-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HeuFvtbEmq5P4Wjvrti9zFVksF60lM3U8M6zS+gT3W/u8pAHN02KYfC2Oa7RkpBy J01wd2sMCWcUMXSB0PXyPg== 0000950149-97-001065.txt : 19970520 0000950149-97-001065.hdr.sgml : 19970520 ACCESSION NUMBER: 0000950149-97-001065 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19970331 FILED AS OF DATE: 19970515 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIGITAL GENERATION SYSTEMS INC CENTRAL INDEX KEY: 0000934448 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-ADVERTISING AGENCIES [7311] IRS NUMBER: 943140772 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-27644 FILM NUMBER: 97606284 BUSINESS ADDRESS: STREET 1: 875 BATTERY ST STREET 2: STE 1850 CITY: SAN FRANCISCO STATE: CA ZIP: 94111 BUSINESS PHONE: 4155466600 MAIL ADDRESS: STREET 1: 875 BATTERY ST CITY: SAN FRANCISCO STATE: CA ZIP: 94111 10-Q 1 QUARTERLY REPORT FOR THE PERIOD ENDED 3/31/97 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ------------------ FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______. COMMISSION FILE NUMBER: 0-27644 DIGITAL GENERATION SYSTEMS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 94-3140772 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 875 BATTERY STREET SAN FRANCISCO, CALIFORNIA 94111 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE) (415) 276-6600 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) NOT APPLICABLE (FORMER NAME, FORMER ADDRESS, FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT) INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO __ NUMBER OF SHARES OF REGISTRANT'S COMMON STOCK, WITHOUT PAR VALUE, OUTSTANDING AS OF APRIL 30, 1997: 11,731,157. ================================================================================ 2 DIGITAL GENERATION SYSTEMS, INC. This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those indicated in the forward-looking statements as a result of certain factors, including those set forth under "Certain Business Considerations" in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in, or incorporated by reference into, this report. The registrant has attempted to identify forward-looking statements in this report by placing an asterisk(*) following each sentence containing such statements. TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE ---- Item 1. Financial Statements..................................................................... 3 Condensed Consolidated Balance Sheets at March 31, 1997 and December 31, 1996.................................................................. 3 Condensed Consolidated Statements of Operations for the three months ended March 31, 1997 and 1996................................................... 4 Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 1997 and 1996................................................... 5 Notes to Condensed Consolidated Financial Statements..................................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................................. 8 PART II. OTHER INFORMATION Item 1. Legal Proceedings........................................................................ 20 Item 2. Changes in Securities.................................................................... 20 Item 3. Defaults upon Senior Securities.......................................................... 20 Item 4. Submission of Matters to a Vote of Security Holders...................................... 20 Item 5. Other Information........................................................................ 20 Item 6. Exhibits and Reports on Form 8-K......................................................... 20 SIGNATURES .............................................................................. 22
2 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS DIGITAL GENERATION SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
MARCH 31, DECEMBER 31, 1997 1996 ---------------- ---------------- (Unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 8,550 $ 9,682 Short-term investments 9,029 10,915 Accounts receivable, net 3,370 3,349 Prepaid expenses and other 562 168 ---------------- ---------------- Total current assets 21,511 24,114 ---------------- ---------------- PROPERTY AND EQUIPMENT, at cost: Network equipment 19,985 17,974 Office furniture and equipment 2,183 2,093 Leasehold improvements 353 353 ---------------- ---------------- 22,521 20,420 Less - Accumulated depreciation and amortization (9,448) (7,790) ---------------- ---------------- Property and equipment, net 13,073 12,630 ---------------- ---------------- GOODWILL AND OTHER ASSETS, net 8,526 8,504 ---------------- ---------------- $ 43,110 $ 45,248 ================ ================ LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 1,475 $ 1,546 Accrued liabilities 1,966 2,174 Note payable from acquisition of PDR 2,500 2,500 Current portion of long-term debt 4,663 3,694 ---------------- ---------------- Total current liabilities 10,604 9,914 ---------------- ---------------- LONG-TERM DEBT, net of current portion 8,919 8,495 ---------------- ---------------- SHAREHOLDERS' EQUITY: Convertible preferred stock, no par value -- Authorized -- 5,000,000 Outstanding -- None outstanding -- -- Common stock, no par value -- Authorized -- 30,000,000 shares Outstanding -- 11,723,970 shares at March 31, 1997 and 11,653,625 shares at December 31, 1996 55,182 55,138 Receivable from issuance of common stock (175) (175) Accumulated deficit (31,420) (28,124) ---------------- ---------------- Total shareholders' equity 23,587 26,839 ---------------- ---------------- $ 43,110 $ 45,248 ================ ================
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 4 DIGITAL GENERATION SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED MARCH 31, -------------------------- 1997 1996 ----------- ---------- (Unaudited) REVENUES $ 4,606 $ 1,894 ----------- ---------- COSTS AND EXPENSES: Delivery and material costs 1,475 595 Customer operations 2,135 920 Sales and marketing 1,015 983 Research and development 648 498 General and administrative 604 384 Depreciation and amortization 1,765 838 ----------- ---------- Total expenses 7,642 4,218 ----------- ---------- LOSS FROM OPERATIONS (3,036) (2,324) ----------- ---------- OTHER INCOME (EXPENSE): Interest income 251 263 Interest expense (511) (327) ----------- ---------- NET LOSS $ (3,296) $ (2,388) =========== ========== NET LOSS PER SHARE $ (0.28) $ (0.20) =========== ========== WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES 11,686 11,675 =========== ==========
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 5 DIGITAL GENERATION SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996 (IN THOUSANDS)
THREE MONTHS ENDED MARCH 31, ----------------------------- 1997 1996 ------------ ------------ (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (3,296) $ (2,388) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization of property and equipment 1,658 838 Amortization of goodwill and intangibles 107 -- Provision for doubtful accounts 36 33 Changes in operating assets and liabilities -- Accounts receivable (57) (215) Prepaid expenses and other assets (523) 255 Accounts payable and accrued liabilities (279) 334 ------------ ------------ Net cash used in operating activities (2,354) (1,143) ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of short-term investments (973) -- Maturities of short-term investments 2,859 -- Acquisition of property and equipment (1,701) (481) ------------ ------------ Net cash provided by (used in) investing activities 185 (481) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock 44 29,502 Proceeds from issuance of long-term debt 2,219 -- Payments on long-term debt (1,226) (490) ------------ ------------ Net cash provided by financing activities 1,037 29,012 ------------ ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,132) 27,388 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 9,682 6,205 ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 8,550 $ 33,593 ============ ============ SUPPLEMENTAL CASH FLOW INFORMATION Property and equipment financed with capitalized lease obligations $ 400 $ 1,289 Conversion of preferred stock to common stock $ -- $ 25,321
The accompanying notes are an integral part of these condensed consolidated financial statements. 5 6 DIGITAL GENERATION SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company's financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 1996. The unaudited condensed consolidated financial statements included herein reflect all adjustments (which include only normal, recurring adjustments) which are, in the opinion of management, necessary to state fairly the results for the three month period ended March 31, 1997. The results for the three month period ended March 31, 1997 are not necessarily indicative of the results expected for the full fiscal year. 2. ACQUISITION On November 8, 1996 the Company completed the acquisition of 100% of the stock of PDR Productions, Inc. ("PDR"), a media duplication and distribution company located in New York City, for consideration totaling $9.0 million. The consideration was $6.5 million in cash and a $2.5 million promissory note with interest payable at 8%. The note and accrued interest are due in November 1997. The acquisition was accounted for as a purchase. The net book value of assets and liabilities acquired was approximately $1.5 million. The excess of purchase price and acquisition costs over the net book value of assets acquired (including customer list, covenant not to compete and goodwill) of approximately $7.9 million, has been included in Goodwill and Other Assets in the accompanying consolidated balance sheet and is being amortized over a twenty year period. Amortization of approximately $107,000 is included in the consolidated statement of operations for the quarter ended March 31, 1997. 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. The following table reflects unaudited pro forma combined results of operations of the Company and PDR on the basis that the acquisition had taken place at the beginning of the first fiscal period presented:
QUARTER ENDED ------------------------- MARCH 31, MARCH 31, 1997 1996 ---------- --------- (In thousands except per share data) Revenues........................................... $ 4,606 $ 3,712 Net Loss........................................... $ (3,296) $ (2,635) Net Loss per Share................................. $ (.28) $ (.23) Number of Shares used in Computation............... 11,686 11,675
3. CASH AND CASH EQUIVALENTS AND SHORT TERM INVESTMENTS In accordance with the Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities", the Company has classified all marketable debt securities as held-to-maturity and has accounted for these investments using the amortized cost method. Cash and cash equivalents consist of liquid investments with original maturities of three months or less. Short-term investments are marketable securities with original maturities greater than three months and less than one year. As of March 31, 1997 and December 31, 1996, cash and cash equivalents consist principally of U.S. 6 7 DIGITAL GENERATION SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Treasury bills and various money market accounts; as a result, the amortized purchase cost approximates the fair market value. As of March 31, 1997 and December 31, 1996, short-term investments consist principally of U.S. Treasury bills and commercial paper and amortized cost approximates the fair market value of these instruments at these balance sheet dates. 4. NET LOSS PER SHARE Net loss per share for the three months ended March 31, 1997 is computed using the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares have been excluded from the computation as their effect is antidilutive. Net loss per share for the three months ended March 31, 1996 is computed on a pro forma basis. Pro forma net loss per share is computed using the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares consist of convertible preferred stock (using the "if converted" method) and stock options and warrants (using the treasury stock method). As the Company has incurred losses since inception, common equivalent shares have been excluded from the computation as their effect is antidilutive; however, pursuant to Securities and Exchange Commission requirements, such computations include all common and common equivalent shares issued within the 12 months preceding the February 1996 For S-1 filing date as if they were outstanding through the end of the quarter in which the offering was completed, using the treasury stock method. Convertible preferred stock outstanding during the period are included (using the "if converted" method) in the computation as common equivalent shares even though the effect is antidilutive. In February 1997, the FASB issued SFAS No. 128, Earnings Per Share, which simplifies the standards for computing earnings per share previously found in Accounting Principles Board Opinion ("APBO") No. 15. SFAS No. 128 replaces the presentation of primary earnings per share with a presentation of basic earnings per share, which excludes dilution. SFAS No. 128 also requires dual presentation of basic and diluted earnings per share on the face of the income statement for all entities with complex capital structures and requires a reconciliation. Diluted earnings per share is computed similarly to fully diluted earnings per share pursuant to APBO No. 15. SFAS No. 128 must be adopted for financial statements issued for periods ending after December 15, 1997, including interim period; earlier application is not permitted. SFAS No. 128 requires restatement of all prior period earnings per share presented. The Company does not anticipate that SFAS No. 128 will have a material impact on its earnings per share calculation. 5. LONG TERM DEBT In January 1997, the Company completed an agreement to finance an additional $6.0 million of equipment purchases through a long-term credit facility which can be drawn against through December 31, 1997. Warrants to purchase 112,500 shares of the Company's Common Stock at a price of $8.00 per share were issued to the lender per the terms of agreement. The value of the warrants at the date of issuance was nominal; therefore no value was assigned to the warrants for accounting purposes. 7 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those indicated in the forward-looking statements as a result of certain factors, including those set forth under "Certain Business Considerations". The Company has attempted to identify forward-looking statements in Management's Discussion and Analysis of Financial Condition and Results of Operations by placing an asterisk (*) following each sentence containing such statements. The following table presents unaudited financial information expressed as a percentage of total revenues and operating data for the period indicated. The information and operating data has been prepared by the Company on a basis consistent with the Company's audited financial statements and includes all adjustments, consisting only of normal recurring adjustments, that management considers necessary for a fair presentation for the periods presented. The operating results for any quarter should not be relied on as indicative of results for any future period. See "Certain Business Considerations -- History of Losses; Future Operating Results Uncertain" and "-- Potential Fluctuations in Quarterly Results; Seasonality."
STATEMENTS OF OPERATIONS: THREE MONTHS ENDED MARCH 31, ------------------------------ 1997 1996 ----------- ----------- Revenues ................................. 100.0% 100.0% Costs and Expenses: Delivery and material costs ........... 32.0 31.4 Customer operations ................... 46.4 48.6 Sales and marketing ................... 22.0 51.9 Research and development .............. 14.1 26.3 General and administrative ............ 13.1 20.3 Depreciation and amortization ......... 38.3 44.2 ----------- ----------- Total expenses ...................... 165.9 222.7 ----------- ----------- Loss from operations ..................... (65.9) (122.7) ----------- ----------- Other income (expense): Interest income ....................... 5.4 13.9 Interest expense ...................... (11.1) (17.3) ----------- ----------- Net loss ................................. (71.6)% (126.1)% =========== =========== OPERATING DATA: Deliveries ............................... 244,000 149,000
8 9 Revenues Revenues were $4,606,000 for the three months ended March 31, 1997, a 143% increase from $1,894,000 for the three months ended March 31, 1996. The increase is due to a 64% increase in the volume of deliveries, including those made from PDR, and increased average revenue per delivery versus the prior year. The Company made 244,000 and 149,000 deliveries in the three months ended March 31, 1997 and March 31, 1996, respectively. The increase in delivery volume is the result of additional deliveries made through the DG Systems Network Operating Center ("NOC") and due to the addition of deliveries made by PDR, acquired in November 1996, in approximately equal proportions. The Company believes that the increase in the volume of deliveries made through the NOC is due to a number of factors, including increased acceptance of the services offered by the Company and the increased availability of an expanded network of Company equipment located in radio and television stations. Average revenue per delivery increased to $18.88 for the three months ended March 31, 1997, a 49% increase from $12.71 for the three months ended March 31, 1996. This increase is primarily due to the addition of video deliveries and related services to the delivery mix. All deliveries performed in the first quarter of 1996 were deliveries of audio content. The retail list prices for the delivery of the first video spot are 50% to 100% greater than those for an audio delivery and can be significantly higher, depending upon the level of value added services (editing, close captioning, etc.) that may be included in an order. In the three months ended March 31, 1997, video deliveries and related services accounted for approximately 21% of total deliveries and 43% of total revenue, including approximately 46,000 video deliveries and $1.9 million of revenue recorded by PDR. Average revenue per audio delivery was $13.54 for the three months ended March 31, 1997, a 7% increase from $12.71 for the three months ended March 31, 1996. This increase is due primarily to an increased proportion of deliveries made using the Company's Priority and Express services, which provide delivery within one hour and four hours, respectively. Such deliveries accounted for 14% of audio volume in the three months ended March 31, 1997 versus 10% of audio volume in the three months ended March 31, 1996. The Priority service, which accounted for approximately 3% of audio volume, was introduced in the fourth quarter of 1996. The increase in the two premium services more than offset the impact of an increase in the proportion of deliveries made using the Company's lower-priced Economy service, which increased to 21% of audio delivery volume in the quarter ended March 31, 1997 from 19% in the same quarter of the prior year. Delivery and Material Costs Delivery and material costs for the three months ended March 31, 1997 were $1,475,000, a 148% increase from $595,000 for the three months ended March 31, 1996. The increase in costs is primarily due to the increased volume of deliveries, in particular video deliveries dubbed and shipped from PDR. The increased costs include both delivery expenses and the direct materials costs required when physically duplicating an audio or video spot. Such material costs are not required in the case of electronic delivery. Delivery and material costs as a percentage of revenues increased to 32% in the quarter ended March 31, 1997 from 31% in the quarter ended March 31, 1996. This increase is primarily because the proportion of the Company's consolidated deliveries performed electronically decreased to 69% in the three months ended March 31, 1997 from 84% in the three months ended March 31, 1996. This shift to 31% physical delivery in the first quarter of 1997 from 16% physical delivery in the first quarter of 1996 is principally due to the addition of the 46,000 physical deliveries performed by PDR. The addition of these PDR deliveries more than offset cost reductions resulting from improvements in long distance rates and an increase in the proportion of deliveries performed electronically through the NOC, which improved to 85% from 84% in the three months ended March 31, 1997 and 1996, respectively. The Company expects that delivery costs will increase in absolute dollars and may fluctuate as a percentage of revenues in future periods.* See "Certain Business Considerations -- Potential Fluctuations In Quarterly Results; Seasonality." 9 10 Customer Operations Customer operations expenses for the three months ended March 31, 1997 were $2,135,000, a 132% increase from $920,000 for the three months ended March 31, 1996. This increase is primarily the result of the consolidation of the costs of PDR operations. In addition, expenses increased versus the prior year due to the addition of the personnel necessary to respond to the greater volume of orders and deliveries and to establish the operational capacity to support growth in the video delivery business. During the first quarter of 1997, these costs included the costs, primarily labor expenses, of personnel involved in assembly of ADvantage Digital Video Playback Systems ("DVPSs") as well as customer and technical support. Customer operations expenses as a percentage of revenues decreased to 46% from 49% in the three months ended March 31, 1997 and 1996, respectively, as the Company has realized the benefits of economies of scale from the increased volume of deliveries and has also improved the efficiency of its order processing procedures versus the first quarter of the prior year. The Company expects that customer operations expenses will increase in absolute dollars and may fluctuate as a percentage of sales in future periods.* The Company believes that in order to compete effectively and manage future growth it will be required to continue to implement changes which improve and increase the efficiency of its customer operations.* See "Certain Business Considerations -- Ability to Maintain and Improve Service Quality" and "-- Ability to Manage Growth." Sales and Marketing Sales and marketing expenses were $1,015,000 for the three months ended March 31, 1997, a 3% increase from $983,000 for the three months ended March 31, 1996. The increase in sales and marketing expenses is due primarily to the consolidation of the costs of the PDR sales group. Increased compensation expense from additional growth of the Company's sales and marketing staff was offset by reduced spending on third party marketing resources and programs. The Company expects to continue to expand sales and marketing programs designed to introduce the Company's services to the marketplace and to attract new customers for its services.* See "Certain Business Considerations -- Dependence on Emerging Markets." 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.* Research and Development Research and development expenses were $648,000 for the three months ended March 31, 1997, a 30% increase from $498,000 for the three months ended March 31, 1996. The increase is due primarily to the compensation expense associated with hiring and retaining engineering staff and the testing costs, principally frame relay and satellite transmissions, incurred in preparing the network for the transmission of video content. The Company expects that research and development expenses will increase in absolute dollars and may fluctuate as a percentage of revenue in future periods.* General and Administrative General and administrative expenses for the three months ended March 31, 1997 were $604,000, a 57% increase from $384,000 for the three months ended March 31, 1996. The increase is primarily due to the consolidation of the expenses of PDR administrative staff and the additional costs necessary to meet the reporting requirements of a publicly traded company. The Company expects that general and administrative expenses will increase in absolute dollars and may fluctuate as a percentage of sales in future periods.* 10 11 Depreciation and Amortization Depreciation and amortization expenses increased 111% to $1,765,000 in the quarter ended March 31, 1997 from $838,000 for the quarter ended March 31, 1996. This increase is due to the continued expansion of the Company's network. The Company's total investment in network equipment has increased 117% to $20.0 million at March 31, 1997 from the $9.2 million balance at March 31, 1996. In particular, the number of units located at broadcast stations at March 31, 1997 has increased by approximately 33% from the number at March 31, 1996 and the Company has made total capital additions of approximately $7.0 million between March 31, 1996 and March 31, 1997 in support of its video delivery service plan. In addition, the Company recorded amortization expense of $107,000 in the three months ended March 31, 1997 related to the goodwill and other intangible assets recorded in connection with the November 1996 acquisition of PDR. The Company expects to continue to invest in the expansion of its network.* In particular, the Company is in the process of expanding its infrastructure within the television broadcast industry that will require additional DG Video Transmission Systems ("VTSs") 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 "Certain Business Considerations -- Future Capital Need; Uncertainty of Additional Funding." Interest Income and Interest Expense Interest income decreased 5% to $251,000 in the three months ended March 31, 1997 from $263,000 for the three months ended March 31, 1996. This decrease is primarily the result of reduced levels of cash and cash equivalents and short term investments in the first quarter of 1997 versus the first quarter of 1996. The Company's initial public offering was completed in February 1996 and since that time the offering's proceeds have been used to fund the Company's operating, investing and financing activities. The Company expects that interest income will decrease in the future based on the levels of cash used in the Company's operations.* See Liquidity and Capital Resources. Interest expense increased 56% to $511,000 in the three months ended March 31, 1997 from $327,000 in the three months ended March 31, 1996. The increase is primarily due to increased debt resulting from leasing and loan agreements used to fund the acquisition of components and equipment needed to develop the Company's network and to provide Company personnel with the capital resources necessary to support the Company's business growth. Debt outstanding under these agreements has increased to $13.6 million at March 31, 1997 from $7.1 million at March 31, 1996. In addition, during the quarter ended March 31, 1997, the Company incurred interest expense of $50,000 on the $2.5 million promissory note given as consideration in the November 1996 acquisition of PDR. The Company expects that interest expense will increase in the future based on the increased levels of borrowing.* See Liquidity and Capital Resources. Liquidity and Capital Resources Net cash used in operating activities, including the adjustment for depreciation and amortization, increased to $2.4 million in the three months ended March 31, 1997 from $1.1 million in the three months ended March 31, 1996. This change is primarily the result of changes in working capital balances. The net loss, exclusive of depreciation and amortization was approximately equal in the two periods. The Company used cash of $1.7 million for the purchase of property and equipment and acquired an additional $.4 million of property and equipment through capital lease obligations in the three months ended March 31, 1997. In the three months ended March 31, 1996 the Company purchased $.5 million of property and equipment and an additional $1.3 million of additions had been financed with capital lease 11 12 obligations. The capital additions in the three months ended March 31, 1997 were a result of the Company's continued expansion of its network, particularly the video delivery service plan. Proceeds from issuance of common stock were $44,000 and $29,502,000 in the quarters ended March 31, 1997 and 1996, respectively. This variance is due to the $29,490,000 of proceeds received from the Company's initial public offering, completed in February 1996. Principal payments on long-term debt were $1,226,000 in the three months ended March 31, 1997 versus $490,000 in the three months ended March 31, 1996, reflecting the increase in regularly scheduled repayment of the increased capital lease liability and term debt incurred to finance equipment and property acquisitions. In January 1997 the Company completed an agreement to finance an additional $6.0 million of equipment purchases through a long-term credit facility. In the first quarter of 1997, this facility was used to finance a total of $2.2 million of property and equipment which had been purchased late in 1996 as well as in the first quarter of 1997. At March 31, 1997, the Company's current sources of liquidity included cash and cash equivalents of $8.6 million, short-term investments of $9.0 million, and $3.8 million available to finance capital expenditures under a long-term credit facility which can be drawn on through December 1997. The Company currently has no significant capital commitments other than the commitments under capital leases, term debt, and the note payable issued in connection with the acquisition of PDR. The Company believes that its existing sources of liquidity will satisfy the Company's projected working capital, capital lease and term loan commitments through December 1997. * See "Certain Business Considerations -- Future Capital Needs; Uncertainty of Additional Funding." CERTAIN BUSINESS CONSIDERATIONS The Company's business is subject to the following risks and uncertainties, in addition to those described elsewhere in this report. History of Losses; Future Operating Results Uncertain. The Company was founded in 1991 and has been unprofitable since its inception and expects to continue to generate net losses for a minimum of the next twelve months. As of March 31, 1997, the Company's accumulated deficit was $31.4 million. The Company has had difficulty in accurately forecasting its future sales and operating results due to its limited operating history. Accordingly, although the Company has recently experienced significant growth in sales, such growth rates may not be sustainable and should not be used as an indication of future sales growth, if any, or of future operating results. The Company's future success will depend in part on obtaining continued reductions in delivery and service costs, particularly continued automation of order processing and reductions in telecommunications costs.* There can be no assurance the Company's sales will grow or be sustained in future periods or that the Company will achieve or sustain profitability in any future period. Potential Fluctuations in Quarterly Results; Seasonality. The Company's quarterly operating results have in the past and may in the future vary significantly depending on factors such as the volume of advertising in response to seasonal buying patterns, the timing of new product and service introductions, increased competition, the timing of the Company's promotional efforts, general economic factors, and other factors. For example, the Company has historically experienced lower sales in the first quarter and higher sales in the fourth quarter, due to increased customer advertising volumes for the Christmas selling season. As a result, the Company believes that period to period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as an indication of future performance. In any period, the Company's revenues and delivery costs are subject to variation based on changes in the volume and mix of deliveries performed during the period. In particular, the Company's operating results have historically been significantly influenced by the volume of deliveries ordered by television stations during the "Sweeps" rating periods that currently take place in February, May, August and November. The increased volume of these deliveries during such periods and the Company's pricing for "Sweeps" advertisements have historically increased the total revenues and revenues per delivery of the Company and tended to reduce delivery costs as a percentage of revenues. The Company's expense levels are based, in part, on its expectations of future sales levels. If sales levels are below expectations, operating results 12 13 are likely to be materially adversely affected. In addition, the Company has historically operated with little or no backlog. The absence of backlog increases the difficulty of predicting sales and operating results. Fluctuations in sales due to seasonality may become more pronounced as the growth rate of the Company's sales slows. Due to the unique nature of the Company's products and services, the Company believes that it will incur significant expenses for sales and marketing, including advertising, to educate potential customers about such products and services.* Dependence on Radio Advertising. The Company's revenues to date have been derived principally from a single line of business, the delivery of radio advertising spots from advertising agencies, production studios and dub and ship houses to radio stations in the United States, and such services are expected to continue to account for a substantial majority of the Company's revenues for some time.* A decline in demand for, or average selling prices of, the Company's radio advertising delivery services, whether as a result of competition from new advertising media, new product introductions or price competition from competitors, a shift in purchases by customers away from the Company's premium services such as DG Express, technological change or otherwise, would have a material adverse effect on the Company's business, operating results and financial condition. Additionally, the Company is dependent upon its relationship with and continued support of the radio stations in which it has installed communications equipment. Should a substantial number of these stations go out of business or experience a change in ownership, it could materially adversely affect the Company's business, operating results and financial condition. Dependence on Video Advertising Delivery Service Deployment. The Company has made a substantial investment in upgrading and expanding its network operating center and populating television stations with the units necessary for the delivery of video advertising content. However there can be no assurance that this service offering will achieve market acceptance. The inability to place units in an adequate number of stations or the inability to capture market share as a result of price competition or new product introductions from competitors would have a material adverse effect on the Company's business, operating results and financial position. In addition, the Company believes that in order to more fully address the needs of potential customers it will need to develop a set of ancillary services which are typically provided today by dub and ship houses. These ancillary services, which include physical archiving, closed captioning, modification of slates and format conversions, will need to be provided on a localized basis in each of the major cities in which the Company provides services directly to agencies and advertisers. The Company currently has the capability to provide such services to the New York City market through PDR. However, there can be no assurance that the Company will successfully contract for and provide these services in each major metropolitan area or be able to provide competitive video distribution services throughout the major U.S. markets. Unless the Company can successfully continue to develop and provide video transmission services, it may be unable to retain current or attract future audio delivery customers who may ultimately demand delivery of both media content. Dependence on New Product Introductions. The Company's future growth depends on its successful and timely introduction of new products and services in markets that do not currently exist or are just emerging. The Company's goals are to introduce new services, such as media archiving and the ability to quickly and reliably give an agency the ability to preview and authorize delivery of video advertising spots. There can be no assurance that the Company will successfully complete that development of such products and services, or that if any such development is completed, the Company's planned introduction of these products and services will realize market acceptance or will meet the technical or other requirements of potential customers. During the first quarter of 1997, the Company and ABC Radio Networks ("ABC") concluded field trials for an extension to the Company's existing network through which ABC could distribute advertising and programming to ABC's affiliate radio stations. Further development of these products for ABC is not currently planned. The Company does not foresee any material adverse impact to future operations as a result of this decision.* Uncertainties Relating to Integration of Operations. DG Systems acquired PDR with the expectation that this would result in enhanced efficiencies for the combined company. Achieving the anticipated benefits of the PDR acquisition will depend in part upon whether the integration of the two companies' organizations and businesses is achieved in an efficient, effective and timely manner; however, there can be no assurance that this will occur. The successful integration and expansion of the Company's business following its acquisition of PDR requires communication and cooperation among the senior executives and key technical personnel of DG Systems and PDR. Given the inherent difficulties involved in completing a business combination, there can be no assurance that such cooperation will occur or that the integration of the respective organizations will be successful and will not result in disruptions in one or more sectors of the Company's business. Failure to effectively accomplish the integration of the two companies' operations could have a material adverse effect on DG Systems' results of operations and financial 13 14 condition. In addition, there can be no assurance that the market will favorably view DG Systems' offering of duplication, distribution and editing services through PDR or that DG Systems will realize any of the other anticipated benefits of the PDR acquisition. As a result of the acquisition, certain DG Systems customers may perceive PDR to be a competitor, and this could affect such customers' willingness to do business with DG Systems in the future. The loss of significant customers could have a material adverse effect on DG Systems' results of operations and financial condition. 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, long standing relationships with existing dub and ship vendors, and, currently, a service offering which is limited in comparison to the offerings of some dub and ship vendors. Therefore, it is difficult to predict the rate at which the market for the electronic delivery of digital audio and video transmissions will grow, if at all. If the market fails to grow, or grows more slowly than anticipated, the Company's business, operating results and financial condition will be materially adversely affected. Even if the market does grow, there can be no assurance that the Company's products and services will achieve commercial success. Although the Company intends to conform its products and services to meet existing and emerging standards in the market for the electronic delivery of digital audio and video transmissions, there can be no assurance that the Company will be able to conform its products to such standards in a timely fashion, or at all. The Company believes that its future growth will depend, in part, on its ability to add these services and additional customers in a timely and cost-effective manner, and there can be no assurance that the Company will be successful in developing such services, in obtaining new customers, or 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 installing and supporting the Company's field receiving equipment, including rooftop satellite antennae. The Company's limited marketing efforts to date with regard to the Company's products and services have involved identification and characterization of specific market segments for these products and services with a view to determining the target markets that will be the most receptive to such products and services. There can be no assurance that the Company has correctly identified such markets or that its planned products and services will address the needs of such markets. Furthermore, there can be no assurance that the Company's technologies, in their current form, will be suitable for specific applications or that further design modifications, beyond anticipated changes to accommodate different markets, will not be necessary. Broad commercialization of the Company's products and services will require the Company to overcome significant market development hurdles, many of which may not currently be foreseen. Dependence on Technological Developments. The market for the distribution of digital audio and video transmissions is characterized by rapidly changing technology. The Company's ability to remain competitive and its future success will depend in significant part upon the technological quality of its products and processes relative to those of its competitors and its ability both to develop new and enhanced products and services and to introduce such products and services at competitive prices and in a timely and cost-effective fashion. The Company's development efforts have been focused on the areas of satellite transmission technology, video compression technology and work on reliability and throughput enhancement of the network. The Company's ability to successfully introduce electronic video delivery services depends on its ability to obtain satellite delivery capability. Work in satellite technology is oriented to development deployment of software to lower transmission costs and increase delivery reliability. Work in video compression technology is directed toward integration of emerging broadcast quality compression systems, which further improve picture quality while increasing the compression ratio, with the Company's existing network. The Company has an agreement with Hughes Network Systems, Inc. ("Hughes") which allows the Company to use Hughes' satellite capacity for electronic delivery of digital audio and video transmissions by that media. The Company has developed and incorporated software designed to enable the current RPTs to receive digital satellite transmissions over the Hughes satellite system. There can be no assurance that the Hughes satellite system will have the capacity to meet the Company's future delivery commitments and broadcast quality requirements and to do so on a cost-effective basis. 14 15 The introduction of products embodying new technologies can render existing products obsolete or unmarketable. There can be no assurance that the Company will be successful in identifying, developing, contracting for the manufacture of, and marketing product enhancements or new products that respond to technological change, that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of these products, or that its new products and product enhancements will adequately meet the requirements of the marketplace and achieve market acceptance. Delays in the commencement of commercial availability of new products and services and enhancements to existing products and services may result in customer dissatisfaction and delay or loss of revenue. If the Company is unable, for technological or other reasons, to develop and introduce new products and services or enhancements of existing products and services in a timely manner or if new versions of existing products do not achieve a significant degree of market acceptance, there could be a material adverse effect on the Company's business, financial condition and results of operations. 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 the Company to replace. Some of these dub and ship houses and production studios have greater financial, distribution and marketing resources and have achieved a higher level of brand recognition than the Company. Moreover, Digital Courier International Corporation has begun deployment of a system to electronically deliver audio content in Canada and the United States and several other companies have announced such systems. As a result, there can be no assurance that the Company will be able to compete effectively against these competitors merely on the basis of ease of use, timeliness and accuracy of delivery. In the market for the electronic distribution of digital video transmissions to television stations, the Company encounters competition from Indenet, VDI Media and Vyvx Advertising Distribution Services ("VADS"), a subsidiary of The Williams Companies which includes CycleSat, Inc., in addition to dub and ship houses and production studios, certain of which currently function as marketing partners with the Company in the audio distribution market. To the extent that the Company is successful in entering new markets, such as the delivery of other forms of content to radio and television stations and content delivery to radio and television stations, it would expect to face competition from companies in related communications markets and/or package delivery markets which could offer products and services with functionality similar or superior to that offered by the Company's products and services. Telecommunications providers such as AT&T, MCI and Regional Bell Operating Companies could also enter the market as competitors with materially lower electronic delivery transportation costs. The Company could also face competition from entities with package delivery expertise such as Federal Express, United Parcel Service, DHL and Airborne if any such companies enter the electronic data delivery market. Radio networks such as ABC or Westwood One could also become competitors by selling and transmitting advertisements as a complement to their content programming. In addition, Applied Graphics technologies, Inc., a provider of digital pre-press services, has indicated its intention to provide electronic distribution services and acquired Spotlink, a dub and ship house, in December 1996. Although Spotlink revenues were less than 5% of the Company's revenues in 1996, the Company considers Spotlink to be a significant customer for the Company's audio delivery service. There can be no assurance that Spotlink will continue to be a customer of the Company, and the loss of Spotlink as a customer could have a material adverse effect on the Company's operating results. Many of the Company's current and potential competitors in the markets for audio and video transmissions have substantially greater financial, technical, marketing and other resources and larger installed customer bases than the Company. There can be no assurance that the Company will be able to compete successfully against current and future competitors based on these and other factors. The Company expects that an increasingly competitive environment will result in price reductions that could result in reduced unit profit margins and loss of market share, all of which would have a material adverse effect on the Company's business, results of operations and financial condition. Moreover, the market for the distribution of audio and video transmissions has become increasingly concentrated in recent years as a result of acquisitions, which are likely to permit many of the Company's competitors to devote significantly greater resources to the development and marketing of new competitive products and services. The Company expects that competition will increase substantially as a result of these and other industry 15 16 consolidations and alliances, as well as the emergence of new competitors. There can be no assurance that the Company will be able to compete successfully with new or existing competitors or that competitive pressures faced by the Company will not materially and adversely affect its business, operating results and financial condition. Ability to Maintain and Improve Service Quality. The Company's business is dependent on its ability to make deliveries to broadcast stations within the time periods requested by customers. Any failure to do so, whether or not within the control of the Company, could result in an advertisement not being run and in the station losing air-time which it could have otherwise sold. Although the Company disclaims any liability for lost air-time, there can be no assurance that claims by stations for lost air-time would not be asserted in these circumstances or that dissatisfied advertisers would refuse to make further deliveries through the Company in the event of a significant occurrence of lost deliveries, either of which would have a material adverse effect on the Company's business, results of operations and financial condition. Although the Company maintains insurance against business interruption, there can be no assurance that such insurance will be adequate to protect the Company from significant loss in these circumstances or that a major catastrophe (such as an earthquake or other natural disaster) would not result in a prolonged interruption of the Company's business. In particular, the Company's network operating center is located in the San Francisco Bay area, which has in the past and may in the future experience significant, destructive seismic activity that could damage or destroy the Company's network operating center. In addition, the Company's ability to make deliveries to stations within the time periods requested by customers depends on a number of factors, some of which are outside of its control, including equipment failure, interruption in services by telecommunications service providers, and the Company's inability to maintain its installed base of Record Send Terminals ("RSTs"), RPTs and DVPS video units that comprise its distribution network. The result of the Company's failure to make timely deliveries for whatever reason could be that dissatisfied advertisers would refuse to make further deliveries through the Company which would have a material adverse effect on the Company's business, results of operations and financial condition. Ability to Manage Growth. The Company has recently experienced a period of rapid growth that has resulted in new and increased responsibilities for management personnel and has placed and continues to place a significant strain on the Company's management, operating and financial systems and resources. To accommodate this recent growth and to compete effectively and manage future growth, if any, the Company will be required to continue to implement and improve its operational, financial and management information systems, procedures and controls on a timely basis and to expand, train, motivate and manage its work force. In particular, the Company believes that to achieve these objectives it must complete its automation of the customer order entry process and the integration of the delivery fulfillment process into the customer billing system. There can be no assurance that the Company's personnel, systems, procedures and controls will be adequate to support the Company's existing and future operations. Any failure to implement and improve the Company's operational, financial and management systems or to expand, train, motivate or manage employees could have a material adverse effect on the Company's business, operating results and financial condition. Future Capital Needs; Uncertainty of Additional Funding. The Company intends to continue making capital expenditures to produce and install RSTs, RPTs, and DVPS video units and to introduce additional services.* The Company continually analyzes the costs and benefits of acquiring certain businesses, products or technologies that it may from time to time identify, and its related ability to finance such acquisitions. Assuming the Company does not pursue one or more significant acquisitions, the Company anticipates that the net proceeds of its initial public offering completed in February 1996, together with its existing capital and cash from operations, will be adequate to satisfy its capital requirements through at least December 1997.* There can be no assurance, however, that the net proceeds of the Company's initial public offering and such other sources of funding will be sufficient to satisfy the Company's future capital requirements. Based on its current business plan, the Company anticipates that it will eventually use the entire proceeds of its initial public offering and there can be no assurance that other sources of funding will be adequate to fund the Company's capital needs, which depend upon numerous factors, including the progress of the Company's product development activities, the cost of increasing the Company's sales and marketing activities and the amount of revenues generated from operations, none of which can be predicted with certainty. There can be no assurance that the Company will not require additional capital sooner than currently anticipated. In addition, the Company is unable to predict the precise amount of future capital that it will require, particularly if it were to pursue one or more acquisitions, and there can be no assurance that any additional financing will be available to the Company on acceptable terms, or at all. The inability to obtain required financing would have a material adverse effect on the Company's business, financial condition and results of operations. Consequently, the 16 17 Company could be required to significantly reduce or suspend its operations, seek a merger partner or sell additional securities on terms that are highly dilutive to existing investors. Expansion into International Markets. Although the Company's 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 the Company to incur substantial costs and expend significant managerial resources to obtain any necessary regulatory approvals and comply with differing equipment interface and installation standards promulgated by regulatory authorities of those countries. Changes in government policies, regulations and telecommunications systems in foreign countries could require the Company's products and services to be redesigned, causing product and service delivery delays that could materially adversely affect the Company's operating results. The Company's ability to successfully enter these new markets will depend, in part, on its ability to attract personnel with experience in these locations and to attract partners with the necessary local business relationships.* There can be no assurance, however, that the Company's products and services will achieve market acceptance in foreign countries. The inability of the Company to successfully establish and expand its international operations may also limit its ability to obtain significant international revenues and could materially adversely affect the business, operating results and financial condition of the Company. Furthermore, international business is subject to a number of country-specific risks and circumstances, including different tax laws, difficulties in expatriating profits, currency exchange rate fluctuations, and the complexities of administering business abroad. Moreover, to the extent the Company increases its international sales, the Company's business, operating results and financial condition could be materially adversely affected by these risks and circumstances, as well as by increases in duties, price controls or other restrictions on foreign currencies, and trade barriers imposed by foreign governments, among other factors. Dependence on Key Personnel. The Company's success depends to a significant degree upon the continuing contributions of, and on its ability to attract and retain, qualified management, sales, operations, marketing and technical personnel. The competition for qualified personnel, particularly engineering staff, is intense and the loss of any of such persons, as well as the failure to recruit additional key personnel in a timely manner, could adversely affect the Company. There can be no assurance that the Company will be able to continue to attract and retain qualified management, sales and technical personnel for the development of its business. The Company generally has not entered into employment or noncompetition agreements with any of its employees. The Company does not maintain key man life insurance on the lives of any of its key personnel. The Company's failure to attract and retain key personnel could have a material adverse effect on its business, operating results and financial condition. Dependence on Certain Suppliers. The Company relies on certain single or limited-source suppliers for certain integral components used for the assembly of the Company's RSTs, RPTs and video units. Although the Company's suppliers are generally large, well-financed organizations, in the event that a supplier were to experience financial or operational difficulties that resulted in a reduction or interruption in component supply to the Company, it would delay the Company's deployment of RSTs, RPTs and video units which would have the effect of depressing the Company's business until the Company established sufficient component supply through an alternative source. The Company believes that there are alternative component manufacturers that could supply the components required to produce the Company's products, but the Company is not currently pursuing agreements or understandings with such alternative sources. If a reduction or interruption of supply were to occur, it could take a significant period of time for the Company to qualify an alternative subcontractor, redesign its products as necessary and contract for the manufacture of such products. The Company does not have long-term supply contracts with its sole- or limited-source vendors and purchases its components on a purchase order basis. The Company has experienced component shortages in the past and there can be no assurance that material component shortages or production or delivery delays will not occur in the future. The inability in the future to obtain sufficient quantities of components in a timely manner as required, or to develop alternative sources as required, could result in delays or reductions in product shipments or product redesigns, which would materially and adversely affect the Company's business, operating results and financial condition. Pursuant to its development efforts in the area of satellite transmission technology, the Company has successfully completed live field trials of software designed to enhance and enable the current RPTs to receive digital satellite transmissions over the Hughes satellite system. The Company's dependence on Hughes entails a number of significant risks. The Company's business, results of operations and financial 17 18 condition would be materially adversely affected if Hughes were unable for any reason to continue meeting the Company's delivery commitments on a cost-effective basis or if any transmissions failed to satisfy the Company's quality requirements. In the event that the Company were unable to continue to use Hughes' satellite capacity, the Company would have to identify, qualify and transition deliveries to an acceptable alternative satellite transmission vendor. This identification, qualification and transition process could take nine months or longer, and no assurance can be given that an alternative satellite transmission vendor would be available to the Company or be in a position to satisfy the Company's delivery requirements on a timely and cost-effective basis. The Company obtains its local access telephone transmission services through Teleport Communications Group. The Company obtains its long distance telephone access through an exclusive contract with MCI which expires in 1997. The Company is currently negotiating with MCI and other long distance carriers to reach agreement on terms for providing this service in the future. Any material interruption in the supply or a material adverse change in the price of either local access or long distance carrier service could have a material adverse effect on the Company's business, results of operations and financial condition. Dependence on Proprietary Technology, Protection of Trademarks, Copyrights, and Other Proprietary Information; Risk of Third Party Claims of Infringement. The Company considers its trademarks, copyrights, advertising, and promotion design and artwork to be of value and important to its business. The Company relies on a combination of trade secret, copyright and trademark laws and nondisclosure and other arrangements to protect its proprietary rights. The Company does not have any patents or patent applications pending. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy or obtain and use information that the Company regards as proprietary. There can be no assurance that the steps taken by the Company to protect its proprietary information will prevent misappropriation of such information and such protection may not preclude competitors from developing confusingly similar brand names or promotional materials or developing products and services similar to those of the Company. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. While the Company believes that its trademarks, copyrights, advertising and promotion design and artwork do not infringe upon the proprietary rights of third parties, there can be no assurance that the Company will not receive future communications from third parties asserting that the Company's trademarks, copyrights, advertising and promotion design and artwork infringe, or may infringe, on the proprietary rights of third parties. Any such claims, with or without merit, could be time-consuming, require the Company to enter into royalty arrangements or result in costly litigation and diversion of management personnel. No assurance can be given that any necessary licenses can be obtained or that, if obtainable, such licenses can be obtained on commercially reasonable terms. In the event of a successful claim of infringement against the Company and failure or inability of the Company to license the infringed or similar proprietary information, the Company's business, operating results and financial condition could be materially adversely affected. Concentration of Stock Ownership; Potential Issuance of Preferred Stock; Anti-Takeover Provisions. The present executive officers and directors of the Company and their affiliates own approximately 36% of the Company's 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 approval of significant corporate transactions. Such concentration of ownership may have the effect of delaying or preventing a change in control of the Company. In addition, the Company's Board of Directors has the authority to issue up to 5,000,000 shares of Preferred Stock and to determine the price, rights, preferences, privileges and restrictions thereof, including voting rights, without any further vote or action by the Company's shareholders. Although the Company has no current plans to issue any shares of Preferred Stock, the rights of the holders of Common Stock would be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. Issuance of Preferred Stock could have the effect of delaying, deferring or preventing a change in control of the Company. Furthermore, certain provisions of the Company's Articles of Incorporation and Bylaws and of California law could have the effect of delaying, deferring or preventing a change in control of the Company. Possible Volatility of Share Price. The trading prices of the Company's Common Stock may be subject to wide fluctuations in response to a number of factors, including variations in operating results, changes in earnings estimates by securities analysts, announcements of extraordinary events such as 18 19 litigation or acquisitions, announcements of technological innovations or new products or services by the Company or its competitors, as well as general economic, political and market conditions. In addition, stock markets have experienced extreme price and volume trading volatility in recent years. This volatility has had a substantial effect on the market prices of the securities of many high technology companies for reasons frequently unrelated to the operating performance of specific companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. 19 20 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From time to time the Company has been, or may become, involved in litigation proceedings incidental to the conduct of its business. The Company does not believe that any such proceedings presently pending will have a material adverse affect on the Company's financial position or its results of operations. ITEM 2. CHANGES IN SECURITIES Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits
EXHIBIT NUMBER EXHIBIT TITLE ------ ------------- 3.1(d) Restated Articles of Incorporation of registrant. 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 Nonstatutory Stock Option Agreement. 10.2(b) Form of Directors' and Officers' Indemnification Agreement. 10.3(b) 1995 Director Option Plan and form of Incentive Stock Option Agreement thereto. 10.4(b) Form of Restricted Stock Agreement. 10.5.1(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. 10.7.1(c) Corporate Service Plan Agreement between the Company and MCI Telecommunications Corporation, dated March 23, 1994. 10.7.2(c) First Amendment to Corporate Service Plan Agreement between the Company and MCI Telecommunications Corporation, dated November 2, 1995. 10.8(b) Master Lease Agreement between the Company and Comdisco, Inc., dated October 20, 1994, and Exhibits thereto. 10.9(b) Loan and Security Agreement between the Company and Comdisco, Inc., dated October 20, 1994, and Exhibits thereto. 10.10(b) Master Equipment Lease between the Company and Phoenix Leasing, Inc., dated January 7, 1993.
20 21
EXHIBIT NUMBER EXHIBIT TITLE ------ ------------- 10.15(c) Audio Server Network Prototype Vendor Agreement and Satellite Vendor Agreement between the Company and ABC Radio Networks, dated December 15, 1995. 10.17(b) Promissory Note between the Company and Henry W. Donaldson, dated March 18, 1994, December 5, 1994, December 5, 1994, and March 14, 1995. 10.18(b) Warrant Agreement to purchase Series B Preferred Stock between the Company and Comdisco, Inc., dated as of October 20, 1994. 10.19(b) Warrant Agreement to purchase Series C Preferred Stock between the Company and Comdisco, Inc., dated as of June 13, 1995. 10.20(b) Warrant Agreement to purchase Series D Preferred Stock between the Company and Comdisco, Inc., dated as of January 11, 1996. 10.22(d) Agreement of Sublease for 9,434 rentable square feet at 855 Battery Street, San Francisco, California between the Company and T.Y. Lin International dated September 8, 1995 and exhibits thereto. 10.23(d) Agreement of Sublease for 5,613 rentable square feet at 855 Battery Street, San Francisco, California between the Company and Law/Crandall, Inc. dated September 29, 1995 and exhibits thereto. 10.24(e) Digital Generation Systems, Inc. Supplemental Stock Option Plan. 10.25(e) Stock Purchase Agreement by and among Digital Generation Systems, Inc. and PDR Productions, Inc. and Pat DeRosa dated as of October 15, 1996 and exhibits thereto. 10.26(f) Amendment to Stock Purchase Agreement dated November 8, 1996, among Digital Generation Systems, Inc., and Pat DeRosa. 10.27(a) 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. 11.1(a) Statements of computation of pro forma common shares and equivalents. 21.1(g) Subsidiaries of the Registrant. 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 number filed with registrant's Current Report on Form 8-K/A filed January 21, 1997. (g) Incorporated by reference to the exhibit bearing the same number filed with registrant's Annual Report on Form 10-K filed March 18, 1997. (b) REPORTS ON FORM 8-K. Current Report on Form 8-K/A filed January 21, 1997, filing as exhibits certain audited financial statements of PDR Productions, Inc. and certain pro forma information required by Item 7(b) of Form 8-K regarding its acquisition by the registrant. 21 22 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DIGITAL GENERATION SYSTEMS, INC. Dated: May 15, 1997 BY: /S/ THOMAS P. SHANAHAN ------------------------------- THOMAS P. SHANAHAN VICE PRESIDENT & CHIEF FINANCIAL OFFICER (PRINCIPAL FINANCIAL AND CHIEF ACCOUNTING OFFICER) 22 EX-10.27 2 LOAN AGREEMENT 1 EXHIBIT 10.27 ================================================================================ LOAN AGREEMENT Dated as of January 28, 1997 between DIGITAL GENERATION SYSTEMS, INC. as Borrower, and VENTURE LENDING & LEASING, INC., as Lender ================================================================================ 2 TABLE OF CONTENTS
Page ---- ARTICLE 1 - DEFINITIONS.................................................................... 1 ARTICLE 2 - THE COMMITMENT AND LOANS....................................................... 6 2.1 The Commitment.............................................................. 6 2.2 Limitation on Loans......................................................... 6 2.3 Notes Evidencing Loans; Repayment........................................... 6 2.4 Procedures for Borrowing.................................................... 7 2.5 Interest.................................................................... 7 2.6 Interest Rate Calculation................................................... 7 2.7 Default Interest............................................................ 7 2.8 Lender's Records............................................................ 7 2.9 Security.................................................................... 7 2.10 Issuance of Warrant to Lender............................................... 8 ARTICLE 3 - REPRESENTATIONS AND WARRANTIES................................................. 8 3.1 Due Organization............................................................ 8 3.2 Authorization, Validity and Enforceability.................................. 8 3.3 Compliance with Applicable Laws............................................. 8 3.4 Copyrights, Patents, Trademarks and Licenses................................ 8 3.5 No Conflict................................................................. 9 3.6 No Litigation, Claims or Proceedings........................................ 9 3.7 Correctness of Financial Statements......................................... 9 3.8 No Subsidiaries............................................................. 9 3.9 Environmental Matters....................................................... 9 3.10 No Event of Default......................................................... 9 3.11 Full Disclosure............................................................. 9 ARTICLE 4 - CONDITIONS PRECEDENT........................................................... 10 4.1 Conditions to First Loan.................................................... 10 4.2 Conditions to All Loans..................................................... 10 ARTICLE 5 - AFFIRMATIVE COVENANTS.......................................................... 11 5.1 Notice to Lender............................................................ 11 5.2 Financial Statements........................................................ 11 5.3 Managerial Assistance from Lender........................................... 12 5.4 Existence................................................................... 13 5.5 Insurance................................................................... 13 5.6 Accounting Records.......................................................... 13 5.7 Compliance With Laws........................................................ 13 5.8 Taxes and Other Liabilities................................................. 13 5.9 Use of Proceeds............................................................. 14 ARTICLE 6 - NEGATIVE COVENANTS............................................................. 14 6.1 Indebtedness................................................................ 14 6.2 Liens....................................................................... 14 6.3 Dividends................................................................... 14 6.4 Changes/Mergers............................................................. 14 6.5 Sales of Assets............................................................. 15
i 3 TABLE OF CONTENTS (continued)
Page ---- ARTICLE 7 - EVENTS OF DEFAULT.............................................................. 15 7.1 Events of Default........................................................... 15 ARTICLE 8 - GENERAL PROVISIONS............................................................. 16 8.1 Notices..................................................................... 16 8.2 Binding Effect.............................................................. 16 8.3 No Waiver................................................................... 17 8.4 Rights Cumulative........................................................... 17 8.5 Unenforceable Provisions.................................................... 17 8.6 Accounting Terms............................................................ 17 8.7 Indemnification; Exculpation................................................ 17 8.8 Reimbursement............................................................... 18 8.9 Execution in Counterparts................................................... 18 8.10 Entire Agreement............................................................ 18 8.11 Governing Law and Jurisdiction.............................................. 18 8.12 Waiver of Jury Trial........................................................ 18
LIST OF EXHIBITS Exhibit "A" Form of Note Exhibit "B" Form of Borrowing Request Exhibit "C" Security Agreement Exhibit "D" Form of Warrant ii 4 LOAN AGREEMENT This LOAN AGREEMENT is entered into as of January 28, 1997, between DIGITAL GENERATION SYSTEMS, INC., a California corporation ("Borrower"), and VENTURE LENDING & LEASING, INC., a Maryland corporation ("VLLI" or "Lender"). WHEREAS, Lender has agreed to make available to Borrower a term loan facility upon the terms and conditions set forth in this Agreement. NOW, THEREFORE, in consideration of the mutual agreements, provisions and covenants contained herein, the parties agree as follows: ARTICLE 1 - DEFINITIONS The definitions appearing in this Agreement or any supplement or addendum to this Agreement, shall be applicable to both the singular and plural forms of the defined terms: "AFFILIATE" means any Person which directly or indirectly controls, is controlled by, or is under common control with, Borrower. "Control," "controlled by" and "under common control with" means direct or indirect possession of the power to direct or cause the direction of management or policies (whether through ownership of voting securities, by contract or otherwise); provided that control shall be conclusively presumed when any Person or affiliated group directly or indirectly owns five percent (5%) or more of the securities having ordinary voting power for the election of directors of a corporation. "AGREEMENT" means this Loan Agreement as it may be amended or supplemented from time to time. "BANKRUPTCY CODE" means the Federal Bankruptcy Reform Act of 1978 (11 U.S.C. Section.101, et seq.), as amended. "BASIC INTEREST" means the amount of interest payable on the outstanding balance of each Loan at the applicable Designated Rate. "BORROWING DATE" means the Business Day on which the proceeds of a Loan are disbursed by Lender. "BORROWING REQUEST" means a written request from Borrower in substantially the form of Exhibit "B" hereto, requesting the funding of one or more Loans on a particular Borrowing Date. "BUSINESS DAY" means any day other than a Saturday, Sunday or other day on which commercial banks in New York City or San Francisco are authorized or required by law to close. "CLOSING DATE" means the date of this Agreement. 1 5 "COLLATERAL" has the meaning ascribed thereto in the Security Agreement. "COMMITMENT" means the obligation of Lender to make Loans to Borrower in an aggregate, original principal amount not exceeding Six Million Dollars ($6,000,000.00). "DEFAULT" means an event which with the giving of notice, passage of time, or both would constitute an Event of Default. "DEFAULT RATE" is defined in Section 2.7. "DESIGNATED RATE" means a fixed rate of interest per annum applicable to a Loan calculated at ten percent (10%) interest rate. "ENVIRONMENTAL LAWS" means all federal, state or local laws, statutes, common law duties, rules, regulations, ordinances and codes, together with all administrative orders, directed duties, requests, licenses, authorizations and permits of, and agreements with, any governmental authorities, in each case relating to environmental, health, or safety matters. "EVENT OF DEFAULT" means any event described in Article 7. "GAAP" means generally accepted accounting principles and practices consistent with those principles and practices promulgated or adopted by the Financial Accounting Standards Board and the Board of the American Institute of Certified Public Accountants, their respective predecessors and successors. "INDEBTEDNESS" of any Person means at any date, without duplication and without regard to whether matured or unmatured, absolute or contingent: (i) all obligations of such Person for borrowed money; (ii) all obligations of such Person evidenced by bonds, debentures, notes, or other similar instruments; (iii) all obligations of such Person to pay the deferred purchase price of property or services, except trade accounts payable arising in the ordinary course of business; (iv) all obligations of such Person as lessee under capital leases; (v) all obligations of such Person to reimburse or prepay any bank or other Person in respect of amounts paid under a letter of credit, banker's acceptance, or similar instrument, whether drawn or undrawn; (vi) all obligations of such Person to purchase securities which arise out of or in connection with the sale of the same or substantially similar securities; (vii) all obligations of such Person in connection with any agreement to purchase, redeem, exchange, convert or otherwise acquire for value any capital stock of such Person or any warrants, rights or options to acquire such capital stock, now or hereafter outstanding, except to the extent that such obligations remain performable solely at the option of such Person; (viii) all obligations to repurchase assets previously sold (including any obligation to repurchase any accounts or chattel paper under any factoring, receivables purchase, or similar arrangement); (ix) obligations of such Person under interest rate swap, cap, collar or similar hedging arrangements; and (x) all obligations of others of any type described in clause (i) through clause (ix) above guaranteed by such Person. 2 6 "INSOLVENCY PROCEEDING" means (a) any case, action or proceeding before any court or other governmental authority relating to bankruptcy, reorganization, insolvency, liquidation, receivership, dissolution, winding-up or relief of debtors, or (b) any general assignment for the benefit of creditors, composition, marshalling of assets for creditors, or other, similar arrangement in respect of its creditors generally or any substantial portion of its creditors, undertaken under U.S. Federal, state or foreign law, including the Bankruptcy Code. "LIEN" means any voluntary or involuntary security interest, mortgage, pledge, claim, charge, encumbrance, title retention agreement, or third party interest, covering all or any part of the property of Borrower or any other Person. "LOAN" means an extension of credit by Lender under Section 2 of this Agreement. "LOAN DOCUMENTS" means, individually and collectively, this Agreement, each Note, the Security Agreement and any other security or pledge agreement(s), and all other contracts, instruments, addenda and documents executed in connection with this Agreement or the extensions of credit which are the subject of this Agreement. "MATERIAL ADVERSE EFFECT" or "MATERIAL ADVERSE CHANGE" means (a) a material adverse change in, or a material adverse effect upon, the operations, business, properties, or condition (financial or otherwise) of Borrower; (b) a material impairment of the ability of Borrower to perform under any Loan Document; or (c) a material adverse effect upon the legality, validity, binding effect or enforceability against Borrower of any Loan Document. "MATURITY DATE" means, with regard to a Loan, the earlier of (i) its maturity by reason of acceleration, or (ii) its stated maturity date, which is the first day of the [37th] full month after the Borrowing Date of such Loan; and is the date on which payment of all outstanding principal, accrued interest, and the Terminal Payment is due. "NOTE" means a promissory note substantially in the form of Exhibit "A" hereto, executed by Borrower evidencing each Loan. "OBLIGATIONS" means all advances, debts, liabilities, obligations, covenants and duties arising under any Loan Document, owing by Borrower to Lender, whether direct or indirect (including those acquired by assignment), absolute or contingent, liquidated or unliquidated, due or to become due, now existing or hereafter arising. "PERMITTED LIEN" means a) involuntary Liens which, in the aggregate, would not have a Material Adverse Effect and which in any event would not exceed Three-Hundred Thousand Dollars ($300,000); b) Liens for current taxes or other governmental or regulatory assessments which are not delinquent, or which are contested 3 7 in good faith by the appropriate procedures and for which appropriate reserves are maintained; c) purchase money security interests on any property held or acquired by Borrower in the ordinary course of business securing Indebtedness incurred or assumed for the purpose of financing all or any part of the cost of acquiring such property; provided, that such Lien attaches solely to the property acquired with such Indebtedness and that the principal amount of such Indebtedness does not exceed one hundred percent (100%) of the cost of such property; and further provided, that such property is not equipment with respect to which a Loan has been made hereunder. d) Liens in favor of Lender; e) bankers' liens, rights of setoff and similar Liens incurred on deposits made in the ordinary course of business; f) materialmen's, mechanics', repairmen's, employees' or other like Liens arising in the ordinary course of business and which are not delinquent for more than 45 days or are being contested in good faith by appropriate proceedings; g) any judgment, attachment or similar Lien, unless the judgment it secures has not been discharged or execution thereof effectively stayed and bonded against pending appeal within 30 days of the entry thereof; h) licenses or sublicenses of Patents, Patent Licenses, Trademarks or Trademark Licenses permitted under the Trademark Collateral Assignment or the Patent Collateral Assignment (all as defined in the Security Agreement); and i) Liens which have been approved by Lender prior to the Closing Date. "PERSON" means any individual or entity. "RELATED PERSON" means any Affiliate of Borrower, or any officer, employee, director or equity security holder of Borrower or any Affiliate. "REPORTING COMPANY" means an issuer subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended. "SEC" means the Securities and Exchange Commission. "SECURITY AGREEMENT" means the Security Agreement substantially in the form of Exhibit "C" hereto, executed by Borrower. "TERMINAL PAYMENT" means, with respect to each Loan, an amount payable on the Maturity Date of such Loan in an amount equal to [fifteen percent (15%)] of the original principal amount of such Loan. 4 8 "TERMINATION DATE" means the earlier of: (a) the date Lender may terminate making loans or extending credit pursuant to the rights of Lender under Article 7, or (b) December 31, 1997. "UCC" means the Uniform Commercial Code as enacted in the applicable jurisdiction, in effect on the Closing Date and as amended from time to time. 5 9 ARTICLE 2 - THE COMMITMENT AND LOANS 2.1 THE COMMITMENT. Subject to the terms and conditions of this Agreement, Lender agrees to make term loans to Borrower from time to time from the Closing Date and to, but not including, the Termination Date in an aggregate principal amount not exceeding the Commitment. The Commitment is not a revolving credit commitment, and Borrower shall not have the right to repay and reborrow hereunder. 2.2 LIMITATION ON LOANS. Each Loan shall be in an amount not to exceed one hundred percent (100%) of the amount paid or payable by Borrower to a non-affiliated manufacturer, vendor or dealer for an item of equipment as shown on an invoice therefor (excluding any commissions and any portion of the payment which relate to the servicing of the equipment and sales taxes payable by Borrower upon acquisition, and delivery charges). Lender shall not be obligated to make any Loan under its Commitment if at the time of or after giving effect to the proposed Loan Lender would no longer qualify as: (A) a "venture capital operating company" under U.S. Department of Labor Regulations Section 2510.3-101(d), Title 29 of the Code of Federal Regulations, as amended; and (B) a "business development company" under the provisions of federal Investment Company Act of 1940, as amended; and (C) a "regulated investment company" under the provisions of the Internal Revenue Code of 1986, as amended. Each Loan requested by Borrower to be made on a single Business Day shall be for a principal amount of Fifty Thousand Dollars ($50,000) or a multiple thereof, except to the extent the remaining Commitment is a lesser amount. 2.3 NOTES EVIDENCING LOANS; REPAYMENT. Each Loan shall be evidenced by a separate Note payable to the order of Lender substantially in the form of Exhibit "A" to this Agreement, in the total principal amount of the Loan. Each Note shall be payable as follows: Principal and Basic Interest shall be paid in thirty-six (36) equal and successive monthly payments, in advance, beginning on the Borrowing Date and continuing on the first Business Day of each month thereafter; provided, that the first and last such amortization installment payments shall be paid in advance on the Borrowing Date. If the Borrowing Date is not the first day of a month, then the 36-month amortization period shall commence on the first day of the next month following the Borrowing Date, and interest only shall accrue and be payable for the period from the Borrowing Date to the first day of the next month. Borrower shall pay to Lender, in advance, on the Borrowing Date a payment of Basic Interest on the amount of any Loan that is not made on the first day of the month for interest that will accrue on such Loan from the Borrowing Date through the last day of the same month. The payment of amortization installments of principal of and interest on a Loan in advance results in a higher effective rate of interest than the stated Designated Rate applicable to such Loan. The full amount of the Terminal Payment with respect to each Loan shall be due and payable on the Maturity Date of such Loan. 6 10 2.4 PROCEDURES FOR BORROWING. a) Borrower shall give Lender, at least five (5) Business Days prior to a proposed Borrowing Date, written notice of any request for borrowing hereunder (a "Borrowing Request"). Each Borrowing Request shall be in substantially the form of Exhibit "B" hereto, shall be executed by the chief financial officer of Borrower, and shall state how much is requested, and shall be accompanied by such additional information and documentation as Lender may deem reasonably necessary to determine whether the proposed borrowing will comply with the limitations in Section 2.2. To the Borrower's best knowledge after due inquiry of its senior officers, the Borrowing Request shall also certify that all equipment to be financed thereby is, or will upon acquisition be, owned by Borrower free and clear of all Liens except in favor of Lender. b) No later than 1:00 p.m. Pacific Standard Time or Pacific Daylight Time, as the case may be, on the Borrowing Date, if Borrower has satisfied the conditions precedent in Article 4, Lender shall make the Loan available to Borrower in immediately available funds. 2.5 INTEREST. Basic Interest on the outstanding principal balance of the each Loan shall accrue daily at the Designated Rate from the Borrowing Date until the Maturity Date. 2.6 INTEREST RATE CALCULATION. Basic Interest, along with charges and fees under this Agreement and any Loan Document, shall be calculated for actual days elapsed on the basis of a 360-day year, which results in higher interest, charge or fee payments than if a 365-day year were used. In no event shall Borrower be obligated to pay Lender interest, charges or fees at a rate in excess of the highest rate permitted by applicable law from time to time in effect. 2.7 DEFAULT INTEREST. Any unpaid payments of principal or interest or the Terminal Payment with respect to any Loan shall bear interest from their respective maturities, whether scheduled or accelerated, at the Designated Rate for such Loan plus five percent (5.00%) per annum, until paid in full, whether before or after judgment (the "Default Rate"). Borrower shall pay such interest on demand. 2.8 PREPAYMENT OF LOANS. No Loan may be voluntarily prepaid except as provided in this Section 2.8. Borrower may prepay any Loan, in whole or in part at any time after the second anniversary of the Borrowing Date for such Loan. Notwithstanding the provisions of Article 6, Borrower may (x) sell, transfer, lease or otherwise dispose of all of substantially all of Borrower's assets or (y) enter into a merge in which Borrower will not be the surviving corporation if, immediately prior to the consummation of such transaction Borrower prepays all Loans then outstanding. Any prepayment, including any prepayment pursuant to this Section 2.8, whether voluntary or involuntary as a result of acceleration or otherwise, must be accompanied by payment of: (i) a premium equal to one percent (1.00%) of the amount of principal so prepaid if such prepayment is made; (ii) accrued Basic Interest to the date of such prepayment; and (iii) the Terminal Payment on the Loan so prepaid (or a ratable portion of such Terminal Payment, if less than all of the Loan is prepaid). Unless otherwise agreed 7 11 by Lender, any partial prepayment of a Loan (whether a Term Loan or an Equipment Loan) shall be applied in inverse order of maturity to the most remote principal installment then unpaid on such Loan. 2.9 LENDER'S RECORDS. Principal, Basic Interest, Terminal Payments and all other sums owed under any Loan Document shall be evidenced by entries in records maintained by Lender for such purpose. Each payment on and any other credits with respect to principal, Basic Interest, Terminal Payments and all other sums outstanding under any Loan Document shall be evidenced by entries in such records. Absent manifest error or Borrower's notice to the contrary, Lender's records shall constitute prima facie evidence thereof. 2.10 SECURITY. As security for all Obligations to Lender, Borrower shall grant concurrently to Lender, or ensure that Lender is concurrently granted, perfected security interests of first priority in all of the Collateral pursuant to the Security Agreement, subject only to Permitted Liens. 2.11 ISSUANCE OF WARRANT TO LENDER. As additional consideration for the making of the commitment, and as a condition to, the initial Loan, Lender shall be entitled to receive a warrant to purchase 112,500 shares of common stock of Borrower ("Warrant Shares") with a per share exercise price of $8.00. The warrant issued under this Agreement shall be in substantially the form attached hereto as Exhibit "D"; shall be transferable by Lender, subject to compliance with applicable securities laws; shall expire not earlier than December 31, 2002; and shall include piggy-back registration rights and "net issuance" provisions reasonably satisfactory to Lender and its counsel. ARTICLE 3 - REPRESENTATIONS AND WARRANTIES Borrower represents and warrants that as of the Closing Date and each Borrowing Date: 3.1 DUE ORGANIZATION. Borrower is a corporation duly organized and validly existing in good standing under the laws of California, and is duly qualified to conduct business and is in good standing in each other jurisdiction in which its business is conducted or its properties are located, except where the failure to be so qualified would not reasonably be expected to have a Material Adverse Effect. 3.2 AUTHORIZATION, VALIDITY AND ENFORCEABILITY. The execution, delivery and performance of all Loan Documents executed by Borrower are within Borrower's powers, have been duly authorized, and are not in conflict with Borrower's articles of incorporation or by-laws, as amended from time to time; and all such Loan Documents constitute valid and binding obligations of Borrower, enforceable in accordance with their terms (except as may be limited by bankruptcy, insolvency and similar laws affecting the enforcement of creditors' rights in general, and subject to general principles of equity). 3.3 COMPLIANCE WITH APPLICABLE LAWS. Borrower has complied with all licensing, permit and fictitious name requirements necessary to lawfully 8 12 conduct the business in which it is engaged, and to any sales, leases or the furnishing of services by Borrower, including without limitation those requiring consumer or other disclosures, the noncompliance with which would have a Material Adverse Effect. 3.4 COPYRIGHTS, PATENTS, TRADEMARKS AND LICENSES. a) Borrower owns or is licensed or otherwise has the right to use all of the patents, trademarks, service marks, trade names, copyrights, contractual franchises, authorizations and other similar rights that are reasonably necessary for the operation of its business, without material conflict with the rights of any other Person. b) To Borrower's knowledge, no slogan or other advertising device, product, process, method, substance, part or other material now employed, or now contemplated to be employed, by Borrower materially infringes upon any rights held by any other Person. c) No claim or litigation regarding any of the foregoing is pending or, to Borrower's knowledge, threatened in writing, and no patent, invention, device, application, principle or any statute, law, rule, regulation, standard or code is pending or proposed which, in either case, would reasonably be expected to have a Material Adverse Effect. 3.5 NO CONFLICT. The execution, delivery, and performance by Borrower of all Loan Documents are not in conflict with any law, rule, regulation, order or directive, or any indenture, agreement, or undertaking to which Borrower is a party or by which Borrower may be bound or affected, except for such conflicts as in the aggregate would not have a Material Adverse Effect. 3.6 NO LITIGATION, CLAIMS OR PROCEEDINGS. There is no litigation, tax claim, proceeding or dispute pending, or, to the knowledge of Borrower, threatened in writing against or affecting Borrower or its property. 3.7 CORRECTNESS OF FINANCIAL STATEMENTS. Borrower's financial statements which have been delivered to Lender fairly and accurately reflect Borrower's financial condition as of September 30, 1996; and, since that date there has been no Material Adverse Change. 3.8 NO SUBSIDIARIES. Borrower is not a majority owner of any other business entity, except that Borrower owns all of the outstanding Capital Stock of PDR Productions, Inc., a New York corporation (the "Subsidiary"). 3.9 ENVIRONMENTAL MATTERS. Borrower is in compliance with applicable Environmental Laws, except to the extent a failure to be in such compliance would not reasonably be expected to have a Material Adverse Effect on Borrower's operations, properties or financial condition. 3.10 NO EVENT OF DEFAULT. No Default or Event of Default has occurred and is continuing. 9 13 3.11 FULL DISCLOSURE. None of the representations or warranties made by Borrower in the Loan Documents as of the date such representations and warranties are made or deemed made, and none of the statements contained in any exhibit, report, statement or certificate furnished by or on behalf of Borrower in connection with the Loan Documents (including disclosure materials delivered by or on behalf of Borrower to Lender prior to the Closing Date), contains any untrue statement of a material fact or omits any material fact required to be stated therein or necessary to make the statements made therein, in light of the circumstances under which they are made, not misleading as of the time when made or delivered. ARTICLE 4 - CONDITIONS PRECEDENT 4.1 CONDITIONS TO FIRST LOAN. The obligation of Lender to make its first Loan hereunder is, in addition to the conditions precedent specified in Section 4.2, subject to the fulfillment of the following conditions and to the receipt by Lender of the documents described below, duly executed and in form and substance satisfactory to Lender and its counsel: a) RESOLUTIONS. A certified copy of the resolutions of the Board of Directors of Borrower authorizing the execution, delivery and performance by Borrower of the Loan Documents. b) INCUMBENCY AND SIGNATURES. A certificate of the secretary of Borrower certifying the names of the officer or officers of Borrower authorized to sign the Loan Documents, together with a sample of the true signature of each such officer. c) OPINION OF COUNSEL. The opinion of Wilson, Sonsini, Goodrich & Rosati, counsel for Borrower, together with any opinions, certificates and other matters on which such opinion relies. d) ARTICLES AND BY-LAWS. Certified copies of the Articles of Incorporation and By-Laws of Borrower, as amended through the Closing Date. e) THE AGREEMENT. A counterpart of this Agreement with all schedules completed and attached thereto, and disclosing such information as is acceptable to Lender. f) SECURITY AGREEMENT; FINANCING STATEMENTS. A Security Agreement executed by Borrower, substantially in the form of Exhibit "C", together with filing copies (or other evidenced of filing satisfactory to Lender and its counsel) of such Uniform Commercial Code financing statements, collateral assignments and termination statements, with respect to the Collateral (as defined in such Security Agreement) as Lender shall request. g) LIEN SEARCHES. Uniform Commercial Code lien, judgment, bankruptcy and tax lien searches of Borrower from the California Secretary of State, and such other jurisdictions as Lender may reasonably request, all as of a date reasonably satisfactory to Lender and its counsel. 10 14 h) GOOD STANDING CERTIFICATE. A Certificate of Good Standing as of a date acceptable to Lender with respect to Borrower from the California Secretary of State. i) WARRANT. A warrant issued by Borrower to Lender exercisable for the Warrant Shares, as described in Section 2.11 hereof. 4.2 CONDITIONS TO ALL LOANS. The obligation of Lender to make its initial Loan and each subsequent Loan is subject to the following further conditions precedent that: a) NO DEFAULT. No Default or Event of Default has occurred and is continuing or will result from the making of any such Loan, and the representations and warranties of Borrower contained in Article 3 of this Agreement are true and correct as of the Borrowing Date of such Loan. b) NO ADVERSE MATERIAL CHANGE. No Material Adverse Change shall have occurred since the date of the most recent financial statements submitted to Lender. c) NOTE. Borrower shall have delivered an executed Note evidencing such Loan, in form and substance satisfactory to Lender. d) BORROWING REQUEST. Borrower shall have delivered to Lender a Borrowing Request for such Loan. e) VCOC LIMITATION. The making of the Loan will not result in a violation of the condition applicable to Lender described in Section 2.2. ARTICLE 5 - AFFIRMATIVE COVENANTS During the term of this Agreement and until its performance of all obligations to Lender, Borrower will: 5.1 NOTICE TO LENDER. Upon receipt of notice thereof by an officer of Borrower, promptly give written notice to Lender of: a) Any litigation or administrative or regulatory proceeding to which Borrower is a party where the granting of the relief requested would have a Material Adverse Effect. b) Any substantial dispute which may exist between Borrower or any governmental or regulatory authority. c) The occurrence of any Default or any Event of Default. d) Any change in the location of Borrower's principal executive office of business at least thirty (30) days in advance of such change, or of the establishment of any new, or the discontinuance of any existing, place of business. 11 15 e) Any other matter which has resulted or would reasonably result in a Material Adverse Change. 5.2 FINANCIAL STATEMENTS. Deliver to each Lender or cause to be delivered to Lender, in form and detail satisfactory to Lender the following financial information, which Borrower warrants shall present fairly Borrower's financial condition in all material respects: a) QUARTERLY FINANCIAL STATEMENTS. As soon as available but no later than forty-five (45) days after the end of each month, Borrower's balance sheet as of the end of such period, and Borrower's income statement for such period and for that portion of Borrower's financial reporting year ending with such period, prepared and attested by a responsible financial officer of Borrower as being complete and correct and fairly presenting Borrower's financial condition and the results of Borrower's operations; provided, however, that, so long as Borrower is a Reporting Company, Borrower may satisfy its obligations under this Section 5.2(a) by delivering to Lender promptly after filing with the SEC, copies of Borrower's Quarterly Reports on Form 10-Q (without exhibits) and any amendments thereto. b) YEAR-END FINANCIAL STATEMENTS. As soon as available but no later than one hundred twenty (120) days after and as of the end of each financial reporting year, a complete copy of Borrower's audit report, which shall include balance sheet, income statement, statement of changes in equity and statement of cash flows for such year, prepared and certified by an independent certified public accountant selected by Borrower and satisfactory to Lender (the "Accountant"). The Accountant's certification shall not be qualified or limited due to a restricted or limited examination by the Accountant of any material portion of Borrower's records or otherwise. Notwithstanding the foregoing, so long as Borrower is a Reporting Company, Borrower may satisfy its obligations under this Section 5.2(b) by delivering to Lender promptly after filing with the SEC copies of Borrower's Annual Reports on Form 10-K (without exhibits) and any amendments thereto. c) COMPLIANCE CERTIFICATES. Simultaneously with the delivery of each set of financial statements referred to in paragraphs (a) and (b) above, a certificate of the chief financial officer of Borrower stating whether any Default or Event of Default exists on the date of such certificate, and if so, setting forth the details thereof and the action which Borrower is taking or proposes to take with respect thereto. d) OTHER INFORMATION. Such other statements, lists of property and accounts, budgets, forecasts, reports, or other information as Lender may from time to time reasonably request. 5.3 MANAGERIAL ASSISTANCE FROM LENDER. Solely to permit Lender, as a "venture capital operating company" to participate in, and influence the conduct of management of Borrower through the exercise of "management rights," as such terms are defined in 29 C.F.R. Section 2510.3-101(d), Borrower will: 12 16 a) Permit Lender to make available to Borrower, at no cost to Borrower, "significant managerial assistance", as defined in Section 2(a)(47) of the Investment Company Act of 1940, as amended, either in the form of: (i) consulting arrangements with Lender or any of its officers, directors, employees or affiliates, (ii) Borrower's allowing Lender to provide recommendations of prospective candidates for election to Borrower's Board of Directors, or (iii) Lender, at Borrower's request, seeking the services of third-party consultants to aid Borrower with respect to its management and operations; b) Permit Lender to make available consulting and advisory services to officers of Borrower regarding Borrower's equipment acquisition and financing plans, and such other matters affecting the business, financial condition and prospects of Borrower as Lender shall reasonably deem relevant; and c) If Lender reasonably believes that financial or other developments affecting Borrower have impaired or are likely to impair Borrower's ability to perform its obligations under this Agreement, permit Lender reasonable access to Borrower's management and/or Board of Directors and opportunity to present Lender's views with respect to such developments. 5.4 EXISTENCE. Maintain and preserve Borrower's existence, present form of business, and all rights and privileges necessary or desirable in the normal course of its business; and keep all Borrower's property in good working order and condition, ordinary wear and tear excepted. 5.5 INSURANCE. Obtain and keep in force insurance in such amounts and types as is usual in the type of business conducted by Borrower, with insurance carriers having a policyholder rating of not less than "A" and financial category rating of Class VII in "Best's Insurance Guide," unless otherwise approved by Lender. Such insurance policies must be in form and substance satisfactory to Lender, and shall list Lender as an additional insured or loss payee, as applicable, on endorsement(s) in form reasonably acceptable to Lender. Borrower shall furnish to Lender such endorsements, and upon Lender's request, copies of any or all such policies. 5.6 ACCOUNTING RECORDS. Maintain adequate books, accounts and records, and prepare all financial statements delivered to Lender pursuant to Section 5.2 in accordance with GAAP, and in compliance with the regulations of any governmental or regulatory authority having jurisdiction over Borrower or Borrower's business; and permit employees or agents of Lender at such reasonable times as Lender may request, at Borrower's expense, to inspect Borrower's properties, and to examine, and make copies and memoranda of Borrower's books, accounts and records. 5.7 COMPLIANCE WITH LAWS. Comply with all laws (including Environmental Laws), rules, regulations applicable to, and all orders and directives of any governmental or regulatory authority having jurisdiction over, Borrower or Borrower's business, and with all material agreements to which Borrower is a party, except where the failure to so comply would not have a Material Adverse Effect. 13 17 5.8 TAXES AND OTHER LIABILITIES. Except as may be contested in good faith by the appropriate procedures and for which Borrower shall maintain appropriate reserves under GAAP, (i) pay all Borrower's material obligations when due (ii) pay all material taxes and other governmental or regulatory assessments before delinquency or before any penalty attaches thereto, Pay all Borrower's material obligations when due; (iii) timely file all required tax returns, except where the failure to file the same, singly or in the aggregate, would not result in a Material Adverse Change. 5.9 USE OF PROCEEDS. Use the proceeds of Loans only as set forth in Article 2 of this Agreement; and not directly or indirectly to purchase or carry any margin stock, as defined from time to time by the Board of Governors of the Federal Reserve System in Federal Regulation U. 5.10 LOCATIONS OF COLLATERAL. Not later than June 15 and December 15 of each year during the term of this Agreement, Borrower shall deliver to Lender a list of the location of each item of Equipment (as defined in the Security Agreement) as of June 1 and December 1, respectively, of such year. ARTICLE 6 - NEGATIVE COVENANTS During the term of this Agreement and until the performance of all obligations to Lender, Borrower will not without Lenders approval (i) sell, transfer, lease or otherwise dispose of all substantially all of Borrower's assets, or (ii) enter into any merger unless Borrower is the surviving corporation thereof, or (iii) liquidate or dissolve. ARTICLE 7 - EVENTS OF DEFAULT 7.1 EVENTS OF DEFAULT. Upon the occurrence and during the continuation of any Default, the obligation of Lender to make any additional Loan shall be suspended. The occurrence of any of the following shall terminate any obligation of Lender to make any additional Loan; and shall, at the option of Lender (1) make all sums of Basic Interest and principal, all Terminal Payments, and any other amounts owing under any Loan Documents immediately due and payable without notice of default, presentment or demand for payment, protest or notice of nonpayment or dishonor or any other notices or demands, and (2) give Lender the right to exercise any other right or remedy provided by contract or applicable law: a) Borrower shall fail to pay any principal, interest or Terminal Payment under this Agreement, or fail to pay any fees or other charges when due under any Loan Document, and such failure continues for five (5) Business Days or more after Borrower's receipt of notice from Lender that the same has become due; or an Event of Default as defined in any other Loan Document shall have occurred. b) Any representation or warranty made, or financial statement, certificate or other document provided, by Borrower under any Loan Document shall be determined by a court of competent jurisdiction to have been false or misleading in any material respect when made or deemed made herein. 14 18 c) Borrower shall fail to pay its debts generally as they become due or shall commence any Insolvency Proceeding with respect to itself; an involuntary Insolvency Proceeding shall be filed against Borrower, or a custodian, receiver, trustee, assignee for the benefit of creditors, or other similar official, shall be appointed to take possession, custody or control of the properties of Borrower, and such involuntary Insolvency Proceeding, petition or appointment is acquiesced to by Borrower or is not dismissed within ninety (90) days; or the dissolution or termination of the business of Borrower. d) Borrower shall be in default beyond any applicable period of grace or cure under any other agreement involving the borrowing of money, the purchase of property, the advance of credit or any other monetary liability of any kind to Lender or to any Person which results in the acceleration of payment of such obligation in an amount in excess of Five Hundred Thousand Dollars ($500,000). e) Any governmental or regulatory authority shall take any judicial or administrative action, or any defined benefit pension plan maintained by Borrower shall have any unfunded liabilities, any of which, in the reasonable judgment of Lender, would have a Material Adverse Effect. f) Any sale, transfer or other disposition of all or a substantial or material part of the assets of Borrower, including without limitation to any trust or similar entity, shall occur. g) Any judgment(s) singly or in the aggregate in excess of Five Hundred Thousand Dollars ($500,000) shall be entered against Borrower which remain unsatisfied, unvacated or unstayed pending appeal for thirty (30) or more days after entry thereof. h) Borrower shall fail to perform or observe any covenant contained in Article 6 of this Agreement. i) Borrower shall fail to perform or observe any covenant contained in this Agreement or any other Loan Document (other than a covenant which is dealt with specifically elsewhere in this Article 7) and the breach of such covenant is not cured within 30 days after the sooner to occur of Borrower's receipt of notice of such breach from Lender or the date on which such breach first becomes known to any officer of Borrower; provided, however that if such breach is not capable of being cured within such 30-day period and Borrower timely notifies Lender of such fact and Borrower diligently pursues such cure, then the cure period shall be extended to the date requested in Borrower's notice but in no event more than 90 days from the initial breach; provided, further, that such additional 60-day opportunity to cure shall not apply in the case of any failure to perform or observe any covenant which has been the subject of a prior failure within the preceding 180 days or which is a willful and knowing breach by Borrower. ARTICLE 8 - GENERAL PROVISIONS 15 19 8.1 NOTICES. Any notice given by any party under any Loan Document shall be in writing and personally delivered, sent by overnight courier, or United States mail, postage prepaid, or sent by facsimile, to be promptly confirmed in writing, or other authenticated message, charges prepaid, to the other party's or parties' addresses shown on the signature pages hereto. Each party may change the address or facsimile number to which notices, requests and other communications are to be sent by giving written notice of such change to each other party. Notice given by hand delivery shall be deemed received on the date delivered; if sent by overnight courier, on the next business day after delivery to the courier service; if by first class mail, on the third business day after deposit in the U.S. Mail; and if by telecopy, on the date of transmission. 8.2 BINDING EFFECT. The Loan Documents shall be binding upon and inure to the benefit of Borrower and Lender and their respective successors and assigns; provided, however, that Borrower may not assign or transfer Borrower's rights or obligations under any Loan Document without Lender's prior written consent. Lender reserves the right to sell, assign, transfer, negotiate or grant participations in all or any part of, or any interest in, Lender's rights and obligations under the Loan Documents. In connection with any of the foregoing, Lender may disclose all documents and information which Lender now or hereafter may have relating to the Loans, Borrower, or its business; provided that any person who receives such information shall have agreed in writing in advance to maintain the confidentiality of such information on terms reasonably acceptable to Borrower. 8.3 NO WAIVER. Any waiver, consent or approval by Lender of any Event of Default or breach of any provision, condition, or covenant of any Loan Document must be in writing and shall be effective only to the extent set forth in writing. No waiver of any breach or default shall be deemed a waiver of any later breach or default of the same or any other provision of any Loan Document. No failure or delay on the part of Lender in exercising any power, right, or privilege under any Loan Document shall operate as a waiver thereof, and no single or partial exercise of any such power, right, or privilege shall preclude any further exercise thereof or the exercise of any other power, right or privilege. Lender has the right at its sole option to continue to accept interest and/or principal payments due under the Loan Documents after default, and such acceptance shall not constitute a waiver of said default or an extension of the Maturity Date unless Lender agrees otherwise in writing. 8.4 RIGHTS CUMULATIVE. All rights and remedies existing under the Loan Documents are cumulative to, and not exclusive of, any other rights or remedies available under contract or applicable law. 8.5 UNENFORCEABLE PROVISIONS. Any provision of any Loan Document executed by Borrower which is prohibited or unenforceable in any jurisdiction, shall be so only as to such jurisdiction and only to the extent of such prohibition or unenforceability, but all the remaining provisions of any such Loan Document shall remain valid and enforceable. 8.6 ACCOUNTING TERMS. Except as otherwise provided in this Agreement, accounting terms and financial covenants shall be determined in accordance with GAAP. 16 20 8.7 INDEMNIFICATION; EXCULPATION. Borrower shall pay and protect, defend and indemnify Lender and Lender's employees, officers, directors, shareholders, affiliates, correspondents, agents and representatives (other than Lender, collectively "Agents") against, and hold Lender and each such Agent harmless from, all claims, actions, proceedings, liabilities, damages, losses, expenses (including, without limitation, reasonable attorneys' fees and costs) and other amounts incurred by Lender and each such Agent, arising from (i) the matters contemplated by this Agreement or any other Loan Documents or (ii) any contention that Borrower has failed to comply with any law, rule, regulation, order or directive applicable to Borrower's business; PROVIDED, HOWEVER, that this indemnification shall not apply to any of the foregoing incurred principally as the result of Lender's or any Agent's gross negligence or willful misconduct. This indemnification shall survive the payment and satisfaction of all of Borrower's Obligations to Lender. 8.8 REIMBURSEMENT. Borrower shall reimburse Lender for all costs and expenses, including without limitation reasonable attorneys' fees and disbursements expended or incurred by Lender in any arbitration, mediation, judicial reference, legal action or otherwise in connection with (a) the preparation and negotiation of the Loan Documents, including without limitation during any workout, attempted workout, and/or in connection with the rendering of legal advice as to Lender's rights, remedies and obligations under the Loan Documents, (b) collecting any sum which becomes due Lender under any Loan Document, (c) any proceeding for declaratory relief, any counterclaim to any proceeding, or any appeal, or (d) the protection, preservation or enforcement of any rights of Lender. For the purposes of this section, attorneys' fees shall include, without limitation, fees incurred in connection with the following: (1) contempt proceedings; (2) discovery; (3) any motion, proceeding or other activity of any kind in connection with an Insolvency Proceeding; (4) garnishment, levy, and debtor and third party examinations; and (5) postjudgment motions and proceedings of any kind, including without limitation any activity taken to collect or enforce any judgment. All of the foregoing costs and expenses shall be payable upon demand by Lender, and if not paid within forty-five (45) days of presentation of invoices shall bear interest at the highest applicable Default Rate. 8.9 EXECUTION IN COUNTERPARTS. This Agreement may be executed in any number of counterparts which, when taken together, shall constitute but one agreement. 8.10 ENTIRE AGREEMENT. The Loan Documents are intended by the parties as the final expression of their agreement and therefore contain the entire agreement between the parties and supersede all prior understandings or agreements concerning the subject matter hereof. This Agreement may be amended only in a writing signed by Borrower and Lender. 8.11 GOVERNING LAW AND JURISDICTION. a) THIS AGREEMENT AND THE LOAN DOCUMENTS SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE INTERNAL LAWS OF THE STATE OF CALIFORNIA. 17 21 b) ANY LEGAL ACTION OR PROCEEDING WITH RESPECT TO THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT SHALL BE BROUGHT IN THE COURTS OF THE STATE OF CALIFORNIA OR OF THE UNITED STATES FOR THE NORTHERN DISTRICT OF CALIFORNIA, AND BY EXECUTION AND DELIVERY OF THIS AGREEMENT, EACH OF BORROWER AND LENDER CONSENTS, FOR ITSELF AND IN RESPECT OF ITS PROPERTY, TO THE NON-EXCLUSIVE JURISDICTION OF THOSE COURTS. EACH OF BORROWER AND LENDER IRREVOCABLY WAIVES ANY OBJECTION, INCLUDING ANY OBJECTION TO THE LAYING OF VENUE OR BASED ON THE GROUNDS OF FORUM NON CONVENIENS, WHICH IT MAY NOW OR HEREAFTER HAVE TO THE BRINGING OF ANY ACTION OR PROCEEDING IN SUCH JURISDICTION IN RESPECT OF THIS AGREEMENT OR ANY DOCUMENT RELATED HERETO. BORROWER AND LENDER EACH WAIVE PERSONAL SERVICE OF ANY SUMMONS, COMPLAINT OR OTHER PROCESS, WHICH MAY BE MADE BY ANY OTHER MEANS PERMITTED BY CALIFORNIA LAW. 8.12 WAIVER OF JURY TRIAL. BORROWER AND LENDER EACH WAIVES ITS RESPECTIVE RIGHTS TO A TRIAL BY JURY OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF OR RELATED TO THIS AGREEMENT, THE OTHER LOAN DOCUMENTS, OR THE TRANSACTIONS CONTEMPLATED HEREBY OR THEREBY, IN ANY ACTION, PROCEEDING OR OTHER LITIGATION OF ANY TYPE BROUGHT BY ANY OF THE PARTIES AGAINST ANY OTHER PARTY OR ANY PARTICIPANT OR ASSIGNEE, WHETHER WITH RESPECT TO CONTRACT CLAIMS, TORT CLAIMS, OR OTHERWISE. BORROWER AND LENDER EACH AGREES THAT ANY SUCH CLAIM OR CAUSE OF ACTION SHALL BE TRIED BY A COURT TRIAL WITHOUT A JURY. WITHOUT LIMITING THE FOREGOING, THE PARTIES FURTHER AGREE THAT THEIR RESPECTIVE RIGHT TO A TRIAL BY JURY IS WAIVED BY OPERATION OF THIS SECTION AS TO ANY ACTION, COUNTERCLAIM OR OTHER PROCEEDING WHICH SEEMS, IN WHOLE OR IN PART, TO CHALLENGE THE VALIDITY OR ENFORCEABILITY OF THIS AGREEMENT OR THE OTHER LOAN DOCUMENTS OR ANY PROVISION HEREOF OR THEREOF. THIS WAIVER SHALL APPLY TO ANY SUBSEQUENT AMENDMENTS, RENEWALS, SUPPLEMENTS OR MODIFICATIONS TO THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS. IN WITNESS WHEREOF, Borrower and Lender have executed this Agreement as of the date set forth in the preamble. ADDRESSES FOR NOTICES: DIGITAL GENERATION SYSTEMS, INC. 875 Battery Street San Francisco, CA 94111 By: /s/ THOMAS P. SHANAHAN Attn: Thomas P. Shanahan -------------------------------- Fax No.: 415-276-6601 Name: Thomas P. Shanahan Its: Chief Financial Officer Venture Lending & Leasing, Inc. VENTURE LENDING & LEASING, INC. 2010 North First Street, Suite 310 San Jose, CA 95131 Attn: Salvador O. Gutierrez By: /s/ SALVADOR O. GUTIERREZ President -------------------------------- Fax No. 408-436-8625 Name: Salvador O. Gutierrez Its: President 18 22 EXHIBIT "A" [Note No. X-XXX] FORM OF PROMISSORY NOTE $____________________ ____________________, 199___ San Jose, California The undersigned ("Borrower") promises to pay to the order of VENTURE LENDING & LEASING, INC., a Maryland corporation ("Lender") at its office at 2010 North First Street, Suite 310, San Jose, California 95131, or at such other place as Lender may designate in writing, in lawful money of the United States of America, the principal sum of _________ Dollars ($__________), with Basic Interest thereon from the date hereof until maturity, whether scheduled or accelerated, at a fixed rate per annum of ten percent (10%), and a Terminal Payment in the sum of _____ [15% of face amount] Dollars ($__________) payable on the Maturity Date. This Note is one of the Notes referred to in, and is entitled to all the benefits and subject to all of the provisions of, a Loan Agreement dated January 28, 1997, between Borrower and Lender. Each capitalized term not otherwise defined herein shall have the meaning set forth in the Loan Agreement. The Loan Agreement contains provisions for the acceleration of the maturity of this Note upon the happening of certain stated events. Principal of and interest on this Note shall be payable as follows: On the Borrowing Date, Borrower shall pay (i) Basic Interest, in advance, on the outstanding principal balance of this Note at the Designated Rate for the period from the Borrowing Date through [THE LAST DAY OF THE SAME MONTH]; and (ii) a first (1st) and last (36th) amortization installment of principal and Basic Interest in the amount of _________________, in advance for the months of [ first and last full month after Borrowing Date ]. Commencing on the first day of the second full month after the Borrowing Date, and continuing on the first day of each consecutive month thereafter, principal and Basic Interest shall be payable, in advance, in thirty-four (34) equal consecutive installments of _________ Dollars ($__________) each, with a thirty-sixth (36th) installment equal to the entire unpaid principal balance and accrued Basic Interest thereon on _______________, 200_. The Terminal Payment amount shall be payable on [ONE MONTH LATER], 200_. Any unpaid payments of principal or interest on this Note shall bear interest from their respective maturities, whether scheduled or accelerated, at a rate per annum equal to the Default Rate. Borrower shall pay such interest on demand. 23 Interest, charges and fees shall be calculated for actual days elapsed on the basis of a 360-day year, which results in higher interest, charge or fee payments than if a 365-day year were used. In no event shall Borrower be obligated to pay interest, charges or fees at a rate in excess of the highest rate permitted by applicable law from time to time in effect. This Note shall be governed by, and construed in accordance with, the internal laws of the State of California. DIGITAL GENERATION SYSTEMS, INC. By:________________________________ Name: _____________________________ Its: ______________________________ 24 Exhibit "B" BORROWER REQUEST ____________, 1997 Venture Lending & Leasing, Inc. 2010 North First Street, Suite 310 San Jose, CA 95131 RE: DIGITAL GENERATION SYSTEMS, INC. Gentlemen: Reference is made to the Loan Agreement dated as of January 28, 1997 (as it has been and may be amended from time to time, the "Loan Agreement", the capitalized terms used herein as defined therein), between Venture Lending & Leasing, Inc. and Digital Generation Systems, Inc. (the "Company"). The undersigned is the Chief Financial Officer of the Company, and hereby requests a Loan under the Loan Agreement, and in that connection certifies as follows: 1. The amount of the proposed Loan is $____________. The Business Day of the proposed Loan is _____ ___ 1997. 2. As of this date, no Default or Event of Default has occurred and is continuing, or will result from the making of the proposed Loan, and the representations and warranties of the Company contained in Article 3 of the Loan Agreement are true and correct. 3. No Material Adverse Change has occurred since the date of the most recent financial statements submitted to you by the Company. The Company agrees to notify you promptly before the funding of the Loan if any of the matters to which I have certified above shall not be true and correct on the Borrowing Date. Very Truly Yours, ------------------------- Chief Financial Officer 25 Exhibit "C" SECURITY AGREEMENT (EQUIPMENT) This Agreement is made as of January 28, 1997, by DIGITAL GENERATION SYSTEMS, INC. a California corporation ("Debtor") in favor of VENTURE LENDING & LEASING, INC., a Maryland corporation ("Secured Party"). ARTICLE 1 - DEFINITIONS The following definitions shall be applicable to both the singular and plural forms of the defined terms: "AGREEMENT" means this Security Agreement, as it may be amended from time to time. "COLLATERAL" means all Debtor's Equipment and Fixtures now owned or hereafter acquired, wherever located, and whether held by Debtor or any third party, and all proceeds and products thereof, including all insurance and condemnation proceeds ("Proceeds"), and all monies now or at any time hereafter in the possession or under the control of Secured Party or a bailee or affiliate of Secured Party, including any cash collateral in any cash collateral or other account, and all Records relating or useful to, or used in connection with any of the foregoing. "EQUIPMENT" means all of Debtor's specific equipment identified and described on Schedule 1 attached to this Agreement and incorporated herein by reference (as such Schedule may be amended or supplemented from time to time), all replacements, parts, accessions and additions thereto, and all proceeds thereof arising from the sale, lease, rental or other use or disposition thereof, including all rights to payment with respect to insurance or condemnation, returned premiums, or any cause of action relating to any of the foregoing. "EVENT OF DEFAULT" means an event described in Article 6. "FIXTURES" means all items of Equipment that are so related to the real property upon which they are located that an interest in them arises under real property law, and all proceeds thereof arising from the sale, lease, rental or other use or disposition thereof. "INDEBTEDNESS" means all debts, obligations and liabilities of Debtor to Secured Party currently existing or now or hereafter made, incurred or created, whether pursuant to the Loan Documents, whether voluntary or involuntary and however arising or evidenced, whether direct or acquired by Secured Party by assignment or succession, whether due or not due, absolute or contingent, liquidated or unliquidated, determined or undetermined, and whether Debtor may be liable individually or jointly, or whether recovery upon such debt may be or become barred by any statute of limitations or otherwise unenforceable and all renewals, extensions and modifications thereof, and all attorneys' fees and costs incurred by Secured Party in connection with the collection and enforcement thereof. 26 "LIEN" means with respect to an item of property, any voluntary or involuntary security interest, mortgage, pledge, claim, charge, encumbrance, title retention agreement, or third party interest covering all or any part of such property. "LOAN AGREEMENT" means that certain Loan Agreement between Debtor and Secured Party of even date herewith, as amended from time to time. "PERSON" means any individual or entity. "PERMITTED LIEN" means a) involuntary Liens which, in the aggregate, would not have a Material Adverse Effect and which in any event would not exceed Three-Hundred Thousand Dollars ($300,000); b) Liens for current taxes or other governmental or regulatory assessments which are not delinquent, or which are contested in good faith by the appropriate procedures and for which appropriate reserves are maintained; c) purchase money security interests on any property held or acquired by Borrower in the ordinary course of business securing Indebtedness incurred or assumed for the purpose of financing all or any part of the cost of acquiring such property; provided, that such Lien attaches solely to the property acquired with such Indebtedness and that the principal amount of such Indebtedness does not exceed one hundred percent (100%) of the cost of such property; and further provided, that such property is not equipment with respect to which a Loan has been made hereunder. d) Liens in favor of Lender; e) bankers' liens, rights of setoff and similar Liens incurred on deposits made in the ordinary course of business; f) materialmen's, mechanics', repairmen's, employees' or other like Liens arising in the ordinary course of business and which are not delinquent for more than 45 days or are being contested in good faith by appropriate proceedings; g) any judgment, attachment or similar Lien, unless the judgment it secures has not been discharged or execution thereof effectively stayed and bonded against pending appeal within 30 days of the entry thereof; and h) Liens which have been approved by Lender prior to the Closing Date and disclosed on Schedule 6.2 to this Agreement. "RECORDS" means all Debtor's computer programs, software, hardware, source codes and data processing information, all written documents, books, invoices, ledger sheets, financial information and statements, and all other writings concerning Debtor's business. "UNIFORM COMMERCIAL CODE" means the California Uniform Commercial Code, as amended from time to time. 2 27 Terms not specifically defined in this Agreement have the meanings prescribed in the Loan Agreement, and if not defined therein then the meanings prescribed in the Uniform Commercial Code. ARTICLE 2 - GRANT OF SECURITY INTEREST To secure the timely payment of the Indebtedness and performance of all obligations of Debtor to Secured Party arising under the Loan Documents (as defined in the Loan Agreement), Debtor grants to Secured Party a security interest in the Collateral. ARTICLE 3 - REPRESENTATIONS AND WARRANTIES Debtor represents and warrants that, at all times during the term of this Agreement: 3.1 GOVERNMENTAL ACTIONS. Debtor has obtained all consents and actions of, and has performed all filings with, any governmental or regulatory authority required to authorize the execution, delivery or performance of this Agreement, except for such consents, acting and filings, the absence of which would not result in a Material Adverse Change. Debtor has, at the time Lender makes a Loan with respect to an item of equipment in accordance with Section 2.2 of the Loan Agreement, and at all times thereafter while such Loan is outstanding, obtained all consents and actions of, and has performed all filings with, any governmental or regulatory authority required on the part of the debtor to grant and perfect Secured Party's security interest in any Collateral acquired with the proceeds of such Loan. 3.2 TITLE. Debtor is and will be the unconditional legal and beneficial owner of the Collateral. The Collateral is subject to no Liens, rights or defenses of others, except Permitted Liens. 3.3 CHIEF EXECUTIVE OFFICE. Debtor's chief executive office is located at: 875 Battery Street San Francisco, CA 94111 3.4 RECORDS LOCATION. Other than as set forth in Section 3.3, Records are maintained at: 875 Battery Street San Francisco, CA 94111 3.5 EQUIPMENT OR FIXTURES LOCATION. Other than as set forth in Section 3.3, Equipment or Fixtures are located at: to be designated by Company 3 28 3.6 OTHER PLACES OF BUSINESS. In addition to the locations set forth in Sections 3.3 through 3.5, Debtor maintains the following place(s) of business: to be designated by Company 3.7 BUSINESS NAMES. Debtor has conducted business in the following names other than as stated in the preamble to this Agreement: ARTICLE 4 - AFFIRMATIVE COVENANTS During the term of this Agreement and until payment of all the Indebtedness and performance of all obligations to Secured Party that are secured by this Agreement, Debtor will, unless Secured Party otherwise consents in writing: 4.1 DELIVERY OF CERTAIN ITEMS. Deliver to Secured Party promptly (a) after an Event of Default, all Proceeds; (b) such specific acknowledgments, assignments or other agreements as Secured Party may reasonably request relating to the Collateral; and (c) copies of such Records and other reports in such form and detail and at such times as Secured Party may reasonably require relating to the Collateral. 4.2 MAINTENANCE OF COLLATERAL; INSPECTION. Do all things necessary to maintain, preserve, protect and keep all Collateral in good working order and saleable condition, dealing with the Collateral in all ways as are considered good practice by owners of like property, and use the Collateral lawfully and only as permitted by Debtor's insurance policies. Debtor hereby authorizes Secured Party's officers, employees, representatives and agents, upon reasonable notice, at reasonable times and with reasonable frequency, to inspect the Collateral and to discuss the Collateral and the Records relating thereto with Debtor's officers. 4.3 MAINTENANCE OF RECORDS; INSPECTION. Maintain, or cause to be maintained, complete and accurate Records relating to the Collateral. Secured Party, its officers, employees, agents and representatives, upon reasonable notice, shall have the right, from time to time, to examine the Records relating to the Collateral and to make copies or extracts therefrom. 4.4 DEBTOR'S DUTY TO GIVE NOTICE. Give prompt notice to Secured Party of: (a) any decrease in the value of any Collateral and the amount of such decrease (other than depreciation calculated in the ordinary course of business under applicable tax laws and regulations and in accordance with generally accepted accounting principles); (b) any threatened or asserted dispute or claim with respect to the Collateral; (c) any litigation or administrative or regulatory proceeding which is reasonably likely to have a Material Adverse Effect on Debtor or its business; (d) any change in ownership of any property on which any Collateral is located; (e) the relocation of or intent to relocate any Collateral to a location not listed in Sections 3.3 through 3.6 hereof; and (f) the occurrence of any Event of Default or of any 4 29 other development, financial or otherwise, which is reasonably likely to materially adversely affect the Collateral or Debtor's ability to pay the Indebtedness or perform its obligations to Secured Party. 4.5 FINANCING STATEMENTS AND OTHER ACTIONS. Execute and deliver to Secured Party, and file or record at Debtor's expense all financing statements, notices and other documents from time to time requested by Secured Party to maintain a first perfected security interest in the Collateral in favor of Secured Party, all in form and substance satisfactory to Secured Party, perform such other acts and execute and deliver to Secured Party such additional conveyances, assignments, agreements and instruments, as Secured Party may at any time reasonably request in connection with the administration and enforcement of this Agreement or Secured Party's rights, powers and remedies hereunder; provided, however, that Debtor liability for such expenses shall be limited to no more than $7,000 per calendar year and shall be payable against Secured Party's presentation of receipts for such expense. 4.6 DECALS, MARKINGS. At the request of Secured Party, firmly affix a decal, stencil or other marking to designated items of Collateral, indicating thereon the security interest of Secured Party. 4.7 AGREEMENT WITH REAL PROPERTY OWNER/LANDLORD. At the request of Secured Party, use Debtor's commercially reasonable efforts to obtain and maintain such acknowledgments, consents, waivers and agreements from the owner, lienholder, mortgagee and landlord with respect to any real property on which Collateral is located as Secured Party may require, all in form and substance reasonably satisfactory to Secured Party. ARTICLE 5 - NEGATIVE COVENANTS During the term of this Agreement and until payment of all the Indebtedness and performance of all obligations to Secured Party, Debtor will not, without Secured Party's prior written consent: 5.1 LIENS. Create, incur, assume or permit to exist any Lien on any Collateral, except Permitted Liens. 5.2 DOCUMENTS OF TITLE. Sign or authorize the signing of any financing statement or other document naming Debtor as debtor or obligor, except those which do not relate to the Collateral or which, with respect to the Collateral are permitted under the Loan Documents (as defined in the Loan Agreement), or acquiesce or cooperate in the issuance of any warehouse receipt or other document of title with respect to any Collateral, except those negotiated to Secured Party or those naming Secured Party as secured party. 5.3 DISPOSITION OF COLLATERAL. Sell, transfer, lease or otherwise dispose of any Collateral. 5.4 CHANGE IN LOCATION, NAME, LEGAL STRUCTURE. If and to the extent the same would in any manner impair the creation, perfection or priority of Secured Party's security interest in the Collateral, (a) maintain items of Collateral, Records, its chief executive office or residence, or a place of business at a location other than as specified in Article 3; or (b) change its 5 30 name, mailing address, the nature of its business, or its legal structure. ARTICLE 6 - EVENTS OF DEFAULT 6.1 EVENTS OF DEFAULT. The occurrence of any "Event of Default" as defined in the Loan Agreement shall constitute an Event of Default hereunder. (a) Any failure by Debtor to perform any of its duties or obligations under this Agreement, or breach by Debtor of any of its representations herein, if such failure or breach continues for 45 days or more after Debtor's receipt of notice of such failure or breach. 6.2 ACCELERATION AND REMEDIES. Upon the occurrence and during the continuance of any Event of Default, Secured Party shall be entitled to, at Secured Party's option, (a) declare all or any part of the Indebtedness immediately due and payable; (b) exercise any or all of the rights and remedies available to a secured party under the Uniform Commercial Code or any other applicable law; and (c) exercise any or all of Secured Party's rights and remedies provided for in this Agreement and in any other Loan Document. The obligations of Debtor under this Agreement shall continue to be effective or be reinstated, as the case may be, if at any time any payment of any Indebtedness is rescinded or must otherwise be returned by Secured Party upon, on account of, or in connection with, the insolvency, bankruptcy or reorganization of Debtor, or otherwise, all as though such payment had not been made. 6.3 SALE OF COLLATERAL. After the occurrence and during the continuance of an Event of Default, Secured Party may sell all or any part of the Collateral, at public or private sales, to itself, a wholesaler, retailer or investor, for cash, upon credit or for future delivery, and at such price or prices as Secured Party may deem commercially reasonable. To the extent permitted by law, Debtor hereby specifically waives all rights of redemption and any rights of stay or appraisal which it has or may have under any applicable law in effect from time to time. Any such public or private sales shall be held at such times and at such place(s) as Secured Party may determine. In case of the sale of all or any part of the Collateral on credit or for future delivery, the Collateral so sold may be retained by Secured Party until the selling price is paid by the purchaser, but Secured Party shall not incur any liability in case of the failure of such purchaser to pay for the Collateral and, in case of any such failure, such Collateral may be resold. Secured Party may, instead of exercising its power of sale, proceed to enforce its security interest in the Collateral by seeking a judgment or decree of a court of competent jurisdiction. 6.4 DEBTOR'S OBLIGATION UPON DEFAULT. Upon the request of Secured Party after the occurrence of an Event of Default Debtor will: (a) Assemble and make available to Secured Party the Collateral at such place(s) as Secured Party shall designate, segregating all Collateral so that each item is capable of identification; and (b) Subject to rights of any previous lessor, permit Secured Party, by Secured Party's officers, employees, agents and representatives, to 6 31 enter any premises where any Collateral is located, to take possession of the Collateral and to remove the Collateral or to conduct any public or private sale of the Collateral, all without any liability of Secured Party for rent or other compensation for the use of Debtor's premises. ARTICLE 7 - SPECIAL COLLATERAL PROVISIONS 7.1 PERFORMANCE OF DEBTOR'S OBLIGATIONS. Without having any obligation to do so, upon reasonable prior notice to Debtor, Secured Party may perform or pay any obligation which Debtor has agreed to perform or pay under this Agreement, including, without limitation, the payment or discharge of taxes or Liens levied or placed on or threatened against the Collateral. In so performing or paying, Secured Party shall determine the action to be taken and the amount necessary to discharge such obligations. Debtor shall reimburse Secured Party on demand for any amounts paid by Secured Party pursuant to this Section, which amounts shall constitute Indebtedness secured by the Collateral and shall bear interest from the date of demand at the rate applicable to overdue payments under the Loan Agreement. 7.2 POWER OF ATTORNEY. For the purpose of protecting, preserving and enforcing the Collateral and Secured Party's rights under this Agreement, Debtor hereby irrevocably appoints Secured Party, with full power of substitution, as its attorney-in-fact with full power and authority to do any act which Debtor is obligated to do, or Secured Party has the right to do, hereunder; upon the occurrence and during the continuance of an Event of Default, to enter Debtor's premises; to give notice of Secured Party's security interest in and to collect the Collateral and the Proceeds; and to execute and file in Debtor's name any financing statements, amendments and continuation statements necessary or desirable to perfect or continue the perfection of Secured Party's security interests in the Collateral. Debtor hereby ratifies all that Secured Party shall lawfully do or cause to be done by virtue of this appointment. 7.3 AUTHORIZATION FOR SECURED PARTY TO TAKE CERTAIN ACTION. The power of attorney created in Section 7.2 is a power coupled with an interest and shall be irrevocable. The powers conferred on Secured Party hereunder shall be exercised solely to protect its interests in the Collateral and shall not impose any duty upon Secured Party to exercise such powers. Secured Party shall be accountable only for amounts that it actually receives as a result of the exercise of such powers and in no event shall Secured Party or any of its directors, officers, employees, agents or representatives be responsible to Debtor for any act or failure to act, except for gross negligence or willful misconduct. Secured Party may exercise this power of attorney without notice to or assent of Debtor, in the name of Debtor, or in Secured Party's own name, from time to time in Secured Party's sole discretion and at Debtor's expense. To further carry out the terms of this Agreement, Secured Party may upon the occurrence and during the continuance of an Event of Default: (a) Execute any statements or documents to take possession of, and endorse and collect and receive delivery or payment of, any checks, drafts, notes, acceptances or other instruments and documents constituting the payment of amounts due and to become due or any performance to be rendered with respect to the Collateral. 7 32 (b) Sign and endorse any invoices, freight or express bills, bills of lading, storage or warehouse receipts, drafts, certificates and statements under any commercial or standby letter of credit, assignments, leases, bills of sale, or any other documents relating to the Collateral, including without limitation the Records. (c) Use or operate Collateral or any other property of Debtor for the purpose of preserving or liquidating Collateral. (d) File any claim or take any other action or proceeding in any court of law or equity or as otherwise deemed appropriate by Secured Party for the purpose of collecting any and all monies due or securing any performance to be rendered with respect to the Collateral. (e) Commence, prosecute or defend any suits, actions or proceedings or as otherwise deemed appropriate by Secured Party for the purpose of protecting or collecting the Collateral. In furtherance of this right, upon the occurrence and during the continuance of an Event of Default Secured Party may apply for the appointment of a receiver or similar official to operate Debtor's business. (f) Prepare, adjust, execute, deliver and receive payment under insurance claims, and collect and receive payment of and endorse any instrument in payment of loss or returned premiums or any other insurance refund or return, and apply such amounts, at Secured Party's sole discretion, toward repayment of the Indebtedness or replacement of the Collateral. 7.4 APPLICATION OF PROCEEDS. Any Proceeds and other monies or property received by Secured Party pursuant to the terms of this Agreement or any other Loan Document may be applied by Secured Party first to the payment of expenses of collection, including without limitation to reasonable attorneys' fees, and then to the payment of the Indebtedness in such order of application as Secured Party may elect. 7.5 DEFICIENCY. If the proceeds of any sale of the Collateral are insufficient to cover all costs and expenses of such sale and the payment in full of all Indebtedness, plus all other sums required to be expended or distributed by Secured Party, then Debtor shall be liable for any such deficiency. 7.6 SECURED PARTY TRANSFER. Upon the transfer of all or any part of the Indebtedness, Secured Party may transfer all or any part of its interest in the Collateral and shall be fully discharged thereafter from all liability and responsibility with respect to such interest in the Collateral so transferred, and the transferee shall be vested with all the rights and powers of Secured Party hereunder with respect to such interest in the Collateral so transferred. ARTICLE 8 - GENERAL PROVISIONS 8.1 NOTICES. Any notice given by any party under this Agreement shall be given in the manner prescribed in the Loan Agreement. 8 33 8.2 BINDING EFFECT. This Agreement shall be binding upon Debtor, its permitted successors, representatives and assigns, and shall inure to the benefit of Secured Party and its successors, representatives and assigns. 8.3 RIGHTS CUMULATIVE. All rights and remedies existing under this Agreement are cumulative to, and not exclusive of, any other rights or remedies available under contract or applicable law. 8.4 UNENFORCEABLE PROVISIONS. Any provision of this Agreement which is prohibited or unenforceable in any jurisdiction shall be so only as to such jurisdiction and only to the extent of such prohibition or unenforceability, but all the remaining provisions of this Agreement shall remain valid and enforceable. 8.5 GOVERNING LAW, WAIVER OF NOTICE. Except as may be otherwise provided by the Uniform Commercial Code, this Agreement shall be governed by and construed in accordance with the internal laws of the State of California. 8.6 ENTIRE AGREEMENT. This Agreement, together with the other Loan Documents, is intended by Debtor and Secured Party as the final expression of Debtor's obligations to Secured Party in connection with the Collateral and supersedes all prior understandings or agreements concerning the subject matter hereof. This Agreement may be amended only by a writing signed by Debtor and accepted by Secured Party in writing. 9 34 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date set forth in the preamble. DIGITAL GENERATION SYSTEMS, INC. VENTURE LENDING & LEASING, INC. By: ________________________ Thomas P. Shanahan By: _______________________ Chief Financial Officer Salvador O. Gutierrez President 10 35 SCHEDULE 1 TO SECURITY AGREEMENT DESCRIPTION OF EQUIPMENT
QUANTITY ARTICLE MAKE Y. MFG. MODEL SERIAL OR MOTOR NO. - -------- ------- ---- ------- ----- -------------------
See attached continuation to Schedule 1 together with all improvements, replacements, accessions and additions thereto, wherever located, and all Proceeds thereof arising from the sale, lease, rental or other use or disposition of any such property, including all rights to payment with respect to insurance or condemnation, returned premiums, or any cause of action relating to any of the foregoing. DIGITAL GENERATION SYSTEMS, INC. By: _______________________________ Thomas P. Shanahan Chief Financial Officer VENTURE LENDING & LEASING, INC. By: _______________________________ Salvador O. Gutierrez President 36 EXHIBIT A TO FINANCING STATEMENT BETWEEN DIGITAL GENERATION SYSTEMS, INC. AS DEBTOR, AND VENTURE LENDING & LEASING, INC., AS SECURED PARTY ------------------------------------ Item 6 continued: All of Debtor's right, title and interest in and to the Collateral, as such term is defined below. "COLLATERAL" means all Debtor's Equipment and Fixtures now owned or hereafter acquired, wherever located, and whether held by Debtor or any third party, and all proceeds and products thereof, including all insurance and condemnation proceeds ("Proceeds"), and all monies now or at any time hereafter in the possession or under the control of Secured Party or a bailee or affiliate of Secured Party, including any cash collateral in any cash collateral or other account, and all Records relating or useful to, or used in connection with any of the foregoing. "EQUIPMENT" means all of Debtor's specific equipment identified and described on Schedule 1 attached to this Agreement and incorporated herein by reference (as such Schedule may be amended or supplemented from time to time), all replacements, parts, accessions and additions thereto, and all proceeds thereof arising from the sale, lease, rental or other use or disposition thereof, including all rights to payment with respect to insurance or condemnation, returned premiums, or any cause of action relating to any of the foregoing. "FIXTURES" means all items of Equipment that are so related to the real property upon which they are located that an interest in them arises under real property law, and all proceeds thereof arising from the sale, lease, rental or other use or disposition thereof. "RECORDS" means all Debtor's computer programs, software, hardware, source codes and data processing information, all written documents, books, invoices, ledger sheets, financial information and statements, and all other writings concerning Debtor's business. 37 EXHIBIT D THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR INVESTMENT AND HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR ANY STATE SECURITIES LAWS. SUCH SECURITIES MAY NOT BE SOLD OR TRANSFERRED IN THE ABSENCE OF SUCH REGISTRATION OR AN EXEMPTION THEREFROM UNDER SAID ACT AND ANY APPLICABLE STATE SECURITIES LAWS. WARRANT TO PURCHASE 112,500 SHARES OF COMMON STOCK OF DIGITAL GENERATION SYSTEMS, INC. (Void after December 31, 2002) This certifies that VENTURE LENDING & LEASING, INC., a Maryland corporation, or assigns (the "Holder"), for value received, is entitled to purchase from DIGITAL GENERATION SYSTEMS, INC., a California corporation (the "Company"), 112,500 fully paid and nonassessable shares of the Company's Common Stock ("Common Stock") for cash at a price of $8.00 per share (the "Stock Purchase Price") at any time or from time to time up to and including 5:00 p.m. (Pacific time) on December 31, 2002 (the "Expiration Date"), upon surrender to the Company at its principal office at 875 Battery Street, San Francisco, CA 94111 (or at such other location as the Company may advise Holder in writing) of this Warrant properly endorsed with the Form of Subscription attached hereto duly filled in and signed and upon payment in cash or by check of the aggregate Stock Purchase Price for the number of shares for which this Warrant is being exercised determined in accordance with the provisions hereof. The Stock Purchase Price and the number of shares purchasable hereunder are subject to adjustment as provided in Section 4 of this Warrant. This Warrant is subject to the following terms and conditions: 1. Exercise; Issuance of Certificate; Payment for Shares. (a) Unless an election is made pursuant to clause (b) of this Section 1, this Warrant shall be exercisable at the option of the Holder, at any time or from time to time, on or before the Expiration Date for all or any portion of the shares of Common Stock (but not for a fraction of a share) which may be purchased hereunder for the Stock Purchase Price multiplied by the number of shares to be purchased. The Company agrees that 38 the shares of Common Stock purchased under this Warrant shall be and are deemed to be issued to the holder hereof as the record owner of such shares as of the close of business on the date on which this Warrant shall have been surrendered and payment made for such shares. Subject to the provisions of Section 2, certificates for the shares of Common Stock so purchased, together with any other securities or property to which the Holder hereof is entitled upon such exercise, shall be delivered to the Holder hereof by the Company at the Company's expense within a reasonable time after the rights represented by this Warrant have been so exercised. Except as provided in clause (b) of this Section 1, in case of a purchase of less than all the shares which may be purchased under this Warrant, the Company shall cancel this Warrant and execute and deliver a new Warrant or Warrants of like tenor for the balance of the shares purchasable under the Warrant surrendered upon such purchase to the Holder hereof within a reasonable time. Each stock certificate so delivered shall be in such denominations of Common Stock as may be requested by the Holder hereof and shall be registered in the name of such Holder or such other name as shall be designated by such Holder, subject to the limitations contained in Section 2. (b) The Holder, in lieu of exercising this Warrant by the payment of the Stock Purchase Price pursuant to clause (a) of this Section 1, may elect, at any time on or before the Expiration Date, to receive, through conversion of this Warrant or any portion hereof into that number of shares of Common Stock equal to the quotient of: (i) the difference between (A) the Per Share Price (as hereinafter defined) of the Common Stock, less (B) the Stock Purchase Price then in effect, multiplied by the number of shares of Common Stock the Holder would otherwise have been entitled to purchase hereunder pursuant to clause (a) of this Section 1 (or such lesser number of shares as the Holder may designate in the case of a partial exercise of this Warrant); over (ii) the Per Share Price. (c) For purposes of clause (b) of this Section 1, "Per Share Price" means (i) if the Company's Common Stock is then listed or admitted to trading on any national securities exchange or traded on any national market system, the average of the closing bid and asked prices of the Company's Common Stock as reported on such exchange or market system for the ten (10) consecutive trading days prior to the date of the Holder's election to convert hereunder; (ii) if this Warrant is being converted in conjunction with a public offering of stock, the price to the public per share pursuant to the offering; or (iii) if no shares of the Company's Common Stock are listed or admitted to trading on any national securities exchange or traded on any national market system, the price per share which the Company would obtain from a willing buyer for shares sold by the Company from authorized but unissued shares as such price 2 39 shall be agreed upon by the Holder and the Company or, if agreement cannot be reached within ten (10) business days of the Holder's election hereunder, as such price shall be determined by a panel of three (3) appraisers, one (1) to be chosen by the Company, one (1) to be chosen by the Holder and the third to be chosen by the first two (2) appraisers. If the appraisers cannot reach agreement within 30 days of the Holder's election hereunder, then each appraiser shall deliver its appraisal and the appraisal which is neither the highest nor the lowest shall constitute the Per Share Price. In the event either party fails to choose an appraiser within 30 days of the Holder's election hereunder, then the appraisal of the sole appraiser shall constitute the Per Share Price. Each party shall bear the cost of the appraiser selected by such party and the cost of the third appraiser shall be borne one-half by each party. In the event either party fails to choose an appraiser, the cost of the sole appraiser shall be borne one-half by each party. 2. Limitation on Transfer. (a) The Warrant and the Common Stock shall not be transferable except upon the conditions specified in this Section 2, which conditions are intended to insure compliance with the provisions of the Securities Act. Each holder of this Warrant or the Common Stock issuable hereunder will cause any proposed transferee of the Warrant or Common Stock to agree to take and hold such securities subject to the provisions and upon the conditions specified in this Section 2. (b) Each certificate representing this Warrant or the Common Stock shall (unless otherwise permitted by the provisions of this Section 2 or unless such securities have been registered under the Securities Act or sold under Rule 144) be stamped or otherwise imprinted with a legend substantially in the following form (in addition to any legend required under applicable state securities laws): THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR INVESTMENT AND HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR ANY STATE SECURITIES LAWS. SUCH SECURITIES MAY NOT BE SOLD OR TRANSFERRED IN THE ABSENCE OF SUCH REGISTRATION OR AN EXEMPTION THEREFROM UNDER SAID ACT AND ANY APPLICABLE STATE SECURITIES LAWS. (c) The Holder of this Warrant and each person to whom this Warrant is subsequently transferred represents and warrants to the Company (by acceptance of such transfer) that it will not transfer the Warrant (or securities issuable upon exercise hereof unless a registration statement under the Securities Act was in effect with respect to such securities at the time of issuance thereof) except pursuant to (i) an 3 40 effective registration statement under the Securities Act, (ii) Rule 144 under the Securities Act (or any other rule under the Securities Act relating to the disposition of securities), or (iii) an opinion of counsel, reasonably satisfactory to counsel for the Company, that an exemption from such registration is available. 3. Shares to be Fully Paid; Reservation of Shares. The Company covenants and agrees that all shares of Common Stock which may be issued upon the exercise of the rights represented by this Warrant will, upon issuance, be duly authorized, validly issued, fully paid and nonassessable and free from all preemptive rights of any shareholder and free of all taxes, liens and charges with respect to the issue thereof. The Company further covenants and agrees that during the period within which the rights represented by this Warrant may be exercised, the Company will at all times have authorized and reserved, for the purpose of issue or transfer upon exercise of the subscription rights evidenced by this Warrant, a sufficient number of shares of authorized but unissued Common Stock, or other securities and property, when and as required to provide for the exercise of the rights represented by this Warrant. The Company will take all such action as may be necessary to assure that such shares of Common Stock may be issued as provided herein without material violation of any applicable law or regulation, or of any requirements of any domestic securities exchange upon which the Common Stock may be listed. The Company will not take any action which would result in any adjustment of the Stock Purchase Price (as defined in Section 4 hereof) (i) if the total number of shares of Common Stock issuable after such action upon exercise of all outstanding warrants, together with all shares of Common Stock then outstanding and all shares of Common Stock then issuable upon exercise of all options and upon the conversion of all convertible securities then outstanding, would exceed the total number of shares of Common Stock then authorized by the Company's Articles of Incorporation. 4. Adjustment of Stock Purchase Price Number of Shares. The Stock Purchase Price and the number of shares purchasable upon the exercise of this Warrant shall be subject to adjustment from time to time upon the occurrence of certain events described in this Section 4. Upon each adjustment of the Stock Purchase Price, the Holder of this Warrant shall thereafter be entitled to purchase, at the Stock Purchase Price resulting from such adjustment, the number of shares obtained by multiplying the Stock Purchase Price in effect immediately prior to such adjustment by the number of shares purchasable pursuant hereto immediately prior to such adjustment, and dividing the product thereof by the Stock Purchase Price resulting from such adjustment. 4 41 4.1 Subdivision or Combination of Stock. In case the Company shall at any time subdivide its outstanding shares of Common Stock into a greater number of shares, the Stock Purchase Price in effect immediately prior to such subdivision shall be proportionately reduced, and conversely, in case the outstanding shares of Common Stock of the Company shall be combined into a smaller number of shares, the Stock Purchase Price in effect immediately prior to such combination shall be proportionately increased. 4.2 Dividends in Preferred Stock, Other Stock, Property, Reclassification. If at any time or from time to time the holders of Common Stock (or any shares of stock or other securities at the time receivable upon the exercise of this Warrant) shall have received or become entitled to receive, without payment therefor, (a) by way of dividend or other distribution any shares of stock or other securities, whether or not such securities are at any time directly or indirectly convertible into or exchangeable for Common Stock, or any rights or options to subscribe for, purchase or otherwise acquire any of the foregoing, or (b) any cash paid or payable otherwise than as a cash dividend, or (c) additional stock or other securities or property (including cash) by way of spin-off, split-up, reclassification, combination of shares or similar corporate rearrangement, (other than shares of Common Stock issued as a stock split, adjustments in respect of which shall be covered by the terms of Section 4.1 above), then and in each such case, the Holder hereof shall, upon the exercise of this Warrant, be entitled to receive, in addition to the number of shares of Common Stock receivable thereupon, and without payment of any additional consideration therefore, the amount of stock and other securities and property (including cash in the cases referred to in clauses (b) and (c) above) which such Holder would hold on the date of such exercise had he been the holder of record of such Common Stock as of the date on which holders of Common Stock received or became entitled to receive such shares and/or all other additional stock and other securities and property. 4.3 Reorganization, Reclassification, Consolidation, Merger or Sale. If any capital reorganization of the capital stock of the Company, or any consolidation or merger of the Company with another corporation, or the sale of all or substantially all of its assets to another corporation shall be effected in such a way that holders of Common Stock shall be 5 42 entitled to receive stock, securities or assets with respect to or in exchange for Common Stock, then, as a condition of such reorganization, reclassification, consolidation, merger or sale, lawful and adequate provisions shall be made whereby the holder hereof shall thereafter have the right to purchase and receive (in lieu of the shares of the Common Stock of the Company immediately theretofore purchasable and receivable upon the exercise of the rights represented hereby) such shares of stock, securities or assets as may be issued or payable with respect to or in exchange for a number of outstanding shares of such Common Stock equal to the number of shares of such stock immediately theretofore purchasable and receivable upon the exercise of the rights represented hereby. In any such case, appropriate provision shall be made with respect to the rights and interests of the Holder of this Warrant to the end that the provisions hereof (including, without limitation, provisions for adjustments of the Stock Purchase Price and of the number of shares purchasable and receivable upon the exercise of this Warrant) shall thereafter be applicable, as nearly as may be possible, in relation to any shares of stock, securities or assets thereafter deliverable upon the exercise hereof. The Company will not effect any such consolidation, merger or sale unless, prior to the consummation thereof, the successor corporation (if other than the Company) resulting from such consolidation or the corporation purchasing such assets shall assume by written instrument, executed and mailed or delivered to the registered Holder hereof at the last address of such Holder appearing on the books of the Company, the obligation to deliver to such Holder such shares of stock, securities or assets as, in accordance with the foregoing provisions, such Holder may be entitled to purchase. 4.4 Intentionally Deleted. 4.5 Notice of Adjustment. Upon any adjustment of the Stock Purchase Price, and/or any increase or decrease in the number of shares purchasable upon the exercise of this Warrant the Company shall give written notice thereof, by first class mail, postage prepaid, addressed to the registered holder of this Warrant at the address of such holder as shown on the books of the Company. The notice shall be signed by the Company's chief financial officer and shall state the Stock Purchase Price resulting from such adjustment and the increase or decrease, if any, in the number of shares purchasable at such price upon the exercise of this Warrant, setting forth in reasonable detail the method of calculation and the facts upon which such calculation is based. 4.6 Other Notices. If at any time: (a) the Company shall declare any cash dividend upon any of its stock; 6 43 (b) the Company shall declare any dividend upon its stock payable in stock, or make any special dividend or other distribution to the holders of its stock; (c) the Company shall offer for subscription pro rata to the holders of its Common Stock any additional shares of stock of any class or other rights; (d) there shall be any capital reorganization or reclassification of the capital stock of the Company, or consolidation or merger of the Company with, or sale of all or substantially all of its assets to, another corporation; (e) there shall be a voluntary or involuntary dissolution, liquidation or winding-up of the Company; or (f) the Company shall take or propose to take any other action, notice of which is actually provided to holders of the Common Stock; then, in any one or more of said cases, the Company shall give, by first class mail, postage prepaid, addressed to the holder of this Warrant at the address of such holder as shown on the books of the Company, (i) at least 20 day's prior written notice of the date on which the books of the Company shall close or a record shall be taken for such dividend, distribution or subscription rights or for determining rights to vote in respect of any such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation or winding-up, or other action and (ii) in the case of any such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation or winding- up, or other action, at least 20 day's written notice of the date when the same shall take place. Any notice given in accordance with the foregoing clause (i) shall also specify, in the case of any such dividend, distribution or subscription rights, the date on which the holders of stock shall be entitled thereto. Any notice given in accordance with the foregoing clause (ii) shall also specify the date on which the holders of Common Stock shall be entitled to exchange their Common Stock for securities or other property deliverable upon such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation or winding-up, or other action as the case may be. Notwithstanding anything to the contrary, the Company's failure to give any notice required under Section 4.5 or 4.6 shall not affect the validity of any Company action requiring such notice to be given. 4.7 Certain Events. If in the reasonable judgment of the Company's Board of Directors any change in the outstanding Common Stock of the Company or any other event occurs as to which the other provisions of this Section 4 are not strictly 7 44 applicable or if strictly applicable would not fairly protect the purchase rights of the Holder of the Warrant in accordance with the essential intent and principles of such provisions, then the Board of Directors of the Company shall make an adjustment in the number and class of shares available under the Warrant, the Stock Purchase Price and/or the application of such provisions, in accordance with such essential intent and principles, so as to protect such purchase rights as aforesaid. The adjustment shall be such as will give the Holder of the Warrant upon exercise for the same aggregate Stock Purchase Price the total number, class and kind of shares as he would have owned had the Warrant been exercised prior to the event and had he continued to hold such shares until after the event requiring adjustment. 5. Issue Tax. The issuance of certificates for shares of Common Stock upon the exercise of the Warrant shall be made without charge to the Holder of the Warrant for any issue tax in respect thereof; provided, however, that the Company shall not be required to pay any tax which may be payable in respect of any transfer involved in the issuance and delivery of any certificate in a name other than that of the then Holder of the Warrant being exercised. 6. Closing of Books. The Company will at no time close its transfer books against the transfer of any warrant or of any shares of Common Stock issued or issuable upon the exercise of any warrant in any manner which interferes with the timely exercise of this Warrant. 7. No Voting or Dividend Rights; Limitation of Liability. Nothing contained in this Warrant shall be construed as conferring upon the Holder hereof the right to vote or to consent as a shareholder in respect of meetings of shareholders for the election of directors of the Company or any other matters or any rights whatsoever as a shareholder of the Company. No dividends or interest shall be payable or accrued in respect of this Warrant or the interest represented hereby or the shares purchasable hereunder until, and only to the extent that, this Warrant shall have been exercised. No provisions hereof, in the absence of affirmative action by the holder to purchase shares of Common Stock, and no mere enumeration herein of the rights or privileges of the Holder hereof, shall give rise to any liability of such Holder for the Stock Purchase Price or as a shareholder of the Company, whether such liability is asserted by the Company or by its creditors. 8. Amendment of Articles of Incorporation. Unless the holder of this Warrant consents thereto in writing, the Company shall not amend its Articles of Incorporation prior to the exercise of this Warrant in any manner that would adversely affect the holder's rights hereunder. 8 45 9. Registration Rights. The Holder hereof shall be entitled, with respect to the shares of Common Stock issued upon exercise hereof to all of the registration rights set forth in the Amendment and Restatement No. 4 to Rights Agreement dated as of July 27, 1995 to the same extent and on the same terms and conditions as possessed by the Holders thereunder pursuant to Section 1.3 ("Company Registration") thereto. The Company shall take such action as may be reasonably necessary to assure that the granting of such registration rights to the Holder does not violate the provisions of such agreement or any of the Company's charter documents or rights of prior grantees of registration rights. 10. Rights and Obligations Survive Exercise of Warrant. The rights and obligations of the Company, of the Holder of this Warrant and of the holder of shares of Common Stock issued upon exercise of this Warrant, contained in Sections 8 and 9 shall survive the exercise of this Warrant. 11. Modification and Waiver. This Warrant and any provision hereof may be changed, waived, discharged or terminated only by an instrument in writing signed by the party against which enforcement of the same is sought. 12. Notices. Any notice, request or other document required or permitted to be given or delivered to the holder hereof or the Company shall be deemed to have been given (i) upon receipt if delivered personally or by courier, (ii) upon confirmation of receipt if by telecopy, or (iii) three business days after deposit in the U.S. mail, with postage prepaid and certified or registered, to each such holder at its address as shown on the books of the Company or to the Company at the address indicated therefor in the first paragraph of this Warrant. 13. Binding Effect on Successors. This Warrant shall be binding upon any corporation succeeding the Company by merger, consolidation or acquisition of all or substantially all of the Company's assets. All of the obligations of the Company relating to the Common Stock issuable upon the exercise of this Warrant shall survive the exercise and termination of this Warrant. All of the covenants and agreements of the Company shall inure to the benefit of the successors and assign of the holder hereof. The Company will, at the time of the exercise of this Warrant, in whole or in part, upon request of the Holder hereof but at the Company's expense, acknowledge in writing its continuing obligation to the Holder hereof in respect of any rights (including, without limitation, any right to registration of the shares of Common Stock) to which the holder hereof shall continue to be entitled after such exercise in accordance with this Warrant; provided, that the failure of the holder hereof to 9 46 make any such request shall not affect the continuing obligation of the Company to the Holder hereof in respect of such rights. 14. Descriptive Headings and Governing Law. The descriptive headings of the several sections and paragraphs of this Warrant are inserted for convenience only and do not constitute a part of this Warrant. This Warrant shall be construed and enforced in accordance with, and the rights of the parties shall be governed by, the internal laws of the State of California. 15. Lost Warrants or Stock Certificates. The Company represents and warrants to the Holder hereof that upon receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction, or mutilation of any Warrant or stock certificate and, in the case of any such loss, theft or destruction, upon receipt of an indemnity reasonably satisfactory to the Company, or in the case of any such mutilation upon surrender and cancellation of such Warrant or stock certificate, the Company at its expense will make and deliver a new Warrant or stock certificate, of like tenor, in lieu of the lost, stolen, destroyed or mutilated Warrant or stock certificate. 16. Fractional Shares. No fractional shares shall be issued upon exercise of this Warrant. The Company shall, in lieu of issuing any fractional share, pay the holder entitled to such fraction a sum in cash equal to such fraction multiplied by the then effective Stock Purchase Price. 17. Representations of Holder. With respect to this Warrant, Holder by acceptance of this Warrant represents and warrants to, and covenants with, the Company as follows: 17.1 Experience. It is experienced in evaluating and investing in companies engaged in businesses similar to that of the Company; it understands that investment in the Warrant involves substantial risks; it has made detailed inquiries concerning the Company, its business and services, its officers and its personnel; the officers of the Company have made available to Holder any and all written information it has requested; the officers of the Company have answered to Holder's satisfaction all inquiries made by it; in making this investment it has relied upon information made available to it by the Company; it has such knowledge and experience in financial and business matters that it is capable of evaluating the merits and risks of investment in the Company and it is able to bear the economic risk of that investment; and it is an "accredited investor", as that term is defined in Section 501 of Regulation D promulgated under the Securities Act of 1933, as amended. 10 47 17.2 Investment. It is acquiring the Warrant for investment for its own account and not with a view to, or for resale in connection with, any distribution thereof. It understands that the Warrant, the shares of Common Stock issuable upon exercise thereof, have not been registered under the Securities Act of 1933, as amended, nor qualified under applicable state securities laws. 17.3 Rule 144. It acknowledges that the Warrant and the Common Stock must be held indefinitely unless they are subsequently registered under the Securities Act or an exemption from such registration is available. It has been advised or is aware of the provisions of Rule 144 promulgated under the Securities Act. 17.4 Access to Data. It has had an opportunity to discuss the Company's business, management and financial affairs with the Company's management and has had the opportunity to inspect the Company's facilities. 17.5 Neither Holder nor anyone acting on its behalf will take any action hereafter that would cause the loss of the exemptions referred to in Section 18.3. 18. Additional Representations and Covenants of the Company. The Company hereby represents, warrants and agrees as follows: 18.1 Corporate Power. The Company has all requisite corporate power and corporate authority to issue this Warrant and to carry out and perform its obligations hereunder. 18.2 Authorization. All corporate action on the part of the Company, its directors and shareholders necessary for the authorization, execution, delivery and performance by the Company of this has been taken. This Warrant is a valid and binding obligation of the Company, enforceable in accordance with its terms (except as may be limited by bankruptcy, insolvency and similar laws affecting the enforcement of creditors' rights in general, and subject to general principles of equity). 18.3 Offering. Subject in part to the truth and accuracy of Holder's representations set forth in Section 17 hereof, the offer, issuance and sale of the Warrant is, and the issuance of Common Stock upon exercise of the Warrant will be exempt from the registration requirements of the Securities Act, and are exempt from the qualification requirements of any applicable state securities laws; and neither the Company nor anyone acting on its behalf will take any action hereafter that would cause the loss of such exemptions. 11 48 18.4 Stock Issuance. Upon exercise of the Warrant, the Company will use its reasonable commercial efforts to cause stock certificates representing the shares of Common Stock purchased pursuant to the exercise to be issued in the individual names of Holder, its nominees or assignees, as appropriate at the time of such exercise. IN WITNESS WHEREOF, the Company has caused this Warrant to be duly executed by its officers, thereunto duly authorized this ___ day of January, 1997. DIGITAL GENERATION SYSTEMS, INC. By:________________________________ Title:_____________________________ 12 49 FORM OF SUBSCRIPTION (To be signed only upon exercise of Warrant) To:_____________________________ The undersigned, the holder of the within Warrant, hereby irrevocably elects to exercise the purchase right represented by such Warrant for, and to purchase thereunder, __________________________________ (_____) (1) shares of Common Stock of __________________________________ and herewith makes payment of _____________________________________ Dollars ($________) therefor, and requests that the certificates for such shares be issued in the name of, and delivered to, __________________________________________, whose address is __________________________. The undersigned represents that it is acquiring such Common Stock for its own account for investment and not with a view to or for sale in connection with any distribution thereof (subject, however, to any requirement of law that the disposition thereof shall at all times be within its control. DATED:______________________ ____________________________________(Signature must conform in all respects to name of holder as specified on the face of the Warrant) ____________________________________________________ ____________________________________________________ (Address) - --------------------- (1) Insert here the number of shares called for on the face of the Warrant (or, in the case of a partial exercise, the portion thereof as to which the Warrant is being exercised), in either case without making any adjustment for additional Common Stock or any other stock or other securities or property or cash which, pursuant to the adjustment provisions of the Warrant, may be deliverable upon exercise. 13 50 ASSIGNMENT FOR VALUE RECEIVED, the undersigned, the holder of the within Warrant, hereby sells, assigns and transfers all of the rights of the undersigned under the within Warrant, with respect to the number of shares of Common Stock covered thereby set forth hereinbelow, unto:
Name of Assignee Address No. of Shares - ---------------- ------- -------------
Dated: ____________________________________________ ____________________________________________ (Signature must conform in all respects to name of holder as specified on the face of the Warrant) 14 EX-11.1 3 STATEMENTS OF COMPUTATION 1 EXHIBIT 11.1 DIGITAL GENERATION SYSTEMS, INC. STATEMENTS OF COMPUTATION OF WEIGHTED AVERAGE AND PRO FORMA COMMON SHARES AND EQUIVALENTS (IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
THREE MONTHS ENDED MARCH 31, ---------------------------- 1997 1996 ------------ ------------ (Unaudited) Net loss $ (3,296) $ (2,338) ============ ============ Weighted average common shares outstanding 11,686 2,856 Weighted average common equivalent shares: Weighted average preferred stock outstanding 7,274 Adjustments to reflect requirements of the Securities and Exchange Commission's Staff Accounting Bulletin No. 83: Common stock issuances 195 Convertible preferred stock issuances 581 Preferred stock warrants 21 Common stock option grants 748 ------------ ------------ Total weighted average common shares and equivalents 11,686 =========== Pro forma total weighted average common shares and equivalents 11,675 ============ Net loss per share $ (0.28) =========== Pro forma net loss per share $ (0.20) ============
EX-27 4 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS DEC-31-1997 JAN-01-1997 MAR-31-1997 8,550 9,029 3,370 0 0 21,511 22,521 (9,448) 43,110 10,604 8,919 0 0 55,182 (31,595) 43,110 0 4,606 0 7,642 0 36 511 (3,296) 0 0 0 0 0 (3,296) (.28) (.28)
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