The following management's discussion and analysis of financial condition and results of operations ("MD&A") should be read in conjunction with our consolidated financial statements and notes thereto contained elsewhere in this Annual Report on Form 10-K.

Introduction

MD&A is provided as a supplement to the accompanying consolidated financial statements and notes to help provide an understanding of Digital Generation, Inc.'s (the "Company," "we," "us" or "our") financial condition, changes in financial condition and results of operations. MD&A is organized as follows:

º •
º Overview. This section provides a general description of our business, as well as recent developments that we believe are important to understanding our results of operations and financial condition or in understanding anticipated future trends. In addition, significant transactions that impact the comparability of the results being analyzed are summarized.

º •
º 2012 Highlights. This section provides some of the highlights of our 2012 year.

º •
º Results of Operations. This section provides an analysis of our results of operations for the three years in the period ended December 31, 2012.

º •
º Financial Condition. This section provides a summary of certain major balance sheet accounts and a discussion of the factors that tend to cause these accounts to change, or the reasons for the change.

º •
º Liquidity and Capital Resources. This section provides a summary of our cash flows for the three years in the period ended December 31, 2012, as well as a discussion of those cash flows. Also included is a discussion of our sources of liquidity and cash requirements.

º •
º Critical Accounting Policies. This section discusses accounting policies that are considered important to our results of operations and financial condition, require significant judgment and require estimates on the part of management. Our significant accounting policies, including those considered to be critical accounting policies, are summarized in Note 2 to the accompanying consolidated financial statements.

º •
º Recently Adopted and Recently Issued Accounting Guidance. This section provides a discussion of recently issued accounting guidance that has been adopted or will be adopted in the near future, including a discussion of the impact or potential impact of such guidance on our consolidated financial statements when applicable.

º •
º Contractual Payment Obligations. This section provides a summary of our contractual payment obligations by major category and in total, and a breakdown by period.

º •
º Off-Balance Sheet Arrangements. This section provides a summary of our off-balance sheet arrangements and the purpose of these arrangements.

Overview

We operate a leading ad management and distribution platform. We help advertisers engage with consumers across television and online media, while delivering timely and impactful ad campaigns. Our technology and high quality service help advertisers overcome the fragmentation in the market and get optimal results for their advertising spending. We operate our business in two distinct segments, television and online. As detailed below, we have completed six acquisitions in the last three years which affects the comparability of our financial results.

Our business can be impacted by several factors, including general economic conditions, the overall advertising market, new emerging digital technologies, the trend towards delivering high definition ("HD") data files, and the continued growth of online advertising.

Television Segment

Revenues from our television segment are principally derived from delivering advertisements, syndicated programs, and video news releases from advertising agencies and other content providers to traditional broadcasters and other media outlets. The television segment includes the operating results of our ADS operation, SourceEcreative, Match Point, MIJO and North Country. The majority of our television segment revenue results from the delivery of television advertisements, or spots, which are typically delivered digitally but sometimes physically. We generally bill our services on a per transaction basis. We also offer a variety of other ancillary products that serve the television advertising industry. These services include creative research, media production and duplication, management and storage of existing advertisements and broadcast verification. This suite of innovative services addresses the needs of our customers at multiple stages along the value chain of advertisement creation and delivery in a cost-effective manner that helps simplify the overall process of content delivery.

Online Segment

Revenues from our online segment are principally derived from services relating to online advertising. We earn fees from our customers to create, execute, monitor and measure advertising campaigns on our platforms. Currently, we operate three separate online advertising platforms (the MediaMind, EyeWonder and Unicast platforms). However, we are in the process of transitioning all of our online business over to the MediaMind platform and plan to cease operating the EyeWonder and Unicast platforms in 2013.

Our MediaMind platform offers an integrated campaign management solution that helps advertisers and agencies simplify the complexities of managing their advertising budgets across multiple digital media channels and formats, including online, mobile, rich media, in-stream video, display and search. The MediaMind platform provides our customers with an easy-to-use, end-to-end solution to enhance planning, creative, delivery, measurement and optimization of digital media campaigns. Our solutions are delivered through a scalable technology infrastructure that allows delivery of digital media advertising campaigns of any size. In 2012, we managed campaigns for customers in 78 countries throughout North America, South America, Europe, Asia Pacific, Africa and the Middle East.

Acquisitions

Part of our business strategy is to acquire similar and/or ancillary businesses that will increase our market penetration and, in some cases, result in operating synergies. During the last three fiscal years, we acquired six businesses involved in the distribution of media content as follows:

Net Assets Acquired Operating Business Acquired Date of Closing (in millions) Segment North Country July 31, 2012 $ 3.7 Television Peer 39 April 30, 2012 15.7 Online EyeWonder September 1, 2011 61.0 Online MediaMind July 26, 2011 499.3 Online MIJO April 1, 2011 43.8 Television Match Point October 1, 2010 27.7 Television

Each of the acquired businesses has been included in our results of operations since the date of closing.

Political Advertising

Our revenues are affected by political advertising, which peaks every other year consistent with the national, state and local election cycles in the United States.

2012 Highlights

º •
º Overall revenues increased $62.4 million, or 19%, from 2011.

º •
º Revenues from our online segment increased $63.2 million, or 82%, from 2011, principally due to the acquisitions of MediaMind and EyeWonder during the third quarter of 2011. We lost some of our former EyeWonder and Unicast customers in 2012 during the transition to the MediaMind platform.

º •
º Revenues from our television segment declined slightly in 2012 compared with 2011. The 2012 television revenues benefited from having
(i) increased political advertising ($6.5 million) due to the 2012 elections in the United States, (ii) twelve months of MIJO's operating results in 2012 vs. only nine months 2011 ($5.9 million), and
(iii) five months of North Country's operating results in 2012 ($1.4 million) vs. zero months in 2011.

º •
º We incurred $8.5 million of acquisition and integration costs, compared to $15.1 million in 2011. The 2012 costs primarily relate to exploring strategic alternatives, the integration of our 2011 acquisitions and the 2012 acquisitions of Peer 39 and North Country. The 2011 costs relate primarily to the acquisitions of MediaMind and EyeWonder.

º •
º We reduced our long-term forecasts for the online segment and determined that a portion of the online unit's goodwill was impaired. As a result, we recorded goodwill impairment charges before income taxes of $219.6 million. We reduced our forecasts due to softer operating results than expected and weaker market conditions and trends. See Note 5 of our consolidated financial statements.

º •
º We reduced our cost structure during 2012 by eliminating duplicative personnel and facilities as we integrated our online advertising platforms.

º •
º We repaid $29.9 million of our Amended Credit Facility which leaves a remaining balance of $453.9 million at year end. See Note 7 in the accompanying financial statements.

º •
º We made several amendments to our credit facility in March 2013, including (i) relaxing our financial covenants, (ii) requiring an additional $50 million principal payment, (iii) increasing our future principal payments, (iv) increasing the interest rates under the facility and (v) reducing the revolving loans to a maximum of $50 million. See Notes 7 and 18 of our consolidated financial statements.

Results of Operations

2012 vs. 2011

The following table sets forth certain historical financial data (dollars in thousands).

                                                                                As a % of
                                                                                 Revenue
                                                                % Change
                                           Years Ended                         Years Ended
                                           December 31,           2012        December 31,
                                                                  vs.
                                         2012        2011         2011       2012      2011
Revenues                              $  386,613   $ 324,257           19 %   100.0 %   100.0 %
Costs and expenses:
Cost of revenues(a)                      137,278     106,441           29      35.5      32.8
Sales and marketing(a)                    64,246      33,679           91      16.6      10.4
Research and development(a)               23,612      19,142           23       6.1       5.9
General and administrative(a)             53,248      42,831           24      13.8      13.2
Acquisition and integration                8,513      15,119          (44 )     2.2       4.7
Depreciation and amortization             57,300      38,736           48      14.8      11.9
Goodwill impairment                      219,593           -           NM      56.8         -

Total costs and expenses                 563,790     255,948          120     145.8      78.9

Income (loss) from operations           (177,177 )    68,309         (359 )   (45.8 )    21.1
Other expense:
Interest expense                          31,329      14,915          110       8.1       4.6
Other expense, net                         2,800         637          340       0.8       0.2

Income (loss) before income
taxes                                   (211,306 )    52,757         (501 )   (54.7 )    16.3
Provision for income taxes                27,449      26,220            5       7.1       8.1

Income (loss) from continuing
operations                              (238,755 )    26,537           NM     (61.8 )     8.2
Loss from discontinued operations         (1,080 )    (2,053 )        (47 )    (0.3 )    (0.6 )

Net income (loss)                     $ (239,835 ) $  24,484           NM     (62.1 )     7.6

Reconciliation of Income (Loss) from Operations to Adjusted EBITDA (Non-GAAP

financial measure)

     Income (loss) from operations   $ (177,177 ) $  68,309     (359 )%   (45.8 )%   21.1 %
     Depreciation and amortization       57,300      38,736       48       14.8      11.9
     Share-based compensation            17,470      12,430       41        4.5       3.8
     Acquisition and integration          8,513      15,119      (44 )      2.2       4.7
     Goodwill impairment                219,593           -       NM       56.8         -

     Adjusted EBITDA(b)              $  125,699   $ 134,594       (7 )     32.5      41.5

NM-Not meaningful

Revenues. For 2012, revenues increased $62.4 million, or 19%, as compared to 2011 due to the 2011 acquisitions of MediaMind, EyeWonder and MIJO and the 2012 acquisitions of Peer 39 and North Country. For further discussion of revenues by reportable segment, see discussion for the television and online segments further below.

Cost of Revenues. For 2012, cost of revenues increased $30.8 million, or 29%, as compared to 2011. As a percentage of revenues, cost of revenues increased to 35.5% in 2012, as compared to 32.8% in 2011. The increase was principally due to (i) including twelve months of MIJO's, MediaMind's and EyeWonder's operating results in the 2012 period versus only nine months, five months and four months, respectively, in the 2011 period and (ii) increases in television segment cost (excluding MIJO) ($2.5 million) largely due to higher employee and facilities costs. The increase in our cost of revenues percentage was primarily due to reduced revenue as a result of lowering of our prices in each of the television and online segments.

Sales and Marketing. For 2012, sales and marketing expense increased $30.6 million, or 91%, as compared to 2011. The increase was principally due to
(i) including twelve months of MIJO's, MediaMind's and EyeWonder's operating results and eight months of Peer 39's operating results in the 2012 period versus only nine months, five months, four months and zero months, respectively, in the 2011 period and (ii) higher television segment expenses (excluding MIJO) ($2.5 million) largely due to higher employee costs and professional fees. The percentage increase was principally due to the inclusion of MediaMind, EyeWonder and Peer 39 in our operating results as our online business has higher sales and marketing expenses than the balance of the Company.

Research and Development. For 2012, research and development costs increased $4.5 million, or 23%, as compared to 2011. The increase was principally due to (i) including twelve months of MIJO's, MediaMind's and EyeWonder's operating results and eight months of Peer 39's operating results in the 2012 period versus only nine months, five months, four months and zero months, respectively, in the 2011 period and (ii) higher compensation and consulting costs ($1.6 million) in the television segment. The percentage of revenue for both periods was largely unchanged (6.1% in 2012 vs. 5.9% in 2011).

General and Administrative. For 2012, general and administrative expense increased $10.4 million, or 24%, as compared to 2011. The increase was principally due to (i) including twelve months of MIJO's, MediaMind's and EyeWonder's operating results and eight months of Peer 39's operating results in the 2012 period versus only nine months, five months, four months and zero months, respectively, in the 2011 period and (ii) higher professional fees ($4.0 million) in the television segment related to increased audit, tax and legal fees.

Acquisition and Integration. For 2012, acquisition and integration expense decreased $6.6 million as compared to 2011. In 2012, acquisition and integration expense relates primarily to severance charges, legal fees incurred related to our evaluation of strategic alternatives, acquisition costs and costs related to integrating EyeWonder and Unicast into our MediaMind platform. In 2011, acquisition and integration expense related primarily to investment banking, legal and accounting fees in connection with the MediaMind, EyeWonder and MIJO acquisitions.

Depreciation and Amortization. For 2012, depreciation and amortization expense increased $18.6 million, or 48%, as compared to 2011. The increase was primarily due to (i) twelve months of depreciation and amortization on the tangible and intangible assets of the 2011 acquisitions of MIJO, MediaMind and EyeWonder in 2012 as compared to only nine months, five months and four months, respectively, in 2011, (ii) including the 2012 acquisitions of Peer 39 and North Country and (iii) greater depreciation associated with the increase in property and equipment.

Goodwill Impairment. For 2012, we recognized goodwill impairment charges of $219.6 million related to our online reporting unit. See Note 5 of our consolidated financial statements.

Interest Expense. For 2012, interest expense increased $16.4 million as compared to 2011. The increase was due to the debt under our Amended Credit Facility being outstanding for twelve months in 2012 as compared to slightly more than five months in 2011.

Other Expense, net. For 2012, other expense, net increased $2.2 million as compared to 2011. The increase relates to the write-down of two investments that we deemed to be impaired.

Provision for Income Taxes. For 2012 and 2011, the provision for income taxes was (13.0%) and 49.7%, respectively, of income (loss) before income taxes. The provision for each period differs from the expected federal statutory rate of 35.0% as a result of certain non-deductible expenses, state income taxes and, for 2012, the recording of a $27.2 million valuation allowance against our federal and state net operating loss ("NOLs") carryforwards as a result of our third quarter goodwill impairment charge. For 2012, the vast majority of the goodwill impairment charge is not deductible for income tax purposes. In 2011, a large portion of the costs to acquire MediaMind and EyeWonder were not deductible for income tax purposes.

2011 vs. 2010

The following table sets forth certain historical financial data (dollars in thousands).

                                                                                As a % of
                                                                                 Revenue
                                                                % Change
                                            Years Ended                        Years Ended
                                           December 31,           2011        December 31,
                                                                  vs.
                                         2011        2010         2010       2011      2010
Revenues                               $ 324,257   $ 241,328           34 %   100.0 %   100.0 %
Costs and expenses:
Cost of revenues(a)                      106,441      73,230           45      32.8      30.4
Sales and marketing(a)                    33,679      13,534          149      10.4       5.6
Research and development(a)               19,142      10,601           81       5.9       4.4
General and administrative(a)             42,831      32,620           31      13.2      13.5
Acquisition and integration               15,119         269           NM       4.7       0.1
Depreciation and amortization             38,736      29,236           32      11.9      12.1

Total costs and expenses                 255,948     159,490           60      78.9      66.1

Income from operations                    68,309      81,838          (17 )    21.1      33.9
Other (income) expense:
Interest expense                          14,915       7,350          103       4.6       3.0
Interest (income) and other expense,
net                                          637        (221 )       (388 )     0.2      (0.1 )

Income before income taxes                52,757      74,709          (29 )    16.3      31.0
Provision for income taxes                26,220      29,407          (11 )     8.1      12.2

Income from continuing operations         26,537      45,302          (41 )     8.2      18.8
Loss from discontinued operations         (2,053 )    (3,733 )        (45 )    (0.6 )    (1.6 )

Net income                             $  24,484   $  41,569          (41 )     7.6      17.2

Reconciliation of Income from Operations to Adjusted EBITDA (Non-GAAP financial

measure)

       Income from operations          $  68,309   $  81,838     (17 )%   21.1 %   33.9 %
       Depreciation and amortization      38,736      29,236      32      11.9     12.1
       Share-based compensation           12,430       4,805     159       3.8      2.0
       Acquisition and integration        15,119         269      NM       4.7      0.1

       Adjusted EBITDA(b)              $ 134,594   $ 116,148      16      41.5     48.1

NM-Not meaningful.

Revenues. For 2011, revenues increased $82.9 million, or 34%, as compared to 2010 due to the 2010 acquisition of Match Point and the 2011 acquisitions of MediaMind, EyeWonder and MIJO. For further discussion on revenues by reportable segment, see each of the television and online segments.

Cost of Revenues. For 2011, cost of revenues increased $33.2 million, or 45%, as compared to 2010. As a percentage of revenues, cost of revenues increased to 32.8% in 2011, as compared to 30.4% in 2010. Costs of revenues increased due to (i) including the 2011 acquisitions of MIJO, MediaMind and EyeWonder ($21.9 million) in our operating results, (ii) including twelve months of Match Point's costs in 2011 vs. three months in 2010, Match Point was acquired in October 2010 ($8.8 million) and (iii) higher Unicast costs ($2.1 million), largely attributable to an increase in related revenues. Cost of revenues also includes a $0.9 million reduction, due to the reversal of a portion of an earnout liability that had been established in the Match Point purchase accounting. The earnout liability was reduced when Match Point's 2011 revenues failed to reach the threshold necessary for an earnout payment. The increase in our cost of revenues percentage is principally due to the acquisitions of Match Point and MIJO, which have higher cost of revenue percentages than the balance of the Company.

Sales and Marketing. For 2011, sales and marketing expense increased $20.1 million, or 149%, as compared to 2010. The increase was due to (i) the inclusion of MIJO, MediaMind and EyeWonder ($21.9 million) in our operating results and (ii) including twelve months of Match Point's expenses in 2011 vs. three months in 2010 ($0.3 million), partially offset by (iii) a decrease ($2.1 million) in Unicast's sales and marketing expenses due to lower compensation, advertising and promotion costs. As a percentage of revenues, sales and marketing expenses increased to 10.4% in 2011, as compared to 5.6% in 2010. The percentage increase is attributable to the inclusion of MediaMind and EyeWonder in our operating results as they have higher selling expenses than the balance of the Company.

Research and Development. For 2011, research and development costs increased $8.5 million, or 81%, as compared to 2010. The increase was due to the inclusion of MIJO, MediaMind and EyeWonder ($8.1 million) in our operating results. The percentage increase is attributable to the inclusion of MediaMind and EyeWonder in our operating results, as they have higher research and development expenses than the balance of the Company.

General and Administrative. For 2011, general and administrative expense increased $10.2 million, or 31%, as compared to 2010. As a percentage of revenues, general and administrative expense decreased to 13.2% in 2011, as compared to 13.5% in 2010. The decrease was primarily due to the inclusion of MediaMind in our operating results as MediaMind has lower general and administrative expenses than the balance of the Company.

Acquisition and Integration. For 2011, acquisition and integration expense increased $14.9 million as compared to 2010. The increase was due to costs associated with the acquisitions and integration of MIJO, MediaMind and EyeWonder.

Depreciation and Amortization. For 2011, depreciation and amortization expense increased $9.5 million, or 32%, as compared to 2010. The increase was due to additional depreciation and amortization associated with the assets of businesses acquired in 2011 ($10.8 million related to MIJO, MediaMind and EyeWonder) and 2010 ($1.6 million related to Match Point), partially offset by a reduction in depreciation of certain capitalized software projects that were fully depreciated during 2010 ($3.3 million).

Interest Expense. For 2011, interest expense increased $7.6 million as compared to 2010. Interest expense in 2011 was attributable to issuing $490 million of Term Loans in connection with the acquisition of MediaMind in July 2011. Interest expense in 2010 was attributable to (i) borrowings on a prior credit facility that was paid off in April 2010, (ii) interest rate swap termination charges, and (iii) the write off of debt issuance costs associated with the prior credit facility.

Interest Income and Other Expense, net. For 2011, interest income and other expense, net decreased $0.9 million as compared to 2010. The decrease was due to
(i) the recognition of losses on foreign currency forward contracts that are used to hedge foreign currency exchange rates (primarily the Israeli Shekel) and
(ii) foreign currency exchange losses.

Provision for Income Taxes. For 2011 and 2010, the provision for income taxes was 49.7% and 39.4%, respectively, of income before income taxes. The provision for each period differs from the expected federal statutory rate of 35%, as a result of certain non-deductible expenses and state income taxes. The increase in our effective tax rate was primarily due to incurring $15.1 million of acquisition and integration expenses in connection with our purchases of MediaMind, EyeWonder and MIJO, a portion of which is not deductible for federal income tax purposes.

2012 vs. 2011

. . .