative expenses were $3,169,000, $4,314,000 and
15
$6,552,000 in 1997, 1998 and 1999, respectively. These increases were 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 acquisitions of Mediatech and DCI. As a percent of revenues, general and
administrative expenses were 11%, 10% and 13% in 1997, 1998, and 1999,
respectively. The Company expects that general and administrative expenses will
increase in absolute dollars and may fluctuate as a percentage of revenues in
future periods.
Depreciation and Amortization
Depreciation and amortization expense was $9,306,000 and $10,266,000 and
$8,591,000 in 1997, 1998 and 1999, respectively. The increase in expenses in
1998 versus 1997 was due to the continued expansion of the Company's network.
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 reached the end of their depreciable
lives. The decline of depreciation expense in 1999 versus 1998 reflects this
fact. The Company's total investment in network equipment has increased from
$30.4 million to $33.2 million to $35.3 million at the end of 1997, 1998 and
1999, respectively.
Included in depreciation and amortization is amortization expense of $787,000,
$1,163,000 and $1,648,000 in 1997, 1998, and 1999, respectively, related to the
goodwill and other intangible assets recorded in connection with the
acquisitions of PDR Mediatech, and DCI. As discussed in the Notes to the
Condensed Consolidated Financial Statements, in September 1998, the Company
wrote off the remaining goodwill of its Mediatech subsidiary, approximately
$16.7 million, and wrote down Mediatech's fixed assets by an additional $340,000
because it was determined that the carrying values of these assets may not be
recoverable. Because of a change in Mediatech's business, it was determined that
the value of the investment had permanently declined. The fair value of the
Mediatech assets was determined by discounting the related expected future cash
flows over the remaining life of the goodwill amortization period of 19 years.
The Company expects to continue to invest in the expansion of its network. In
particular, the Company is in the process of expanding its infrastructure within
the television broadcast industry that will require additional VRTSs and DVPSs
to be built and installed in production studios and television stations. The
Company expects depreciation and amortization to increase in absolute dollars in
proportion to this growth. However, there can be no assurance that the Company
will make such investments or that such investments will result in future
revenue growth. See "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
The Company has derived interest income from the short-term investment of the
proceeds received in various stock offerings, including $23.7 million of net
proceeds from the private placements of Common Stock in August and December 1998
and $16.4 million of net proceeds from the Series A Convertible Preferred Stock
offering in July 1997. Fluctuations in interest income are due to differences
in the amounts raised and the timing of each offering as well as the differences
in the levels of cash used to fund Company operations and strategic acquisitions
and interest rates. The Company expects that interest income will decrease in
the future in proportion to the levels of cash used to fund operations and
acquisition activity. See "Management's Discussion and Analysis of Financial
Position and Results of Operations ---Liquidity and Capital Resources."
Interest expense incurred by the Company was $2,607,000, $3,014,000 and
$1,903,000 in 1997, 1998 and 1999, respectively. This expense relates primarily
to lease agreements used to fund the acquisition of components and equipment
needed to develop the network and to provide Company personnel with the capital
resources necessary to support the Company's business growth. Total long-term
debt outstanding was $19,407,000, $17,533,000 and $10,202,000 at December 31,
1997, 1998 and 1999, respectively. The Company expects that interest expense
will fluctuate in the future based on the levels of borrowing. See
"Management's Discussion and Analysis of Financial Position and Results of
Operations ---Liquidity and Capital Resources."
Liquidity and Capital Resources
The Company used cash in operating activities of $6.3 million and $4.8 million
in 1997 and 1998, respectively, and generated cash from operating activities of
$0.2 million in 1999. Cash flows from operating activities improved during 1999
16
as compared to 1998 primarily because revenue increased by 18% and operating
expenses increased by only 8%. Cash flows from operating activities improved
during 1998 as compared to 1997 primarily due to a 42% increase in revenue in
1998 as compared to 1997, while operating expense (net of the impairment of
goodwill and operating assets of its subsidiary), increased by only 23% during
1998 over 1997. Additionally, the Company's accounts receivable balance, net of
reserves, increased 24% from 1997; however, revenues increased 42% in 1998 over
1997, reflecting an improvement in cash collections in 1998 over the prior year.
The Company's earnings before interest, taxes, depreciation and amortization has
improved from a loss of $3.6 million in 1997, to a loss of $204,000 in 1998, to
a gain of $1.4 million in 1999.
The Company used $5.1 million, $2.2 million and $2.7 million of cash in 1997,
1998 and 1999, respectively, to purchase property and equipment. In addition,
$0.4 million, $1.7 million and $2.0 million of property and equipment has been
acquired through term lease or credit agreements in 1997, 1998 and 1999,
respectively. The capital additions for each of the three years were a result of
the Company's continued expansion of its network. In particular, capital
additions in 1997 and 1998 were primarily in support its video delivery service
plan.
The Company completed its initial public offering in February 1996. The net
proceeds to the Company in 1996 after underwriting discounts and offering
expenses were $29.5 million. The Company raised $16.4 million, net of offering
expenses, through its Series A Convertible Preferred Stock offering in 1997. The
proceeds from these two offerings have been used in the acquisitions of PDR in
November 1996 and Mediatech in July 1997, as well as to fund the acquisition of
property and equipment, the payment of lease obligations and to fund the
continuing operations of the Company. Approximately $20.5 million has been
invested in the purchases of PDR and Mediatech and an additional $2.5 million
was used to repay the promissory note payable in November 1997 as a result of
the PDR acquisition. In connection with the July 1997 acquisition of Mediatech,
the Company also issued 324,355 shares of the Company's Common Stock, $3.8
million of promissory notes, and assumed $5.4 million of term and line of credit
debt payable by Mediatech. In August 1998, the Company raised approximately
$12.7 million from a private placement of 4.6 million shares of Common Stock and
in December 1998 raised approximately $11.0 million from a private placement of
3.8 million shares of Common Stock. The proceeds from these two offerings were
used to fund the purchase of DCI in September 1998, as well as to fund the
purchase of property and equipment, payment of lease obligations and to fund the
continuing operations of the Company. In December 1999, the Company raised an
additional $3.8 million from a private placement of 725,199 shares of Common
Stock. See the Notes to the Financial Statements.
The Company, through its Mediatech subsidiary, made net payments on the
Mediatech line of credit of $1,402,000 in 1998. As mentioned above, the maximum
available under the Mediatech line is $3,525,000, dependent upon the level of
qualifying receivables maintained by Mediatech. There was no balance outstanding
under this agreement at December 31, 1999, and the outstanding balance was
$1,433,000 at December 31, 1998, which was approximately equal to the maximum
amount available under the agreement at that time. The company repaid the
outstanding balance of $476,603 on January 17, 2000.
Principal payments on long-term debt were $8.0 million, $7.1 million and $9.3
million in 1997, 1998 and 1999, respectively, reflecting the increases in
regularly scheduled payments of the increased capital lease liability incurred
to finance equipment and property acquisitions. Principal payments in 1997 also
included the following scheduled payments: repayment of a $2.5 million
promissory note issued in connection with the PDR acquisition, $500,000 of
payments on the promissory notes issued in connection with the Mediatech
acquisition and $346,000 of payments on other long-term debt of Mediatech
assumed by the Company in conjunction with the Mediatech acquisition.
The Company currently has no significant capital commitments other than the
commitments under capital leases and the debt assumed and notes payable issued
in conjunction with the purchase of Mediatech. Based on management's current
plans and forecasts, the Company believes that its existing sources of liquidity
will satisfy the Company's projected working capital, capital lease and term
loan commitments and other cash requirements through the fourth quarter of 2000.
See "Certain Business Considerations -- Future Capital Needs; Uncertainty of
Additional Funding."
Certain Business Considerations
The Company's business is subject to the following risks in addition to those
described elsewhere in this Report.
17
History of Losses; Future Operating Results Uncertain. DG Systems was founded
in 1991 and has incurred net losses since its inception. As of December 31,
1999, the accumulated deficit was $98.8 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.
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, its NOC 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
18
. 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 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 has experienced 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, 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.
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
19
from time to time identify, and its related ability to finance such
acquisitions. The Company anticipates that its existing capital and cash from
operations should be adequate to satisfy its capital requirements during 2000.
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 more 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 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:
. 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.
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
20
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.
Many of its current and potential competitors in the markets for audio and
video transmissions have substantially greater financial, technical, marketing
and other resources 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
21
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.
Risks Associated with Nasdaq National Market Listing. 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. This benefit would be lost if the Company were to be delisted from the
Nasdaq National Market. In the past, the Company has received notice from
Nasdaq that it was not in compliance with the requirements for continued
listing.
The Company believes it is currently in compliance with Nasdaq's continued
listing requirements and corporate governance rules. However, 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 Impact. We have not experienced any problems with our computer
systems relating to such systems being unable to recognize appropriate dates
related to the year 2000. We are also not aware of any material problems with
our customers or suppliers. Accordingly, we do not anticipate incurring material
expenses or experiencing any material operational disruption as a result of any
year 2000 issues.
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. The Company's expense
levels are based, in part, on its expectations of future sales levels. If sales
levels are below expectations, operating results are likely to be 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,
22
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.
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. The Company generally enters 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
23
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 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 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 44% 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.
Registration Rights. In connection with the August and December 1998 and
December 1999 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 Securities 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 until the earlier of the date upon
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
Securities Act of 1933 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, 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;
24
. 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.
ITEM 7A. 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is set forth in the Company's
Consolidated Financial Statements and the Notes thereto beginning at Page F-1 of
this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Arthur Andersen LLP resigned as the Company's certifying accountant on October
20, 1999. Effective October 27, 1999, the Company appointed KPMG LLP as the
Company's certifying accountant. The change of certifying accountant was
approved by the Audit Committee of the Board of Directors.
Arthur Andersen's reports on the consolidated financial statements of the
Company and its subsidiaries as of and for the years ended December 31, 1998
and1997, were unqualified. There were no disagreements between the Company and
Arthur Andersen on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure or reportable events during
such periods or through the interim period ended October 20, 1999 (the date of
the resignation).
25
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item with respect to the Company's directors
is incorporated by reference to the information contained in the section
captioned "Proposal One -- Election of Directors" in the definitive proxy
statement to be filed with the Securities and Exchange Commission by the Company
for its 2000 Annual Meeting of Shareholders (the "Proxy Statement"). The Proxy
Statement is anticipated to be filed within 120 days after the end of the
Company's fiscal year ended December 31, 1999. For information with respect to
executive officers of the Company, see Item 4A of this Annual Report on Form 10-
K.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the
section captioned "Executive Compensation" contained in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from the
section captioned "Security Ownership of Certain Beneficial Owners and
Management" contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to the
information contained in the sections captioned "Compensation Committee
Interlocks and Insider Participation" and "Certain Transactions with Management"
contained in the Proxy Statement.
26
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS
The following financial statements are filed as part of this Report:
Page
-------
Independent Auditors' Report......................................................................... F-2
Report of Independent Public Accountants............................................................. F-3
Consolidated Balance Sheets, as of December 31, 1999 and 1998........................................ F-4
Consolidated Statements of Operations for the three years ended December 31, 1999.................... F-5
Consolidated Statements of Shareholders' Equity for the three years ended December 31, 1999.......... F-6
Consolidated Statements of Cash Flows for the three years ended December 31, 1999.................... F-7
Notes to Consolidated Financial Statements........................................................... F-8
(a) 2. FINANCIAL STATEMENT SCHEDULES
II - Valuation and Qualifying Accounts............................................................... S-1
(a) 3. EXHIBITS
Exhibit Number Exhibit Title
- ------------------ ------------------
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.
27
Exhibit Number Exhibit Title
- ------------------ ------------------
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 (k) 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.
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.
28
Exhibit Number Exhibit Title
- ------------------ ------------------
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
10.44 (a) Registration Rights Agreement, dated December 17, 1999, by and among the Registrant and certain of
its securityholders.
10.45 (a) Common Stock Purchase Agreement dated December 17, 1999 by and among the Registrant and investors
listed in Schedule A thereto.
11.1 (a) Statements of computation of weighted average common shares.
21.1 (a) Subsidiaries of the Registrant.
23.1 (a) Consent of KPMG LLP.
23.2 (a) Consent of Arthur Andersen, LLP.
27 (a) Financial Data Schedule.
__________
(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.
29
(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 number filed with
registrant's Annual Report on Form 10-K filed March 29, 1999.
(b) Reports on Form 8-K
Current Report on Form 8-K filed on October 27, 1999 regarding the October
20, 1999 resignation of Arthur Andersen, LLP as the Company's Certified Public
Accountants and the October 27, 1999 appointment of KPMG LLP as the Company's
Certified Public Accountants.
Current Report on Form 8-K filed on August 4, 1999 regarding the appointment
of Matthew Devine as the Chief Executive Officer and Omar Choucair as Chief
Financial Officer; and the appointment of Matthew Devine and Michael Linnert to
the Company's Board of Directors.
(c) Exhibits
See items 14 (a) (3) above.
(d) Financial Statement Schedules
See Item 14(a) (2) above.
30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
DIGITAL GENERATION SYSTEMS, INC.
Dated: March 28, 2000 By: /S/ MATTHEW E. DEVINE
-----------------------
Matthew E. Devine
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints Scott K. Ginsburg as his attorney-in-fact,
with full power of substitution for him in any and all capacities, to sign any
and all amendments to this report on Form 10-K, and to file the same, with
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
- --------------------------------------- -------------------------------------------------- --------------------------
/s/ SCOTT K. GINSBURG Chairman of the Board March 28, 2000
- ---------------------------------------
Scott K. Ginsburg and Director (Principal Executive Officer)
/s/ MATTHEW E. DEVINE Chief Executive Officer March 28, 2000
- ---------------------------------------
Matthew E. Devine and Director
/s/ OMAR A. CHOUCAIR Chief Financial Officer March 28, 2000
- ---------------------------------------
Omar A. Choucair (Principal Financial and Accounting Officer)
/s/ DAVID M. KANTOR Director March 28, 2000
- ---------------------------------------
David M. Kantor
/s/ MICHAEL G. LINNERT Director March 28, 2000
- ---------------------------------------
Michael G. Linnert
/s/ LAWRENCE D. LENIHAN, JR. Director March 28, 2000
- ---------------------------------------
Lawrence D. Lenihan, Jr.
31
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
Independent Auditors' Report.................................................................................. F-2
Report of Independent Public Accountants....................................................................... F-3
Consolidated Balance Sheets as of December 31, 1999 and 1998................................................... F-4
Consolidated Statements of Operations for the three years ended December 31, 1999.............................. F-5
Consolidated Statements of Shareholders' Equity for the three years ended December 31, 1999.................... F-6
Consolidated Statements of Cash Flows for the three years ended December 31, 1999.............................. F-7
Notes to Consolidated Financial Statements..................................................................... F-8
F-1
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Digital Generation Systems, Inc.:
We have audited the accompanying consolidated balance sheet of Digital
Generation Systems, Inc. and subsidiaries as of December 31, 1999, and the
related consolidated statements of operations, shareholders' equity and cash
flows for the year then ended. In connection with our audit of the consolidated
financial statements, we have also audited the financial statement schedule as
listed in the accompanying index for the year ended December 31, 1999. These
consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and financial statement schedule based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Digital
Generation Systems, Inc. and subsidiaries as of December 31, 1999, and the
results of their operations and their cash flows for the year then ended, in
conformity with generally accepted accounting principles. Also in our opinion,
the related financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.
KPMG LLP
Dallas, Texas
February 25, 2000
F-2
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Digital Generation Systems, Inc.:
We have audited the accompanying consolidated balance sheet of Digital
Generation Systems, Inc. (a California Corporation) and subsidiaries as of
December 31, 1998, and the related consolidated statements of operations,
shareholders' equity and cash flows for the years ended December 31, 1998 and
1997. These financial statements and the schedule referred to below are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Digital Generation Systems,
Inc. and subsidiaries as of December 31, 1998, and the results of its operations
and its cash flows for the years ended December 31, 1998 and 1997, in conformity
with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed under Item 14(a)2 is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not a required part of the basic financial statements.
Information included in this schedule for the years ended December 31, 1998 and
1997 has been subjected to the auditing procedures applied in our audits of the
basic financial statements and, in our opinion, fairly states in all material
respects the financial data required to be set forth therein in relation to the
basic financial statements taken as a whole.
ARTHUR ANDERSEN, LLP
San Francisco, California
January 26, 1999
F-3
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
December 31, December 31,
1999 1998
------------------ -----------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 5,420 $ 13,025
Accounts receivable, less allowance for doubtful
accounts of $1,659 in 1999 and $1,895 in 1998 12,799 9,995
Prepaid expenses and other 1,717 933
-------- --------
Total current assets 19,936 23,953
-------- --------
PROPERTY AND EQUIPMENT, at cost:
Network equipment 35,304 33,211
Office furniture and equipment 5,833 3,730
Leasehold improvements 793 542
-------- --------
41,930 37,483
Less - Accumulated depreciation and amortization (33,772) (25,738)
-------- --------
Property and equipment, net 8,158 11,745
-------- --------
GOODWILL AND OTHER ASSETS, net 13,672 14,094
-------- --------
$ 41,766 $ 49,792
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 7,781 $ 3,035
Accrued liabilities 3,230 4,081
Line of credit -- 1,433
Current portion of long-term debt 7,689 8,226
-------- --------
Total current liabilities 18,700 16,775
-------- --------
LONG-TERM DEBT, net of current portion 2,513 9,307
-------- --------
COMMITMENTS AND CONTINGENCIES (Note 5)
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 at December 31, 1999;
40,000,000 shares at December 31, 1998
Outstanding - - 27,530,170 shares at December 31, 1999
and 26,239,520 shares at December 31, 1998 119,519 114,131
Receivable from issuance of common stock (194) (369)
Accumulated other comprehensive income 52 9
Accumulated deficit (98,824) (90,061)
-------- --------
Total shareholders' equity 20,553 23,710
-------- --------
$ 41,766 $ 49,792
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Years Ended December 31,
-------------------------------------------------------------
1999 1998 1997
------------------- ------------------- -------------------
REVENUES $48,724 $ 41,270 $ 29,175
------- -------- --------
COSTS AND EXPENSES:
Delivery and material costs 17,857 14,630 11,334
Customer operations 15,138 14,780 11,388
Sales and marketing 4,818 4,970 4,417
Research and development 2,577 2,780 2,473
General and administrative 6,552 4,314 3,169
Write down of goodwill and fixed assets (Note 3) -- 17,006 --
Non-recurring charges 370 -- --
Depreciation and amortization 8,591 10,266 9,306
------- -------- --------
Total expenses 55,903 68,746 42,087
------- -------- --------
LOSS FROM OPERATIONS (7,179) (27,476) (12,912)
OTHER INCOME (EXPENSE):
Interest income and other, net 319 253 744
Interest expense (1,903) (3,014) (2,607)
------- -------- --------
NET LOSS $(8,763) $(30,237) $(14,775)
======= ======== ========
BASIC AND DILUTED NET LOSS PER COMMON SHARE (Note 11) $(0.33) $(1.97) $(2.52)
======= ======== ========
WEIGHTED AVERAGE COMMON SHARES 26,653 16,272 11,893
======= ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands, except share and per share amounts)
Convertible Receivable Accumulated
Preferred stock Common stock From Other
---------------------- -------------------- Issuance of Comprehensive
Shares Amount Shares Amount Common stock Income (Loss)
----------- --------- ---------- -------- ------------- --------------
BALANCE AT DECEMBER 31, 1996 -- -- 11,653,625 $ 55,138 $(175) $ --
Issuance of Series A preferred
stock, net of issuance costs
of $1,100 4,950,495 $ 16,400 -- -- -- --
Preferred stock deemed dividend -- (15,161) -- -- -- --
Issuance of Common Stock in
connection with acquisition
of Mediatech -- -- 324,355 1,906 -- --
Exercise of stock options -- 144,699 79 -- --
Net loss -- -- -- -- -- --
------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1997 4,950,495 31,561 12,122,679 57,123 (175) --
Conversion of Series A preferred
stock to Common Stock, net
of issuance costs of $486 (4,950,495) (31,561) 4,950,495 31,075 -- --
Preferred stock deemed dividend
resulting from conversion of
Series A preferred stock -- -- 495,035 1,764 -- --
Issuance of common stock in
private placements, net of
issuance costs of $370 -- -- 8,432,499 23,480 -- --
Warrants issued in relation to
common stock private placement -- -- -- 12 -- --
Issuance of restricted stock
for promissory note -- -- 50,000 194 (194) --
Exercise of stock options -- -- 164,701 371 -- --
Stock issued for services -- -- 10,000 80 -- --
Purchase of shares through ESPP -- -- 14,111 32 -- --
Foreign currency translation
adjustment -- -- -- -- -- 9
Net loss -- -- -- -- -- --
--------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1998 -- -- 26,239,520 114,131 (369) 9
Issuance of common stock in
private placement -- -- 725,199 3,750 -- --
Exercise of Warrants -- -- 11,967 -- -- --
Forgiveness of promissory note -- -- -- -- 175 --
Exercise of stock options -- -- 507,686 1,518 -- --
Purchase of shares through ESPP -- -- 45,798 120 -- --
Foreign currency translation
adjustment -- -- -- -- -- 43
Net loss -- -- -- -- -- --
--------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1999 -- $ -- 27,530,170 $119,519 $(194) $52
================================================================================
Total
Accumulated Shareholders' Comprehensive
Deficit Deficit Loss
------------ -------------- --------------
BALANCE AT DECEMBER 31, 1996 $(28,124) $(28,124)
Issuance of Series A preferred
stock, net of issuance costs
of $1,100 -- 16,400 --
Preferred stock deemed dividend $(15,161) -- --
Issuance of Common Stock in
connection with acquisition
of Mediatech -- 1,906 --
Exercise of stock options -- 79 --
Net loss (14,775) (14,775) $(14,775)
---------------------------------------------
BALANCE AT DECEMBER 31, 1997 (58,060) 30,449 (14,775)
=============
Conversion of Series A preferred
stock to Common Stock, net
of issuance costs of $486 -- (486) --
Preferred stock deemed dividend
resulting from conversion of
Series A preferred stock (1,764) -- --
Issuance of common stock in
private placements, net of
issuance costs of $370 -- 23,480 --
Warrants issued in relation to
common stock private placement -- 12 --
Issuance of restricted stock
for promissory note -- -- --
Exercise of stock options -- 371 --
Stock issued for services -- 80 --
Purchase of shares through ESPP -- -- --
Foreign currency translation
adjustment -- 9 9
Net loss (30,237) (30,237) (30,237)
---------------------------------------------
BALANCE AT DECEMBER 31, 1998 (90,061) 23,710 (30,228)
=============
Issuance of common stock in
private placement -- 3,750 --
Exercise of Warrants -- -- --
Forgiveness of promissory note -- 175 --
Exercise of stock options -- 1,518 --
Purchase of shares through ESPP -- 120 --
Foreign currency translation
adjustment -- 43 43
Net loss (8,763) (8,763) (8,763)
---------------------------------------------
BALANCE AT DECEMBER 31, 1999 $(98,824) $ 20,553 $ (8,720)
=============================================
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Years Ended December 31,
---------------------------------
1999 1998 1997
--------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(8,763) $(30,237) $(14,775)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 8,106 9,103 8,519
Amortization of goodwill and intangibles 486 1,163 787
Write-down of goodwill and fixed assets (Note 3) -- 17,006 --
Common stock issued for services -- 80 --
Provision for doubtful accounts 538 1,142 246
Changes in operating assets and liabilities --
Accounts receivable (3,512) (1,953) (122)
Prepaid expenses and other assets (659) (213) (212)
Accounts payable and accrued liabilities 3,957 (882) (751)
------- -------- --------
Net cash provided by (used in) operating activities 153 (4,791) (6,308)
------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments -- (2,013) (8,810)
Maturities of short-term investments -- 3,000 18,738
Acquisition of Mediatech, net of cash acquired -- -- (13,921)
Proceeds from the sale of property, plant and equipment 75 -- --
Acquisition of DCI -- (9,131) --
Purchase of property and equipment (2,653) (2,162) (5,131)
------- -------- --------
Net cash used in investing activities (2,578) (10,306) (9,124)
------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net 5,563 23,975 79
Proceeds from issuance of convertible preferred stock -- -- 16,400
Costs of converting preferred stock to common stock -- (486) --
Proceeds from line of credit 1,148 13,365 7,686
Payments on line of credit (2,581) (14,767) (8,027)
Proceeds from short-term loans -- -- 6,000
Repayment of short-term loans -- -- (6,000)
Proceeds from issuance of long-term debt -- 5,233 5,419
Payments on long-term debt (9,308) (7,106) (7,974)
------- -------- --------
Net cash (used in) provided by financing activities (5,178) 20,214 13,583
------- -------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 2 (75) --
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (7,605) 5,192 (1,849)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 13,025 7,833 9,682
------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 5,420 $ 13,025 $ 7,833
======= ======== ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 2,199 $ 2,777 $ 2,502
======= ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company:
Digital Generation Systems, Inc. (the "Company") was incorporated in 1991. The
Company operates a nationwide multimedia network designed to provide media
distribution and related services to the broadcast industry by linking content
providers to radio and television stations. The Company is primarily a provider
of electronic and physical distribution of audio and video spot advertising to
radio and television stations. The Company primarily generates its revenues from
advertising agencies and production studios.
The Company is subject to certain risks that include, but are not limited to:
the continued development of technology to enhance the delivery and variety of
the Company's services in the most cost-effective manner, including the
successful integration of the operations of its recently acquired subsidiaries;
the ability to compete successfully against current and future competitors; and
dependence on key personnel and the need for additional financing to fund
operations and its capital expenditure requirements. The Company obtains certain
components used in the assembly of the units which are placed at radio and
television stations and production studios from a few single or limited source
suppliers and obtains its primary long distance telephone access through an
exclusive contract with a telephone service provider which expires in 2001. Any
material interruption in these services could have a material adverse effect on
the Company's business. Although the Company believes that alternate vendors can
be obtained, the transition to alternative vendors could have a material adverse
impact on the Company's costs and shipping schedules.
2. Summary of Significant Accounting Policies:
Consolidation
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All significant intercompany balances and transactions have
been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Foreign Currencies
Assets and liabilities recorded in foreign currencies are translated at the
exchange rate on the balance sheet date. Translation adjustments resulting from
this process are included in other comprehensive income. Revenue, costs, and
expenses are translated at average rates of exchange prevailing during the year.
Gains (losses) on foreign currency transactions of ($28,000) and $10,000 for the
years ended December 31, 1999 and 1998, respectively, are included in interest
income and other, net in the consolidated statements of operations.
Research and Development
Research and development costs are charged to expense as incurred.
Goodwill
Goodwill, which represents the excess of purchase price over the fair value of
net identifiable assets acquired, is amortized on a straight-line basis over the
expected periods to be benefited, generally 20 years. The company assesses the
recoverability of this intangible asset by determining whether the amortization
of the goodwill balance over its remaining life can be recovered through
undiscounted future operating cash flows of the acquired operation. The amount
of goodwill
F-8
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
impairment, if any, is measured based on projected discounted future operating
cash flows using a discount rate reflecting the Company's average cost of
funds. The assessment of the recoverability of goodwill will be impacted if
estimated future operating cash flows are not achieved.
Impairment of Long-Lived Assets
Long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying value of assets may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the
carrying amount of an asset to future net cash flows expected to be generated by
the asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets. Assets to be disposed of are reported at
the lower of the carrying amount or fair value less costs to sell.
Cash and Cash Equivalents
Cash and cash equivalents consist of liquid investments with original
maturities of three months or less. As of December 31, 1999 and December 31,
1998, cash equivalents consist principally of U.S. Treasury Bills.
Property and Equipment
Network equipment includes the network operating center, record send
terminals, receive playback terminals, video record transmission systems,
digital video playback systems and the related terminal and system components as
well as audio and video taping and dubbing equipment. The Company records its
property and equipment at cost and depreciates it on a straight-line basis over
its estimated useful life, generally three years. Equipment held under capital
leases and leasehold improvements are amortized straight-line over the shorter
of the lease term or estimated useful life of the asset.
Revenue Recognition
Revenues for distribution services which are digitally transmitted are
recognized for each transaction on the date audio, video or related information
is successfully transmitted from the Company's operating facilities to the
destination ordered. Revenues for distribution services of analog audio or
videotapes are recognized as the tapes are shipped.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Stock Option Plans
The Company applies the intrinsic value-based method of accounting prescribed
by Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations, in accounting for its fixed
plan stock options. As such, compensation expense would be recorded on the date
of grant only if the current market price of the underlying stock exceeded the
exercise price. SFAS No. 123, "Accounting for Stock-Based Compensation,"
established accounting and disclosure requirements using a fair value-based
method of accounting for stock-based employee compensation plans. As allowed by
SFAS No. 123, the Company has elected to continue to apply the intrinsic value-
based method of accounting described above, and has adopted the disclosure
requirements of SFAS No. 123.
F-9
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Concentration of Credit Risk
Financial instruments that potentially subject the Company to a concentration
of credit risk consist principally of cash and cash equivalents and accounts
receivable.
The Company believes that a concentration of credit risk with respect to
accounts receivable is limited because its customers are geographically
dispersed and the end users (the customer's clients) are diversified across
industries.
The Company's receivables are principally from advertising agencies, dub and
ship houses, and syndicated programmers. The Company's revenues are not
contingent on its customers' sales or collections. However, the timing of
collections from its customers is affected by the billing cycle in which the
customer bills its end-users (the customer's clients). The Company provides
reserves for credit losses.
Supplemental Cash Flow Information
Non-cash investing and financing activities for 1999, 1998 and 1997 consisted
of the following (in thousands):
Years Ended December 31,
-------------------------
1999 1998 1997
------- ------- -------
Property and equipment financed with capitalized lease obligations......... $1,977 $ 1,663 $ 400
Long-term debt used to finance Mediatech acquisition....................... -- -- 3,850
Common Stock issued to finance Mediatech acquisition....................... -- -- 1,906
Preferred stock deemed dividend............................................ -- 1,764 15,161
Conversion of preferred stock to Common Stock.............................. -- 31,561 --
Common Stock issued for services........................................... -- 80 --
Reclassifications
Certain reclassifications were made to the 1997 and 1998 condensed
consolidated financial statements to conform to the 1999 presentation.
3. Acquisitions:
Mediatech
On July 18, 1997, the Company acquired 100% of the capital stock of Starcom
Mediatech, Inc. ("Mediatech"), a wholly owned subsidiary of IndeNet, Inc.
("IndeNet"), for final consideration totaling approximately $25.2 million
("Mediatech Acquisition"). The consideration consisted of approximately $14.0
million in cash, 324,355 shares of the Company's Common Stock and $9.2 million
of debt. Mediatech is a media duplication and distribution company whose
principal offices are located in Chicago, Illinois.
The Mediatech acquisition was accounted for as a purchase. The excess of
purchase price and acquisition costs over the fair value of net assets acquired
of approximately $17.8 million was included in Goodwill and Other Assets. The
operating results of Mediatech have been included in the consolidated results of
the Company from the date of the closing of the transaction, July 18, 1997.
Due to a change in Mediatech's business, in September 1998 the Company wrote
off the remaining goodwill resulting from the Mediatech acquisition ($16.7
million) and a portion of the fixed assets ($340,000), as it was determined that
their carrying values were not recoverable.
F-10
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DCI
On September 25, 1998, the Company acquired substantially all of the property
and assets of Digital Courier International, Inc. ("DCI"), including all
accounts receivable, inventories, contracts, equipment, real property leases and
other related assets. 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 is included in Goodwill and Other Assets
in the accompanying consolidated balance sheets, 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.
Pro Forma Results
The following table reflects unaudited pro forma combined results of
operations of the Company on the basis that the acquisitions of both Mediatech
and DCI had taken place at the beginning of the fiscal years presented:
Years Ended
December 31,
------------------------------------
1999 1998
----------------- -----------------
Revenues.................................................................................. $48,724 $ 44,506
Net loss.................................................................................. (8,763) (35,277)
Basic and diluted net loss per common share............................................... $ (0.33) $ (3.10)
The unaudited pro forma combined results of operations are not necessarily
indicative of the actual results that would have occurred had the acquisitions
of Mediatech and DCI been consummated at the beginning of 1998, or of future
operations of the combined companies.
4. Accrued Liabilities:
Accrued liabilities consist of the following (in thousands):
December 31,
--------------------------------
1999 1998
--------------- ---------------
Telecommunications costs........... $ 4 $ 715
Employee compensation.............. 1,115 897
Legal and professional fees........ 135 557
Other.............................. 1,976 1,912
------ ------
$3,230 $4,081
====== ======
5. Commitments and Contingencies:
The Company leases its facilities and certain equipment under non-cancelable
operating leases. As of December 31, 1999, future minimum annual payments under
these leases are as follows (in thousands):
Years Ending December 31,
- ---------------------------------------
2000................................... $1,485
2001................................... 898
2002................................... 535
2003................................... 503
2004................................... 503
Thereafter............................. 953
------
$4,877
======
F-11
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Rent expense totaled approximately $1,432,000, $1,391,000 and $1,540,000 in
1999, 1998 and 1997, respectively.
In addition, as of December 31, 1999, the Company had non-cancelable future
minimum purchase commitments with its primary telephone service provider. These
commitments range between $4.6 million and $6.2 million per year and extend
through December 2001.
The Company is subject to legal proceedings and claims, either asserted or
unasserted, which arise in the ordinary course of business from time to time.
While the outcome of these claims cannot be predicted with certainty, management
does not believe that the outcome of any of the pending legal matters will have
a material adverse effect on the Company's results of operations, financial
position or liquidity.
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 termination payments.
6. Line of Credit:
Mediatech is party to a financing agreement with a bank which provides a
revolving line of credit to fund the working capital requirements of Mediatech.
The agreement is collateralized by a security agreement covering substantially
all of the assets of Mediatech. The interest rate on advances under the
agreement is the bank's reference rate, approximately equal to the prime rate,
plus 2.25%. There was no balance outstanding under this agreement at December
31, 1999 and this Line of Credit was terminated in January 2000.
7. Long-Term Debt:
The Company has used several lease and loan agreements to finance the purchase
of certain property and equipment. Borrowings are secured by the equipment. The
cost of equipment under lease and term loan obligations at December 31, 1999 and
1998 was $14,321,000 and $22,588,000, respectively. Related accumulated
depreciation at December 31, 1999 and 1998 was $10,135,000 and $15,644,000,
respectively. The primary lease term has expired for certain of the equipment
under lease. Such equipment continues to be leased on a month to month basis.
These loans have repayment terms of 36 to 60 months and the Company has the
option at the end of the terms to purchase the equipment at mutually agreed upon
prices not to exceed 10 to 20% of the equipment's original cost. As of December
31, 1999, approximately $0.1 million remained available under these agreements
to fund future capital requirements.
In December 1997 the Company entered an agreement to finance an additional
$2.0 million of equipment purchases and $3.5 million of working capital through
a long-term facility. At December 31, 1999, $5.4 million has been financed
through this agreement. The agreement has repayment terms consistent with those
discussed in the preceding paragraph.
In August 1999 the Company entered into an agreement to finance an additional
$2.0 million of equipment purchases through a long-term facility with a
repayment term of 24 months. The cost of equipment under this lease obligation
at December 31, 1999 was $2.0 million. Related accumulated depreciation at
December 31, 1999 was $0.2 million.
Mediatech has long-term debt outstanding per the terms of a promissory note
signed in February 1997. The remaining principal balance of the note was $1.1
million at December 31, 1999. The note bears interest at the bank's reference
rate, approximately equal to the prime rate, plus 2.25% (10.75% at December 31,
1999) and principal and interest payments are due monthly. This note is payable
to the same creditor that provided the line of credit discussed in Note 6 and is
collateralized by substantially all of the assets of Mediatech.
F-12
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Future minimum lease and long-term debt payments as of December 31, 1999, are
as follows (in thousands):
Years Ending December 31, Lease Long-term
- ------------------------- Payments Debt
2000.................................................................... $ 6,694 $1,690
2001.................................................................... 2,373 297
------- ------
Total minimum debt payments............................................. 9,067 $1,987
Less - Amount representing interest (effective interest ======
rates ranging from 9 percent to 19 percent)................. (852)
-------
Present value of minimum lease payments................................. 8,215
Less -- Current portion................................................. (5,999)
-------
Long-term portion....................................................... $ 2,216
=======
8. Capital Stock:
In July and August 1998, the Company's Board of Directors authorized the
issuance of up to $ 13.0 million of Common Stock in a private placement
transaction. The Company issued 4,589,287 common shares to current institutional
and closely associated investors at $2.80 per share. Proceeds to the Company,
net of issuance costs, was approximately $12.7 million.
In December 1998, the Company's Board of Directors authorized the issuance of
up to $11.0 million of Common Stock in a private placement transaction. The
Company issued 2,920,134 common shares to Scott Ginsburg, the Company's Chief
Executive Officer, at $3.25 per share. In addition, the Company authorized the
sale and issuance of up to $3.0 million of Common Stock in a private placement
transaction. The Company issued 923,078 common shares to current institutional
and closely associated investors at a price of $3.25 per share.
In December 1999, the Company's Board of Directors authorized the issuance of
Common Stock in a private placement transaction. The company issued 725,199
common shares to current institutional and closely associated investors at a
price of $5.17 per share.
In December 1999, the Company wrote off a note receivable from an executive
officer in the amount of $175,000 that was issued in connection with a
restricted stock purchase agreement, pursuant to which the executive officer
purchased an aggregate of 487,500 shares of the Company's Common Stock. A
charge to expense of $175,000 was recorded in 1999 for this transaction.
The Company and an employee are parties to a restricted stock purchase
agreement, pursuant to which the Company loaned the employee money under a
nonrecourse note and the employee purchased an aggregate of 50,000 shares of the
Company's Common Stock. As of December 31, 1999, all of these restricted shares
held by the employee were subject to the Company's right to repurchase within
the terms of the stock purchase agreement.
Series A Convertible Preferred Stock
During 1997, the Company issued 4,950,495 shares of Series A Convertible
Preferred Stock (the "Series A Preferred"). There was a beneficial conversion
feature associated with the Series A Preferred Stock. The difference between the
publicly traded price per share and the sales price per share has been reflected
as a deemed dividend to the preferred shareholders in the accompanying
consolidated statements of shareholders' equity. This deemed dividend results in
an increase in loss attributable to common shareholders in the computation of
basic and diluted loss per share for the year ended December 31, 1997. In July
1998, the Series A Preferred Stock was converted to Common Stock per the terms
of the Series A Preferred Stock Conversion Agreement effective August 14, 1998.
The conversion of the Series A Preferred Stock to Common Stock resulted in an
additional deemed dividend to the preferred shareholders. This deemed dividend
results in an increase in loss attributable to common shareholders in the
computation of basic and diluted earnings per share for the year ended December
31, 1998.
F-13
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Warrants
The Company has issued warrants in connection with certain financing and
leasing transactions and common stock offerings. All of the outstanding
warrants are convertible into common stock. A summary of outstanding warrants
at December 31, 1999, 1998 and 1997 and changes during the years then ended
follows:
1999 1998 1997
--------------------- -------------------- -------------------
Wtd Avg Wtd Avg Wtd Avg
Warrants Ex. Price Warrants Ex. Price Warrants Ex. Price
---------- --------- --------- --------- -------- ---------
Outstanding at beginning of the year 3,926,244 $3.55 492,177 $5.69 193,025 $5.58
Granted -- -- 3,470,067 3.25 299,152 5.77
Exercised (71,174) 2.70 -- -- -- --
--------- ----- --------- ----- ------- -----
Outstanding at end of the year 3,891,070 $3.57 3,962,244 $3.55 492,177 $5.69
========= ===== --------- ===== ======= =====
The warrants outstanding at December 31, 1999 expire on various dates from
2001 through 2006. The warrants exercised in 1999 were done by exchanging the
entire warrant for shares of common stock equal to the net value of the warrant.
9. Stock Plans:
The Company has three Stock Option Plans:
1992 Stock Option Plan
Under the Company's 1992 Stock Option Plan, (the "1992 Plan"), the Company may
issue up to 4,950,000 shares of Common Stock to employees, officers, directors
and consultants. At the Company's Annual Shareholders' Meeting in September
1999, the shareholders approved an increase of 2,000,000 shares from the
previously authorized total of 2,950,000. The exercise price and terms of the
options granted is determined by the Board of Directors, provided that such
price cannot be less than the fair value of the Common Stock on the date of
grant for incentive stock options or, in the case of non-statutory options, less
than 85 percent of the fair value of the Common Stock on the date of grant. The
options generally vest over four years. The 1992 Plan provides that, in the
event of a change in control of the Company, executive officers of the Company
will receive accelerated vesting for a portion of their unvested option shares.
The term of the options granted is seven years. No options have been granted at
less than fair value under this plan.
1996 Supplemental Option Plan
In 1996, the Company's Board of Directors adopted the 1996 Supplemental Option
Plan. Under this Plan, the Company may issue up to 750,000 shares of Common
Stock to employees, officers, directors and consultants. The exercise price and
terms of the options granted are determined by the Board of Directors. The
options generally vest over four years. The term of the options granted is seven
years.
1995 Director Option Plan
In 1995, the Company's Board of Directors adopted the 1995 Director Option
Plan (the "Director Plan"). A total of 300,000 shares of Common Stock has been
reserved for issuance under the Director Plan. At the Company's Annual
Shareholders' Meeting in September 1999, the shareholders approved an increase
of 200,000 shares from the previously authorized total of 100,000. The Director
Plan provides that each future non-employee director of the Company will be
automatically granted an option to purchase 10,000 shares of Common Stock (the
"First Option") on the date on which the optionee first becomes a non-employee
director of the Company and an additional option to purchase 2,500 shares of
Common Stock (the "Subsequent Option") on each anniversary date thereafter. The
exercise price per share of all options granted under the Director Plan shall be
equal to the fair market value of a share of the Company's Common Stock on the
date of grant. Shares subject to the First Option vest over 36 months, and the
Subsequent Option shares vest over 12 months beginning with the month following
the second anniversary of its date of grant. The terms of the options granted is
ten years.
F-14
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Accounting for Stock Option Compensation Expense
The Company applies the principles of APB Opinion No. 25 and related
interpretations in accounting for the its stock option plans. Had compensation
cost for the Company's stock option plans been determined based on the fair
value at the date of grant of the stock options consistent with the method of
SFAS No. 123, the Company's net loss (in thousands) and loss per share would
have been changed to the pro forma amounts indicated below:
1999 1998 1997
------------- ------------- -------------
Net Loss As reported $ (8,763) $(30,237) $(14,775)
Pro forma $(11,689) $(32,409) $(15,876)
Basic and diluted net loss per common share As reported $ (0.33) $ (1.97) $ (2.52)
Pro forma $ (0.44) $ (2.10) $ (2.61)
The fair value of each option grant is estimated on the date of grant using
the multiple option approach of the Black-Scholes option pricing model with the
following assumptions used for grants in 1999, 1998 and 1997, respectively;
risk-free interest rates of 6.4%, 4.7% and 7.8%; a dividend yield of 0%; and
volatility factors of the expected market price of the Company's common stock of
112%, 194% and 75%.
A summary of the Company's fixed stock option plans at December 31, 1999, 1998
and 1997 and changes during the years then ended is presented below:
1999 1998 1997
----------------------- ----------------------- ------------------------
Wtd Avg Ex. Wtd Avg Ex. Wtd Avg Ex.
Shares Price Shares Price Shares Price
---------- ----------- ---------- ----------- ----------- -----------
Outstanding at beginning of the year 3,087,031 $3.78 2,682,707 $4.21 1,806,355 $5.29
Granted 2,024,500 4.95 1,270,250 3.12 2,187,000 4.94
Exercised (507,686) 2.99 (164,701) 2.25 (144,699) 0.55
Canceled (573,006) 4.50 (701,225) 4.61 (1,165,949) 7.71
--------- ----- --------- ----- ---------- -----
Outstanding at end of the year 4,030,839 $4.36 3,087,031 $3.78 2,682,707 $4.21
========= ===== ========== ===== ========== =====
Exercisable at end of the year 1,262,767 $3.90 1,159,767 $3.79 543,653 $2.74
Weighted average fair value of options granted $3.55 $2.85 $2.69
The following table summarizes information about stock options outstanding at
December 31, 1999:
Options Outstanding Options Exercisable
- -------------------------------------------------------------------------------------- ----------------------------------
Number Weighted-Average Weighted-Average Number Weighted-Average
Range of Exercise Prices Outstanding Remaining Contractual Life Exercise Price Exercisable Exercise Price
- --------------------------- ----------- -------------------------- ---------------- ---------------- ----------------
$0.20 - $2.65 381,673 4.70 $1.87 232,974 $1.42
$2.75 - $5.00 1,714,916 5.15 $3.75 821,088 $4.02
$5.125 - $10.125 1,934,250 6.18 $5.40 208,705 $6.21
--------- ---------
$0.20 - $10.125 4,030,839 1,262,767
========= =========
As of December 31, 1999, there were 937,804 shares available for future grant
under the stock option plans.
10. Income Taxes
There was no income tax expense (benefit) in 1999, 1998, or 1997 due to the
existence of net operating losses and a full valuation allowance for related
deferred tax assets.
F-15
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Components of deferred tax assets at December 31, 1999 and 1998 are as follows
(in thousands):
1999 1998
------------- -------------
Net operating loss carryforwards.......................................... $ 16,992 $ 16,338
Cumulative temporary differences.......................................... 3,841 3,366
Research and development credit........................................... 768 768
-------- --------
Total gross deferred tax asset............................................ 21,601 20,472
Less valuation allowance.................................................. (21,601) (20,472)
-------- --------
Net deferred tax assets................................................... $ -- $ --
============ ============
The net operating loss and research and development credit carryforwards of
approximately $48 million and $768,000, respectively, will expire on various
dates from 2007 to 2019. Utilization of these carryforwards may be annually
limited if there is a change in the Company's ownership, as defined by the
Internal Revenue Code.
A valuation allowance has been recorded for the entire deferred tax asset as a
result of uncertainties regarding the realization of the asset including the
limited operating history of the Company, the lack of profitability to date and
the variability of operating results.
11. Net Loss Per Share
Under Statement of Financial Accounting Standards (SFAS) No. 128 "Earnings per
Share," the Company is required to compute earnings per share under two
different methods (basic and diluted). Basic earnings per share is calculated by
dividing net income (loss) attributable to common shareholders by the weighted
average shares of Common Stock outstanding during the period. Diluted earnings
per share is calculated by dividing net income (loss) attributable to common
shareholders by the weighted average shares of outstanding Common Stock and
Common Stock equivalents during the period. Due to losses, inclusion of Common
Stock equivalents would be anti-dilutive. Therefore, basic and diluted earnings
per share for the Company are the same.
For the year ended December 31, 1998, the net loss per share was computed as
net loss of $30,237,000 plus $1,764,000 relating to the preferred stock deemed
dividend (Note 8) divided by the weighted average common shares outstanding. For
the year ended December 31, 1997, the net loss per share was computed as net
loss of $14,775,000 plus $15,161,000 relating to the preferred stock deemed
dividend (Note 8) divided by the weighted average common shares outstanding.
12. 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 operating segments based on these geographic areas.
The information in the following tables is derived directly from the 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 December 31, 1999, 5% of operating assets are located
outside of the United States. At December 31, 1998 and 1997, the balance sheet
information for the Company's Los Angles segment was maintained as part of the
Chicago segment and was impractical to break out separately.
For the Year Ended December 31, 1999
In $000's
--------------------------------------------------------------------------
San Francisco New York Chicago Los Angeles Vancouver Consolidated
-------------- -------- -------- ----------- ---------- -------------
Revenue $ 16,340 $12,037 $13,605 $2,219 $ 4,523 $48,724
Net income (loss) $(12,458) $ 2,877 $ 1,805 $ 240 $(1,227) $(8,763)
Total identifiable assets $ 15,875 $10,081 $ 4,943 $1,996 $ 8,871 $41,766
F-16
DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Year Ended December 31, 1998
In $000's
-----------------------------------------------------------------------------
San Francisco New York Chicago Los Angeles Vancouver Consolidated
-------------- -------- ---------- ------------ ---------- -------------
Revenue $ 15,976 $10,125 $ 10,829 $2,842 $1,498 $ 41,270
Net income (loss) $(10,910) $ 1,265 $(19,975) $ (191) $ (426) $(30,237)
Total identifiable assets $ 22,737 $10,060 $ 7,514 $ -- $9,481 $ 49,792
For the Year Ended December 31, 1997
In $000's
--------------------------------------------------------------------------
San Francisco New York Chicago Los Angeles Vancouver Consolidated
-------------- -------- --------- ----------- --------- -------------
Revenue $ 13,461 $8,384 $ 7,330 $ -- $ -- $ 29,175
Net income (loss) $(12,745) $ 410 $(2,440) $ -- $ -- $(14,775)
Total identifiable assets $ 29,997 $2,485 $28,214 $ -- $ -- $ 60,697
13. Pretax Savings Plan
The Company has a 401(k) retirement plan for full-time U.S. based employees.
Employees who are at least 21 years of age and have completed at least six
months of service are eligible to participate in the plan. Employees may
contribute up to 20% of gross pay with a maximum dollar limit for 1998 of
$10,000. The employer contribution is made at the end of the plan year in an
amount set by corporate resolution, based on participants' compensation. The
Company made no contributions to the plan in 1999, 1998 or 1997 to the plan.
14. 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 deferred item, 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 on the Company.
F-17
DIGITAL GENERATION SYSTEMS, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Balance at Additions
Beginning of Charged to Balance at
Classification Period Operations Other (a) Writeoffs End of Period
- ------------------------------- ----------------- ---------------- -------------- -------------- --------------
Allowance for Doubtful Accounts
Year Ended:
December 31, 1997.............. $ 257,000 $ 246,000 $259,000 $(177,000) $ 585,000
December 31, 1998.............. $ 585,000 $1,142,000 $186,000 $ (18,000) $1,895,000
December 31, 1999.............. $1,895,000 $ 538,000 $ - $(774,000) $1,659,000
(a) Additions resulting from acquisitions of Mediatech in 1997 and DCI in 1998.
S-1