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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED APRIL 3, 1999.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13(d) OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______TO _______.
COMMISSION FILE NUMBER: 0-18690
DIGITAL ORIGIN, INC.
(FORMERLY RADIUS INC.)
(Exact name of Registrant as specified in its charter)
CALIFORNIA 68-0101300
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
460 E. MIDDLEFIELD ROAD
MOUNTAIN VIEW, CA 94043
(Address of principal executive offices and zip code)
(650) 404-6000
(Registrant's telephone number, including area code)
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INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 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
--- ---
THE NUMBER OF SHARES OUTSTANDING OF THE REGISTRANT'S COMMON STOCK ON MAY 12,
1999 WAS 5,534,936.
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DIGITAL ORIGIN, INC.
INDEX
PART I. FINANCIAL INFORMATION PAGE
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Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 1999 (unaudited) and
September 30, 1998 3
Consolidated Statements of Operations for the Three and Six Months Ended
March 31, 1999 and 1998 (unaudited) 4
Consolidated Statements of Cash Flows for the Six Months Ended
March 31, 1999 and 1998 (unaudited) 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 11
PART II. OTHER INFORMATION
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Item 1. Legal Proceedings 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 19
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-2-
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIGITAL ORIGIN, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
MARCH 31, SEPTEMBER 30,
1999 1998 (1)
---------- -------------
(unaudited)
ASSETS:
Current assets:
Cash $ 1,814 $ 600
Accounts receivable, net 871 364
Note receivable from Korea Data Systems America, Inc. 2,400 4,500
Inventories 408 803
Prepaid expenses and other current assets 65 156
--------- ---------
Total current assets 5,558 6,423
Property and equipment, net 64 133
Purchased technology 150 --
--------- ---------
$ 5,772 $ 6,556
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY (Net capital deficiency):
Current liabilities:
Accounts payable $ 1,728 $ 1,971
Accrued payroll and related expenses 446 324
Other accrued liabilities 1,169 2,069
Deferred income 2,461 4,833
Accrued income taxes 1,101 1,102
Short-term borrowings -- 1,340
--------- ---------
Total current liabilities 6,905 11,639
Shareholders' equity (Net capital deficiency):
Common stock 169,177 169,102
Accumulated deficit (170,310) (174,185)
--------- ---------
Total shareholders' equity (Net capital deficiency) (1,133) (5,083)
--------- ---------
$ 5,772 $ 6,556
========= =========
(1) The balance sheet at September 30, 1998 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
See accompanying notes.
-3-
DIGITAL ORIGIN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data; unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31, MARCH 31,
---------------------------- -------------------------------
1999 1998 1999 1998
-------- -------- -------- -------
Net sales $ 2,919 $ 4,584 $ 5,417 $ 9,691
Commissions and royalties 10 431 50 864
---------- ---------- ----------- ------------
Total net sales 2,929 5,015 5,467 10,555
Cost of sales 1,116 3,463 2,110 7,060
---------- ---------- ----------- ------------
Gross profit 1,813 1,552 3,357 3,495
---------- ---------- ----------- ------------
Operating expenses:
Research and development 613 820 1,289 1,314
Selling, general and administrative 1,750 1,719 3,392 3,813
---------- ---------- ----------- ------------
Total operating expenses 2,363 2,539 4,681 5,127
---------- ---------- ----------- ------------
Loss from operations (550) (987) (1,324) (1,632)
Other income, net 1,634 4,417 5,254 5,496
Interest expense (1) (165) (55) (338)
----------- ----------- ------------ -------------
Income before income taxes 1,083 3,265 3,875 3,526
Provision for income taxes - - - -
---------- ---------- ----------- ------------
Net income $ 1,083 $ 3,265 $ 3,875 $ 3,526
========== ========== =========== ============
Net income per share:
Basic net income per share $ 0.20 $ 0.59 $ 0.70 $ 0.64
========= ========= ========== ===========
Diluted net income per share $ 0.19 $ 0.59 $ 0.69 $ 0.63
========= ========= ========== ===========
Shares used in per share computations:
Shares used in computing basic net
income per share 5,525 5,514 5,525 5,513
========== ========== =========== ============
Shares used in computing diluted net
income per share 5,722 5,534 5,643 5,575
========== ========== =========== ============
See accompanying notes.
-4-
DIGITAL ORIGIN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(in thousands, unaudited)
SIX MONTHS ENDED
MARCH 31,
--------------------------
1999 1998
--------- ---------
Cash flows from operating activities:
Net income $ 3,875 $ 3,526
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization 69 82
Gain on the sale of Splash Common Stock -- (5,345)
Gain on the sale of the Color Server Group and other assets to Splash (2,485) --
Gain on the monitor license and sale of other assets to KDS (2,135) --
(Increase) decrease in assets:
Accounts receivable (507) (202)
Note receivable 2,100 --
Inventories 395 197
Prepaid expenses and other current assets 91 53
Increase (decrease) in liabilities:
Accounts payable (243) 1
Accrued payroll and related expenses 122 (698)
Other accrued liabilities (900) (762)
Deferred income (2,372) --
Accrued restructuring costs -- (827)
Accrued income taxes (1) 16
------- -------
Total adjustments (5,866) (7,485)
------- -------
Net cash used in operating activities (1,991) (3,959)
Cash flows from investing activities:
Other assets (150) (1)
Net proceeds from the sale of Splash Common Stock -- 4,235
Net proceeds on the sale of the Color Server Group and other assets to Splash 2,485 --
Net proceeds from the monitor license and sale of other assets to KDS 2,135 --
------- -------
Net cash provided by investing activities 4,470 4,234
Cash flows from financing activities:
Short-term borrowings, net (1,340) (267)
Principal payments of long-term debt and capital leases -- (273)
Issuance of common stock 75 31
------- -------
Net cash used in financing activities (1,265) (509)
------- -------
Net increase (decrease) in cash and cash equivalents 1,214 (234)
Cash and cash equivalents, beginning of period 600 773
------- -------
Cash and cash equivalents, end of period $ 1,814 $ 539
======= =======
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 55 $ 324
======= =======
Income taxes $ 1 $ 3
======= =======
Non-cash investing activity:
Receivable from sale of shares of Splash Technology Holdings, Inc. $ -- $ 1,110
======= =======
See accompanying notes.
-5-
DIGITAL ORIGIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The consolidated financial statements of Digital Origin, Inc. ("Digital
Origin" or the "Company") as of March 31, 1999 and for the three and six
months ended March 31, 1999 and 1998 are unaudited. In the opinion of
management, the consolidated financial statements reflect all adjustments
(consisting only of normal recurring items) necessary for a fair
presentation in conformity with generally accepted accounting principles.
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses. Examples include provisions for returns and bad debts
and the length of product life cycles. Actual results may differ from
management's estimates. Results for the three and six months ended March 31,
1999 will not necessarily indicate the results to be expected for the fiscal
year ending September 30, 1999 or any other future period. The information
included in this Form 10-Q should be read in conjunction with the
Consolidated Financial Statements and notes thereto included in the
Company's Annual Report on Form 10-K for the fiscal year ended September 30,
1998.
For clarity of presentation, all fiscal periods are reported as ending
on a calendar month end.
NOTE 2. INVENTORIES
Inventories, stated at the lower of cost or market, consist of (in
thousands):
MARCH 31, SEPTEMBER 30,
1999 1998
----------- -------------
(unaudited)
Raw materials $ 2 $ 20
Work in process 128 238
Finished goods 278 545
--------- ----------
$ 408 $ 803
========= ==========
NOTE 3. COMMITMENTS AND CONTINGENCIES
(a) On January 13, 1999 and January 28, 1999, the Company and one of
its directors, Charles Berger, were named as defendants in two shareholder
class action lawsuits against Splash Technology Holdings, Inc. ("Splash"),
various directors and executives of Splash and certain selling shareholders
of Splash. The suits were filed in the United States District Court in
Northern District of California and have been consolidated and captioned IN
RE SPLASH TECHNOLOGY HOLDINGS INC. SECURITIES LITIGATION (Master File No.
C99-0109 SBA). The law firm of Milberg Weiss Bershad Hynes & Lerach LLP has
been designated lead counsel for the eight lead plaintiffs.
The lawsuit alleges, among other things, that the defendants made
or were responsible for material misstatements, and failed to disclose
information concerning Splash's business, finances and future business
prospects in order to artificially inflate the price of Splash Common
Stock. The complaint does not identify any statements alleged to have
been made by either Digital Origin or Charles Berger. The complaint
further alleges that Digital Origin (then Radius Inc.) engaged in a
scheme to artificially inflate the price of Splash Common Stock to reap
a large return on the sale of the Common Stock in order to pay off the
Company's substantial debt. Digital Origin and Charles Berger vigorously
deny all allegations of wrongdoing and intend to aggressively defend
themselves in these matters. Defendants intend to file a motion to
dismiss the action on June 11, 1999 with a hearing on that motion
scheduled for October 19, 1999.
(b) On July 18, 1997, Intelligent Electronics, Inc. and its affiliates
filed a suit in the United States District Court for the District of
Colorado alleging a breach of contract and related claims in the approximate
amount of $800,000, maintaining that the Company failed to comply with
various return, price protection, inventory balancing and marketing
development funding undertakings. In 1997, the Company filed an answer to
the complaint and cross-claimed against the plaintiffs and in October 1997
additionally cross claimed against Deutsche Financial, Inc., a factor in the
account relationship between the Company and the plaintiffs, seeking the
recovery of approximately $2 million. The Company continues to investigate
these claims as well as cross claims and expects to vigorously defend and
prosecute them as applicable. The Company has provided reserves for the full
amount of accounts receivable due from Intelligent Electronics, Inc. and
Deutsche Financial, Inc.
(c) The Company is involved in a number of other judicial and
administrative proceedings incidental to its business. The Company intends
to defend such lawsuits vigorously and although adverse decisions (or
settlements) may occur in one or more of such cases, the final resolution of
these lawsuits, individually or in the aggregate, is not expected to have a
material adverse effect on the financial position of the Company. However,
depending on the
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amount and timing of an unfavorable resolution of these lawsuits, it is
possible that the Company's future results of operations or cash flows
could be materially adversely affected in a particular period. In
addition, the costs of defense, regardless of the outcome, could have a
material adverse effect on the results of operations and financial
condition of the Company.
NOTE 4. LICENSING OF ASSETS TO KOREA DATA SYSTEMS AMERICA, INC.
In June 1998, the Company licensed certain technology and assets
necessary to conduct its monitor and color publishing business to Korea Data
Systems America, Inc. ("KDS"), leaving the Company free to focus on its
digital video software business. The brand name and trademark RADIUS was one
of the assets so licensed because of its primary association with monitors.
In August 1998, the Company amended and restated this license and agreed to
sell the licensed assets to KDS pursuant to an asset transfer agreement,
subject to certain contingencies at the discretion of KDS. The monitor
business has accounted for substantially all of the revenues of the color
publishing product line and 55.3% of the Company's revenues during fiscal
1998. Under the license and asset transfer agreement, the Company has
transferred (by licensing or by assignment if KDS elects to close the asset
transfer agreement) its Radius, Supermac, PressView and certain other
trademarks to KDS and has licensed certain intellectual property pertaining
to PressView and PrecisionView monitors. The expected value of the
transaction is $6.2 million to be paid in installments. As of March 31,
1999, $3.3 million was paid under the amended license and $0.5 million under
the original license in June 1998. The remaining amount is payable in
installments through October 1999. These installment payment obligations
have been pledged to secure a line of credit from Silicon Valley Bank (as of
March 31, 1999, the amount available to borrow was $1.9 million). KDS'
performance on the note is guaranteed by a Korean corporation and its US
affiliate. The agreement is expected to close by June 1999 if contingencies
are satisfied. In the interim, the Company has licensed KDS the use of its
monitor trademarks and specific technology and expects to wind down its
monitor business activities as current supplies of monitors are sold,
whether or not the asset purchase agreement is completed. In the event that
the asset purchase agreement is not completed, the license agreement will
continue as a perpetual license. Digital Origin will continue to use the
transferred trademarks and technology until the transition is completed over
the next several months and expects to focus on its digital video line of
business during this transition period and for the foreseeable future.
As of March 31, 1999, the remaining balance receivable under the
agreement was $2.4 million, which is included as note receivable and
deferred revenue in the accompanying Consolidated Balance Sheets. The
Company will recognize other income under the license agreement as cash is
received on the note.
On December 4, 1998, the Company and KDS supplementally agreed to the
sale of certain tangible personal property and the transfer of rights in the
Radius Emachines and Colormatch trademarks for $100,000 and other
consideration.
NOTE 5. TECHNOLOGY PURCHASE FROM POST DIGITAL SOFTWARE, INC.
On November 23, 1998, the Company acquired certain software and other
intangible property from Post Digital Software, Inc. for (i) an initial
payment of $50,000, (ii) earnout payments equal to at least $50,000 but not
exceeding $700,000 based on subsequent sales of the Company's digital video
products incorporating such software and (iii) a warrant to purchase up to
50,000 shares of the Company's Common Stock at an exercise price of $1.50
per share. The warrant is non-forfeitable and exercisable over a four year
period through November 23, 2002. The warrant can be exercised for up to
12,000 shares on May 1, 1999, plus an additional 2,000 shares for each full
month that transpires thereafter, up to a total of 50,000 shares. The value
of this agreement, as noted below, is included as purchased technology in
the accompanying Consolidated Balance Sheet. The technology is being
amortized over a three year period and future royalties based on digital
video products sold will be expensed as they are incurred.
Initial purchase price $ 50,000
Guaranteed earnout 50,000
Value assigned to warrant 50,000
-----------
Purchased technology $ 150,000
===========
-7-
NOTE 6. TRANSACTIONS WITH SPLASH TECHNOLOGY HOLDINGS, INC.
ESCROW FUND RELEASE
In connection with the Company's sale of its Color Server Group to
Splash Technology Holdings, Inc. in January 1996, an escrow fund was
established to secure certain indemnification obligations. On December 31,
1998, the balance of the escrow fund of approximately $2.2 million was
released to the Company as a result of the Federal Circuit Court affirming
the summary judgment in favor of the Company in the EFI litigation. The
Company used approximately $1.0 million of the proceeds to repay all
outstanding indebtedness to Silicon Valley Bank under the working capital
line of credit and will use the remaining proceeds to fund future working
capital needs.
SALE OF CERTAIN COLOR PUBLISHING TECHNOLOGY
On December 4, 1998, the Company agreed to sell certain software and
other intangible property associated with its monitor and color publishing
business to Splash Technology Holdings, Inc. for $275,000 and other
consideration.
NOTE 7. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, FASB issued SFAS 131, "Disclosures about Segments of an
Enterprise and related Information." This statement establishes standards
for the way companies report information about operating segments in
financial statements. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. The
disclosures prescribed by SFAS 131 will be adopted for the fiscal year
ending September 30, 1999.
In December 1998, the American Institute of Certified Public
Accountants issued SOP 98-9, "Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions," which amends SOP 97-2
and supersedes SOP 98-4. The Company will adopt SOP 98-9 in fiscal 2000,
with the exception of certain provisions of this SOP that extend the
deferral of the application of certain provisions of SOP 97-2 which were
effective December 15, 1998. The adoption of SOP 98-9 is not expected to
have a significant impact on the Company.
NOTE 8. EARNINGS PER SHARE
Basic earnings per share is computed using the weighted average number
of common shares outstanding during the period. Diluted earnings per share
is computed using the weighted average number of common and dilutive common
equivalent shares outstanding during the period. Dilutive common equivalent
shares consist of employee stock options and warrants using the treasury
stock method.
-8-
The following table shows the computation of basic and diluted earnings
per share:
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31, MARCH 31,
---------------------------- ------------------------
1999 1998 1999 1998
---------- ------------- ---------- ----------
(in thousands, except per share data)
NUMERATOR:
Numerator for basic and diluted earnings per share
Net income $ 1,083 $ 3,265 $ 3,875 $ 3,526
========= ========== ========= ==========
DENOMINATOR:
Denominator for basic earnings per share - weighted-average
shares outstanding 5,525 5,514 5,525 5,513
Effect of dilutive securities:
Employee stock options 147 20 93 62
Warrants 50 - 25 -
--------- ---------- --------- ----------
Dilutive potential common shares 197 20 118 62
Denominator for diluted earnings per share - adjusted
weighted-average shares outstanding 5,722 5,534 5,643 5,575
========= ========== ========= ==========
Basic earnings per share $ 0.20 $ 0.59 $ 0.70 $ 0.64
========= ========== ========= ==========
Diluted earnings per share $ 0.19 $ 0.59 $ 0.69 $ 0.63
========= ========== ========= ==========
NOTE 9. COMPREHENSIVE NET INCOME
As of October 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income."
SFAS 130 requires foreign currency translation adjustments and changes in
the fair value of available-for-sale-securities to be included in
comprehensive income. However, it has no impact on the net income or
stockholders' equity as presented in the financial statements.
The components of comprehensive net income, net of tax, are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31, MARCH 31,
---------------------------- --------------------------
1999 1998 1999 1998
---------- ------------- ---------- ------------
Net income $ 1,083 $ 3,265 $ 3,875 $ 3,526
Unrealized loss on available-for-sale-securities
(net of reclassification adjustment) - (1,615) - (11,320)
--------- ----------- --------- ------------
Comprehensive net income (loss) $ 1,083 $ 1,650 $ 3,875 $ (7,794)
========= ========== ========= ============
-9-
NOTE 10. OPERATING LEASE
The Company has signed an operating lease for its headquarters in
Mountain View, California, for a period of three years beginning April 15,
1999, with an option to extend the lease for an additional two years. The
base rent will be $25,000 per month the first year, $27,500 the second year
and $30,000 for years three through five, if extended.
NOTE 11. 1999 EMPLOYEE STOCK PURCHASE PLAN
The Company's Employee Stock Purchase Plan allows eligible employee
participants to purchase shares of the Company's common stock at a discount
through payroll deductions. Employees purchase shares at 85% of the market
value at either the beginning of the offering period or the end of the
purchase period, whichever price is lower. The plan consists of one year
offering periods with two six-month purchase periods in each offering
period. The Company has reserved 137,500 shares of its common stock for
issuance under the plan.
NOTE 12. SUBSEQUENT EVENT
On May 17, 1999, the Company completed the sale of its monitor and
color publishing business to Korea Data Systems America, Inc. See Note 4.
In connection with this transaction, the Company received the sum of
$1,000,000 which represents the final three installment payments on the
note related to the license agreement. As of May 17, 1999, the balance
due on the note was $700,000 payable through July 1999.
-10-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS: The following discussion
contains forward-looking statements within the meaning of Section 21E of the
Securities Exchange Act of 1934 that are subject to risks and uncertainties.
Statements indicating that the Company or management "intends", "plans",
"expects," "estimates" or "believes" are forward-looking, as are all other
statements concerning future financial results, product offerings or other
events that have not yet occurred. There are several important factors that
could cause actual results or events to differ materially from those anticipated
by the forward-looking statements contained in this discussion and other
sections of this Form 10-Q. Such factors include, but are not limited to: the
Company's ability to achieve profitability; receipt of timely installment
payments from KDS; the Company's ability to repay any amounts it may borrow from
Silicon Valley Bank; the Company's ability to successfully conclude its
litigation with Intelligent Electronics, Inc. and Splash shareholders; the
success of the Company's digital video software products; the success of the
Apple Macintosh computer line and operating system, the success of Apple, as
well as the Company's ability to compete successfully with Apple in its markets,
including the non linear digital video editing software market; the success of
Apple's Quicktime technology for Windows; favorable licensing terms for
Quicktime from Apple; the Company's reliance on Adobe Systems for products which
are bundled with the Company's products; the Company's ability to successfully
develop, introduce and market new software products, including products for the
Windows operating system, to keep pace with technological innovation,
particularly in light of its limited financial resources; the Company's ability
to compete in the digital video software market, including with Apple; the
ability of the Company's manufacturers and suppliers to deliver components and
manufacture the Company's products; the Company's ability to achieve Year 2000
readiness in its business operations and its dealings with significant third
parties; the Company's reliance on international sales and its new distributor
arrangements with respect to Europe and Japan; and the Company's ability to
attract and retain its key personnel.
Each forward-looking statement should be read in conjunction with the entire
consolidated interim financial statements and the notes thereto in Part I, Item
1 of this Quarterly Report, with the information contained in Item 2, including,
but not limited to, "Certain Factors That May Affect Future Results," and with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" contained in the Company's Annual Report on Form 10-K for the fiscal
year ended September 30, 1998, including, but not limited to, "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Certain Factors That May Affect the Company's Future Results of Operations."
OVERVIEW
The Company designs, develops, assembles, markets and supports
digital video computer products for creative professionals and consumers who use
digital camcorders. The Company's current product line includes: multimedia
authoring and editing video systems and software that can acquire and manipulate
video and audio information.
The primary target markets for the Company's products are video
editors, video producers, and creators of multimedia. These markets encompass
creative professionals involved in such areas as multimedia authoring, video
editing, video and multimedia production and corporate training.
Historically, substantially all of the Company's products have been
designed for and sold to users of Macintosh computer products (the "Macintosh")
manufactured by Apple Computer, Inc. ("Apple") as Apple products have been the
preferred platform in the Company's target markets. During fiscal 1998, the
Company added cross platform (Windows and Macintosh) capabilities to many of the
Company's products in order to market these products to users of the Windows
operating system. In the fourth quarter of fiscal 1998, 30% of unit sales were
made to cross-platform users. This compares to 38% and 60% of unit sales to
cross-platform users in the first and second quarter of fiscal 1999,
respectively.
As shown in the accompanying consolidated financial statements, the
Company has incurred substantial operating losses. During fiscal 1997 and 1998,
management implemented a number of actions to address its cash flow and
operating issues including; refocusing its efforts on providing solutions for
digital video customers; discontinuing sales of mass market and other low value
added products; divesting a number of businesses and product lines, including
most recently the agreement for the sale and related license of significant
assets of its monitor business to Korea Data Systems America, Inc. ("KDS");
significantly reducing expenses and headcount; and reducing its lease
obligations given its reduced occupancy requirements. There can be no assurance
that these measures will be sufficient to allow the Company to achieve
profitability. As of March 31, 1999, the Company had a working capital deficit
of $1.3 million. The Company intends
-11-
to finance its working capital needs through cash generated by operations and
borrowings under a working capital line of credit with Silicon Valley Bank.
The Company may need to further reduce its operating expenses or seek
additional sources of working capital if software product sales do not
increase at the rate assumed in the Company's current operating plans.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain
operational data as a percentage of net sales (may not add due to rounding).
THREE MONTHS ENDED SIX MONTHS ENDED
MARCH 31, MARCH 31,
1999 1998 1999 1998
---- ---- ---- ----
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 38.1 69.1 38.6 66.9
----- ----- ----- -----
Gross profit 61.9 30.9 61.4 33.1
----- ----- ----- -----
Operating expenses:
Research and development 20.9 16.3 23.6 12.5
Selling, general and administrative 59.8 34.3 62.0 36.1
----- ----- ----- -----
Total operating expenses 80.7 50.6 85.6 48.6
----- ----- ----- -----
Loss from operations (18.8) (19.7) (24.2) (15.5)
Other income, net 55.8 88.1 96.1 52.1
Interest Expense 0.0 (3.3) (1.0) (3.2)
----- ----- ----- -----
Income before income taxes 37.0 65.1 70.9 33.4
Provision for income taxes 0.0 0.0 0.0 0.0
----- ----- ----- -----
Net income 37.0% 65.1% 70.9% 33.4%
===== ===== ===== =====
NET SALES
The Company's total net sales decreased 41.6% to $2.9 million in the
second quarter of fiscal 1999 from $5.0 million for the same quarter in fiscal
1998. Net sales for the first six months of fiscal 1999 decreased 48.2% to $5.5
million from $10.6 in the same period of fiscal 1998. The decline is due
primarily to the following factors: the Company's decision to refocus its
efforts on its digital video software product lines while discontinuing the
development of its color publishing and accelerated color graphics products; a
decline in the sales of its color publishing products due to the agreement for
the license of significant assets of its monitor business to KDS; and reduced
commissions paid by its international distributors due to the Company's change
in product focus.
As a result of the KDS transaction, the Company anticipates lower
overall net sales in the immediate future as compared to net sales in fiscal
1998. Future sales will be predominately attributable to sales of software
products since the Company's digital video product line is primarily software.
Shipments of digital video products in the three month period ended March 31,
1999 were $2.8 million, an increase of 20% from the first quarter of fiscal 1999
and represented approximately 96.8% of net revenue. There can be no assurance
that sales of these software products will continue to increase or that they
will increase to a sufficient extent to offset the anticipated decline in
hardware sales. The Company also experienced continued growth in direct and
on-line sales, which represented 15% of net revenue in the second quarter of
fiscal 1999 as compared with 12% of net revenue in the previous quarter. Revenue
recognition related to software product sales is as follows: revenue from the
sale of software, net of estimated returns, is recognized upon either shipment
of the physical product or delivery of electronic product, at which time
collectibility is probable and the Company has no remaining obligations.
Sales to Ingram Micro, Canon U.S.A., Inc. and Radius KK accounted for
23.2%, 19.5% and 16.3% of net sales for the second quarter of fiscal 1999,
respectively. For the corresponding period of fiscal 1998, the same customers
accounted for 48.8%, 0.0% and 9.1% of the Company's net sales. For the six month
period of fiscal 1999, Ingram Micro,
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Canon U.S.A., Inc. and Radius KK accounted for 25.4%, 16.4% and 11.6%,
respectively, as compared to 55.2%, 0.0% and 5.3% for the corresponding
period of fiscal 1998.
GROSS PROFIT
The Company's gross profit margin was 61.9% and 61.4% for the three
and six month periods ended March 31, 1999, respectively, compared with 30.9%
and 33.1% for the same periods in fiscal 1998. The increase in gross profit
margin in fiscal 1999 was due primarily to increased sales of higher gross
margin digital video software products. The gross profit margin for the three
and six month periods ended March 31, 1998 reflects the sales of discontinued
accelerated graphics and DOS on Mac products at very low profit margins.
Excluding these products the gross profit margin would have been 38.7% and
38.9%, respectively.
The Company anticipates the gross profit margins will be higher in
fiscal 1999 as compared to the gross profit margins in fiscal 1998 due to the
Company's decision to refocus its business on higher margin digital video
software products. Additionally, the Company is taking further steps to reduce
product costs and control expenses. However, there can be no assurance that the
Company's gross margins will improve or remain at current levels.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses decreased to $0.6 million or 20.9%
of net sales in the second quarter of fiscal 1999 from $0.8 million or 16.3% of
net sales in the same quarter of fiscal 1998. Research and development expenses
were $1.3 million or 23.6% of net sales for the first six months of fiscal 1999
and $1.3 million or 12.5% of net sales for the corresponding period of fiscal
1998. The increase in research and development expenses expressed as a
percentage of net sales were primarily attributed to the decrease in net sales.
The Company expects that decreases in its research and development expenses due
to the KDS transaction will be offset by increases in the expenses for the
digital video product line and, therefore, expects to devote approximately $3.0
million to research and development during the entire fiscal 1999.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were $1.8 million or
59.8% of net sales and $3.4 million or 62.0% of net sales for the three and six
month periods ended March 31, 1999, respectively, compared to $1.7 million or
34.3% and $3.8 million or 36.1% of net sales for the same periods of the prior
year. The Company decreased its selling, general and administrative expenses
primarily by reducing expenses related to headcount resulting from the efforts
to refocus its business, partially offset by an increase to incentive
compensation expense as the Company's financial performance improved from fiscal
1998.
OTHER INCOME, NET
Other income was $1.6 million and $5.3 million for the three and six
month periods ended March 31, 1999, respectively, compared to $4.4 million and
$5.5 million for the same periods in fiscal 1998. In the six month period ended
March 31, 1999, other income resulted from $2.1 million in income from KDS, a
reversal of approximately $0.6 million of previously accrued sales taxes as a
result of settlement of various sales tax exposures in certain jurisdictions,
the release of approximately $2.2 million from escrow related to the 1996
divestiture of the Color Server Group, and $0.4 million for the license of
intellectual property unrelated to the digital video business. In the first six
months of fiscal 1998, other income resulted from the sale of 290,000 shares of
Splash Common Stock.
INTEREST EXPENSE
Interest expense was minimal in the second quarter of fiscal 1999 and
$55,000 for the six months ended March 31, 1999, compared with $165,000 and
$338,000 for the same periods in the prior year. This decrease was due to the
repayment of the working capital line of credit to IBM Credit in July 1998 and
Silicon Valley Bank working capital line of credit in January 1999.
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INCOME TAXES
The Company did not record a provision for income taxes for the three
and six month periods ended March 31, 1999 and March 31, 1998 due to the
availability of net operating loss carryforwards.
FAS 109 provides for the recognition of deferred tax assets if
realization of such assets is more likely than not. Based on the weight of
available evidence, the Company has provided a full valuation allowance against
its deferred tax assets. The company will continue to evaluate the realization
of the deferred tax assets on a quarterly basis.
NET PROFIT
As a result of the above factors, the Company had a net income of
$1.1 million and $3.9 for the three and six months ended March 31 1999,
respectively, compared to a net income of $3.3 million and $3.5 for the three
and six months ended March 31, 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents increased to $1.8 million at
March 31, 1999, a $1.2 million increase from September 30, 1998. Approximately
$0.1 million of the $1.8 million of cash and cash equivalents available at March
31, 1999 was restricted under a letter of credit. The increase in the Company's
cash and cash equivalents was primarily attributable to funds received from the
Splash escrow and income from the license agreement with KDS which was offset by
funding of operating losses of the Company. However, the Company had a working
capital deficit of $1.3 million at March 31, 1999.
Under the license and asset transfer agreement with KDS, the Company
has transferred (by licensing or by assignment if KDS elects to close the asset
transfer agreement) its Radius, Supermac, PressView and certain other trademarks
to KDS and has licensed certain intellectual property pertaining to PressView
and PrecisionView monitors. The expected value of the transaction is $6.2
million which is payable in installments. As of March 31, 1999, $3.3 million was
paid under the amended license and $0.5 million under the original license in
June 1998. The remaining amount is payable in installments through October 1999.
KDS' performance on the note is guaranteed by a Korean corporation and its US
affiliate. The asset transfer agreement is expected to close by June 1999, if
contingencies are satisfied. These installment payment obligations have been
pledged to secure a line of credit from Silicon Valley Bank. There can be no
assurance that the closing will occur or that installment payments under the
license will be timely made.
The Company believes that the cash flows from KDS, results of
operations, and other sources of financing, will be sufficient to fund
operations for at least the remainder of this fiscal year. However, there can be
no assurances that the sale of software products will continue to increase to a
sufficient extent to offset the loss of revenues and gross margin from the
monitor business or that the installment payments will be timely made. The
Company may need to further reduce its operating expenses or seek additional
sources of working capital if software product sales do not increase at the rate
assumed in the Company's current operating plans. The Company and its management
believe that other sources of financing will be available and that it can
further reduce such operating expenses, if necessary.
The Company's principal sources of liquidity currently are cash
generated by operations, if any, and a working capital line of credit provided
by Silicon Valley Bank which is secured by the installment payment obligations
of the KDS transaction. Under the terms of the working capital line of credit,
the amount available to borrow will be decreased by eighty percent of the
payments made by KDS, since the borrowing base under the working capital line of
credit is eighty percent of the unpaid balance of KDS' installment obligations.
As of March 31, 1999, the amount available to borrow was $1.9 million. Interest
is paid at the rate of 1.25% per month of 125% of the average daily outstanding
balance of the loan. In addition, a one time administrative fee of 0.50% of 125%
of each advance amount is also paid to Silicon Valley Bank. As of March 31,
1999, the Company had no outstanding balance on the working capital line of
credit. With the proceeds from the release of approximately $2.2 million from
the escrow related to the divestiture of the Color Server Group, the Company
repaid all outstanding debt to Silicon Valley Bank in January 1999. However, the
associated working capital line of credit remains in effect.
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The Company anticipates that it will have cash available for its
ordinary course of business operating expenses. Although the Company has
achieved favorable trade terms with its critical vendors, certain suppliers may
put the Company on a cash or prepay basis and/or require the Company to provide
security for their risk in procuring components or reserving manufacturing time.
In the event the Company were unable to generate sufficient net sales or if the
Company incurs unforeseen operating expenses, it may not be able to meet its
operating expenses without additional financing.
CERTAIN FACTORS THAT MAY AFFECT THE COMPANY'S FUTURE RESULTS OF OPERATIONS
A number of uncertainties exist that could affect the Company's
future operating results, including, without limitation, the following factors:
the Company's ability to achieve profitability; receipt of timely installment
payments from KDS; the Company's ability to repay any amounts it may borrow from
Silicon Valley Bank; the Company's ability to successfully conclude its
litigation with Intelligent Electronics, Inc. and Splash shareholders; the
success of the Company's digital video software products; the success of the
Apple Macintosh computer line and operating system, the success of Apple, as
well as the Company's ability to compete successfully with Apple in its markets,
including the non linear digital video editing software market; the success of
Apple's Quicktime technology for Windows; favorable licensing terms for
Quicktime from Apple; the Company's reliance on Adobe Systems for products which
are bundled with the Company's products; the Company's ability to successfully
develop, introduce and market new software products, including products for the
Windows operating system, to keep pace with technological innovation,
particularly in light of its limited financial resources; the Company's ability
to compete in the digital video software market, including with Apple; the
ability of the Company's manufacturers and suppliers to deliver components and
manufacture the Company's products; the Company's ability to achieve Year 2000
readiness in its business operations and its dealings with significant third
parties; the Company's reliance on international sales and its new distributor
arrangements with respect to Europe and Japan; the Company's ability to attract
and retain its key personnel; and the risk factors identified from the Company's
Annual Report on Form 10-K for the fiscal year ended September 30, 1998.
IMPACT OF YEAR 2000
The year 2000 Issue ("Y2K Issue") is the result of computer programs
being written using two digits rather than four to define the applicable year.
Any of the Company's computer programs or hardware that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices, distribute via Internet, or engage in
similar normal business activities. The Company's plan to resolve the Y2K Issue
involves the following four phases: assessment, remediation, testing, and
implementation. To date, the Company has fully completed its assessment of all
internal systems and products that could be significantly affected. The
assessment of risks associated with suppliers and distributors is not yet
complete.
Based on recent assessments of its information management and
accounting systems, the Company has determined that it will be required to
modify or replace significant portions of its software and certain hardware so
that those systems will properly utilize dates beyond December 31, 1999. The
Company presently believes that with such modifications and replacements, the
Y2K Issue can be mitigated without a material adverse impact on the Company.
However, if such modifications and replacements are not timely made, the Y2K
Issue could have a material impact on the operations of the Company. None of
these systems interoperate directly with the systems of suppliers or
distributors.
Based on a review of its product line, the Company has determined
that primarily all of the products it has sold and will continue to sell do not
require remediation to be Year 2000 compliant, as primarily all operate in
conjunction with the MacOS. Accordingly, the Company does not believe that the
Y2K Issue presents a material risk with respect to the Company's products.
The Company is approximately 75% through the remediation phase with
respect to its information management and accounting systems and expects to
complete software and hardware replacement no later than September 30, 1999.
Once the software and hardware is replaced for a system, the Company begins
testing and implementation. These phases run concurrently for different systems.
Completion of the testing phase for all significant existing software systems
was completed as of January 31, 1999, with all remediated systems to be fully
tested and implemented by December 31, 1999.
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None of the Company systems interface directly with significant third
party suppliers. The Company is starting the process of working with third party
suppliers and distributors to ensure that any Company systems that could
interface directly with third parties are Year 2000 compliant by December 31,
1999. Remediation and testing of all significant systems is expected no later
than December 31, 1999. The Company believes that its key suppliers, two of whom
are sole sources, are in the process of making their billing systems Year 2000
compliant. The Company is not aware of any supplier or distributor with a Y2K
Issue that would materially impact the Company's results of operations,
liquidity, or capital resources. However, the Company has no means of ensuring
that such suppliers and distributors will be Year 2000 ready. The inability of
suppliers and distributors to complete their Year 2000 resolution process in a
timely fashion could materially impact the Company. There are no vendors that
could not be replaced in a reasonable period of time, except for transport
vendors. The failure of Fedex, UPS, Airborne and the U.S. Mail would impact
direct sales. The effect of this occurrence is not determinable.
The Company will utilize both internal and external resources to
reprogram, or replace, test, and implement the software and operating equipment
for Year 2000 compliance. The total future cost of the Year 2000 compliance is
estimated at $200,000 to $600,000 and is being funded through net cash flows or
capital leases. Some of these expenditures were likely to have been made in the
ordinary course of upgrading and replacing obsolete systems without regard to
the Y2K Issue. Through the second quarter of fiscal 1999, the Company has
incurred less than $100,000 related to all phases of the Year 2000 project and
$100,000 has been budgeted for fiscal 1999, under the assumption that most of
the new system cost will be funded via leasing.
Management of the Company believes it has an effective program in
place to resolve those aspects of the Y2K Issue within its control in a timely
manner. As noted above, the Company has not completed all necessary phases of
the Year 2000 program. In the event that the Company does not complete these
phases, the Company would be unable in some degree to take customer orders,
manufacture and ship products, invoice customers and collect payments. In
addition, disruptions in the economy generally resulting from Year 2000 issues
could also materially adversely affect the Company. The Company could be subject
to litigation for computer systems product failure, for example, equipment
shutdown or failure to properly date business records. Furthermore, although
management is not aware of any Y2K Issue with products sold, there can be no
assurance that the use of such products alone or in conjunction with other
products will not malfunction and expose the Company to liability. The amount of
potential liability and lost revenue associated with these risks cannot be
reasonably estimated at this time.
The Company has contingency plans for certain critical applications
and is working on such plans for others. These contingency plans involve, among
other actions, manual workarounds, increasing inventories, and adjusting
staffing strategies. All of the Company's production, shipping, purchasing,
billing and inventory functions could be accomplished via outsource vendors that
are currently readily available, although there can be no assurance that such
vendors will be available on reasonable terms as the millennium approaches.
The above discussion regarding costs, risks and estimated completion
dates for the Year 2000 is based on the Company's good faith estimates based on
information that is currently available, and is subject to change. As the
Company continues to progress with this initiative, it may discover that actual
results will differ materially from these estimates.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 3 to Consolidated Financial Statements - Commitments and Contingencies.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of Shareholders held on February 26, 1999, the following
proposals were adopted by the margins indicated:
1. To elect a Board of Directors to hold office until the next annual meeting of
shareholders and until their respective successors have been elected and
qualified or until their earlier resignation or removal.
Number of Shares
For Withheld
Charles W. Berger 4,279,297 80,916
Michael D. Boich 4,308,898 51,315
John Cirigliano 4,335,985 24,228
Mark M. Housley 4,334,330 25,883
John C. Kirby 4,318,462 41,751
Stephen Manousos 4,332,035 28,178
Henry V. Morgan 4,335,660 24,553
2. To approve an amendment to the Company's 1995 Stock Option Plan to reserve an
additional 137,500 shares of Common Stock for issuance thereunder.
For 4,155,962
Against 162,998
Abstain 41,253
Broker Non-Vote 1,171,961
3. To approve the adoption of the Company's 1999 Employee Stock Purchase Plan
and authorize 137,500 shares of Common Stock for issuance thereunder.
For 4,198,079
Against 123,707
Abstain 38,427
Broker Non-Vote 1,171,961
4. To authorize the amendment of the articles of incorporation of the Company to
effectuate a name change.
For 4,281,720
Against 38,801
Abstain 39,692
Broker Non-Vote 1,171,961
5. To ratify the appointment of Ernst & Young LLP as independent auditors of the
Company for it's fiscal year ending September 30, 1999.
For 4,329,027
Against 8,901
Abstain 22,285
Broker Non-Vote 1,171,961
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ITEM 5. OTHER INFORMATION
On February 26, 1999, the shareholders approved a name change of the
Company. On March 1, 1999, the Company filed an amendment to article I of the
Sixth Amended and Restated Articles of Incorporation of Radius, Inc. with the
California Secretary of State to change its name to Digital Origin, Inc.
Simultaneously, the Company changed its NASDAQ symbol from RDUS to DODV.
Possible Delisting from Nasdaq SmallCap Market: As of March 31, 1999,
the Company had assets of $5.8 million and total liabilities of $6.9 million and
therefore had net tangible assets of $(1.1 million). In order for the Company's
Common Stock to continue to be listed on the Nasdaq SmallCap Market, the Company
will be required to maintain net tangible assets of at least $2.0 million, or
must have net income in its most recently completed fiscal year or in two of the
three prior fiscal years. The Company had net income in fiscal years 1997 and
1998. However, in the event that the Company does not increase its net tangible
assets to greater than $2.0 million, the Company's Common Stock would be subject
to delisting if it also failed to achieve net income for its next two fiscal
years.
On February 26, 1999, the shareholders approved the addition of John
Cirigliano, Henry V. Morgan and Stephen Manousos to the Board of Directors. See
Item 4.
Mr. Cirigliano, as president and founder of the privately held
consulting firm of CLB Associates, has advised or invested in dozens of emerging
companies in a range of industries including manufacturing, marketing,
communications, software and hardware since 1986. Such work has focused on
operating or strategic initiatives and implementations designed to significantly
improve client company operations and enhance equity values. In such capacity,
Mr. Cirigliano advised the Company from 1995 until 1998. Prior to his
association with CLB Associates, Mr. Cirigliano was a managing director with
Merrill Lynch Capital Markets for ten years, where he headed the team that
developed a highly successful zero coupon convertible product. Mr. Cirigliano
also co-founded Copaquen Associates, a privately-held computer software
development and advisory firm, and Corporate Property Investors, a large,
privately held real estate investment trust now part of Simon DeBartolo. From
1991 to 1997, he was a Director of Ajax Electric Corp., a leading domestic
distributor of electric motors and served as a Senior Advisor to "The Red
Herring" magazine as well as on the Advisory Board of Outward Bound U.S.A. and
The Endowment Trust. Mr. Cirigliano received his BA from Columbia University and
his JD from New York Law School.
Mr. Morgan joined the Company in February 1997 as Chief Financial
Officer and Senior Vice President, Finance and Administration. He resigned from
these positions in September 1998 in order to assume his current duties as chief
financial officer at Redcreek Communications, Inc., an Internet start up
company. He remained Secretary to the Company and was appointed to the Board of
Directors in October 1998. During 1995 and 1996, Mr. Morgan was Executive Vice
President and Chief Financial Officer of Connect, Inc. of Mountain View,
California, an Internet-based interactive commerce applications software
company. From 1989 through 1994, Mr. Morgan was Executive Vice President and
Chief Financial Officer of Logitech International, S.A., a computer mouse
manufacturer.
Mr. Manousos co-founded and has served as Chief Executive Officer and
Director of Post Digital Software, Inc. since June 1996. Post Digital is an
electronic prepress and digital printing company dedicated to creating and
marketing powerful, professional video applications. Post Digital's business is
currently being wound down. From April 1991 until June 1996, Mr. Manousos
co-founded and served as Vice President of Sales and Marketing, and later Vice
President of Sales at Fractal Design Corporation, and was a member of its Board
of Directors until the company was acquired by MetaTools in May 1997. While at
Fractal, Mr. Manousos managed the sales and marketing teams and was responsible
for the company's product packaging. Prior to Fractal, Mr. Manousos spent 17
years in newspaper editing and writing, including a stint as an editor on the
national desk of the Los Angeles Times.
Mary Bobel joined the Company on May 3, 1999 as Chief Financial
Officer and Vice-President, Operations and Administration. Ms. Bobel served as
the Executive Vice-President and Chief Financial Officer of Genus, Inc., a
publicly traded manufacturer of semiconductor equipment from March 1997 through
August 1998. Prior to Genus, she was Vice-President and Chief Financial Officer
of Educational Publishing Corporation, a privately held supplier of educational
materials from September 1994 until September 1996. From March 1990 through
September 1994 she was Vice-President and Corporate Controller for Adobe
Systems, a publicly traded software company.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
--------
The following exhibits are filed with this Quarterly Report:
10.01 Registrant's 1999 Employee Stock Purchase Plan
27.01 Financial Data Schedule (EDGAR version only).
(b) Reports on Form 8-K
-------------------
No report on Form 8-K was filed during the three months ended March 31,
1999.
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.
Dated: May 14, 1999 DIGITAL ORIGIN, INC.
By:/s/
--------------------------------
Mary Bobel
Chief Financial Officer
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