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DGIT > SEC Filings for DGIT > Form 10-Q on 8-Nov-2013All Recent SEC Filings

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Form 10-Q for DIGITAL GENERATION, INC.


8-Nov-2013

Quarterly Report


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 ("MD&A") should be read in conjunction with our unaudited consolidated financial statements and notes thereto contained elsewhere in this Quarterly Report on Form 10-Q ("Report").

Critical Accounting Policies and Estimates

The following discussion and analysis of the financial condition and results of operations are based on the unaudited consolidated financial statements and notes to unaudited consolidated financial statements contained in this Report that have been prepared in accordance with the rules and regulations of the SEC and do not include all the disclosures normally required in annual consolidated financial statements prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. We base these estimates on historical results and various other assumptions believed to be reasonable, all of which form the basis for making estimates concerning the carrying values of our assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates.

Our significant accounting policies are described in Note 2 to the consolidated financial statements presented in our Annual Report for the year ended December 31, 2012. Our critical accounting policies are described in MD&A in our Annual Report. Our significant and critical accounting policies have not changed significantly since the filing of our Annual Report. See also Recently Adopted Accounting Guidance in Note 2 to our unaudited consolidated financial statements contained in this Report.

See Note 5 of our unaudited consolidated financial statements regarding the risk of a future impairment of our goodwill.

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 completed two acquisitions in 2012 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.

Pending Merger Transaction with Extreme Reach

See Note 1 of our unaudited consolidated financial statements regarding (i) the pending merger transaction with ER which, in effect, represents the sale of our television business, (ii) the retirement of all our outstanding debt with the proceeds from the sale and (iii) the planned distribution to our stockholders of
(a) the shares of NewCo, the newly formed company containing our online business and (b) $3 per share of our stock in cash. The pending transaction is summarized in Note 1 and will be set forth in greater detail in a proxy and information statement that we will file with the SEC and distribute to our stockholders in advance of a special meeting anticipated to be held in the first quarter of 2014 to approve the transaction.

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


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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 related to online advertising. We earn fees from our customers to create, execute, monitor and measure advertising campaigns on our platforms. During 2013 we operated 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 expect to complete the transition later in 2013. In September 2013, 99% of our online AD serving revenue was processed using the MediaMind platform.

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. We manage campaigns for customers in about 78 countries throughout North America, South America, Europe, Asia Pacific, Africa and the Middle East.

Acquisitions



During 2012, we acquired two 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

Each of the acquired businesses has been included in our results of operations since the date of closing. As a result of these acquisitions, the operating results for 2013 and 2012 are not entirely comparable. In addition, in October 2013 we acquired Republic Project, a cloud based ad platform for $1.4 million in cash and an additional amount ranging from zero to $13.1 million based on reaching revenue and adjusted EBITDA performance targets in 2014 and 2015.

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.

Third Quarter Highlights



          Overall revenues were down $3.7 million, or 4%, compared to 2012.



          Revenues from our online segment increased $4.5 million, or 13%, from
2012.

Revenues from our television segment decreased $8.2 million, or 14%, from 2012 principally due to lower (i) HD and SD pricing, (ii) political advertising ($2.4 million), and (iii) SD volumes.

Excluding the goodwill impairment charge in the 2012 period, our operating income improved $0.5 million, or 7%, from 2012 principally due to lower costs and expenses.


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Results of Operations



Three Months Ended September 30, 2013 vs. Three Months Ended September 30, 2012



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



                                                            % Change      As a % of Revenue
                                   Three Months Ended         2013       Three Months Ended
                                      September 30,           vs.           September 30,
                                   2013          2012         2012        2013        2012
Revenues                         $  90,130    $   93,818          (4 )%    100.0 %      100.0 %
Costs and expenses:
Cost of revenues (a)                33,649        34,697          (3 )      37.3         37.0
Sales and marketing (a)             15,831        16,476          (4 )      17.6         17.5
Research and development (a)         4,305         5,501         (22 )       4.8          5.8
General and administrative
(a)                                 11,252        13,959         (19 )      12.5         14.9
Acquisition, integration and
other                                3,677         1,379         167         4.1          1.5
Depreciation and amortization       13,626        14,542          (6 )      15.1         15.5
Goodwill impairment                      -       208,166        (100 )         -        221.9
Total costs and expenses            82,340       294,720         (72 )      91.4        314.1

Income (loss) from operations        7,790      (200,902 )      (104 )       8.6       (214.1 )

Other expense:
Interest expense                     8,446         7,835           8         9.4          8.3
Interest (income) and other,
net                                    518           346          50         0.5          0.4

Loss before income taxes            (1,174 )    (209,083 )       (99 )      (1.3 )     (222.8 )
Provision (benefit) for
income taxes                          (308 )      10,644        (103 )      (0.3 )       11.3
Loss from continuing
operations                            (866 )    (219,727 )      (100 )      (1.0 )     (234.1 )
Loss from discontinued
operations                               -             -           -           -            -
Net loss                         $    (866 )  $ (219,727 )      (100 )      (1.0 )     (234.1 )



(a) Excludes depreciation and amortization.

Reconciliation of Income (Loss) from Operations to Adjusted EBITDA and Segment Adjusted EBITDA before Corporate Overhead (Non-GAAP financial measures)

Income (loss) from operations    $  7,790    $ (200,902 )      (104 )%     8.6 %   (214.1 )%
Depreciation and amortization      13,626        14,542          (6 )     15.1       15.5
Share-based compensation            3,247         4,439         (27 )      3.6        4.6
Acquisition, integration and
other                               3,677         1,379         167        4.1        1.5
Goodwill impairment                     -       208,166        (100 )        -      221.9
Adjusted EBITDA (b)                28,340        27,624           3       31.4       29.4
Corporate overhead                  5,998         7,284         (18 )      6.7        7.8
Segment adjusted EBITDA
before corporate overhead (b)    $ 34,338    $   34,908          (2 )     38.1       37.2



(b) See discussion of Non-GAAP financial measures on page 34.

Revenues. For the three months ended September 30, 2013, revenues decreased $3.7 million, or 4%, as an increase in our online segment revenues was more than offset by a decrease in our television segment revenues. For further discussion on revenues by reportable segment, see each of the television and online segments.

Cost of Revenues. For the three months ended September 30, 2013, cost of revenues decreased $1.0 million,


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or 3%, as compared to the same period in the prior year. Cost of revenues decreased due to lower (i) personnel costs ($1.2 million) and (ii) facilities costs ($0.4 million), partially offset by an increase in trading costs ($0.8 million). The increase in trading costs is proportional to an increase in our online trading revenues. The reduction in personnel costs is commensurate with a reduction in our television revenues.

Sales and Marketing. For the three months ended September 30, 2013, sales and marketing expense decreased $0.6 million, or 4%, as compared to the same period in the prior year. The decrease was primarily due to lower personnel costs ($0.6 million). Personnel costs decreased due to a reduction in incentive and share-based compensation. The reduction in incentive compensation is consistent with a reduction in our revenues.

Research and Development. For the three months ended September 30, 2013, research and development costs decreased $1.2 million, or 22%, as compared to the same period in the prior year. The decrease was due to higher capitalized wages ($0.9 million) and lower personnel costs ($0.5 million). The increase in capitalized wages was due to an increase in the number of hours worked on software development projects that qualified for capitalization. The decrease in personnel costs is primarily attributable to reductions in incentive and share-based compensation.

General and Administrative. For the three months ended September 30, 2013, general and administrative expense decreased $2.7 million, or 19%, as compared to the same period in the prior year. As a percentage of revenues, general and administrative expense decreased to 12.5% in the current year period, as compared to 14.9% in the same period in the prior year. The decrease was primarily due to lower (i) personnel costs ($1.1 million), (ii) professional fees ($0.7 million), (iii) facilities costs ($0.3 million) and (iv) travel and entertainment costs ($0.2 million). The decrease in personnel costs is attributable to a reduction in the number of employees and the average cost per general and administrative employee. The decrease in professional fees is due to lower legal fees and audit and tax fees.

Acquisition, Integration and Other. For the three months ended September 30, 2013, acquisition, integration and other expense increased $2.3 million as compared to the same period in the prior year. The increase was due to costs associated with our strategic alternatives review process ($3.0 million) which resulted in us entering into a merger transaction with ER (for more information, see Note 1 to the consolidated financial statements), partially offset by lower severance costs ($0.4 million) and integration costs ($0.3 million). Severance and integration costs were higher in the prior year period as in 2012 we were in the process of transitioning our three previously separate online businesses into a single operation.

Depreciation and Amortization. For the three months ended September 30, 2013, depreciation and amortization expense decreased $0.9 million, or 6%, as compared to the same period in the prior year. The decrease was principally due to writing off certain capitalized software development projects in 2012 that were no longer being pursued.

Interest Expense. For the three months ended September 30, 2013, interest expense increased $0.6 million, or 8%, as compared to the same period in the prior year. The increase was attributable to an increase in the interest rate we are charged on our credit facility, partially offset by a lower level of debt outstanding during the 2013 period. In March 2013 we amended our credit facility to, among other things, loosen our financial covenants. As part of the amendment, the interest rate we are charged on the facility increased. See Note 6 of our consolidated financial statements.

Interest Income and Other, net. For the three months ended September 30, 2013, interest income and other, net increased $0.2 million as compared to the same period in the prior year. The increase was due to higher foreign currency exchange losses.

Provision (Benefit) for Income Taxes. For the three months ended September 30, 2013, our effective tax rate was 26.2%, compared to (5.1)% for the three months ended September 30, 2012. The effective tax rates for each period differ from the expected federal statutory rate of 35.0% as a result of state and foreign income taxes, non-deductible expenses, adjustments for uncertain tax positions and, principally for the 2012 period, the recording of a valuation allowance against all of our federal net operating loss carryforwards. For 2012, the vast majority of the goodwill impairment charge was not deductible for income tax purposes.


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Nine Months Ended September 30, 2013 vs. Nine Months Ended September 30, 2012



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



                                                           % Change     As a % of Revenue
                                   Nine Months Ended         2013       Nine Months Ended
                                     September 30,           vs.          September 30,
                                  2013          2012         2012        2013        2012
Revenues                        $ 278,423    $  283,003          (2 )%    100.0 %     100.0 %
Costs and expenses:
Cost of revenues (a)              101,107       103,058          (2 )      36.3        36.4
Sales and marketing (a)            51,900        46,727          11        18.6        16.5
Research and development (a)       14,564        18,599         (22 )       5.2         6.6
General and administrative
(a)                                32,710        40,824         (20 )      11.8        14.4
Acquisition, integration and
other                               7,364         5,556          33         2.7         2.0
Depreciation and
amortization                       42,361        41,403           2        15.2        14.6
Goodwill impairment                     -       208,166        (100 )         -        73.6
Total costs and expenses          250,006       464,333         (46 )      89.8       164.1

Income (loss) from
operations                         28,417      (181,330 )      (116 )      10.2       (64.1 )

Other expense:
Interest expense                   25,842        23,766           9         9.3         8.4
Interest (income) and other,
net                                   441           700         (37 )       0.2         0.2

Income (loss) before income
taxes                               2,134      (205,796 )      (101 )       0.7       (72.7 )
Provision for income taxes          1,530        12,134         (87 )       0.5         4.3
Income (loss) from
continuing operations                 604      (217,930 )      (100 )       0.2       (77.0 )
Loss from discontinued
operations                              -        (1,080 )      (100 )         -        (0.4 )
Net income (loss)               $     604    $ (219,010 )      (100 )       0.2       (77.4 )



(a) Excludes depreciation and amortization.

Reconciliation of Income (Loss) from Operations to Adjusted EBITDA and Segment Adjusted EBITDA before Corporate Overhead (Non-GAAP financial measures)

Income (loss) from
operations                      $  28,417    $ (181,330 )      (116 )%     10.2 %     (64.1 )%
Depreciation and
amortization                       42,361        41,403           2        15.2        14.6
Share-based compensation            9,672        13,816         (30 )       3.5         4.9
Acquisition, integration and
other                               7,364         5,556          33         2.7         2.0
Goodwill impairment                     -       208,166        (100 )         -        73.6
Adjusted EBITDA (b)                87,814        87,611           -        31.6        31.0
Corporate overhead                 18,656        19,936          (6 )       6.7         7.0
Segment adjusted EBITDA
before corporate overhead
(b)                             $ 106,470    $  107,547          (1 )      38.3        38.0



(b) See discussion of Non-GAAP financial measures on page 34.

Revenues. For the nine months ended September 30, 2013, revenues decreased $4.6 million, or 2%, as an increase in our online segment revenues were more than offset by a decrease in our television segment revenues. For further discussion on revenues by reportable segment, see each of the television and online segments.

Cost of Revenues. For the nine months ended September 30, 2013, cost of revenues decreased $2.0 million, or 2%, as compared to the same period in the prior year. As a percentage of revenues, cost of revenues decreased to


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36.3% in 2013, as compared to 36.4% in 2012. Cost of revenues decreased due to lower (i) personnel costs ($2.9 million) and (ii) ad system costs ($1.2 million), partially offset by an increase in trading costs ($2.4 million). The reduction in personnel costs is commensurate with a reduction in our television revenues. Ad systems costs decreased due to transitioning the majority of our customers' online advertising over to a single advertising platform in 2013 from the three separate advertising platforms we operated in 2012. The increase in trading costs is proportional to an increase in our online trading revenues.

Sales and Marketing. For the nine months ended September 30, 2013, sales and marketing expense increased $5.2 million, or 11%, as compared to the same period in the prior year. The increase was primarily due to higher (i) personnel costs ($2.4 million), (ii) sales and marketing expenses ($2.2 million) and
(iii) facilities costs ($0.4 million). Personnel costs increased due to (i) an increase in the number and average cost per sales and marketing employee and
(ii) higher incentive compensation. Sales and marketing expenses increased due to greater spending on business partnerships and advertising. Business partnerships involve paying a commission or fee to the party responsible for causing the customer to use our platform in their online advertising. As a percentage of revenues, sales and marketing expense increased to 18.6% in the current year period, as compared to 16.5% in the same period of the prior year. The percentage increase is due to the factors discussed above.

Research and Development. For the nine months ended September 30, 2013, research and development costs decreased $4.0 million, or 22%, as compared to the same period in the prior year. The decrease was due to higher capitalized wages ($3.6 million) and lower compensation costs ($0.9 million), partially offset by an increase in other expenses. The increase in capitalized wages is due to working on more software development projects that qualify for capitalization. The decrease in compensation costs is primarily attributable to a reduction in share-based compensation.

General and Administrative. For the nine months ended September 30, 2013, general and administrative expense decreased $8.1 million, or 20%, as compared to the same period in the prior year. As a percentage of revenues, general and administrative expense decreased to 11.8% in the current year period, as compared to 14.4% in the same period in the prior year. The decrease was primarily due to lower (i) professional fees ($3.1 million), (ii) personnel costs ($2.9 million) and (iii) facilities costs ($1.3 million). The decrease in professional fees is due to lower (i) legal fees, (ii) audit and tax fees and
(iii) consulting fees. The decrease in personnel costs is attributable to a reduction in the number and average cost per general and administrative employee.

Acquisition, Integration and Other. For the nine months ended September 30, 2013, acquisition, integration and other expense increased $1.8 million as compared to the same period in the prior year. The increase was primarily due to costs associated with our strategic alternatives review process ($4.2 million) which resulted in us entering into a merger transaction with ER (for more information, see Note 1 of our consolidated financial statements), partially offset by a reduction in severance costs ($2.5 million). Severance costs were higher in the prior year period as in 2012 we were in the process of transitioning our three previously separate online businesses into a single operation.

Depreciation and Amortization. For the nine months ended September 30, 2013, depreciation and amortization expense increased $1.0 million, or 2%, as compared to the same period in the prior year. The increase was due to (i) depreciation of leasehold improvements related to our office facility in New York City which was placed into service in June 2012 and (ii) increased amortization associated with the intangibles assets acquired in the Peer 39 and North Country transactions.

Interest Expense. For the nine months ended September 30, 2013, interest expense increased $2.1 million as compared to the same period in the prior year. The increase was due to amending our credit facility in March 2013 ($1.3 million) and increasing the interest rate charged on our borrowings, partially offset by a reduction in interest expense due to a lower average outstanding balance. In March 2013 we amended our credit facility which resulted in (i) an immediate $50 million principal payment, (ii) higher scheduled principal payments, and (iii) a reduction in the size of our revolving credit facility from $120 million to $50 million. These changes caused us to write off $1.3 million of the existing debt issuance costs and original issue discount. In addition, the amendment requires that we pay an increased interest rate on our borrowings. See Note 6 of our consolidated financial statements.

Interest Income and Other, net. For the nine months ended September 30, 2013, interest income and other, net decreased $0.3 million as compared to the same period in the prior year. The decrease was due to a reduction in foreign currency exchange losses.


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Provision for Income Taxes. For the nine months ended September 30, 2013, our effective tax rate was 71.7%, compared to (5.9)% for the nine months ended September 30, 2012. The effective tax rates for each period differ from the expected federal statutory rate of 35.0% as a result of state and foreign income taxes, non-deductible expenses, adjustments for uncertain tax positions and, principally for the 2012 period, the recording of a valuation allowance against all of our federal net operating loss carryforwards. For 2012, the vast majority of the goodwill impairment charge was not deductible for income tax purposes.


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