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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                    FORM 10-K

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934

                  For The Fiscal Year Ended December 31, 2001

                                       OR

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________ TO _________.

                        COMMISSION FILE NUMBER: 0-27644

                        Digital Generation Systems, Inc.
             (Exact Name of Registrant as Specified in its Charter)

                 Delaware                                   94-3140772
     (State or Other Jurisdiction of                     (I.R.S. Employer
      Incorporation or Organization)                  Identification Number)

                   750 West John Carpenter Freeway, Suite 700
                              Irving, Texas 75039
          (Address Of Principal Executive Offices, Including Zip Code)

                                 (972) 581-2000
              (Registrant's Telephone Number, Including Area Code)

     Securities registered pursuant to Section 12(b) of the Act:  None
Securities registered pursuant to the Section 12 (g) of the Act: Common Stock
($0.001 par value)

     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 and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]

     Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

     The aggregate market value of the Common Stock held by non-affiliates of
the registrant, based upon the closing sale price of the Common Stock on March
15, 2002, as reported on the Nasdaq National Market, was approximately $78.6
million. Shares of Common Stock held by each officer and director of the
registrant and by each person who may be deemed to be an affiliate have been
excluded. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.

     As of March 15, 2002, the registrant had 70,784,475 shares of Common Stock
outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

The registrant has incorporated by reference into Part III of this Form 10-K
portions of its definitive Proxy Statement for its 2002 Annual Meeting of
Shareholders to be filed within 120 days after the end of the fiscal year (the
"Proxy Statement"), which meeting will be held on the date set forth in the
Proxy Statement. Except with respect to information specifically incorporated
by reference into this Form 10-K, the Proxy Statement is not deemed to be filed
as a part hereof.

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                        DIGITAL GENERATION SYSTEMS, INC.

The discussion in this Report contains forward-looking statements that involve
risks and uncertainties. The statements contained in this Report that are not
purely historical are forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Words such as "anticipates,"
"believes," "plans," "expects," "future," "intends," and similar expressions
are used to identify forward-looking statements. All forward-looking statements
included in this document are based on information available to the Company on
the date hereof, and we assume no obligation to update any such forward-looking
statements, except as required by law. The Company's actual results could
differ materially from those anticipated in these forward-looking statements as
a result of certain factors, including, but not limited to, those discussed in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Certain Business Considerations" as well as those discussed
elsewhere in this Report, and the risks discussed in the Company's other United
States Securities and Exchange Commission filings.

                               TABLE OF CONTENTS

                                     PART I

ITEM 1.  BUSINESS...........................................................  1
         Industry Background................................................  1
         Products and Services..............................................  2
         Markets and Customers..............................................  5
         Sales, Marketing and Customer Service..............................  5
         Competition........................................................  6
         Intellectual Property and Proprietary Rights.......................  7
         Employees..........................................................  7
ITEM 2.  PROPERTIES.........................................................  8
ITEM 3.  LEGAL PROCEEDINGS..................................................  8
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................  8
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT...............................  9

                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
            SHAREHOLDER MATTERS............................................. 10
ITEM 6.  SELECTED FINANCIAL DATA............................................ 11
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
            CONDITION AND RESULTS OF OPERATIONS............................. 12
         Overview........................................................... 12
         Critical Accounting Policies....................................... 12
         Results of Operations.............................................. 14
         Liquidity and Capital Resources.................................... 16
         Certain Business Considerations.................................... 17
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
            MARKET RISK..................................................... 27
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA......................... 27
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
            ACCOUNTING AND FINANCIAL DISLOSURE.............................. 28

                                     PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................  29
ITEM 11. EXECUTIVE COMPENSATION............................................  30
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
            MANAGEMENT.....................................................  30
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................  31

                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
            ON FORM 8-K....................................................  31
EXHIBITS AND REPORTS ON FORM 8-K...........................................  34
SIGNATURES.................................................................  35

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                       DIGITAL GENERATION SYSTEMS, INC.

                                    PART I

ITEM 1. BUSINESS

General

     Digital Generations Systems, Inc. (the "Company"), incorporated in 1991,
offers a suite of digital technology products and services through Digital
Generation Systems, Inc. ("DGS") and its wholly owned subsidiary StarGuide
Digital Networks, Inc. ("StarGuide"). Through DGS , the Company operates a
nationwide digital network out of its Network Operation Center ("NOC") located
in Dallas, Texas. The network beneficially links hundreds of advertisers and
advertising agencies with more than 7,500 radio and 875 television stations
across the United States and Canada. Through the NOC, the Company delivers
audio, video, image and data content that comprise transactions between the
advertising and broadcast industries. Through StarGuide , the Company develops
and sells proprietary digital software, hardware and communications technology,
including various bandwidth satellite receivers, audio compression codes and
software to operate integrated digital multimedia networks, and offers related
engineering consulting services.

     In January 2001, the Company completed its merger with StarGuide pursuant
to the Agreement and Plan of Merger by and among DG Systems, SG Nevada Merger
Sub Inc., a wholly owned subsidiary of DGS, and StarGuide. The merger has been
accounted for as a reverse acquisition, and accordingly, historical results of
the combined company prior to the merger are those of StarGuide, DGS' results
of operations have been included subsequent to January 1, 2001. Upon the
completion of the merger, each share of StarGuide common stock converted into
the right to receive 1.7332 shares of common stock of the Company. Under the
merger agreement, StarGuide's options and warrants were assumed by the Company
based on the same exchange ratio.

     On March 7, 2001, the Company completed its purchase of the 50% interest
in Musicam Express L.L.C. ("Musicam"), previously owned by Westwood One, Inc.
and Infinity Broadcasting Corporation, in exchange for 690,000 shares of common
stock plus the assumption of outstanding bank debt and other liabilities of
Musicam.

Industry Background

     Increasing demand for reliable and rapid means of information transfer in
the broadcast, scientific, education, entertainment, home-computing, and
telecommunications industries has driven a number of technical innovations in
recent years. In particular, digital distribution technologies are increasingly
used for distributing information in forms such as audio, video, text, and
data. Digitized information can be stored, manipulated, transmitted, and
reproduced more easily, more rapidly, with less degradation, and in greater
volumes than traditional analog or hard copy information.

     While many radio and television broadcasters now embrace digital
technology for much of their production processes and in-station media
management, current methods for the distribution of audio and video advertising
content are based primarily on the manual duplication and physical delivery of
analog tapes. According to industry sources, there are approximately 10,000
commercial radio and 1,100 commercial television stations in the United States.
These stations generate revenue by selling airtime to advertisers. Advertising
is most frequently produced under the direction of advertising agencies for
large national or regional advertisers or by station personnel for local
advertisers. Advertising is characterized as "network" or "spot," depending on
how it is bought and distributed. Network advertising typically is delivered to
stations as part of a "network feed" (bundled with network programming), while
spot advertising is delivered to stations independently of other programming
content.

     Spot advertising airtime typically is purchased by advertising agencies or
media buying firms, on behalf of advertisers. Advertisers and their agencies
select individual stations or groups of stations to support marketing
objectives, which usually are based on the stations' geographic and other
demographic characteristics. The actual commercials or "spots" typically are
produced at a digital production studio and recorded on digital tape.
Variations of the spot intended for specific demographic groups also are
produced at this time. The spots undergo a review of quality and content before
being cleared for distribution to broadcast stations. Tapes containing the spot
and its variations are then duplicated on analog tape, packaged, labeled and
shipped to the radio and television stations and cable head-ends specified by
the advertiser or its agency.

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     The predominant method for distributing spot advertisements to radio and
television stations traditionally has been physical delivery of analog audio or
videotapes. The Company estimates that approximately 30% of radio spots and
more than 60% of video spots are delivered by air express services. Many
companies, commonly known as "dub and ship houses," are in the business of
duplicating audio and video tapes, assembling them according to
agency-specified bills of material and packing them for air express delivery.
The Company estimates that it has transitioned approximately 45% of the market
for audio spot deliveries and approximately 13% of video spot deliveries, to
digital distribution.

     To meet their growing need for solutions that offer reliable, high-quality
digital information distribution, some companies have deployed their own
terrestrial-based local and wide area computer networks. These systems are
typically very costly to deploy, use, and maintain. Additionally, upgrading
these systems to keep abreast of technical innovations can be particularly
difficult and costly.

     Other digital communication and transmission technologies, such as private
network satellite systems, can offer more cost-effective and reliable solutions
for the digital transmission requirements of data intensive businesses,
including radio and television broadcasting. Satellite distribution can be
particularly effective at meeting the needs of point-to-multipoint
transmission, or "multicasting," and other broadcasting applications.

     The Company has developed proprietary software and hardware systems that
can address the need for data distribution services that are both economically
and technologically suitable to various commercial applications. Many of these
systems are currently deployed and in service, and the Company continues to
upgrade its technology, and to deploy additional units in the marketplace.

PRODUCTS AND SERVICES

     The Company currently markets and provides its products and services
through DGS and StarGuide.

     DGS provides electronic and physical distribution of and ancillary
post-production services for audio and video content to advertising agencies,
production studios, and broadcast stations throughout the United States and
Canada. DGS operates a digital network, currently serving approximately 7,500
radio and 875 television stations, controlled through its NOC. This network
enables the rapid, cost-effective, and reliable electronic transmission of
audio and video spots and other content and provides a high level of quality,
accountability, and flexibility to both advertisers and broadcasters. With the
DGS network, transmissions are automatically routed to stations through a
computerized on-line transaction and delivery system and arrive, in text
format, at stations in as little as one hour after an order is received.
Typically, associated traffic instructions are simultaneously transmitted by
facsimile to minimize station handling and scheduling errors. Shortly after a
spot is delivered to a station, DGS sends the customer a confirmation
specifying the time of delivery. Additionally, DGS' digital network delivers
close to "master" quality audio or video to broadcast stations, which is equal
to or superior to that currently delivered on analog tape.

     DGS generates its revenues from advertising agencies as well as from
production studios and dub and ship houses that consolidate and forward the
deliveries to broadcast stations. DGS has historically operated and currently
operates without substantial backlog. DGS receives distribution orders with
specific bills of material, routing and timing instructions provided by the
customer. These orders are entered into DGS' computer system either by the
customer (through an internet-based order-entry system) or by DGS customer
service personnel, and are scheduled for electronic delivery, if a station is
on DGS' network, or for physical delivery via DGS' various dub and ship
facilities, if a destination station is not on the network.

     Audio content is received electronically at DGS' NOC from Record Send
Terminals and Client Workstations that are owned by DGS and deployed primarily
in production studios. In addition, audio can be received using DGS' "iAudio"
internet audio collection system. When audio spots are received, company
personnel quality-assure the audio content and then initiate the electronic
transaction to transmit various combinations of audio to designated radio
stations. Audio transmissions are delivered over standard telephone or ISDN
lines to servers that DGS has placed in each radio station on its network. The
audio spots are thereafter available to the station on demand.

     Video content is received electronically at DGS' NOC primarily from Video
Record Transmission Systems that are owned by DGS and deployed in production
video studios. Video content also can be received through high-speed
communication lines

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from collection points in locations where Video Record Transmission Systems are
not available. When video spots are received, company personnel quality-assure
the spots and release the video to the NOC, where it is combined with the
customer's electronic transaction to transmit the various combinations of video
to designated television stations. Video transmissions are sent via a
high-speed frame relay link to the digital satellite uplink facility over which
they are then delivered directly to servers that DGS has placed in television
stations and cable interconnects.

     Audio and video transmissions are received at designated radio and
television stations on DGS-owned servers, called Receive Playback Terminals,
Client Workstations and ADvantage Digital Video Playback Systems. The servers
enable stations to receive and play back material delivered through DGS'
digital distribution network. The units are owned by DGS and typically are
installed in the "master control" or production area of the stations. Upon
receipt, station personnel generally review the content and transfer the spot
to a standardized internal station format for subsequent broadcast. Through its
NOC, DGS monitors the spots stored in each Receive Playback Terminal, Client
Workstation and Digital Video Playback System and ensures that space is always
available for new transmissions. DGS can quickly transmit audio or video at the
request of a station or in response to the request of a customer who wishes to
alter an existing order, enabling responsiveness not possible in a physical
tape distribution system.

     DGS offers various levels of digital audio and video distribution services
from its NOC to broadcast advertisers distributing content to broadcast
stations. These include the following: DG Priority, a service which guarantees
arrival of the first audio spot on an order within one hour (available for
audio only); DG Express, which guarantees arrival within four hours; DG
Standard, which guarantees arrival by noon the next day; and DG Economy, which
guarantees arrival by noon on the second day. DGS also offers a set of premium
services enabling advertisers to distribute audio or video spots provided after
normal business hours.

     In addition to its standard services, DGS has developed unique products to
service markets with particular time-sensitive delivery needs. "Sweeps"
delivery is a specialized service for television stations that wish to
advertise on radio with either topical or cooperative content to stimulate
viewership during the periods of ratings measurements conducted by the A.C.
Nielsen Company. DGS also offers delivery of advertising for daily newspapers
seeking to expand their readership based on a dissemination of breaking news
during the morning rush hour. DGS distributes first release music singles and
uses unique software functionality to insure that the singles are released
throughout the country to all stations simultaneously thereby eliminating
concerns of favoritism or premature release. Finally, DGS delivers political
advertising during election campaigns, providing a rapid response mechanism for
candidates and issue groups.

     StarGuide designs and provides high-speed digital information transmission
and distribution systems. StarGuide's patented technology--digital
distribution, compression, and transmission systems combined with satellite and
Internet technologies--allow StarGuide to achieve high-quality, economical,
flexible, and high-throughput information flow without the need for
point-to-point connections, regardless of digital formatting or compression
protocols. Integrated into many of StarGuide's systems are StarGuide's
proprietary digital audio compression and decompression, or "codec," techniques
and products.

     StarGuide's satellite transmission systems combine varying types of
information into one single transmission, maximizing the amount of information
transmitted through the satellite in a more cost-effective and reliable manner
than other distribution systems available on the market. The systems are also
readily upgradeable, secure, and able to direct transmissions, or components of
transmissions, to multiple points simultaneously. StarGuide's transmission
systems are capable of receiving any type of digitized media including audio,
simultaneous audio, video, text and data from a variety of sources including
satellite, high-bandwidth connections such as ISDN or T1 lines, and other wired
and wireless systems.

     StarGuide has developed a patented store-and-forward system called
Transportal 2000(TM), a cost-effective, reliable, high-speed electronic media
delivery system that serves the broadcast industry with Internet connectivity,
compatible StarGuide satellite transmission and terrestrial overlays, automatic
fall-back dub and ship service, and automated confirmation of delivery. This
proprietary automated media distribution system is being deployed across the
radio broadcasting industry. StarGuide will seek to expand its presence in the
broadcasting industry and will target new market opportunities for
high-quality, high-throughput digital information systems.

     In the United States radio industry, StarGuide has deployed its digital
transmission systems to radio stations owned by or affiliated with Jacor, ABC
Radio, Clear Channel, Infinity, Westwood One, CBS, Bloomberg, Jones Broadcast
Programming,

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One-On-One Sports, and Voice of America. Abroad, StarGuide has deployed its
digital transmission systems for Osaka-Yusen (Japan), the Shenzhen Stock
Exchange (China), and other entities in Australia, New Zealand, and South
America.

     The core of the StarGuide transmission system is StarGuide's patented MX3
Multiplexer and the StarGuide Receiver. The MX3 Multiplexer can accept up to
120 simultaneous digital, audio, video, or data services in various digital
formats. The StarGuide Multiplexer then breaks up these differing digital
service streams and re-orders and consolidates the various data streams into a
single data stream. The system can then cost-effectively transmit this data
stream in a single transmission signal, via satellites or other wired or
wireless communications vehicles. The MX3 Multiplexer does so in a highly
efficient manner, resulting in less consumption of costly bandwidth capacity on
the satellites than other transmission systems on the market, such as DVB
systems.

     Upon receipt of a transmission, the patented StarGuide Receiver
re-assembles and transmits data packets into their respective types of digital
information streams (audio, video, text, or data). StarGuide's receivers are
flexible and adaptable, employing low cost insertion cards that are installed
in any of a number of slots in the receivers, thus adapting the capabilities of
the receivers to varying needs of broadcasters who use them.

     Current StarGuide receiver insertion cards include:

     .    eDAS (Ethernet Enabled Digital Audio Storage) Card: a unique,
          patented store-and- forward card that allows a "live" broadcast
          through the StarGuide Receiver to be automatically mixed with
          pre-transmitted audio or video clips or advertising spots, thus
          allowing broadcasters to realize or regionalize national programs
          or advertisements distributed through the StarGuide transmission
          system;

     .    10/100 Based-T Ethernet Interface Card: a unique, patented card that
          allows StarGuide Receivers to receive and route digital content,
          particularly Internet Protocol content, directly onto a 10 or 100
          Based-T local or wide area computer network;

     .    Musicam(R) MPEG Layer II Digital Audio Decoder Card: a proprietary
          audio decoder card that provides CD quality audio and additional
          network control capabilities for broadcasters who use the StarGuide
          transmission systems to transmit radio broadcasts or other audio
          content;

     .    Relay Expansion Card: a system card that allows a broadcaster to
          remotely control a network through the StarGuide Receiver; and

     .    MPEG2 Digital Video Decoder Card: a video decoder card that provides
          VCR quality video and additional network control capabilities for
          broadcasters who use the StarGuide transmission systems to transmit
          video broadcasts or other video content.

     StarGuide's transmission systems are controlled by StarGuide's
Windows-based, propriety Network Management Control System, or NMCS, which
allows a system operator to maintain and control the entire transmission system
locally or remotely. The StarGuide NMCS allows the system operator to control
both the use of satellite bandwidth by the system and the accessing of
transmitted data by the individual StarGuide Receivers in the field.

     StarGuide also has developed a StarGuide DVB Multiplexer and mating
StarGuide DVB Receiver. StarGuide developed its StarGuide DVB transmission
system for applications requiring transmission in compliance with the DVB
standard. StarGuide's DVB system is being deployed throughout Japan by
Osaka-Yusen.

     Building on its experience and technology in digital content distribution,
StarGuide also seeks to become the leading provider of Internet-related video
and audio content delivery through the commercial application of its patented
CoolCast(TM) technology. Using this patented technology, viewers and listeners
can simultaneously access high-quality content through personal computers.
Streaming video and audio content, delivered via satellite to Internet points
of presence, can be accessed by subscribers through local area networks and
broadband connections that are capable of supporting CoolCast(TM) technology.
Subscribers can enjoy this streaming content in conjunction with
CoolCast(TM)-enabled web sites, without the degradation of

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signal quality typically caused by the congestion of the Internet backbone.
StarGuide believes that its CoolCast(TM) service represents an efficient and
scalable means to meet the growing demand for broadband video and audio
delivery to Internet users.

MARKETS AND CUSTOMERS

     A large portion of DGS' current revenue is derived from the delivery of
spot radio and television advertising to broadcast stations, cable systems and
networks. DGS derives revenue from advertising agencies directly and from its
marketing partners, which are typically dub and ship houses that have signed
agreements with DGS to consolidate and forward the deliveries of their
advertising agency customers to broadcast stations, cable systems and networks
via DGS' electronic delivery service in exchange for price discounts from DGS.
The advertisements distributed by DGS are representative of the five leading
national advertising categories of automotive, retail, business and consumer
services, food and related products and entertainment. The volume of
advertising from these segments is subject to substantial seasonal and cyclical
variations. DGS also generates revenues from radio stations by providing
distribution between radio stations and radio groups.

     StarGuide maintains established relationships with producers and
broadcasters such as Infinity, Westwood One, Clear Channel, ABC Radio, Jacor,
CBS, Bloomberg, Jones Broadcast Programming, One-on-One Sports and Voice of
America. As part of these relationships, StarGuide has sold or has contracts to
sell approximately 6,000 of its StarGuide II Receiver systems, and has sold or
has contracts to sell over 8,000 of its StarGuide III Receiver systems. In
addition, StarGuide's audio codecs are recognized and used throughout the radio
production and broadcast industries. StarGuide intends to utilize its existing
relationships as reference points and to leverage its technology to develop new
customers in the broadcast industry as well as deploy its delivery services for
content, streaming media and applications to various industries.

SALES, MARKETING AND CUSTOMER SERVICE

     Brand Strategy. DGS' brand strategy is to position itself as the standard
transaction method for the radio, television, cable, and network broadcast
industries. DGS focuses its marketing messages and programs at multiple
segments within the advertising and broadcast industries. Each of the segments
interacts with DGS for a different reason. Agencies purchase services from DGS
on behalf of their advertisers. Production studios facilitate the transmission
of audio and video to DGS' NOC. Production studios and dub and ship houses
resell delivery services to agencies. Stations join the network to receive the
content from their customers: the agencies and advertisers.

     Internet/E-Commerce Strategy. DGS introduced its first Internet-based
services called DG On-line in 1998 to facilitate the electronic remote entry of
work orders and to provide on-line tracking of order status by its customers.
DGS estimates that approximately 30% of its orders were entered electronically
via the Internet during each of 2001 and 2000. In addition, DGS also offers its
"iAudio" Internet audio collection system service that allows audio content to
be received from clients via the Internet.

     Sales. DGS employs a direct sales force that calls on various departments
at advertising agencies to communicate the capabilities and comparative
advantages of DGS' electronic distribution system and related products and
services. In addition, DGS' sales force calls on corporate advertisers who are
in a position to either direct or influence agencies in directing deliveries to
DGS. A separate staff sells to and services audio and video dealers, who resell
DGS' distribution services. An inside sales staff also represents DGS' services
to radio stations. DGS currently has regional sales offices in New York, Los
Angeles and Chicago. DGS' sales force includes regional sales, inside sales,
and telemarketing personnel.

     StarGuide presently markets and sells its transmission and distribution
systems and audio compression products directly to corporate and commercial
end-users, distributors, and to radio stations and networks. StarGuide
currently employs three salespersons who promote and sell the StarGuide
integrated transmission and distribution systems and promote the digital
distribution services provided to the radio broadcast industry. StarGuide also
employs seven salespersons that market and sell StarGuide's audio compression
products. StarGuide currently maintains relationships with distributors
marketing and selling StarGuide's audio compression products in Europe, Asia,
South America, and Australia. StarGuide is presently expanding these
relationships to include the distribution of StarGuide transmission and
information management systems.

     Marketing. DGS' marketing programs are directed to stimulate demand with
an emphasis on popularizing the benefits of digital delivery, including fast
turnaround (same day services), increased flexibility, higher quality, and
greater reliability and

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accountability. These marketing programs include direct mail and telemarketing
campaigns, newsletters, collateral material (including brochures, data sheets,
etc.), application stories, and corporate briefings in major United States
cities. DGS also engages in public relations activities including trade show
participation, the stimulation of articles in the trade and business press,
press tours and advertisements in advertising and broadcast oriented trade
publications.

     DGS markets to broadcast stations to arrange for the placement of its
Receive Playback Terminals and Digital Video Playback Systems for the receipt
only of audio and video advertisements, or Client Workstations, which provide
the ability to both receive and to originate distribution of audio to other
radio stations.

     StarGuide currently engages in several promotions and other activities to
generate interest in its systems and to consummate sales, including trade
shows. StarGuide seeks to maximize its visibility at trade shows by hosting a
customer booth and providing complimentary product literature describing
StarGuide's systems. StarGuide also conducts several on-site demonstrations
with technical and other senior level personnel and regularly contacts
potential customers who have indicated an interest in utilizing StarGuide's
systems or products.

     Customer Service. DGS' approach to customer service is based on a model
designed to provide focused support from key market centered offices, located
in Los Angeles, Dallas, Chicago and New York. Clients work with specific,
assigned account coordinators to place production service and distribution
orders. National distribution orders are electronically routed to the NOC for
electronic distribution or, for off-line destinations, to DGS' national
duplication center in Louisville, Kentucky. DGS' distributed service approach
provides direct support in key market cities enabling DGS to develop closer
relationships with clients as well as the ability to support client needs for
local production services. DGS also maintains a customer service team dedicated
to supporting the needs of radio, television, and network stations. This
support is available 7 days a week, 24 hours a day, to respond to station
requests for information, traffic instructions or additional media. Providing
direct support alleviates the need for client traffic departments to deal with
individual stations or the challenges of staffing for off-hours support. DGS'
customer service operation centers are linked to DGS' order management and
media storage systems, and national distribution network. These resources
enable DGS to manage the distribution of client orders to the fulfillment
location best suited to meet critical customer requirements as well as
providing order status and fulfillment confirmation. This distributed model
also provides DGS with significant redundancy and re-route capability, enabling
DGS to meet customer needs when weather or other conditions prevent deliveries
using traditional courier services.

     An important element of StarGuide's product offering is to support its
sales efforts with comprehensive technical support. Technical personnel often
accompany sales personnel when meeting with prospective customers and aid in
the implementation of StarGuide's products. Customer feedback received through
the sales process is incorporated into the product development process and
allows StarGuide to upgrade its service and support capabilities.

COMPETITION

     DGS competes with a variety of dub and ship houses and production studios
that have traditionally distributed taped advertising spots via physical
delivery. As local distributors, these entities have long-standing ties with
advertising agencies that are often difficult for DGS to replace. In addition,
these dub and ship houses and production studios often provide an array of
ancillary video services, including archival storage and retrieval, closed
captioning and format conversions, enabling them to deliver to their advertiser
and agency customers a full range of customizable, media postproduction,
preparation, distribution and trafficking services. DGS plans to continue
pursuing potential dub and ship house partners where such partnerships make
strategic sense.

     In the video marketplace, DGS competes with dub and ship houses across the
country but additionally with a satellite-based real-time video distribution
network operated by Vyvx, an operating division of Williams Communications
Group. DGS also anticipates that certain common and/or value-added
telecommunications carriers may develop and deploy high bandwidth network
services targeted at the advertising and broadcast industries, although DGS
believes that no such carriers have yet entered the market for spot
distribution.

     We are aware of other companies that are focusing or may in the future
focus significant resources on developing and marketing products and services
that will compete with ours. We believe that our ability to compete
successfully depends on a number of factors, both within and outside of our
control, including: (1) the price, quality and performance of our products and

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those of our competitors; (2) the timing and success of new product
introductions; (3) the emergence of new technologies; (4) the number and nature
of our competitors in a given market; (5) the protection of intellectual
property rights; and (6) general market and economic conditions.

     The Company expects competition to continue to intensify as existing and
new competitors begin to offer products, services, or systems that compete with
our products. Our current or future competitors, many of whom, individually or
together with their affiliates, have substantially greater financial resources,
research, and development resources, distribution, marketing, and other
capabilities than us, may apply these resources and capabilities to compete
successfully against our products and service.. A number of the markets in
which we sell our products and services are also served by technologies that
currently are more widely accepted than ours. Although we believe that its
products and services are less expensive to use and more functional than
competing products and services that rely on other technologies, it is
uncertain whether our potential customers will be willing to make the initial
capital investment that may be necessary to convert to our products and
services. The success of our systems against these competing technologies
depends in part upon whether our systems can offer significant improvements in
productivity and sound quality in a cost-effective manner. It is uncertain
whether our competitors will be able to develop systems compatible with, or
that are alternatives to, our proprietary technology or systems. It is also not
certain that we will be able to compete successfully against current or future
competitors or that competitive pressures faced by us will not materially
adversely affect its business, operating results, and financial condition.

INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS

     The Company primarily relies upon a combination of copyright, trademark
and trade secret laws and license agreements to establish and protect
proprietary rights in its technologies. The Company currently has eleven
patents issued and three others allowed and awaiting issuance and more than
thirty-six other patent applications pending domestically and abroad. The
Company also has four trademark registrations and seventy-six copyright
registrations and many other copyright registrations pending.

     Because the Company's business is characterized by rapid technological
change, it believes that factors such as the technological and creative skills
of its personnel, new computer hardware, software and telecommunications
developments, frequent hardware and software enhancements, name recognition,
and reliable customer service and support are more important to establishing
and maintaining a leadership position than the various legal protections of its
technology.

EMPLOYEES

     As of December 31, 2001, the Company had a total of 397 employees,
including 69 in research and development, 42 in sales and marketing, 247 in
operations and manufacturing, and 39 in finance and administration. All of
these employees were located in the United States. The Company's employees are
not represented by a collective bargaining agreement and the Company has not
experienced a work stoppage. The Company considers its relations with its
employees to be good.

     The Company's business and prospects depend in significant part upon the
continued service of its key management, sales and marketing and administrative
personnel. The Company does not generally have employment agreements with its
key personnel. The loss of key management or technical personnel could
materially adversely affect the Company's operating results and financial
condition. The Company believes that its prospects depend in large part upon
its ability to attract and retain highly skilled managerial, sales and
marketing and administrative personnel. Competition for such personnel is
intense, and the Company may not be successful in attracting and retaining such
personnel. Failure to attract and retain key personnel could have a material
adverse effect on the Company's operating results and financial condition.

                                      7

<PAGE>

ITEM 2. PROPERTIES

     The Company's principal executive offices are at 750 West John Carpenter
Freeway in Irving, Texas. The Irving offices include 26,000 square feet of
leased space, for which the lease expires in June 2006. The Company has
administrative offices located at 77 O'Farrell in San Francisco, California.
The Company's lease at this site is for 8,600 square feet and expires in
February 2005. To sustain uninterrupted network integrity, the Company has an
agreement for non-interruptible access to emergency power and has arranged for
alternative fiber optic routes to maintain its fiber connection between its
computers and its long distance carrier. In addition, the Company leases
approximately 3,000 square feet in Louisville, Kentucky for its dub and ship
facility which expires in 2002; approximately 22,000 square feet in New York
City which is occupied by production service and sales personnel and expires in
2006; approximately 13,000 square feet in Los Angeles occupied by production
service and sales personnel which expires in 2006; and 25,000 square feet in
Chicago, which is occupied by production service and sales personnel which
expires on December 31, 2003. Offices are also located in Reno, Nevada, under a
lease that expired on September 30, 2000 and is on a month-to-month contract.
The Reno facility houses some executives and personnel responsible for repair
services. The total square footage of this location is 9,300. An additional
11,305 square feet of space in San Diego is occupied by engineers under a lease
that expires on April 30, 2002. Negotiations are currently in progress for
renewal of this lease. In addition, the Company leases two separate offices in
Holmdel, New Jersey. The first is 30,000 square feet and includes audio
operations and administrative staff for StarGuide's wholly owned subsidiary
Corporate Computer Systems, Inc. ("CCS") and expires August 31, 2004. The
second facility is for the consultant sales and marketing team and encompasses
2,500 square feet. This lease expires on May 31, 2002.

ITEM 3. LEGAL PROCEEDINGS

     Westwood One, Inc. and Westwood One Radio Networks, Inc. (collectively,
"Westwood One") produce radio programming that is distributed using
satellite-based data distribution equipment produced by StarGuide. On October
12, 2001, Westwood One filed a complaint against StarGuide in the United States
District Court for the District of Columbia alleging that StarGuide has
attempted unlawfully to compel Westwood One to replace existing StarGuide
equipment with later models. The complaint alleges violations of federal
antitrust laws, breach of contract, breach of the duties of good faith and fair
dealing, indemnification and tortuous interference with contracts. Westwood One
has requested an injunction, as well as the award of unspecified general
damages (trebled in accordance with applicable antitrust statutes), costs and
punitive damages. StarGuide has filed a motion to dismiss the complaint. The
court has not entered a decision on StarGuide's motion.

     On March 20, 2002, StarGuide filed a complaint against Westwood One in the
United States District Court for the District of Nevada alleging that Westwood
One has willfully infringed upon various StarGuide patents, copyrights and
trademarks, intentionally interfered with contracts to which StarGuide is a
party, and engaged in various deceptive and unfair trade practices. StarGuide
requests injunctive relief, unspecified damages (including treble damages in
accordance with applicable statute), and punitive and exemplary damages.

     On October 12, 2001, StarGuide filed a complaint against Williams
Communications Group, Inc. in the United States District Court for the District
of Nevada alleging that Williams has infringed on three patents of StarGuide.
StarGuide has requested preliminary and permanent injunctive relief, damages,
trebling of damages and costs and expenses. Williams has denied all material
allegations in the complaint and has asserted that the patents that are the
subject of the complaint are invalid and not infringed by Williams. On February
8, 2002, a subsidiary of Williams, Williams Communications LLC, filed suit
against StarGuide in the Northern District of Oklahoma alleging that the same
three StarGuide patents are invalid and not infringed. StarGuide has moved to
add this subsidiary as a party to the Nevada litigation and has moved to
dismiss or stay the Oklahoma litigation.

     In addition to the matters discussed above, the Company is subject, from
time to time, to various legal proceedings and claims, either asserted or
unasserted, which arise in the ordinary course of business. While the outcome
of these claims cannot be predicted with certainty, management does not believe
that the outcome of any of these legal matters asserted to date will have a
material effect on the financial condition or results of operations of the
Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

                                      8

<PAGE>

     None.

ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT

     The executive officers of the Company and their ages are as follows:

Name                  Age         Title(s)
----                  ---         --------
Matthew E. Devine     53    Chief Executive Officer and Director
Omar A. Choucair      40    Chief Financial Officer and Director
Jeffrey A. Dankworth  46    President of StarGuide and Director
Stephen N. Sparkman   36    Corporate Controller

     Matthew E. Devine joined the Company in July 1999 as Chief Executive
Officer and Director. Prior to joining the Company, Mr. Devine served as Chief
Financial Officer of AMFM Corporation (formerly Chancellor Media) and served as
Chief Financial Officer, Executive Vice President, Treasurer, Secretary and
Director for Evergreen Media Corporation. Between 1975 and 1988, Mr. Devine
served in various finance positions at AMR Corporation, parent company to
American Airlines.

     Omar A. Choucair joined the Company as Chief Financial Officer in July
1999. Prior to joining the Company, Mr. Choucair served as Vice President of
Finance for AMFM Corporation (formerly Chancellor Media), and served as Vice
President of Finance for Evergreen Media before it was acquired by Chancellor
Media in 1997. Prior to entering the media industry, Mr. Choucair was a Senior
Manager at KPMG LLP, where he specialized in media and telecommunications
clients. Mr. Choucair received a B.B.A. from Baylor University and is a
Certified Public Accountant. Mr. Choucair became a Director in February 2001.

     Jeffrey A. Dankworth has been President of StarGuide and a Director since
1995 and a director of the Company since February 2001. Prior to co-founding
StarGuide in 1994, Mr. Dankworth was an entrepreneur in the entertainment media
and professional sports industries where he led the development of various
media joint ventures in professional sports including the NFL Quarterback Club.
As an attorney, Mr. Dankworth has extensive experience in various areas of
business development, including the negotiation and management of media
partnerships, licensing programs, and joint ventures. Between 1984 and 1994,
Mr. Dankworth was Of Counsel with the law firm of Mitchell, Silberberg & Knupp
and prior to that was an associate with the law firm of Gibson, Dunn & Crutcher
(1981-1984).

     Stephen N. Sparkman joined the Company as Corporate Controller in January
2000. Prior to joining the Company, Mr. Sparkman was Corporate Controller of
Alpha Holdings Inc., a plastics manufacturing concern based in Dallas. From
1997 to 1999, Mr. Sparkman was Controller and Chief Financial Officer of Group
& Pension Administrators, Inc., a third party health and pension administrator
based in Richardson, Texas. From 1991 until 1997, Mr. Sparkman served as
Controller of Baker Atlas (formerly Wedge Dia-Log, Inc.), an oil field service
company based in Grand Prairie, Texas. From 1988 until 1991, Mr. Sparkman
worked at KPMG LLP. Mr. Sparkman received a B.B.A. from The University of Texas
at Austin and is a Certified Public Accountant.

                                      9

<PAGE>

                                    PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS

     The Common Stock of the Company has been traded on the Nasdaq National
Market under the symbol DGIT since the Company's initial public offering on
February 6, 1996. Prior to that time there was no public market for the
Company's Common Stock or other securities.

     The following table sets forth the high and low closing sales prices of
our Common Stock from January 1, 2000 to December 31, 2001. Such prices
represent prices between dealers, do no include retail mark-ups, markdowns or
commissions and may not represent actual transactions.

                        Fiscal Year Ended 2001      Fiscal Year Ended 2000
                       ------------------------    ------------------------
                           High         Low            High          Low
                       -----------    ---------    ----------    ----------
First Quarter.........   $  4.19       $  1.16      $  10.06      $  6.38
Second Quarter.......       4.15          1.06          8.25         4.25
Third Quarter.........      3.93          1.19          6.97         4.13
Fourth Quarter........      1.62          1.10          4.69         1.66

     As of December 31, 2001 and March 15, 2002, the Company had issued
70,807,392 and outstanding 70,784,475 shares of its Common Stock. As of March
15, 2002, the Company's Common Stock was held by approximately 147 shareholders
of record. The Company estimates that there are approximately 4,331 beneficial
shareholders.

     The Company has never declared or paid cash dividends on its capital
stock. The Company currently expects to retain any future earnings for use in
the operation and expansion of its business and does not anticipate paying any
cash dividends in the foreseeable future.

                                      10

<PAGE>

ITEM 6.  SELECTED FINANCIAL DATA

     The following selected historical consolidated financial data should be
read in conjunction with the Company's consolidated financial statements and
related notes and the Company's "Management's Discussion and Analysis of
Financial Condition and Results of Operations." The consolidated statement of
operations data for each of the years ended December 31, 2000, 1999, 1998 and
1997 and the consolidated balance sheet data at December 31, 2000, 1999, 1998
and 1997 are derived from the consolidated financial statements of StarGuide,
which have been audited by KPMG LLP, independent public accountants. The
consolidated statement of operations data for the year ended December 31, 2001
and the consolidated balance sheet data at December 31, 2001 is derived from
the consolidated financial statements of the Company, which were audited by
KPMG LLP, independent public accountants.  Statement of Operations:

Statement of Operations:

<TABLE>
<CAPTION>
                                                                     For the years ended December 31,
                                                         2001         2000         1999         1998         1997
                                                         ----         ----         ----         ----         ----
                                                                  (in thousands, except per share amounts)
<S>                                                  <C>          <C>          <C>          <C>          <C>
Revenues                                             $   70,700   $   14,419   $   13,068   $   11,819   $   23,977
                                                    -----------------------------------------------------------------

Costs and expenses
          Cost of revenues                               37,413        9,802        8,128        8,137       14,676
          Sales and marketing                             5,615        2,742        3,209        2,965        2,823
          Research and development                        4,604        3,111        3,383        2,547        2,770
          General and administrative expenses:
           Noncash stock award charges                       -        19,630           -            -            -
           Other                                         12,187        5,330        3,087        2,878        3,101
          Merger charge                                     791           -            -            -            -
          Depreciation and amortization                  17,065          824          973        1,267        1,014
                                                    -----------------------------------------------------------------
               Total expenses                            77,675       41,439       18,780       17,794       24,384
                                                    -----------------------------------------------------------------
Loss from operations                                 $   (6,975)  $  (27,020)  $   (5,712)  $   (5,975)  $     (407)

Other (income) expense:
          Interest and other (income) expense, net        2,054         (279)         258          593          775
          Equity in losses of joint venture                  -         1,125        3,030        2,282        3,276
                                                    -----------------------------------------------------------------
Net loss                                             $   (9,029)  $  (27,866)  $   (9,000)  $   (8,850)  $   (4,458)
                                                    -----------------------------------------------------------------

Basic and diluted net loss per common share          $    (0.13)  $    (0.68)  $    (0.23)  $    (0.27)  $    (0.14)
                                                    -----------------------------------------------------------------
Weighted average common shares outstanding
              Basic                                      70,443       40,912       39,183       33,372       32,957
                                                    =================================================================
              Diluted                                    70,443       40,912       39,183       33,372       32,957
                                                    =================================================================
</TABLE>

<TABLE>
<CAPTION>
Balance Sheet Data:
                                                                             December 31,
                                                      2001         2000         1999         1998         1997
                                                      ----         ----         ----         ----         ----
<S>                                                   <C>         <C>          <C>          <C>          <C>
Cash and cash equivalents                             $    2,724  $     2,891  $     2,145  $     1,876  $       338
Working capital                                           (1,354)         918        3,259       (1,691)      (1,529)
Property and equipment, net                               17,820          870          725          959        1,480
Total assets                                             235,457       11,102       14,062        7,847       10,201
Long-term debt, net of current portion                     9,496           -         5,000        5,586        6,234
Shareholders' equity (deficit)                           196,682      (11,498)     (14,675)      (5,982)      (5,634)
</TABLE>

                                     11

<PAGE>

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

OVERVIEW

     The following Management's Discussion and Analysis of Financial Condition
and Results of Operations should be read in conjunction with the Consolidated
Financial Statements and Notes and contains forward-looking statements that
involve risks and uncertainties.  Actual results could differ materially from
those indicated in the forward-looking statements as a result of various
factors.

     DGS was incorporated in 1991.  The Company owns a nationwide digital
network that beneficially links hundreds of advertisers and advertising
agencies with more than 7,500 radio and 875 television stations across the
United States and Canada.  The Company also owns proprietary digital software,
hardware and communications technology, including various bandwidth satellite
receivers, audio compression codes, software to operate integrated digital
multimedia networks, software development for satellite applications and
engineering consulting services.  The Company has a Network Operation Center
located in Dallas, Texas that delivers audio, video, image and data content
that comprise transactions between the advertising and broadcast industries.

     In January 2001, the Company completed its merger with StarGuide pursuant
to the Agreement and Plan of Merger by and among DGS, SG Nevada Merger Sub
Inc., a wholly owned subsidiary of DGS, and StarGuide.  The merger has been
accounted for as a reverse acquisition, and accordingly, historical results of
the combined company prior to the merger are that of StarGuide and DGS' results
of operations have been included subsequent to January 1, 2001. Upon the
completion of the merger, each share of StarGuide common stock converted into
the right to receive 1.7332 shares of common stock of the Company.  Under the
merger agreement, StarGuide's options and warrants were assumed by the Company
based on the same exchange ratio.

CRITICAL ACCOUNTING POLICIES

     The Securities and Exchange Commission ("SEC") recently released Financial
Reporting Release No. 60, which requires all companies to include a discussion
of critical accounting policies or methods used in the preparation of financial
statements. In addition, Financial Reporting Release No. 61 was recently
released by the SEC to require all companies to include a discussion to
address, among other matters, liquidity, off-balance sheet arrangements,
contractual obligations and commercial commitments.  The Company's significant
accounting policies and methods used in the preparation of the Consolidated
Financial Statements are discussed in Note 2 of the Notes to Consolidated
Financial Statements.  The following is a listing of the Company's critical
accounting policies and a brief discussion of each:

         .     allowance for doubtful accounts;
         .     revenue recognition; and
         .     intangible assets and goodwill.

     Allowance for Doubtful Accounts.  The Company's allowance for doubtful
accounts relates to trade accounts receivable. Financial Statement Schedule II
summarizes the activity in this account. The allowance for doubtful accounts is
an estimate prepared by management based on identification of the
collectibility of specific accounts and the overall condition of the receivable
portfolios.  The Company specifically analyzes trade receivables, historical
bad debts, customer credits, customer concentrations, customer
credit-worthiness, current economic trends and changes in customer payment
terms when evaluating the adequacy of the allowance for doubtful accounts.  If
the financial condition of the Company's customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required.  Likewise, should the Company determine that it
would be able to realize more of its receivables in the future than previously
estimated, an adjustment to the allowance would increase income in the period
such determination was made.  The allowance for doubtful accounts is reviewed
on a monthly basis and adjustments are recorded as deemed necessary.

                                   12

<PAGE>

     Revenue Recognition.  The Company derives revenue from primarily two
sources- (1) services - which consist primarily of revenue for digital and
analog audio, video and videotape distribution as well as outsourcing of
personnel and (2) product sales - which consist of sales of audio and video
distribution equipment.

     The Company's services revenue from digital distribution of audio and
video advertising content is billed based on a contracted rate per
transmission, and the Company recognizes revenue for these services upon
notification of successful transmission of the content at the broadcast
destination.  Revenue for distribution of analog audio and video content by
tape is recognized when delivery has occurred, which is at the time the tapes
are delivered to a common carrier.  The Company also receives revenue from the
provision of outsourcing of personnel.  Revenue for these services is billed
based on timesheets received and approved by customers, and revenue is
recognized on a monthly basis for hours incurred and billed in that month.

     The Company recognizes product revenue when persuasive evidence of an
arrangement exists, delivery has occurred, the sales price is fixed and
determinable and collectibility is probable.  Generally for product sales,
these criteria are met at the time of delivery to a common carrier.  Provision
is made at the time the related revenue is recognized for estimated product
returns, which historically have been immaterial.  The Company analyzes
historical returns, current economic trends, and changes in customer demand
when evaluating the adequacy of provisions for sales returns.  At the time of
the transaction, the Company assesses whether the fee associated with revenue
transactions is fixed and determinable and whether or not collection is
reasonably assured.  The Company assesses whether the fee is fixed and
determinable based on the payment terms associated with the transaction.  The
Company assesses collectibility based on a number of factors, including past
transaction history with the customer and the credit-worthiness of the
customer.  The Company does not request collateral from customers.  For all
sales, the Company uses either a binding purchase order or signed sales
agreement as evidence of an arrangement.  Shipping and handling revenues are
included in product revenues and costs are included in product costs.  Revenue
from arrangements for the sale of products that include software components
that are more than incidental to the functionality of the related product are
accounted for under AICPA Statement of Position 97-2, "Software Revenue
Recognition" ("SOP 97-2").  SOP 97-2 requires that when a product is sold that
contains a significant software component, and the Company has no objective
third party evidence as to the relative fair values of each of the components
sold, the total sales value should be deferred and recognized on a straight
line basis over the life of the arrangement as documented in the sales
agreement.

          Intangible Assets and Goodwill. The Company assesses the impairment
of identifiable intangibles and goodwill whenever events or changes in
circumstances indicate that the carrying value may not be recoverable.  Factors
that the Company considers important which could trigger an impairment review
include the following:

..     significant underperformance relative to expected historical or projected
      future operating results;
..     significant changes in the manner or use of the acquired assets or the
      strategy for the Company's overall business;
..     significant negative industry or economic trends;
..     significant decline in its stock price for a sustained period; and
..     the Company's market capitalization relative to net book value.

     If the Company determines that the carrying value of identifiable
intangibles and goodwill may not be recoverable based upon the existence of one
or more of the above indicators of impairment, the Company assesses the
recoverability of the intangibles by determining whether the amortization of
the asset balance over its remaining life can be recovered through undiscounted
future operating cash flow of the acquired operations.  Any impairment is
measured based on a projected discounted cash flow method using a discount rate
reflecting the Company's average cost of funds.  Net intangible assets and
goodwill amounted to approximately $196 million as of December 31, 2001.

     In 2002, Statement of Financial Accounting Standards ("SFAS") No. 142,
"Goodwill and Other Intangible Assets" became effective, and as a result, the
Company will cease to amortize goodwill at January 1, 2002.  The Company
recorded approximately $9.5 million of goodwill amortization during 2001. In
lieu of amortization, the Company is required to perform an initial impairment
review of goodwill in 2002 and an annual impairment review thereafter.  SFAS
No. 142 will require the Company to test goodwill for impairment at a level
referred to as a reporting unit.  Goodwill is considered impaired and a loss is
recognized, when its carrying value exceeds its implied fair value.  As an
overall check on the reasonableness of the fair values attributed to the
Company's reporting units, the Company will be required to compare and contrast
the aggregate fair values for all reporting units with the Company's average
total market capitalization for a reasonable period of time.  SFAS No.142 does
state that the fair value may exceed market capitalization due to factors such
as control premiums and synergies.  The Company

                                   13

<PAGE>

expects to complete the initial impairment review during the first half of
2002. The transitional impairment loss, which the Company expects to be
significant, will be recognized as the cumulative effect of a change in
accounting principle in the Company's statement of operations.

RESULTS OF OPERATIONS

2001 versus 2000

     Reported operating results for the year ended December 31, 2001 are not
comparable with the same prior year periods due to the merger between DGS and
StarGuide, which occurred effective January 1, 2001.  The merger was accounted
for as a reverse acquisition, thus historical results reflect only StarGuide
for the year ended December 31, 2000.  In order to enhance comparability, the
following discussion of the Company's results of operations is supplemented by
unaudited pro forma financial information that gives effect to the merger as if
it had occurred at the beginning of 2000.

                             Year ended December 31,
                             2001              2000
                             ----              ----
As reported:
       Revenues          $   70,700        $   14,419
       Cost of revenues  $   37,413        $    9,802

Pro Forma:
       Revenues          $   70,700        $   69,130
       Cost of revenues  $   37,413        $   40,098

     Revenues.  Revenues for the year ended December 31, 2001 increased
$56,281,000, or 390%, due to the incremental business that was acquired in the
merger and incremental revenues related to new radio syndication agreements
with major broadcasters.

     On a pro forma basis, revenues increased 2% for the year ended December
31, 2001.  Revenue from sales of products increased $5.8 million, or 40%, due
primarily to sales contracts with major broadcasters.  Revenue from services
decreased $4.3 million, or 8%, due primarily to a decrease in political revenue
from 2000, as 2000 was an election year.

     Cost of revenues.  Cost of revenues, which includes delivery and material
costs and customer operations, increased $27,611,000 for the year ended
December 31, 2001 as follows:

     .     $27,762,000 increase related to revenues of DGS, which were not
           included in 2000.
     .     $151,000 decrease related to the mix of products sold during 2001
           versus 2000.

     On a pro forma basis, cost of revenues decreased 7% for the year ended
December 31, 2001 to $37.4 million compared to $40.1 million for the same
prior-year period.  The decline is primarily a result of lower
telecommunications costs as a result of negotiating a lower rate structure with
our primary telecommunications provider, MCI WorldCom. In addition, reductions
in headcount due to synergies from the merger and reduced operating expenses as
a result of the relocation of the DGS NOC from San Francisco, California to
Irving, Texas during 2001 contributed to the lower costs.

     Sales and marketing.  Sales and marketing expense increased $2,873,000, or
105%, for the year due to additional expenses of $4,158,000 related to the
incremental business acquired in the merger offset by a reduction in expenses
of $1,285,000 due primarily to a reduction in headcount resulting from
synergies from the merger

     Research and development.  Research and development expense increased
$1,493,000, or 48%, of which $2,353,000 relates to the incremental business
that was acquired in the merger, offset by decreases in research and
development activity and the capitalization of salaries and other costs related
to the development of new software.

                                   14

<PAGE>

     General and administrative.  General and administrative expenses decreased
$12,773,000, or 51%, primarily due to the following:

     .     $8,006,000 of expense related to the incremental business that was
           acquired in the merger.
     .     $19,630,000 reduction of expense related to noncash stock awards
           recognized during the year ended December 31, 2000 that was
           nonrecurring.
     .     $1,149,000 reduction in expenses due to reductions in headcount and
           savings resulting from synergies from  the merger.

     Depreciation and Amortization Depreciation and amortization expense was
$17,065,000 and $824,000 in 2001 and 2000, respectively.  The increase in
depreciation expense from 2000 to 2001 is due to the DGS/StarGuide merger that
occurred in January 2001, which added approximately $16 million in property,
plant and equipment and approximately $197 million in goodwill and other
intangible assets.  Included in depreciation and amortization is goodwill
amortization of $9,544,000 in 2001.

     Interest Income and Interest Expense

     The Company has derived interest income from the short-term investment of
its cash in US money market funds.  Fluctuations in interest income are due to
differences in the levels of cash used to fund Company operations and interest
rates.

     Interest expense incurred by the Company was $1,772,000 and $21,000 in
2001 and 2000, respectively. This expense relates primarily to long-term debt
and lease agreements.  The significant increase from 2000 to 2001 was a result
of the purchase of Musicam Express, upon which the Company refinanced debt of
$9.8 million that was assumed as a result of the acquisition. Total long-term
debt and capital lease liabilities outstanding was $16,790,000 at December 31,
2001.  The Company had no long-term debt outstanding at December 31, 2000.

2000 versus 1999

     Revenues. Consolidated revenues for the years ended December 31, 2000 and
1999 were $14,419,000 and $13,068,000 respectively.  The increase in revenue
includes $3,220,000 related to deliveries under new development, supply, and
service agreements with two large broadcasters.  This was offset by the
completion of a satellite project for an international customer in 1999 that
added $1,168,000 of revenue in 1999 but did not contribute any revenue in 2000.

     Cost of revenues. Cost of revenues for the year ended December 31, 2000
was $9,802,000 compared to $8,128,000 for the year ending December 31, 1999,
yielding gross profit margins of 32.1% for 2000 and 37.8% for 1999.  Gross
profit was adversely affected in 2000 by certain fixed costs related to
expanding CoolCast(TM) operations and fulfilling the development, supply, and
service agreements.

     Sales and marketing. Sales and marketing expense for the year ended
December 31, 2000 was $2,742,000 or 19.0% of revenues compared to $3,209,000 or
24.6% of revenues for the year ended December 31, 1999.  The decline is
primarily due to reduced professional consulting fees in 2000 compared to 1999
as a result of performing more of the CoolCast(TM) marketing function in-house
in 2000 versus 1999.  Sales and marketing expense decreased by approximately
$230,000 as a result of a reduction of personnel and not extending related
international sales distributor agreements in April 1999.

     Research and development. Research and development expense was $3,111,000
and $3,383,000 for the years ended December 31, 2000 and 1999, respectively.
The decrease is primarily due to the completion of certain new product
development projects during late 1999.

     General and administrative. General and administrative costs were
$5,330,000 for the year ended December 31, 2000, as compared to $3,087,000 for
the year ended December 31, 1999.  The overall increase is a result of
additional administrative and financial personnel and associated operating
expenses beginning in mid 1999.  The additional personnel were added to develop
and execute strategic corporate, financial, and operational plans.  In
addition, legal and patent fees increased $723,000 due to the increased volume
of contractual and intellectual property activity, professional fees for audit
work increased $161,000, and expenses of $425,000 were incurred as a result of
a dispute with an international distributor.

                                   15

<PAGE>

     Noncash stock compensation expense of $18,375,000 was recorded in the
first quarter of 2000 related to the issuance of warrants to StarGuide's
Chairman and stock purchase rights to a third party to purchase up to 3,899,700
and 346,640 shares of common stock, respectively, at grant prices of less than
the fair value of the stock.  The board of directors formally approved issuance
of these warrants and stock purchase rights in the first quarter of 2000.  In
addition, $1,255,000 of noncash stock compensation expense was recorded in the
fourth quarter of 2000 related to the issuance of stock options to employees
with exercise prices less than the fair value of the stock on the date of grant.

     Depreciation and amortization. Depreciation and amortization expense was
$824,000 for the year ended December 31, 2000, compared to $973,000 for the
year ended December 31, 1999.  The decrease is primarily due to some assets
becoming fully depreciated.  Interest and other income increased $11,000 from
$289,000 for the year ended December 31, 1999 to $300,000 for the year ended
December 31, 2000.  This increase was due to higher cash and cash equivalent
balances available for investment in 2000.

     Interest expense. Interest expense was $21,000 for the year ended December
31, 2000 compared to $547,000 for the year ended June 30, 1999.  The decrease
in interest expense is the result of retirement of debt.

     Equity in losses of joint venture. The loss from joint venture decreased
$1,905,000 from $3,030,000 for the year ended December 31, 1999 to $1,125,000
for the year ended December 31, 2000.  This decrease was principally due to the
impairment of fixed assets of the joint venture during the fourth quarter 1999.

LIQUIDITY AND CAPITAL RESOURCES

     The Company's operating activities provided cash of $4.9 million in 2001.
Cash used in operating activities was $3.6 million in 2000 while cash provided
by operating activities in 1999 was $3.3 million.  Cash flows from operating
activities improved during 2001 as compared to 2000.  Such increase is
primarily due to the revenue increase of 390% and operating expense increasing
by only 189%, as discussed above.  Cash flows from operating activities
decreased during 2000 as compared to 1999 primarily due to significant
development, supply, and service agreements executed and delivered during 1999,
resulting in cash payments during 1999.

     The Company used $3.2 million, $0.7 million and $0.5 million of cash in
2001, 2000 and 1999, respectively, to purchase property and equipment. In
addition, $1.6 million of property and equipment has been acquired through
capital leases in 2001. The capital additions for each of the three years were
a result of the Company's continued expansion of its network and continued
product development.

     During June 2001, the Company signed a new long-term credit agreement that
includes a term loan of $12.5 million and a revolving credit facility with a
borrowing base subject to the Company's eligible accounts receivable balance.
The proceeds from the term loan were used in part to refinance outstanding debt
of $9.8 million that was acquired as a result of the acquisition of Musicam
during March 2001.  Approximately $4.0 million was outstanding under the
revolving credit facility at December 31, 2001 and an additional $4.5 million
was available for borrowing.  The Company is required to maintain various
financial covenants, including minimum levels of earnings before interest,
taxes and depreciation and amortization, fixed charge coverage ratios and
current ratios on a quarterly basis.  In addition, the Company is subject to
annual limitations on capital expenditures and capital lease borrowings and is
required to meet an annual leverage ratio.  At December 31, 2001, the Company
was in compliance with these covenants.

     Net principal payments on long-term debt were $0.6 million, $5.7 million
and $0.7 million in 2001, 2000 and 1999, respectively, reflecting the increases
in regularly scheduled payments of the increased capital lease liability
incurred to finance equipment and property acquisitions.  Scheduled debt
repayments for 2002 are $7.3 million.

     The Company has raised cash through the sale of common and preferred stock
in the past, most recently in 1999.  Proceeds from the sale of stock have been
used to fund acquisitions, make capital expenditures, repay debt and fund
continuing operations.  There can be no assurances that the Company could raise
additional funds through the sale of common or preferred stock in the future.

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<PAGE>

     The Company currently has no significant capital commitments other than the
commitments under capital leases.  The Company also has ongoing commitments
with its telephone service provider to spend a minimum of $3.6 million in 2002.
Based on management's current plans and forecasts, the Company believes that
its existing sources of liquidity will satisfy the Company's projected working
capital and capital lease commitments and other cash requirements through the
foreseeable future.

     The Company leases its facilities and certain equipment under
non-cancelable capital and operating leases.  At December 31, 2001, future
minimum annual payments under capital leases are $1,964 in 2002, $486 in 2003
and $49 in 2004. The present value of obligations under capital lease was
$2,290, of which $1,794 is classified as a current liability.  As of December
31, 2001, future minimum annual payments under operating leases are as follows:
2002 - $1,952; 2003 - $1,930; 2004 - $1,527; 2005 - $1,184; 2006 - $746 and
thereafter - $0.

     As of December 31, 2001, the Company has non-cancelable future minimum
purchase commitments with its primary telephone service provider of $3.6
million for 2002.

CERTAIN BUSINESS CONSIDERATIONS

     In evaluating an investment in our common stock, the following business
considerations should be considered.

We  have a history of losses and our future operating results are uncertain.

     We have been unprofitable since our inception and future profitability is
uncertain.  We could continue to generate net losses in the near future, which
could depress our stock price.  Historical revenue growth rates may not be
sustainable and as such, should not be used as an indication of future revenue
growth, if any, or as an indication of future operating results.  Future
success also depends in part on obtaining continued reductions in delivery and
service costs, particularly our ability to continue to automate order
processing and to reduce telecommunications costs.  Our prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered by companies in new and rapidly evolving markets, such as risks
that the market might fail to grow, expenses relating to modifying products and
services to meet industry standards as they change over time, and difficulties
in gaining and maintaining market share.  To address these risks, we must,
among other things, respond to competitive developments, continue to attract,
retain and motivate qualified persons, continue to upgrade our technologies and
begin to commercialize products incorporating such technologies.  We may not be
successful in addressing any or all of these risks and may not be able to
achieve or sustain profitability.

Our revenues are subject to seasonal buying patterns and lengthy sales cycles
that can adversely affect operating results and lead to potential fluctuations
in quarterly results.

     We have historically experienced lower sales for services in the first
quarter and higher sales in the fourth quarter due to increased customer
advertising volumes for the Christmas selling season.  Additionally, in any
single period, our service revenues and delivery costs are subject to variation
based on changes in the volume and mix of deliveries performed during such
period.  In particular, our service operating results have historically been
significantly influenced by the volume of deliveries ordered by television
stations during the "sweeps" rating periods that currently take place in
February, May, August and November. We have historically operated with little
or no backlog.  The absence of backlog increases the difficulty of predicting
revenues and operating results.  Fluctuations in revenues due to seasonality
may become more pronounced as revenue growth rates slow.  In addition, service
revenues are influenced by political advertising, which generally occurs every
two years.

     Due to the complexity and substantial cost associated with providing
integrated product solutions to provide audio, video, data and other
information across a variety of media and platforms, licensing and selling our
products to customers typically involves a significant technical evaluation and
commitment of cash and other resources.  In addition, there are frequently
delays associated with educating customers as to the productive applications of
our products, complying with customers' internal procedures for approving large
expenditures and evaluating and accepting new technologies that affect key
operations.  In addition, certain of our foreign customers have lengthy
purchasing cycles that may increase the amount of time it takes us to place our
products with these customers.  For these and other reasons, the sales cycle
associated with the licensing and selling of our products is lengthy and
subject to a number of significant risks, including customers' budgetary
constraints and internal acceptance evaluations, both of which are beyond our
control.  Because of the lengthy sales cycle and the large size of

                                   17

<PAGE>

customers' average orders, if revenue projected from a specific customer for a
particular quarter is not realized in that quarter, our product revenues and
operating results for that quarter could be negatively affected.  We expect
revenues to vary significantly as a result of the timing of product purchases
and introductions, fluctuations in the rate of development of new markets and
new applications, the degree of market acceptance of new and enhanced version
of our products and services, the level of use of networking satellite and
other transmission systems.  In addition, increased competition and the general
strength of domestic and international economic conditions also impact
revenues.

     Our expense levels are based, in part, on our expectations of future
revenue levels.  If revenue levels are below expectations, operating results
are likely to be seriously harmed.  To the extent that some of our costs are
relatively fixed, such as personnel and facilities costs, any unanticipated
shortfall in revenue in any fiscal quarter would have an adverse effect on our
results of operations in that quarter.

We may not be able to secure additional financing to satisfy future capital
needs.

     We may require additional capital sooner than currently anticipated in
order to fund future operations and growth and we may not be able to obtain
additional funds adequate for our needs.  We intend to continue making capital
expenditures to produce and install various equipment required by our customers
to receive our services and to introduce additional services.  We also expect
to continue making capital expenditures related to our acquisition and
integration of StarGuide.  In addition, we will continue to analyze the costs
and benefits of acquiring certain additional businesses, products or
technologies that we may from time to time identify.  Assuming that we do not
pursue one or more additional acquisitions funded by internal cash reserves, we
anticipate that existing capital, cash from operations and funds available
under existing line of credit agreements should be adequate to satisfy our
capital requirements through the foreseeable future.  Our capital needs depend
upon numerous factors, including:

     .     the progress of  product development activities;

     .     the cost of increasing sales and marketing activities; and

     .     the amount of revenues generated from operations.

     We cannot predict any of the foregoing factors with certainty.  In
addition, we cannot predict the precise amount of future capital that we will
require, particularly if we pursue one or more additional acquisitions.
Furthermore, additional financing may not be available to us, or if it is
available, it may not be available on acceptable terms.  Our inability to
obtain financing for additional acquisitions on acceptable terms may prevent us
from completing advantageous acquisitions and consequently could seriously harm
our prospects and future rates of growth.  Our inability to obtain additional
funding for continuing operations or an acquisition would deter the growth of
our business and could impair our operations.  Consequently, we could be
required to significantly reduce or suspend operations, seek an additional
merger partner or sell additional securities on terms that are dilutive to
existing investors

We operate in developing markets. If these markets do not continue to develop,
or do not accept our products and services, our future growth could be
jeopardized.

     Our products and services are relatively new, and alternative technologies
are rapidly evolving.  It is difficult to predict the rate at which the market
for such products and services will grow, if at all.  If the market fails to
grow, or grows more slowly than anticipated, we may also fail to grow.  Even if
the market does grow, our products and services may not achieve commercial
success.  We may not be able to conform our products to existing and emerging
industry standards in a timely fashion, if at all.  We believe that our future
growth will depend, in part, on our ability to add these services and
additional customers in a timely and cost-effective manner.  However, we may
not be successful in developing such services or in obtaining new customers for
such services.  Furthermore, we may not be successful in obtaining a sufficient
number of radio and television stations, radio and television networks,
advertisers, advertising agencies, production studios and audio and video
distributors who are willing to bear the costs of expanding and increasing the
integration of the Company's network, including the Company's field receiving
equipment and rooftop satellite antennae.

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<PAGE>

     Our marketing efforts to date with regard to our products and services
have involved identification and characterization of specific market segments
for these products and services with a view to determining the target markets
that will be the most receptive to such products and services.  We may not have
correctly identified such markets and our planned products and services may not
address the needs of such markets.  Furthermore, our technologies, in their
current form, may not be suitable for specific applications and further design
modifications, beyond anticipated changes to accommodate different markets, may
be necessary.  Broad commercialization of our products and services will
require us to overcome significant market development hurdles, many of which we
cannot predict.  To achieve sustained growth, the market for such products must
continue to develop and we must expand our product offering to include
additional applications within the broadcast market.  Such new products and
applications for existing products in new markets such as distance learning and
training, finance and retail.  We believe that our products and services are
among the first commercial products to serve the convergence of several
industry segments, including digital networking, telecommunications,
compression products and Internet services. However, the market may not accept
our products.  In addition, it is possible that:

     .     the convergence of several industry segments may not continue;

     .     markets may not develop as a result of such convergence; or

     .     if markets develop, such markets may not develop either in a
           direction beneficial to our products or product positioning or
           within the time frame in which we expect to launch new products and
           product enhancements.

     Because the convergence of digital networking, telecommunications,
compression products and Internet services is new and evolving, we cannot
predict the growth rate, if any, and the size of the potential market for our
products.  If markets for our products fail to develop, develop more slowly
than expected or become served by numerous competitors, or if our products do
not achieve the anticipated level of market acceptance, our future growth could
be jeopardized.

If we are not able to develop new products and services to respond to rapid
technological changes, our success could be compromised.

     If we are not able to develop new products and services in a timely and
cost-effective fashion to respond to technological changes and deliver products
and services at competitive prices, operating results will likely suffer and
our stock price could decline.  The markets for our products and services are
characterized by rapidly changing technology.  The introduction of new products
and services can render existing products obsolete or unmarketable.  We may not
be successful in identifying, developing, contracting for the manufacture of
and marketing product enhancements for new products and services that respond
to technological change or meet emerging industry standards.  In addition, we
may experience difficulties that could delay or prevent the successful
development, introduction and marketing of any new products, product
enhancements or services, and these products and services may not adequately
meet the requirements of the marketplace and achieve market acceptance.  If we
experience delays in introducing new products and services or enhancements to
existing products and services, our customers may begin to use the products and
services of our competitors, resulting in a loss of revenue.  Furthermore, new
or enhanced products offered by us may contain defects when they are first
introduced or released.  If we are unable to develop and introduce new products
and services or enhancements of existing products and services in a timely
manner and with a significant degree of market acceptance, our ability to
become profitable in the future would be jeopardized.

If we are not able to maintain and improve service quality, our business and
results of operations will be susceptible to decline.

     We depend on making cost-effective deliveries to broadcast stations within
the time periods requested by our customers.  If we are unsuccessful, for
whatever reason, a station might be prevented from selling airtime that it
otherwise could have sold.  Although we disclaim any liability for lost
air-time, stations may nevertheless assert claims for lost air-time in these
circumstances and dissatisfied advertisers may refuse to make further
deliveries through us in the event of a significant occurrence of lost
deliveries, which would result in a decrease in our revenues or an increase in
our expenses, either of which could lead to a reduction in net income or an
increase in net loss.  Although we maintain insurance against business
interruption, such insurance may not be adequate to protect us from significant
loss in these circumstances or from the effects of a major catastrophe (such as
an earthquake or other natural disaster), which could result in a prolonged
interruption of our business.  Our ability to make deliveries to stations
within the time periods requested by customers depends on a number of factors,
some of which are outside of our control, including:

                                   19

<PAGE>

     .     equipment failure;

     .     interruption in services by telecommunications service providers;
           and

     .     our inability to maintain our installed base of audio and video
           units that comprise our distribution network.

Our business is highly dependent on radio and television advertising; if demand
for, or margins from, our radio and television advertising delivery services
declines, our business results will decline.

     We expect that a significant portion of our revenues will continue to be
derived from the delivery of radio and television advertising spots from
advertising agencies, production studios and dub and ship houses to radio
stations in the United States.  A decline in demand for, or average selling
prices of, our radio and television advertising delivery services for any of
the following reasons, or otherwise, would seriously harm our business:

     .     competition from new advertising media;

     .     new product introductions or price competition from competitors;

     .     a shift in purchases by customers away from DG Systems' premium
           services; and

     .     a change in the technology used to deliver such services.

     Additionally, we are dependent on our relationship with the radio and
television stations in which we have installed communications equipment.
Should a substantial number of these stations go out of business, experience a
change in ownership or discontinue the use of our equipment in any way, our
revenues and results of operations would decline.

Our business is highly dependent on electronic video advertising delivery
service deployment.

     Our inability to place units necessary for the receipt of electronically
delivered video advertising content in an adequate number of television
stations or our inability to capture market share among content delivery
customers, which may be the result of price competition, new product
introductions from competitors or otherwise, would be detrimental to our
business objectives and deter future growth.  We have made a substantial
investment in upgrading and expanding our NOC and in populating television
stations with the units necessary for the receipt of electronically delivered
video advertising content.  However, we cannot assure the investor that the
placement of these units will cause this service to achieve adequate market
acceptance among customers that require video advertising content delivery.

     In addition, we believe that to more fully address the needs of potential
video delivery customers we will need to develop a set of ancillary services
that typically are provided by dub and ship houses.  These ancillary services
include cataloging, physical archiving, closed-captioning, modification of
slates and format conversions.  We will need to provide these services on a
localized basis in each of the major cities in which we provide services
directly to agencies and advertisers.  We currently provide certain of such
services to a portion of our customers through our facilities in New York, Los
Angeles and Chicago.  However, we may not be able to successfully provide these
services to all customers in those markets or any other major metropolitan area
at competitive prices.  Additionally, we may not be able to provide competitive
video distribution services in other United States markets because of the
additional costs and expenses necessary to do so and because we may not be able
to achieve adequate market acceptance among current and potential customers in
those markets.

     While we are taking the steps we believe are required to achieve the
network capacity and scalability necessary to deliver video content reliably
and cost effectively as video advertising delivery volume grows, we may not
achieve such goals because they are highly dependent on the services provided
by our telecommunication providers and the technological capabilities of both
our customers and the destinations to which content is delivered.  If our
telecommunication providers are unable or unwilling to provide us the services
necessary at a rate we are willing to pay or if our customers and/or their
delivery destinations do not have the technological capabilities necessary to
send and/or receive video content, our goals of adequate network capacity and
scalability could be jeopardized.

                                   20

<PAGE>

     In addition, we may be unable to retain current audio delivery customers or
attract future audio delivery customers who may ultimately demand delivery of
both media content unless we can successfully continue to develop and provide
video transmission services. The failure to retain such customers could result
in a reduction of revenues, thereby decreasing our ability to achieve and
maintain profitability.

     The markets in which we operate are highly competitive, and we may be
unable to compete successfully against new entrants and established
companies with greater resources.

     We provide services that compete with a variety of dub and ship
houses and production studios in the market for the distribution of audio
advertising spots to radio stations and the distribution of video
advertising spots to television stations. The principal competitive
factors affecting these markets are ease of use, price, timeliness and
accuracy of delivery. Although such dub and ship houses and production
studios generally do not offer electronic delivery, they have
long-standing ties to local distributors that may be difficult for us to
replace. Some of these dub and ship houses and production studios have
greater financial, distribution and marketing resources and have achieved
a higher level of brand recognition than we have. Certain of our
competitors in the video distribution market are also our marketing
partners in the audio distribution market.

     To the extent that we are successful in entering new markets, such as
the delivery of other forms of content to radio and television stations,
we would expect to face competition from companies in related
communications markets and/or package delivery markets. Some of these
companies in related markets could offer products and services with
functionality similar or superior to ours. Telecommunications providers,
such as AT&T, MCI Worldcom and Regional Bell Operating Companies, could
also enter the market as competitors with materially lower electronic
delivery transportation costs. We could also face competition from
entities with package delivery expertise such as Federal Express, United
Parcel Service, DHL and Airborne if any such companies enter the
electronic data delivery market. Radio networks such as ABC or Westwood
One could also become competitors by selling and transmitting
advertisements as a complement to their content programming.

     We expect that an increasingly competitive environment will result in
price reductions that could result in lower profits and loss of market
share.  Moreover, the market for the distribution of audio and video
transmissions has become increasingly concentrated in recent years as a
result of acquisitions, which are likely to permit many of our competitors
to devote significantly greater resources to the development and marketing
of new competitive products and services. We expect that competition will
increase substantially as a result of these and other industry
consolidations and alliances, as well as the emergence of new competitors.
Accordingly, we may not be able to compete successfully with new or
existing competitors, and the effects of such competition could result in
a decrease in our anticipated future growth.

     The markets in which we sell products are highly competitive, and we
may be unable to compete successfully against new entrants and established
companies with greater resources. We believe that our ability to compete
successfully depends on a number of factors, both within and outside of
our control, including the price, quality and performance of our products
and those of our competitors, the timing and success of new product
introductions, the emergence of new technologies and the number and nature
of competitors in a given market.  In addition, the assertion of
intellectual property rights by others and general market and economic
conditions factor in to our ability to compete successfully.

     We are aware of other companies that are intensifying their focus and
may commit significant resources on developing and marketing products and
services that will compete with ours. Such competitors and potential
competitors may have substantially greater financial, technical, research
and development, distribution, marketing and other resources and larger
installed customer bases than us. We may not be able to compete
successfully against current and future competitors based on these and
other factors. A number of the markets in which our products are sold are
also served by technologies that are currently more widely accepted. Our
potential customers may not be willing to make the initial capital
investment necessary to convert to StarGuide's products and services.  The
success of our systems against these competing technologies depends in
part upon whether our systems can offer significant improvements in
productivity and sound quality in a cost-effective manner. Additionally,
competitors may be able to develop systems compatible with, or that are
alternatives to, our proprietary technology or systems.

Our business may be adversely affected if we are not able to protect our
intellectual property rights from third-party challenges.

                                       21

<PAGE>

     We cannot assure that our intellectual property does not infringe on
the proprietary rights of third parties. The steps that we have taken to
protect our proprietary information may not prevent misappropriation of
such information, and such protection may not preclude competitors from
developing confusingly similar brand names or promotional materials or
developing products and services similar to ours. We consider our
trademarks, copyrights, advertising and promotion design and artwork to be
of value and important to our business. We rely on a combination of trade
secret, copyright and trademark laws and nondisclosure and other
arrangements to protect our proprietary rights. We do not have any patents
or patent applications pending. We generally enter into confidentiality or
license agreements with our employees, distributors and customers and
limit access to and distribution of our software, documentation and other
proprietary information. Despite our efforts to protect our proprietary
rights, unauthorized parties may attempt to copy or obtain and use
information that we regard as proprietary. In addition, the laws of some
foreign countries do not protect our proprietary rights to the same extent
as do the laws of the United States.

     While we believe that our trademarks, copyrights, advertising and
promotion design and artwork do not infringe upon the proprietary rights
of third parties, we may still receive future communications from third
parties asserting that we are infringing, or may be infringing, on the
proprietary rights of third parties. Any such claims, with or without
merit, could be time-consuming, require us to enter into royalty
arrangements or result in costly litigation and diversion of management
personnel. If such claims are successful, we may not be able to obtain
licenses necessary for the operation of our business, or, if obtainable,
such licenses may not be available on commercially reasonable terms,
either of which could prevent our ability to operate our business.

We face risks associated with international sales that could impact our
business.

     We derive some of our revenues from sales outside of the United
States and have increased and plan to continue to increase our
international sales and marketing efforts and expect that revenues derived
from international sales will continue to grow as a percentage of
revenues. There are a number of factors inherent in our international
business activities, which could result in decreased sales or increases in
expenses if international sales increase as a percentage of sales.  These
factors include the following:

     .  unexpected changes in United States or other government policies
        concerning the import and export of goods, services and technology and
        other regulatory requirements, tariffs and other trade barriers;

     .  costs and risks associated with modifying products for use in
        foreign countries in a timely manner;

     .  longer accounts receivable payment cycles associated with
        international deliveries as compared to accounts receivable generated
        from sales inside the United States due to increased delivery times;

     .  potentially adverse tax consequences due to foreign governments
        attempting to restrict imports; and

     .  increased taxes and regulatory burdens in order to bring earnings
        generated in international markets back into this United States and the
        burdens of complying with or enforcing contracts under a wide variety of
        foreign laws.

     Fluctuations in currency exchange rates could affect revenues
denominated in currencies other than the United States dollar and cause a
reduction in revenues derived from sales in a particular country. Our
ability to recoup our investments in foreign markets would be jeopardized
to the extent that the governments and/or companies of those markets
experience instability sometimes associated with certain international
markets. In addition, our earnings abroad may be subject to taxation by
more than one jurisdiction.

We may enter into or seek to enter into business combinations and
acquisitions that may be difficult to integrate, disrupt our business,
dilute shareholder value or divert management attention.

     Our business strategy includes the acquisition of complementary
businesses and product lines. Any such acquisitions would be accompanied
by the risks commonly encountered in such acquisitions, including:

                                      22

<PAGE>

     .  the difficulty of assimilating the operations and personnel of
        the acquired companies;

     .  the potential disruption of our business;

     .  the inability of our management to maximize our financial and
        strategic position by the successful incorporation of acquired
        technology and rights into our product and service offerings;

     .  the maintenance of uniform standards, controls, procedures and
        policies;

     .  the potential loss of key employees of acquired companies; and

     .  the impairment of relationships with employees and customers as a
        result of changes in management and operational structure.

     We may not be able to successfully complete any acquisition or, if
completed, the acquired business or product line may not be successfully
integrated with our operations, personnel or technologies. Any inability
to successfully integrate the operations, personnel, and technologies
associated with an acquired business and/or product line may negatively
affect our business and results of operation.

Failure to manage our growth could hinder the future success of our
business.

     We have experienced rapid growth over the past several years that has
resulted in new and increased responsibilities for management personnel
and that has placed and continues to place a significant strain on our
operating, management and financial systems and resources. Our personnel,
systems, procedures and controls may not be adequate to support our
existing and future operations. To accommodate this growth and to compete
effectively and manage future growth, if any, we must continue to
implement and improve our operational, financial and management
information systems, procedures and controls on a timely basis and to
expand, train, motivate and manage our work force. We must continue to
further develop our products and services while we manage anticipated
growth by implementing effective planning and operating processes, such as
continue to implement and improve our operational, financial and
management information systems; hire and train additional qualified
personnel; continue to expand and upgrade our core technologies; and
effectively manage multiple relationships with various customers, joint
venture and technological partners and other third parties.

We depend on our key personnel to manage the business effectively, and if we are
unable to retain our key employees or hire additional qualified personnel, our
ability to compete could be harmed.

     We believe that our future success will depend to a significant
extent upon the services of certain key executive officers, particularly
Scott K. Ginsburg, Chairman of the Board; Matthew E. Devine, Chief
Executive Officer; Omar A.  Choucair, Chief Financial Officer; and Jeffrey
A. Dankworth, StarGuide's President. We do not have employment agreements
with any of these key executive officers, and we do not carry key-man
insurance. Uncontrollable circumstances, such as the death or incapacity
of any key executive officer, could have a serious impact on our business.

     Our future success also depends upon our ability to retain and to
attract and retain highly qualified management, sales, operations,
technical and marketing personnel. We believe there is, and will continue
to be, intense competition for personnel with experience in the markets
applicable to our products and services. Because of this intense
competition, we may not be able to retain our key personnel or attract,
assimilate or retain other highly qualified technical and management
personnel in the future. Our inability to retain or to attract additional
qualified personnel as needed could have a considerable impact on our
business.

Certain provisions of our bylaws may have anti-takeover effects that could
prevent a change in control even if the change would be beneficial to our
shareholders.

     Our classified board might discourage the acquisition of a
controlling interest of our stock because such acquirer would not have the
ability to replace our directors, except as the term of each class
expires. Our Board of Directors amended our bylaws so

                                      23

<PAGE>

that, commencing with the 2001 annual meeting of stockholders, the directors
were divided into three classes with respect to the time for which they hold
office. The term of office of the first class expires at the 2002 annual meeting
of stockholders, the term of office of the second class expires at the 2003
annual meeting of stockholders, and the term of office of the third class
expires at the 2004 annual meeting of stockholders. At each annual meeting of
stockholders commencing with the 2002 annual meeting, directors elected to
succeed those directors whose terms then expire will be elected for a term of
office to expire at the third succeeding annual meeting of stockholders after
their election.

Because the Nasdaq National Market is likely to continue to experience extreme
price and volume fluctuations, the price of our common stock may decline, thus
making your investment more risky.

     The stock markets, particularly the Nasdaq National Market, on which
our common stock is listed, have experienced extreme price and volume
fluctuations. These fluctuations have particularly affected the market
prices of equity securities of technology-related companies and have often
been unrelated or disproportionate to the operating performance of those
companies. Our common stock may not trade at the same levels of shares as
that of other technology companies.

     Some of the factors that may cause the market price of our common
stock to fluctuate significantly, include:

     .  the addition or departure of key personnel;

     .  variations in our quarterly operating results;

     .  announcements by us or our competitors of significant contracts,
        new or enhanced products or service offerings, acquisitions,
        distribution partnerships, joint ventures or capital
        commitments;

     .  changes in financial estimates by securities analysts;

     .  sales of common stock or other securities in the future;

     .  changes in market valuations of networking, Internet and
        telecommunications companies;

     .  fluctuations in stock market prices and trading volumes generally;

     .  sale of shares of common stock by significant holders; and

     .  changes in general economic conditions, including interest rate levels.

Sales of substantial amounts of our common stock in the public market
could negatively affect the market price of our common stock.

     Sales of substantial amounts of common stock, or the perception that
these sales could occur, may depress prevailing market prices for the
common stock.  The sale of substantial amounts of our shares (including
shares issued upon exercise of outstanding options) may cause substantial
fluctuations in the price of our common stock. In addition, sales of a
substantial amount of our shares within a short period of time could cause
our stock price to steeply fall.  Because investors would more than likely
be reluctant to purchase shares of our common stock following substantial
sales, our ability to raise capital through the sale of additional stock
could be impaired.

                                      24

<PAGE>

Insiders have substantial control over us, which will limit an investor's
ability to influence corporate actions, including changes in control.

     Our executive officers and directors and their respective affiliates
own approximately 48% of our common stock, not including options or
warrants to purchase additional shares of common stock. As a result, these
shareholders are able to control or significantly influence all matters
requiring shareholder approval, including the election of directors and
the approval of significant corporate transactions. Such concentration of
ownership may have the effect of delaying or preventing a change in
control even if a change of control is in the best interest of all
shareholders.

We face risks associated with being delisted from the Nasdaq National
Market.

     The holders of our registered common stock currently enjoy a
substantial benefit in terms of liquidity by having such common stock
listed on the Nasdaq National Market System. This benefit would be lost if
we were to be delisted from the Nasdaq National Market. Nasdaq rules
require, among other things, that our common stock trade at $1 per share
or more on a consistent basis. While we believe we are currently in
compliance with Nasdaq's listing requirements and corporate governance
rules, we cannot assure the investor that this is the case or that we will
be able to continue to keep our registered common stock listed on the
Nasdaq National Market System or a similar securities exchange.

Our inability to enter into or develop strategic relationships in our key
industry segments could impact our operating results.

     Our strategy depends in part on the development of strategic
relationships with leading companies in key industry segments, including
media broadcasters and digital system providers. We may not be able to
successfully form or enter into such relationships, which may jeopardize
our ability to generate sales of our products or services in those
segments. Specific product lines are dependent to a significant degree on
strategic alliances and joint ventures formed with other companies. This
is particularly true with our CoolCast(tm) service, which depends on
relationships with providers of audio and video content and providers of
broadband Internet access. We may not be able to obtain exclusive
contracts with Internet service providers for deployment of our
CoolCast(tm) service within their networks, and it is possible that many
Internet service providers will allow our competitors to install equipment
at their sites and to provide similar broadband services within their
networks. Various factors could limit our ability to enter into or develop
strategic relationships, including, but not limited to, our relatively
short operating history, history of losses and the resources available to
our competitors.

Our business will suffer if it is not able to overcome the numerous risks
associated with the use of complex technology.

     The networks and the individual components within networks used in
providing our distribution and CoolCast(tm) services are highly complex.
Our services may be subject to errors and defects in software or hardware.
Additional problems in delivery of service could result from a variety of
causes, including human error, physical or electronic security breaches,
natural disasters, power loss, sabotage or vandalism. Such problems or
defects could result in:

     .  loss of or delay in revenues and loss of market share;

     .  loss of customers;

     .  failure to attract new customers or achieve market acceptance;

     .  diversion of development resources;

     .  loss of credibility;

     .  increased service costs; or

     .  legal action by our customers.

     In addition, because some equipment involved in providing our
information distribution and CoolCast(TM) services are located in the
facilities of others, such as broadcast affiliates, Internet service
providers and broadband access providers, we must

                                      25

<PAGE>

rely on third parties to care for equipment needed to provide our
services. For example, after we place our equipment in the facilities of
others and ensures it is functioning properly, we rely on the facility to
monitor the equipment to ensure that it maintains power, continues to
receive a signal from the carrier and is connected to the facilities
network in order to deliver the signal.

Our future growth and profitability depends in part on the strength of the
intellectual property associated with the CoolCast(TM) service and
technology

     Our business plan and future growth depend in part on the successful
deployment of our CoolCast(TM) service. CoolCast(TM) is still in a
preliminary stage of development and has not yet been fully deployed
commercially. There currently is no economic model for CoolCast(TM) that
is proven to generate a profit, and we may not be able to establish a
successful economic model. Our inability to accomplish any of the
following could inhibit the profitability of CoolCast(TM) and could
significantly affect our business:

     .  protecting CoolCast(TTM) intellectual property from infringement;

     .  competing effectively in the market for delivery of
        Internet-related content;

     .  obtaining necessary rights to video or audio content (or avoiding
        the requirement to expend significant capital in obtaining
        such rights);

     .  expand our presence in the broadcasting industry and target new
        market opportunities ;

     .  gaining access to sufficient operational broadband delivery
        networks;

     .  provide Internet-related video and audio content delivery through
        commercial application; or

     .  establishing a workable and profitable business model for
        CoolCast(TM).

We depend upon single or limited-source suppliers, and our ability to produce
audio and video distribution equipment could be impacted if those relationships
were discontinued.

     We rely on fewer than five single or limited-source suppliers for
integral components used in the assembly of our audio and video units.
Although these suppliers are generally large, well-financed organizations,
in the event that a supplier were to experience financial or operational
difficulties that resulted in a reduction or interruption in component
supply to us, it would delay our deployment of audio and video units. We
rely on our suppliers to manufacture components for use in our products.
Some of our suppliers also sell products to our competitors and may in the
future become our competitors , possibly entering into exclusive
arrangements with our existing competitors. In addition, our suppliers may
stop selling their products or components to us at commercially reasonable
prices or completely stop selling their products or components to us.  If
a reduction or interruption of supply were to occur, it could take a
significant period of time for us to qualify an alternative subcontractor,
redesign its products as necessary and contract for the manufacture of
such products. This would have the effect of depressing our business until
we were able to establish sufficient component supply through an
alternative source. We believe that there are currently alternative
component manufacturers that could supply the components required to
produce our products, but based on the financial condition and service
levels of our current suppliers, we do not feel the need to pursue
agreements or understandings with such alternative sources or pursue
long-term contracts with our current suppliers. We have experienced
component shortages in the past, and material component shortages or
production or delivery delays may occur in the future.

     We obtain our local access transmission services and long distance
telephone access through an exclusive contract with MCI Worldcom ("MCI"),
which expires in November 2002. Our agreement with MCI provides for
reduced pricing on various services provided in exchange for minimum
purchases under the contract of $3.6 million per year. The agreement
provides for certain achievement credits once specified purchase levels
are met. Based on our current relationship with MCI, we believe that MCI
will renew the agreement in 2002 on existing or more favorable terms. In
the event that we are unable to renew our agreement with MCI, there are
numerous alternative providers in the current long-distance
telecommunications industry for the

                                      26

<PAGE>

services that are currently provided to us by MCI. However, any material
interruption in the supply or a material change in the price of either
local access or long distance carrier service could increase our costs or
cause a significant decline in our revenues, thereby decreasing our
operating results.

We face various risks associated with purchasing satellite capacity.

     As part of our strategy of providing transmittal of audio, video,
data, and other information using satellite technology, we periodically
purchase satellite capacity from third parties owning satellite systems.
Although we attempt to match these expenditures against anticipated
revenues from sales of our products to customers, we may not be successful
at estimating anticipated revenues, and actual revenues from sales of our
products may not exceed our expenditures for satellite capacity. In
addition, purchases of satellite capacity require a significant amount of
capital. Any inability to purchase satellite capacity or to achieve
revenues sufficient to offset the capital expended to purchase satellite
capacity may make our business more vulnerable and significantly affect
our financial condition and results of operations.

If our relationship with Hughes Network Systems is terminated, or if
Hughes fails to perform as required under our agreement, our business
could be interrupted.

     We have designed and developed the necessary software to enable our
current video delivery systems to receive digital satellite transmissions
over the Hughes Network Systems satellite system. However, the Hughes
satellite system may not have the capacity to meet our future delivery
commitments and broadcast quality requirements on a cost-effective basis,
if at all. We have a non-exclusive agreement with Hughes that expires in
December 2002. The agreement provides for fixed pricing on dedicated
bandwidth and gives us access to satellite capacity for electronic
delivery of digital audio and video transmissions by satellite. Hughes is
required to meet performance specifications as outlined in the agreement,
and we are given a credit allowance for future fees if Hughes does not
meet these requirements. The agreement states that Hughes can terminate
the agreement if we do not make timely payments or become insolvent.

Certain of our products depend on satellites; any satellite failure could
result in interruptions of our service that could negatively impact our
business and reputation.

     A reduction in the number of operating satellites or an extended
disruption of satellite transmissions would impair the current utility of
the accessible satellite network and the growth of current and additional
market opportunities.  Satellites and their ground support systems are
complex electronic systems subject to weather conditions, electronic and
mechanical failures and possible sabotage. The satellites have limited
design lives and are subject to damage by the hostile space environment in
which they operate. The repair of damaged or malfunctioning satellites is
nearly impossible. If a significant number of satellites were to become
inoperable, there could be a substantial delay before they are replaced
with new satellites. In addition, satellite transmission can be disrupted
by natural phenomena causing atmospheric interference, such as sunspots.

     Certain of our products rely on signals from satellites, including,
but not limited to, satellite receivers and head end equipment. Any
satellite failure could result in interruptions of our service, negatively
impacting our business.  We attempt to mitigate this risk by having our
customers procure their own agreements with satellite providers.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     The Company provides some services to entities located outside of the
United States and, therefore, is subject to the risk that the exchange
rates will adversely impact the Company's results of operations. The
Company believes this risk to be immaterial to the Company's results of
operations.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The information required by this Item is set forth in the Company's
Consolidated Financial Statements and the Notes thereto beginning at Page
F-1 of this report.

                                      27

<PAGE>

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

None.

                                      28

<PAGE>

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Name                          Age  Title(s)
----                          ---  --------
Scott K. Ginsburg /(2)/        49  Chairman of the Board
Matthew E. Devine              53  Chief Executive Officer and Director
Omar A. Choucair               40  Chief Financial Officer and Director
Lawrence D. Lenihan, Jr. /(2)/ 35  Director
David M. Kantor /(2)/          45  Director
Cappy R. McGarr /(1)/          50  Director
Jeffrey A. Dankworth           46  Director
Eric L. Bernthal               55  Director
Robert J. Schlegel /(1)/       52  Director
Kevin C. Howe /(1)/            53  Director

/(1)/  Member of the Audit Committee
/(2)/  Member of the Compensation Committee

     Scott K. Ginsburg joined the Company in December 1998 as Chief Executive
Officer and Chairman of the Board. In July 1999, Matthew E. Devine assumed the
responsibilities of Chief Executive Officer, but Mr. Ginsburg remains the
Company's Chairman. Most recently Mr. Ginsburg served as Chief Executive
Officer and Director of AMFM Corporation (formerly Chancellor Media). Mr.
Ginsburg founded Evergreen Media Corporation in 1988, and was the co-founder of
Statewide Broadcasting, Inc. and H&G Communications, Inc. Mr. Ginsburg earned a
B.A. from George Washington University in 1974 and a J.D. from the George
Washington University Law Center in 1978.

     Matthew E. Devine joined the Company in July 1999 as Chief Executive
Officer and Director. Prior to joining the Company, Mr. Devine served as Chief
Financial Officer of AMFM Corporation (formerly Chancellor Media) and served as
Chief Financial Officer, Executive Vice President, Treasurer, Secretary and
Director for Evergreen Media Corporation. Between 1975 and 1988, Mr. Devine
served in various finance positions at AMR Corporation, parent company to
American Airlines.

     Omar A. Choucair joined the Company as Chief Financial Officer in July
1999. Prior to joining the Company, Mr. Choucair served as Vice President of
Finance for AMFM Corporation (formerly Chancellor Media), and served as Vice
President of Finance for Evergreen Media before it was acquired by Chancellor
Media in 1997. Prior to entering the media industry, Mr. Choucair was a Senior
Manager at KPMG LLP, where he specialized in media and telecommunications
clients. Mr. Choucair received a B.B.A. from Baylor University and is a
Certified Public Accountant. Mr. Choucair became a Director in February 2001.

     Lawrence D. Lenihan, Jr. has been a member of the Board of Directors of
the Company since July 1997. Mr. Lenihan is a Managing Director of Pequot
Capital Management, Inc. He joined the predecessor to this firm, Dawson-Samberg
Capital Management, in 1996. He is also a Managing Member of the General
Partner of Pequot Private Equity Fund II, L.P. Prior to joining Pequot, Mr.
Lenihan was a principal at Broadview Associates, LLC from 1993 to 1996. Prior
to joining Broadview, Mr. Lenihan held several positions at IBM, most recently
as the leader of an interactive multimedia software product business. Mr.
Lenihan graduated from Duke University with a B.S. in Electrical Engineering
and he holds an M.B.A. from the Wharton School of Business at the University of
Pennsylvania. He currently serves as a director of several public and private
companies including Netegrity, USSearch, Inc., Performaworks, Nextreme,
Coordinate Care Solutions, Elance and Mediaplex, Inc.

     David M. Kantor has been a member of the Board of Directors of the Company
since August 1999. Mr. Kantor is a media industry consultant. Formerly, he was
Senior Vice President for Network Operations of AMFM, Inc. (formerly Chancellor
Media Corporation) and President of ABC Radio Network, having previously served
as Executive Vice President. Prior to joining ABC Radio Network, he held
executive positions with Cox Cable and Satellite Music Network. Mr. Kantor
holds a B.S. from the University of Massachusetts and an MBA from Harvard
Business School.

                                      29

<PAGE>

     Cappy R. McGarr has been a member of the board since February 2001. Mr.
McGarr is President of McGarr Capital Holdings, LLC, a firm specializing in
managing domestic and offshore hedge funds. He received Bachelor of Arts,
Bachelor of Journalism and Master of Business Administration degrees from the
University of Texas at Austin. Upon completing his graduate degree in 1970,
McGarr was employed by Goldman, Sachs & Co. He serves on the Board of Trustees
of The John F. Kennedy Center for the Performing Arts and the Board of
Directors of the Lyndon Baines Johnson Foundation.

     Jeffrey A. Dankworth has been President and a Director of StarGuide since
1995 and a director of the Company since February 2001. Prior to co-founding
StarGuide in 1994, Mr. Dankworth was an entrepreneur in the entertainment media
and professional sports industries where he led the development of various
media joint ventures in professional sports including the NFL Quarterback Club.
As an attorney, Mr. Dankworth has extensive experience in various areas of
business development, including the negotiation and management of media
partnerships, licensing programs, and joint ventures. Between 1984 and 1994,
Mr. Dankworth was Of Counsel with the law firm of Mitchell, Silberberg & Knupp
and prior to that was an associate with the law firm of Gibson, Dunn & Crutcher
(1981-1984).

     Eric L. Bernthal has been a member of the board since February 2001. Mr.
Bernthal is the Managing Partner of the Washington, DC office of Latham &
Watkins, a law firm with more than 1,400 attorneys worldwide. He has practiced
corporate and telecommunications law for 30 years, specializing in
transactional and regulatory matters. Mr. Bernthal has represented companies in
the media, communications, health care, consumer products and retail
industries. Mr. Bernthal has been a partner in Latham & Watkins since 1986.
Prior to joining Latham, Mr. Bernthal was an associate and then a partner in
the Washington, DC law firm of Arent, Fox, Kintner, Plotkin & Kahn, from 1972
to 1986. He served on that law firm's Executive Committee for five years. Mr.
Bernthal served as law clerk to the Honorable Ruggero J. Aldisert of the United
States Court of Appeals for the Third Circuit in Philadelphia from 1970 to
1972. He earned an undergraduate degree from Columbia University in 1967 and a
graduate degree from George Washington University Law Center.

     Robert J. Schlegel has been a member of the board since February 2001. Mr.
Schlegel has been the CEO of The Pavestone Company, a manufacturer of
decorative, environmental-friendly concrete landscape products, since 1980. Mr.
Schlegel also built a health care company, PeopleCare Heritage Centers,
including 2,200 nursing retirement care beds in 13 Texas facilities. Mr.
Schlegel has been actively involved in the Dallas community with the Trinity
Christian Academy, the Cox School of Business at Southern Methodist University,
the Salvation Army, Students in Free Enterprise, the Alzheimer's Association,
the Dallas Symphony, the Young Presidents' Organization and his own foundation,
the Schlegel Horizons Foundation. Mr. Schlegel graduated with a B.A. degree in
Economics from Wilfrid Laurier University in 1972.

     Kevin C. Howe is the Managing Partner of Mercury Ventures. Mercury Ventures
manages 3 different funds that invest in emerging technology companies that
focus on Internet applications. Mr. Howe serves on the board of three publicly
traded technology firms that are listed on the Nasdaq and London exchanges. Mr.
Howe also sits on the boards of five privately held technology firms. In 1985,
he co-founded DacEasy, an early leader in packaged application software. In
1987, Mr. Howe led the sale of DacEasy to Insilco (a Fortune 500 company). In
1991, Mr. Howe led the carve-out of DacEasy from Insilco and subsequent sale to
Sage Group, plc. which had market capitalization of over $7 billion. He was CEO
of the US operations responsible for operations and acquisitions until 1999. He
remains a director of Sage. In 1993, Mr. Howe also co-founded Martin Howe
Associates, which was an early leader in the merchant credit card processing
industry and a pioneer in wireless solutions. The company was sold in 1997 to
PMT, a Nasdaq listed company. Mr. Howe received his MBA from SMU in 1976.

     Information regarding the executive officers of the Company are included
under Item 4A - Executive Officers of the Registrant

ITEM 11. EXECUTIVE COMPENSATION

     The information required by this Item is incorporated by reference to the
section captioned "Executive Compensation" in the Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The information required by this Item is incorporated by reference to the
section captioned "Security Ownership of Certain Beneficial Owners and
Management" in the Proxy Statement.

                                      30

<PAGE>

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information required by this Item is incorporated by reference to the
sections captioned "Compensation Committee Interlocks and Insider
Participation" and "Certain Transactions with Management" in the Proxy
Statement.

                                    PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) 1. FINANCIAL STATEMENTS

The following financial statements are filed as part of this Report:

                                                                            Page
                                                                            ----
Independent Auditors' Report..............................................  F-2
Consolidated Balance Sheets as of December 31,
2001 and 2000.............................................................  F-3
Consolidated Statements of Operations for the three
years ended December 31,2001..............................................  F-4
Consolidated Statements of Shareholders' Equity
for the three years ended December 31, 2001...............................  F-5
Consolidated Statements of Cash Flows for the three years ended
December 31, 2001.........................................................  F-6
Notes to Consolidated Financial Statements................................  F-7

2. FINANCIAL STATEMENT SCHEDULES

II - Valuation and Qualifying Accounts                                      S-1

3. EXHIBITS

Exhibit Number                               Exhibit Title
--------------                               -------------
     3.1 (d)     Certificate of Incorporation of registrant.

     3.2 (h)     Certificate of Determination of Rights of Series A Convertible
                 Preferred Stock of Digital Generation Systems, Inc., filed by
                 the Secretary of State of the State of California on July 16,
                 1997.

     3.3 (b)     Bylaws of registrant, as amended to date.

     4.1 (b)     Form of Common Stock Certificate.

    10.1 (b)     1992 Stock Option Plan (as amended) and forms of Incentive
                 Stock Option Agreement and Non-statutory Stock Option
                 Agreement. *

    10.2 (b)     Form of Directors' and Officers' Indemnification Agreement.

    10.3 (b)     1995 Director Option Plan and form of Incentive Stock Option
                 Agreement thereto. *

    10.4 (b)     Form of Restricted Stock Agreement. *

    10.5 (c)     Content Delivery Agreement between the Company and Hughes
                 Network Systems, Inc., dated November 28, 1995.

    10.6 (c)     Equipment Reseller Agreement between the Company and Hughes
                 Network Systems, Inc., dated November 28, 1995.

    10.7(j)      Special Customer Agreement between the Company and MCI
                 Telecommunications Corporation, dated May 5, 1997.

    10.8 (b)     Master Lease Agreement between the Company and Comdisco, Inc.,
                 dated October 20, 1994, and Exhibits thereto.

    10.9 (b)     Loan and Security Agreement between the Company and Comdisco,
                 Inc., dated October 20, 1994, and Exhibits thereto.

    10.10 (e)    Digital Generation Systems, Inc. Supplemental Stock Option
                 Plan. *

                                      31

<PAGE>

Exhibit Number                               Exhibit Title
--------------                               -------------
    10.11 (l)    Common Stock Subscription Agreement for private placement of
                 Company's Common Stock at $2.80 per share.

    10.12 (n)    Series A Preferred Stock Conversion Agreement dated as of
                 August 12, 1998.

    10.13 (p)    Amendment and Restatement No. 5 of the Registration Rights
                 Agreement, dated July 14, 1997, by and among the Registrant
                 and certain of its security holders.

    10.14 (p)    Amended and Restated Registration Rights Agreement, dated
                 December 9, 1998, by and among the Registrant and certain of
                 its security holders

    10.15 (p)    Registration Rights Agreement, dated December 9, 1998, by and
                 among the Registrant and certain of its security holders.

    10.16 (q)    Common Stock and Warrant Purchase Agreement dated December 9,
                 1998 by and among the Registrant and investors listed in
                 Schedule A thereto.

    10.17 (q)    Common Stock Subscription Agreement dated December 9, 1998 by
                 and among the Registrant and Scott Ginsburg.

    10.18 (q)    Warrant Purchase Agreement dated December 9, 1998 by and among
                 the Registrant and Scott Ginsburg.

    10.19 (q)    Warrant No. 1 to Purchase Common Stock dated December 9, 1998
                 by and among Registrant and Scott K. Ginsburg.

    10.20 (q)    Warrant No. 2 to Purchase Common Stock dated December 9, 1998
                 by and among Registrant and Scott K. Ginsburg

    10.21 (r)    Registration Rights Agreement, dated December 17, 1999, by and
                 among the Registrant and certain of its security holders.

    10.22 (r)    Common Stock Purchase Agreement dated December 17, 1999 by
                 and among the Registrant and investors listed in Schedule A
                 thereto.

    10.23 (r)    Loan and security agreement, dated as of April 6, 2000 between
                 Digital Generation Systems, Inc. as Borrower, and Foothill
                 Capital Corporation as Lender and exhibits thereto.

    10.24 (s)    Securities Purchase Agreement, dated as of April 4, 2000 by
                 and among StarGuide Digital Networks, Inc., Infinity
                 Broadcasting Corporation and Westwood One, Inc., and Musicam
                 Express, L.L.C.

    10.25 (u )   Agreement and Plan of Merger, dated as of January 18, 2001, by
                 and among DG Systems, DG Nevada Merger Sub Inc., a wholly
                 owned subsidiary of DG Systems, and StarGuide Digital Networks,
                 Inc.

    10.26 (t)    Credit agreement, dated as of June 1, 2001 between Digital
                 Generation Systems, Inc. as borrower and JP Morgan and Bank of
                 New York as Lenders.

    21.1 (a)     Subsidiaries of the Registrant.

    23.1 (a)     Consent of KPMG LLP.

                                      32

<PAGE>

(a)     Filed herewith.

(b)     Incorporated by reference to the exhibit bearing the same number filed
        with registrant's Registration Statement on Form S-1 (Registration No.
        33-80203).

(c)     Incorporated by reference to the exhibit bearing the same number filed
        with registrant's Registration Statement on Form S-1 (Registration No.
        33-80203). The registrant has received confidential treatment with
        respect to certain portions of this exhibit. Such portions have been
        omitted from this exhibit and have been filed separately with the
        Securities and Exchange Commission.

(d)     Incorporated by reference to the exhibit bearing the same number
        filed with registrant's Quarterly Report on Form 10-Q filed May 3, 1996,
        as amended.

(e)     Incorporated by reference to the exhibit bearing the same number filed
        with registrant's Quarterly report on Form 10-Q filed November 13, 1996.

(f)     Incorporated by reference to the exhibit bearing the same title filed
        with registrant's Current Report on Form 8-K/A filed January 21, 1997.

(g)     Incorporated by reference to the exhibit bearing the same number filed
        with registrant's Annual Report on Form 10-K filed March 18, 1997.

(h)     Incorporated by reference to the exhibit bearing the same number filed
        with registrant's quarterly report on Form 10-Q filed May 15, 1997.

(i)     Incorporated by reference to the exhibit bearing the same title filed
        with registrant's Form 8-K filed August 1, 1997.

(j)     Incorporated by reference to the exhibit bearing the same title filed
        with registrant's Quarterly report on Form 10-Q filed August 14, 1997.
        Confidential treatment has been requested with respect to certain
        portions of this exhibit pursuant to a request for confidential
        treatment filed with the Securities and Exchange Commission. Omitted
        portions have been filed separately with the Commission.

(k)     Incorporated by reference to the exhibit bearing the same number filed
        with registrant's Annual Report on Form 10-K filed March 31, 1998.

(l)     Incorporated by reference to the exhibit bearing the same title filed
        with registrant's Quarterly report on Form 10-Q filed May 15, 1998.

(m)     Incorporated by reference to the exhibit bearing the same title filed
        with registrant's Quarterly report on Form 10-Q filed August 14, 1998.

(n)     Incorporated by reference to the exhibit bearing the same title filed
        with registrant's Current Report on Form 8-K filed October 13, 1998.

(o)     Incorporated by reference to the exhibit bearing the same title filed
        with registrant's Quarterly report on Form 10-Q filed November 16,
        1998.

(p)     Incorporated by reference to the exhibit bearing the same title filed
        with registrant's Registration Report on Form S-3 filed on December 31,
        1998.

(q)     Incorporated by reference to the exhibit bearing the same number filed
        with registrant's Annual Report on Form 10-K filed March 29, 1999.

                                      33

<PAGE>

(r)     Incorporated by reference to the exhibit bearing the same number filed
        with registrant's Quarterly report on Form 10-Q filed May 11, 2000

(s)     Incorporated by reference to the exhibit bearing the same title filed
        with registrant's Quarterly Report on Form 10-Q filed on May 15, 2001

(t)     Incorporated by reference to the exhibit bearing the same title filed
        with registrant's Quarterly Report on Form 10-Q filed on August 15, 2001

*       Management contract or compensatory plan or arrangement.

(b)  Reports on Form 8-K

        Current Report on Form 8-K filed on November 1, 2001 regarding the
January 2001 merger with StarGuide Digital Networks, Inc. including the
Consolidated Statement of Earnings and Statement of Cash Flows for the three
years ended December 31, 2000 and Consolidated Balance Sheets as of December
31, 2000 and 1999.

(c)     Exhibits

        See items 14 (a) (3) above.

(d)     Financial Statement Schedules
        See Item 14(a) (2) above.

                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.

                                      DIGITAL GENERATION SYSTEMS, INC.

Dated: March 27, 2002                 By: /S/ MATTHEW E. DEVINE
                                          ---------------------
                                          Matthew E. Devine
                                          Chief Executive Officer

                                POWER OF ATTORNEY

     KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints Matthew E. Devine or Omar A.
Choucair as his attorney-in-fact, with full power of substitution for him in
any and all capacities, to sign any and all amendments to this report on Form
10-K, and to file the same, with exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission.

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

                                      34

<PAGE>

Signature                         Title                               Date
---------                         -----                               ----

/s/ SCOTT K. GINSBURG        Chairman of the Board               March 27, 2002
---------------------  and Director (Principal Executive
Scott K. Ginsburg                  Officer)

/s/ MATTHEW E. DEVINE     Chief Executive Officer                March 27, 2002
---------------------           and Director
Matthew E. Devine

/s/ OMAR A. CHOUCAIR      Chief Financial Officer and Director   March 27, 2002
-------------------- (Principal Financial and Accounting Officer)
Omar A. Choucair

/s/ DAVID M. KANTOR                 Director                     March 27, 2002
-------------------
David M. Kantor

/s/ LAWRENCE D. LENIHAN, JR.        Director                     March 27, 2002
---------------------------
Lawrence D. Lenihan, Jr.

/s/ CAPPY MCGARR                    Director                     March 27, 2002
----------------
Cappy McGarr

/s/ JEFFREY A. DANKWORTH            Director                     March 27, 2002
------------------------
Jeffrey A. Dankworth

/s/ ERIC L. BERNTHAL                Director                     March 27, 2002
-------------------
Eric L. Bernthal

/s/ ROBERT J. SCHLEGEL              Director                     March 27, 2002
---------------------
Robert J. Schlegel

/s/ KEVIN C. HOWE                   Director                     March 27, 2002
-----------------
Kevin C. Howe

                                      35

<PAGE>

              DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
                  ------------------------------------------

Independent Auditors' Report..............................................  F-2
Consolidated Balance Sheets as of December 31, 2001 and 2000..............  F-3
Consolidated Statements of Operations for the three years ended
   December 31, 2001......................................................  F-4
Consolidated Statements of Shareholders' Equity for the three years
   ended December 31, 2001................................................  F-5
Consolidated Statements of Cash Flows for the three years ended
   December 31, 2001......................................................  F-6
Notes to Consolidated Financial Statements................................  F-7

                                     F-1

<PAGE>

              DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                         INDEPENDENT AUDITORS' REPORT

The Board of Directors
Digital Generation Systems, Inc.:

     We have audited the accompanying consolidated balance sheets of Digital
Generation Systems, Inc. and subsidiaries as of December 31, 2001 and 2000, and
the related consolidated statements of operations, stockholders' equity
(deficit) and cash flows for each of the years in the three-year period ended
December 31, 2001.  In connection with our audits of the consolidated financial
statements, we have also audited the financial statement schedule as listed at
Item 14(a) 2 for each of the years in the three-year period ended December 31,
2001. These consolidated financial statements and financial statement schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and financial statement
schedule based on our audits.

     We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements.  An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Digital
Generation Systems, Inc. and subsidiaries as of December 31, 2001 and 2000, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America.  Also in our
opinion, the related financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.

                                          KPMG LLP

Dallas, Texas
February 14, 2002

                                     F-2

<PAGE>

              DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                         CONSOLIDATED BALANCE SHEETS
                   (In thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                                          December 31,     December 31,
                                                                              2001           2000
                                                                              ----           ----
<S>                                                                        <C>              <C>
Assets
------
CURRENT ASSETS:
Cash and cash equivalents                                                  $    2,724       $    2,891
Accounts receivable (less allowance for doubtful accounts of $2,883 in
   2001 and $847 in 2000)                                                      13,842            3,211
Inventories                                                                     2,063            2,109
Other current assets                                                              868              663
                                                                           -------------    ------------
Total current assets                                                           19,497            8,874
                                                                           -------------    ------------

Property and equipment, net                                                    17,820              870
Goodwill, net                                                                 183,228                -
Intangible and other assets , net                                              14,912            1,358
                                                                           -------------    ------------
TOTAL ASSETS                                                               $  235,457       $   11,102
                                                                           -------------    ------------

Liabilities and Stockholders' Equity (Deficit)
----------------------------------------------
CURRENT LIABILITIES:
Accounts payable                                                           $    5,733       $    1,638
Accrued liabilities                                                             4,509            3,058
Deferred revenue, net                                                           3,315            3,260
Current portion of long-term debt and capital leases                            7,294                -
                                                                           -------------    ------------
Total current liabilities                                                      20,851            7,956
                                                                           -------------    ------------

Deferred revenue, net                                                      $    8,428       $   12,076
Long-term debt and capital leases, net of current portion                       9,496                -
Excess of losses over investments in and amounts due from joint venture             -            2,568
                                                                           -------------    ------------
TOTAL LIABILITIES                                                              38,775           22,600
                                                                           -------------    ------------

STOCKHOLDERS' EQUITY (DEFICIT):
Convertible preferred stock, no par value -
   Authorized 15,000 shares; Issued and outstanding - none                          -                -
Common stock, $0.001 par value -
   Authorized 200,000 shares at December 31, 2001; 70,807 issued and
   70,784 outstanding at December 31, 2001 and
   41,660 issued and 41,197 outstanding at December 31, 2000                       72               42
Additional paid-in capital                                                    266,000           49,598
Accumulated deficit                                                           (69,196)         (60,167)
Receivables from issuance of common stock                                         (93)               -
Treasury stock, at cost                                                          (101)            (971)
                                                                           -------------    ------------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT)                                          196,682          (11,498)
                                                                           -------------    ------------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                 $  235,457       $   11,102
                                                                           =============    ============
</TABLE>

     The accompanying notes are an integral part of these financial statements.

                                     F-3

<PAGE>

                DIGITAL GENERATION SYSTEMS,INC.AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                    (In thousands, except per share amounts)

                                                For years ended December 31,
                                              --------------------------------
                                                  2001        2000      1999

Revenues:
 Audio and video content distribution         $   50,447 $         -  $      -
 Product sales                                    13,875       6,117     5,516
 Other                                             6,378       8,302     7,552
                                              ---------- ----------- ----------
 Total revenues                                   70,700      14,419    13,068
                                              ---------- ----------- ----------
Cost of revenues:
 Audio and video content distribution             27,762           -         -
 Product sales                                     5,392       3,701     4,655
 Other                                             4,259       6,101     3,473
                                              ---------- ----------- ----------
 Total cost of revenues                           37,413       9,802     8,128
                                              ---------- ----------- ----------
Operating expenses:
 Sales and marketing                               5,615       2,742     3,209
 Research and development                          4,604       3,111     3,383
 General and administrative expenses:
  Noncash stock award charges                          -      19,630         -
  Other                                           12,187       5,330     3,087
 Merger charge                                       791          --        --
 Depreciation and amortization                    17,065         824       973
                                              ---------- ----------- ----------
Total operating expenses                          77,675      41,439    18,780
                                              ---------- ----------- ----------

Loss from operations                          $   (6,975) $  (27,020) $ (5,712)

Other (income) expense:
Interest and other (income) expense, net             282        (300)     (289)
Interest expense                                   1,772          21       547
Equity in losses of joint venture                      -       1,125     3,030
                                              ---------- ----------- ----------
Net loss                                      $   (9,029) $  (27,866) $ (9,000)
                                              ========== =========== ==========

Basic and diluted net loss per common share   $    (0.13) $    (0.68)  $ (0.23)

Weighted average common shares outstanding
     Basic                                        70,443      40,912    39,183
                                              ========== =========== ==========
     Diluted                                      70,443      40,912    39,183
                                              ========== =========== ==========

     The accompanying notes are an integral part of these financial statements.

                                     F-4

<PAGE>

               DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                                (In thousands)

<TABLE>
<CAPTION>
                                 Common Stock      Treasury Stock      Additional                                Total
                                                                        Paid-in      Notes      Accumulated   Stockholders'
                                Shares   Amount   Shares    Amount      Capital    Receivable     Deficit    Equity (Deficit)
                               -------  -------  -------   -------     --------   -----------     -------    ----------------

<S>                             <C>     <C>        <C>     <C>        <C>               <C>     <C>             <c>
Balance at December 31,
1998                            38,801  $   39         -   $     -    $   17,280        $   -   $   (23,301)    $    (5,982)
Issuance of common stock for
conversion of note payable         724       1         -         -           575            -             -             576
Purchase of treasury stock          -        -      (139)     (270)            -            -             -            (270)
Net loss                            -        -         -         -             -            -        (9,000)         (9,000)
                              -----------------------------------------------------------------------------------------------
Balance at December 31, 1999    39,525      40      (139)     (270)       17,855            -       (32,301)        (14,676)
                              -----------------------------------------------------------------------------------------------

Issuance of common stock         2,110       2         -         -        12,083            -             -          12,085
Exercise of stock options           25       -         -         -            30            -             -              30
Purchase of treasury stock           -       -      (324)     (701)            -            -             -            (701)
Issuance of common stock
warrants and options                 -       -         -         -        19,630            -             -          19,630
Net loss                             -       -         -         -             -            -       (27,866)        (27,866)
                              -----------------------------------------------------------------------------------------------
Balance at December 31, 2000    41,660      42      (463)     (971)       49,598            -       (60,167)        (11,498)
                              -----------------------------------------------------------------------------------------------

Shares issued to effect
   DGS/StarGuide merger         27,796      28       440       870       211,591          (93)            -         212,396
Musicam Express acquisition        693       1         -         -         3,999            -             -           4,000
Exercise of stock options          611       1         -         -           367            -             -             368
Issuance of common stock under
   employee stock purchase plan     47       -         -         -            74            -             -              74
Noncash stock compensation           -       -         -         -           371            -             -             371
Net loss                             -       -         -         -             -            -        (9,029)         (9,029)
                              -----------------------------------------------------------------------------------------------
 Balance at December 31, 2001   70,807  $   72       (23)  $  (101)   $  266,000       $  (93)  $   (69,196)    $   196,682
                              ===============================================================================================
</TABLE>

     The accompanying notes are an integral part of these financial statements.

                                     F-5

<PAGE>

               DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)

<TABLE>
<CAPTION>

                                                                                 Twelve months ended December 31,
                                                                                -----------------------------------
                                                                                   2001         2000        1999
                                                                                   ----         ----        ----
<S>                                                                             <C>          <C>         <C>
Cash flows from operating activities:
  Net loss                                                                      $  (9,029)   $ (27,866)   $  (9,000)
  Adjustments to reconcile net loss to net cash provided by (used in)
  operating activities:
     Depreciation and amortization                                                 17,065          824          973
      Noncash stock award charges                                                     371       19,630            -
     Reduction in notes payable to settle claim                                         -            -         (204)
     Provision for doubtful accounts                                                1,954          531           93
     Noncash interest expense                                                           -            -           30
     Equity in losses of joint venture                                                  -        1,125        3,030
    Changes in operating assets and liabilities, net of working capital
    from acquisitions:
       Accounts receivable                                                            301        4,042       (6,372)
       Inventories                                                                     46         (140)         461
       Other assets                                                                 1,033         (888)        (762)
       Accounts payable and accrued liabilities                                    (3,214)      (1,025)       1,197
       Deferred revenue, net                                                       (3,593)         165       13,827
                                                                                ------------------------------------
Net cash provided by (used in) operating activities                                 4,934       (3,602)       3,273
                                                                                ------------------------------------

Cash flows from investing activities:
     Purchases of property and equipment                                           (3,219)        (664)        (547)
     Acquisitions, net of cash acquired                                              (768)           -            -
     Investment in and advances to joint venture                                        -         (749)      (1,527)
                                                                                ------------------------------------
Net cash used in investing activities                                              (3,987)      (1,413)      (2,074)
                                                                                ------------------------------------

Cash flows from financing activities:
       Proceeds from issuance of common stock                                         442       12,115            -
       Payment of debt issuance cost                                                 (977)           -            -
       Borrowings under long-term debt                                             40,864            -            -
       Payments on long-term debt                                                 (41,443)      (5,653)        (660)
       Purchase of treasury stock                                                       -         (701)        (270)
                                                                                ------------------------------------
Net cash provided by (used in) financing activities                                (1,114)       5,761         (930)
                                                                                ------------------------------------
Net increase (decrease) in cash and cash equivalents                                 (167)         746          269

Cash and cash equivalents at beginning of year                                      2,891        2,145        1,876
                                                                                ------------------------------------
Cash and cash equivalents at end of year                                        $   2,724    $   2,891   $    2,145
                                                                                ====================================

Supplemental disclosures of cash flow information:

  Interest paid                                                                 $     928    $      21   $      132
                                                                                ====================================
  Noncash financing activities:

    Property and equipment acquired through capital lease                       $   1,569    $       -   $        -
                                                                                ====================================
    Common stock issued in lieu of debt payments                                $       -    $       -   $      577
                                                                                ====================================
</TABLE>

  The accompanying notes are an integral part of these financial statements.

                                      F-6

<PAGE>

              DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              (in thousands, except share and per share data)

1. THE COMPANY:

     Digital Generations Systems, Inc. (the "Company") owns a nationwide
digital network that beneficially links hundreds of advertisers and advertising
agencies with more than 7,500 radio and 875 television stations across the
United States and Canada. The Company also owns proprietary digital software,
hardware and communications technology, including various bandwidth satellite
receivers, audio compression codes, software to operate integrated digital
multimedia networks, software development for satellite applications and
engineering consulting services. The Company has a Network Operation Center
located in Dallas, Texas that delivers audio, video, image and data content
that comprise transactions between the advertising and broadcast industries.

     In January 2001, the Company completed its merger with StarGuide Digital
Networks, Inc. ("StarGuide") pursuant to the Agreement and Plan of Merger. The
merger has been accounted for as a reverse acquisition, and accordingly,
historical results of the Company prior to the merger are that of StarGuide.
The results of operations subsequent to January 1, 2001, the consummation date,
included both the Company and StarGuide.

     The Company is subject to certain risks that include, but are not limited
to: the continued development of technology to enhance the delivery and variety
of the Company's services in the most cost-effective manner, including the
successful integration of the operations of its subsidiaries; the ability to
compete successfully against current and future competitors; dependence on key
personnel, and the need for additional financing to fund capital expenditure
requirements. The Company obtains certain components used in the assembly of
the units, which are placed at radio and television stations and production
studios from a few single or limited source suppliers, and obtains its primary
long distance telephone access through an exclusive contract with a telephone
service provider that expires in November 2002. Any material interruption in
these services could have a material adverse effect on the Company's business.
Although the Company believes that alternate vendors can be obtained, the
transition to alternative vendors could have a material adverse impact on the
Company's costs and shipping schedules.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

CONSOLIDATION

     The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany balances and transactions
have been eliminated in consolidation.

CASH AND CASH EQUIVALENTS

     Cash and cash equivalents consist of liquid investments with original
maturities of three months or less. The Company maintains substantially all of
its cash and cash equivalents within a few major financial institutions in the
United States. As of December 31, 2001 and 2000, cash equivalents consisted
primarily of investments in U.S. money market funds.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

     The Company maintains an allowance for doubtful accounts related to trade
accounts receivable. The allowance is an estimate prepared by management based
on identification of the collectibility of specific accounts and the overall
condition of the receivable portfolio. The Company specifically analyzes trade
receivables, historical bad debts, customer credits, customer concentrations,
customer credit-worthiness, current economic trends and changes in customer
payment terms when evaluating the adequacy of the allowance for doubtful
accounts.

INVENTORIES

     Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market. The Company's inventories include parts and
components that are specialized in nature or subject to rapid technological
obsolescence. While the Company has programs to minimize the required
inventories on hand and considers technological obsolescence when estimating
allowances required to reduce recorded amounts to market values, such estimates
could change in the future.

                                      F-7

<PAGE>

              DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              (in thousands, except share and per share data)

PROPERTY AND EQUIPMENT

     Property and equipment are stated at cost. Depreciation is computed over
the estimated useful lives of assets using the straight-line method. Equipment
held under capital leases and leasehold improvements are amortized
straight-line over the shorter of the lease term or estimated useful life of
the asset. Estimated useful lives generally range from 2 to 5 years for network
equipment, 3 to 5 years for office equipment and furniture and 3 to 6 years for
leasehold improvements.

     The cost of equipment under capital lease at December 31, 2001 and 2000
was $4,132 and $0, respectively. Related accumulated depreciation at December
31, 2001 and 2000 was $1,827 and $0, respectively.

IMPAIRMENT OF LONG-LIVED ASSETS

     Long-lived assets are reviewed for impairment whenever events or changes
in circumstances indicate that the carrying value of assets may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets. Assets to be
disposed of are reported at the lower of the carrying amount or fair value less
costs to sell.

GOODWILL

     Goodwill, which represents the excess of purchase price over the fair
value of net identifiable assets acquired, is amortized on a straight-line
basis over the expected periods to be benefited, generally 20 years.
Amortization expense for the year ended December 31, 2001 was $9.5 million
(none in 2000 or 1999). The Company assesses the recoverability of this
intangible asset by determining whether the amortization of the goodwill
balance over its remaining life can be recovered through undiscounted future
operating cash flows of the acquired operation. The amount of goodwill
impairment, if any, is measured based on projected discounted future operating
cash flows using a discount rate reflecting the Company's average cost of
funds. The assessment of the recoverability of goodwill will be impacted if
estimated future operating cash flows are not achieved (see Note 20 -- SFAS
142).

INTELLECTUAL PROPERTY RIGHTS

     Acquired intellectual property rights, which include patents, copyrights,
trademarks, know-how and certain other intangible assets, are recorded as
property and equipment at cost and amortized over estimated useful lives
ranging from five to seven years using the straight-line method.

INVESTMENT IN JOINT VENTURE

     The Company's investment in a joint venture was accounted for using the
equity method during 2000 and 1999. Losses in excess of the Company's
investment and its guaranteed minimum contribution were recognized in full
based on the Company's intent to fund excess losses of the joint venture. The
Company acquired the remaining interest in the joint venture during 2001 (see
Note 3).

USE OF ESTIMATES

     The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. On an ongoing basis, the Company
evaluates its estimates, including those related to the allowance for doubtful
accounts, inventories, intangible assets and income taxes. The Company bases
its estimates on historical experience and on other relevant assumptions that
are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about

                                      F-8

<PAGE>

              DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              (in thousands, except share and per share data)

the carrying values of assets and liabilities that are not readily apparent
from other sources. Actual results could differ from those estimates.

REVENUE RECOGNITION

     Revenues for audio and video content distribution services that are
digitally transmitted are recognized for each transaction on the date audio,
video or related information is successfully transmitted from the Company's
operating facilities to the destination ordered. Revenues for distribution
services of analog audio or videotapes are recognized as the tapes are shipped.

     The Company recognizes revenue from product sales upon shipment or
satisfactory installation, if required by contract. Service revenue is
recognized when services are rendered. Revenue from arrangements for the sale
of products that include software components that are more than incidental to
the functionality of the related product is accounted for under AICPA Statement
of Position 97-2, Software Revenue Recognition. If vendor-specific objective
evidence of the fair values of each of the elements of the arrangement does not
exist, revenue from product sales is initially deferred and recognized on a
straight- line basis over the life of the arrangement.

RESEARCH AND DEVELOPMENT AND SOFTWARE DEVELOPMENT COSTS

     Research and development and other costs incurred to establish the
technological feasibility of a software product to be sold are expensed as
incurred. Costs of producing product masters incurred subsequent to
establishing technological feasibility are capitalized. Capitalized software
development costs are amortized on a product-by-product basis over the
estimated economic life of the product (generally 4-5 years). Amortization is
computed by using either the ratio that current gross revenues for a product
bear to the total of current and anticipated gross revenues for that product or
the straight-line method, whichever results in a greater annual amortization.

INCOME TAXES

     Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between financial statement carrying
amounts of existing assets and liabilities and their respective tax bases and
operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.

FOREIGN CURRENCIES

     The Company provides services to certain entities located outside of the
United States of America. A loss on foreign currency transactions of $28,000
was recognized for the year ended December 31, 2001 (none in 2000 or 1999) and
is included in interest and other (income) expense in the consolidated
statements of operations.

STOCK OPTION PLANS

     The Company applies the intrinsic value-based method of accounting
prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations, in accounting for
its fixed plan stock options. As such, compensation expense would be recorded
on the date of grant only if the current market price of the underlying stock
exceeded the exercise price. Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation," established
accounting and disclosure requirements using a fair value-based method of
accounting for stock-based employee compensation plans. As allowed by SFAS No.
123, the Company has elected to continue to apply the intrinsic value-based
method of accounting described above, and has adopted the disclosure
requirements of SFAS No. 123.

                                      F-9

<PAGE>

              DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              (in thousands, except share and per share data)

FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK

     Financial instruments that potentially subject the Company to a
concentration of credit risk consist primarily of cash and cash equivalents and
accounts receivable. The Company performs ongoing credit evaluations of its
customers, generally does not require collateral from its customers and
maintains a reserve for potential credit losses. The Company believes that a
concentration of credit risk with respect to accounts receivable related to
audio and video content distribution (the primary source of revenues and
related accounts receivable) is limited because its customers are
geographically dispersed and the end users (the customers' clients) are
diversified across industries. The Company's receivables are principally from
advertising agencies, dub and ship houses, and syndicated programmers. The
Company's revenues are not contingent on its customers' sales or collections.
However, the timing of collections from its customers is affected by the
billing cycle in which the customer bills its end-users (the customers'
clients). The Company provides reserves for credit losses.

     The carrying values of accounts receivable and accounts payable
approximate fair value due to their short maturities. The carrying value of
long-term debt approximates fair value due to the variable rate of interest.

3. ACQUISITIONS:

     During January 2001, the Company completed its merger with StarGuide, which
was accounted for under the purchase method of accounting. In this merger, the
holders of StarGuide common stock received approximately 1.7332 shares of the
Company's common stock for each StarGuide share held, and the holders of Company
common stock continued to hold their shares. StarGuide effectively issued
approximately 27,796,000 shares of common stock as a result of the merger.
StarGuide was the acquirer for financial reporting purposes and as a result, the
historical results of operations do not include DGS' results of operations for
the years ended December 31, 2000 and 1999. The total purchase consideration of
$217.2 million included $212.6 million related to the fair value of the
Company's common stock (at $6.50 per share), options and warrants and merger
transaction costs of $4.6 million. The purchase price was allocated to working
capital ($6.0 million), property and equipment ($15.0 million), other assets
($0.4 million), long-term debt ($1.7 million) and identifiable intangible assets
($16.0 million) based on their fair values. The excess of purchase price over
fair value of net assets acquired of $181.5 million was allocated to goodwill
and is being amortized over a 20-year period. The Company finalized the initial
purchase price allocation in the third quarter of 2001, upon receipt of final
independent valuations of tangible and intangible assets acquired. Changes to
the preliminary purchase price allocation did not have a significant impact on
previously recorded depreciation and amortization or the consolidated financial
position of the Company.

     During March 2001, the Company completed its purchase of the 50% interest
in Musicam Express L.L.C. ("Musicam") owned by Westwood One, Inc. and Infinity
Broadcasting Corporation. The transaction was accounted for under the purchase
method of accounting. The total purchase price of $13.7 million included $4.0
million for the issuance of approximately 693,000 shares of common stock plus
the assumption of outstanding bank debt and other liabilities of Musicam of
$9.7 million. The purchase price was allocated to working capital ($2.2
million) and property and equipment ($0.4 million) based on their fair values.
The excess of purchase price over the fair value of net assets acquired of
$11.1 million was allocated to goodwill and is being amortized over a 20-year
period. Prior to the purchase, the Company accounted for its 50% interest in
Musicam under the equity method of accounting and recognized losses in excess
of its investment and its guaranteed minimum contribution based on its intent
to fund these excess losses. Results of operations of Musicam have been
consolidated beginning January 1, 2001. Pre-acquisition losses of $96,000
related to the 50% acquired interest have been eliminated in determining net
loss and are included in interest expense and other in the consolidated
statement of operations (see Note 7).

     The table below presents the Company's total revenues and net loss, as
reported and on an unaudited pro forma basis for the years ended December 31,
2001 and 2000, respectively, as if the StarGuide and Musicam acquisitions had
occurred at the beginning of each period presented, unless already included in
the historical results. The unaudited pro forma results are presented for
informational purposes only and are not indicative of the operating results that
would have occurred had the transactions actually occurred on the indicated
dates, nor are they necessarily indicative of future operating results.

                                      F-10

<PAGE>

              DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              (in thousands, except share and per share data)

                                                Year ended December 31,
                                                  2001       2000
                                                  ----       ----
Total revenues :
   As reported                                  $ 70,700   $ 14,419
   Pro forma                                    $ 70,700   $ 69,130

Net loss :
   As reported                                   ($9,029)  ($27,866)
   Pro forma                                     ($9,125)  ($35,893)

Basic and diluted net loss per share:
   As reported                                    ($0.13)    ($0.68)
   Pro forma                                      ($0.13)    ($0.88)

4. INVENTORIES:

   Inventories as of December 31, 2001 and 2000 are summarized as follows :

                                                  2001       2000
                                                  ----       ----
Raw materials                                  $   679     $   582
Work-in-process                                    482         202
Finished goods                                     902       1,325
                                               --------    -------
Total inventories                              $ 2,063     $ 2,109
                                               ========    =======

5. PROPERTY AND EQUIPMENT:

   Property and equipment as of December 31, 2001 and 2000 are summarized as
   follows :

                                                  2001      2000
                                                  ----      ----
Network equipment                                $ 18,672  $  2,352
Office furniture and equipment                      5,601     1,382
Leasehold improvements                                636        14
                                                 --------  --------
                                                   24,909     3,748
Less accumulated depreciation and amortization    (7,089)   (2,878)
                                                 --------  --------
                                                 $ 17,820  $    870
                                                 ========  ========

6. INTANGIBLE AND OTHER ASSETS:

   Other assets as of December 31, 2001 and 2000 are summarized as follows :

                                                  2001       2000
                                                  ----       ----
Brand name                                      $  8,804          -
Employee workforce                                 4,174          -
Customer base                                      3,044          -
Deferred merger costs                                  -      1,092
Other assets                                       1,736        266
                                                --------   --------
                                                  17,758      1,358
Less: accumulated amortization                    (2,846)    (   -)
                                                --------   --------
                                                $ 14,912   $  1,358
                                                ========   ========

                                      F-11

<PAGE>

              DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
              (in thousands, except share and per share data)

7. INVESTMENT IN JOINT VENTURE

     During 2000 and 1999, the Company owned a 50% interest in Musicam, which
serves the radio industry by enabling the transmission, exchange, storage and
retrieval of programming, commercials, music releases, affidavits of
performance and other information over high-speed digital telecommunications
circuits on an on-demand basis.  The Company recognized losses in excess of its
investment and its guaranteed minimum contribution based on its intent to fund
these excess losses.  In addition, the Company made noninterest-bearing
advances to Musicam to fund operations.  The remaining 50% interest in Musicam
was acquired in 2001. (See Note 3.)

     Included in revenues in the consolidated statements of operations for 2000
and 1999 is $104 and $122, respectively, of product sales to Musicam.  The
Company initially deferred 50% of the gross profit related to these sales. The
amounts deferred are recognized as equity in earnings (loss) of the joint
venture on a straight-line basis over the period that Musicam depreciates the
related equipment sold by the Company. Included in the excess of losses over
investment in and amounts due from joint venture are amounts due from Musicam
to the Company of $4,442 at December 31, 2000, related to these sales and
advances.

Summarized financial information for Musicam as of December 31, 2000 and for
the years ended December 31, 2000 and 1999 is as follows :

                                           2000      1999
                                           ----      ----
Results of operations:
Sales                                   $  1,289    $ 1,609
Gross profit                                 297        118
Net loss                                  (2,542)    (7,308)

Financial position:
Current assets                          $    547
Long-term assets                             481
                                        --------
Total assets                            $  1,028
                                        ========

Current liabilities                     $ 15,054
Long-term liabilities                          -
Members' deficit                         (14,026)
                                        --------
Total liabilities and members'
deficit                                 $  1,028
                                        ========

8. ACCRUED LIABILITIES:

   Accrued liabilities consist of the following :

                                           2001     2000
                                        --------  --------
Telecommunications costs                $   575   $   211
Employee compensation                       856     1,450
Merger liabilities                        1,765         -
Other                                     1,313     1,397
                                          -----    ------
                                        $ 4,509   $ 3,058
                                        =======   =======

                                      F-12

<PAGE>

                DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (in thousands, except share and per share data)

9.   DEFERRED REVENUE, NET:

     During 1999, the Company entered into contracts with two major radio
broadcasting companies to produce and supply the Company's receivers, hubs and
other items. The terms of the contracts are five and seven years and cover the
related equipment and software, future software enhancements, technical
support, development work and training. As the equipment to be sold under the
contracts includes software components that are more than incidental to the
functionality of the equipment, the entire arrangement has been accounted for
under AICPA Statement of Position 97-2, "Software Revenue Recognition". Cash
received related to these contracts in advance of shipping product is recorded
as customer deposits and reclassified to deferred revenue when the product is
shipped, with revenue and cost of revenue being recognized on a straight-line
basis over the respective contract terms.

     Revenues and cost of revenues under these two contracts were $5,025 and
$1,783, respectively, during 2001 and $3,462 and $1,177, respectively, during
2000 and $242 and $84, respectively, in 1999. Accounts receivable related to
these contracts were $0 and $1,294 at December 31, 2001 and 2000, respectively.

     The components of deferred revenue at December 31, 2001 and 2000 are as
follows:

                                2001       2000
                           ---------   ---------
Deferred revenue          $  18,012   $  21,707
Deferred cost of revenue     (6,301)     (7,424)
Customer deposits                32       1,053
                           ---------   ---------
                             11,743      15,336
   Less current portion      (3,315)     (3,260)
                           ---------   ---------
                          $   8,428   $  12,076
                           =========   =========

10.  LONG-TERM DEBT:

     Long-term debt as of December 31, 2001 is summarized as follows:

Term loan                    $  10,500
Revolving line of credit         4,000
Capital lease obligations        2,290
                            -------------
                                16,790
Less current portion            (7,294)
                            -------------
                             $   9,496
                            =============

     During June 2001, the Company signed a new long-term credit agreement with
a bank that includes a term loan with an original principal amount of $12.5
million and a revolving credit facility with a borrowing base subject to the
Company's eligible accounts receivable balance. The proceeds from the term loan
were used in part to refinance outstanding debt of $9.8 million that was
assumed as a result of the acquisition of Musicam during March 2001.
Approximately $4.0 million was outstanding under the revolving credit facility
at December 31, 2001 and an additional $4.5 million was available for
borrowing. The Company pays interest on borrowings at a variable rate. At
December 31, 2001, the weighted average interest rate on outstanding borrowings
was 5.9%. The credit facility requires the Company to pay a quarterly facility
fee of 0.50% of the average unused portion of the revolving line of credit and
a commission fee on outstanding letters of credit. At December 31, 2001, the
Company has $0.3 million outstanding in letters of credit.

                                     F-13

<PAGE>

                DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (in thousands, except share and per share data)

     Under the long-term credit agreement, as amended on November 9, 2001, the
Company is required to maintain various financial covenants, including minimum
levels of earnings before interest, taxes, depreciation and amortization, fixed
charge coverage ratios and current ratios on a quarterly basis. In addition,
the Company's capital expenditures and capital lease borrowings are limited on
an annual basis and the Company is required to meet an annual leverage ratio.
At December 31, 2001, the Company was in compliance with these covenants.

     At December 31, 2001, the long-term debt outstanding under this facility
matures as follows: $5.5 million in 2002, $5.0 million in 2003 and $4.0 million
in 2004. See Note 15 for discussion of lease obligations.

11.  INCOME TAXES:

     Components of deferred tax assets at December 31, 2001 and 2000 are as
follows:

                                             2001       2000
                                         ---------    ---------
Net operating loss carryforwards         $  25,703    $   8,379
Noncash stock award charges                  7,532        7,839
Other temporary differences                  4,765          544
Research and development credits             1,174          406
                                         ---------    ---------
Total gross deferred tax asset              39,174       17,168
Less valuation allowance                   (39,174)     (17,168)
                                         ---------    ---------
Net deferred tax assets                  $       -    $       -
                                         =========    =========

     The net operating losses (NOL) and research and development credit
carryforwards of approximately $76.0 million and $1.2 million, respectively,
will expire on various dates ranging from 2007 to 2020. Utilization of
approximately $31.0 million of these carryforwards will be limited on an annual
basis as a result of the merger, pursuant to Section 382 of the Internal Revenue
Code.

     In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Based upon the
level of historical taxable income and projections for future taxable income
over the periods that the deferred tax assets are deductible, management
believes it is more likely than not that the Company will not realize the
benefits of those deductible differences. Accordingly, a full valuation
allowance has been recorded for the deferred tax assets.

12.  EMPLOYEE BENEFIT PLAN:

     The Company has a 401(k) retirement plan for full-time U.S. based
employees. Employees who are at least 21 years of age and have completed at
least six months of service are eligible to participate in the plan. Employees
may contribute up to 20% of gross pay with a maximum dollar limit for 2001 of
$10,500. The employer contribution is made at the end of the plan year in an
amount set by corporate resolution, based on participants' compensation. The
Company made no contributions to the plan in 2001, 2000 or 1999.

13. STOCKHOLDERS' EQUITY (DEFICIT):

(A) CAPITAL STOCK

     In December 1999, the Company issued 724,000 common shares as a result of
the conversion of a note payable.

     In March 2000, the Company sold 2,109,738 shares of common stock,
resulting in net proceeds of $12.1 million. A portion of these proceeds was
used to repay the Company's $5.0 million convertible note payable. In addition,
the Company paid the holder of the note $0.7 million in exchange for 324,164
shares previously issued to the holder in lieu of interest.

                                     F-14

<PAGE>

                DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (in thousands, except share and per share data)

(B) STOCK OPTIONS

     In March 2000, the Company issued an award of stock purchase rights to a
third party for 346,640 shares at $1.44 per share, resulting in a noncash
charge of $1,500. The stock purchase rights expired in March 2001. In addition,
$1,255 of noncash stock compensation expense was recorded in the fourth quarter
of 2000 related to the issuance of stock options to employees with exercise
prices less than the fair value of the stock on the date of grant.

(C) WARRANTS

     The Company has issued warrants in connection with certain financing and
leasing transactions and Common stock offerings. In February 2000, the Company
issued warrants to its Chairman to purchase up to 3,899,700 shares of common
stock at $1.44 per share, resulting in a noncash compensation charge of
$16,875. The warrant expires in February 2005. All of the outstanding warrants
are convertible into common stock. The warrants outstanding at December 31,
2001 expire on various dates from 2003 through 2008. A summary of outstanding
warrants at December 31, 2001, 2000 and 1999 and changes during the years then
ended follows:

<TABLE>
<CAPTION>
                                             2001                   2000                   1999
                                   -----------------------  ---------------------   --------------------
                                                 Wtd. Avg.              Wtd. Avg.              Wtd. Avg.
                                                 Exercise               Exercise               Exercise
                                    Warrants       Price     Warrants     Price    Warrants     Price
                                   ----------    ---------  ----------  ---------  ---------   ---------
<S>                                 <C>           <C>        <C>         <C>         <C>       <C>
Outstanding at beginning of the
year                                4,766,300     $  2.62      866,600   $   2.88    866,600   $   2.88
Issued as a result of merger        3,891,070        3.57            -          -          -          -
Granted                                     -           -    3,899,700       1.44          -          -
Canceled                             (112,500)       7.20            -          -          -          -
Exercised                                   -           -            -          -          -          -
                                   ----------    ---------  ----------  ---------  ---------   ---------
Outstanding at end of the year      8,544,870     $  3.04    4,766,300   $   2.62    866,600   $   2.88
                                   ==========    =========  ==========  =========  =========   =========
</TABLE>

14.  STOCK PLANS:

     The Company has three Stock Option Plans:

1992 STOCK OPTION PLAN

     Under the Company's 1992 Stock Option Plan, (the "1992 Plan"), the Company
may issue up to 14,950,000 shares of common stock to employees, officers,
directors and consultants. The exercise price and terms of the options granted
are determined by the Board of Directors, provided that such price cannot be
less than the fair value of the common stock on the date of grant for incentive
stock options or, in the case of non-statutory options, less than 85 percent of
the fair value of the common stock on the date of grant. The options generally
vest over four years. The 1992 Plan provides that, in the event of a change in
control of the Company, executive officers of the Company will receive
accelerated vesting for a portion of their unvested option shares. The term of
the options granted is seven years. No options have been granted at less than
fair value under this plan.

1996 SUPPLEMENTAL OPTION PLAN

     Under the Company's 1996 Supplemental Option Plan, the Company may issue
up to 750,000 shares of Common Stock to employees, officers, directors and
consultants. The exercise price and terms of the options granted are determined
by the Board of Directors. The options generally vest over four years. The term
of the options granted is seven years.

                                     F-15

<PAGE>

                DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (in thousands, except share and per share data)

1995 DIRECTOR OPTION PLAN

     Under the Company's 1995 Director Option Plan (the "Director Plan"), the
Company may issue up to 800,000 shares of common stock to non-employee
directors. The Director Plan provides that each future non-employee director of
the Company will be automatically granted an option to purchase 10,000 shares
of common stock (the "First Option") on the date on which the optionee first
becomes a non-employee director of the Company and an additional option to
purchase 2,500 shares of common stock (the "Subsequent Option") on each
anniversary date thereafter. The exercise price per share of all options
granted under the Director Plan shall be equal to the fair market value of a
share of the Company's common stock on the date of grant. Shares subject to the
First Option vest over 36 months, and the Subsequent Option shares vest over 12
months beginning with the month following the second anniversary of its date of
grant. The term of the options granted is ten years.

ACCOUNTING FOR STOCK OPTION COMPENSATION EXPENSE

     Had compensation cost for the Company's stock option plans been determined
based on the fair value at the date of grant of the stock options, the
Company's net loss and net loss per share would have been reduced to the pro
forma amounts indicated below:

<TABLE>
<CAPTION>
                                                             2001          2000         1999
                                                             ----          ----         ----
<S>                                      <C>             <C>           <C>           <C>
Net loss                                 As Reported     $   (9,029)   $  (27,866)   $  (9,000)
                                         Pro Forma       $  (12,169)   $  (28,757)   $  (9,254)

Basic and diluted net loss per share     As Reported     $    (0.13)   $    (0.68)   $   (0.23)
                                         Pro Forma       $    (0.17)   $    (0.70)   $   (0.23)
</TABLE>

     The fair value of each option grant is estimated on the date of grant
using the multiple option approach of the Black-Scholes option pricing model
with the following assumptions used for grants in 2001, 2000 and 1999,
respectively; risk-free interest rates of 5.1%, 6.4% and 6.4%; a dividend yield
of 0%; expected life of five years; and volatility factors of the expected
market price of the Company's common stock of 136%, 113% and 112%.

     A summary of the Company's fixed plan stock options at December 31, 2001,
2000 and 1999 and changes during the years then ended is presented below:

<TABLE>
<CAPTION>
                                                          2001                    2000                    1999
                                               ------------------------  --------------------     --------------------
                                                              Wtd. Avg.              Wtd. Avg.               Wtd. Avg.
                                                              Exercise               Exercise                Exercise
                                                  Shares       Price     Shares        Price       Shares      Price
                                               ----------    ---------  ---------    ---------    ---------  ---------
<S>                                            <C>           <C>        <C>           <C>         <C>         <C>
Outstanding at beginning of the year            5,356,888    $   1.75   5,254,109         1.68    2,709,425   $   1.19
Issued as a result of the merger                3,427,608        4.78           -            -            -          -
Granted                                         1,811,500        3.22     329,308         2.39    2,610,459       2.16
Exercised                                        (609,810)       1.26     (24,702)        1.21            -          -
Canceled                                       (1,930,358)       3.93    (201,827)        1.17      (65,775)      1.17
                                               ----------    ---------  ---------    ---------    ---------  ---------
Outstanding at end of the year                  8,055,828    $   2.92   5,356,888     $   1.75    5,254,109   $   1.68
                                               ==========    =========  =========    =========    =========  =========
Exercisable at end of the year                  6,090,862    $   2.69   3,882,801     $   1.60    2,395,071   $   1.17
Weighted average fair  value  of
options granted                                              $   2.31                 $   3.31                $   0.59
</TABLE>

                                     F-16

<PAGE>

                DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (in thousands, except share and per share data)

     The following table summarizes information about stock options outstanding
at December 31, 2001:

<TABLE>
<CAPTION>
                               Options Outstanding                                           Options Exercisable
-----------------------------------------------------------------------------------    -------------------------------
                                                Weighted-Average      Weighted-                            Weighted-
                                     Number        Remaining            Average          Number             Average
Range of Exercise Prices          Outstanding   Contractual Life     Exercise Price    Exercisable       Exercise Price
------------------------          -----------   -----------------     --------------   ------------      ---------------
<S>                                 <C>                <C>                  <C>           <C>                  <C>
$0.20 - $ 2.65                      4,248,902          6.08 years           $   1.72      4,135,304            $    1.72
$2.75 - $5.00                       2,131,218          5.43 years           $   3.43        650,528            $    3.67
$5.125 - $10.125                    1,675,708          4.68 years           $   5.30      1,305,030            $    5.29
                                  -----------                                          ------------
$0.20 - $10.125                     8,055,828                                             6,090,862
                                  ===========                                          ============
</TABLE>

     As of December 31, 2001, there were 14,719,553 shares available for future
grant under the stock option plans.

15.  COMMITMENTS AND CONTINGENCIES:

(A)  LEASES

     The Company leases its facilities and certain equipment under
non-cancelable capital and operating leases. At December 31, 2001, future
minimum annual payments under capital leases are $1,964 in 2002, $486 in 2003
and $49 in 2004. The present value of obligations under capital lease was
$2,290, of which $1,794 is classified as a current liability. As of December
31, 2001, future minimum annual payments under operating leases are as follows:
2002 -$1,952; 2003 - $1,930; 2004 - $1,527; 2005 - $1,184; 2006 - $746 and
thereafter - $0.

     Rent expense totaled $2,908, $980 and $1,029 in 2001, 2000 and 1999,
respectively.

     As of December 31, 2001, the Company has non-cancelable future minimum
purchase commitments with its primary telephone service provider of $3.6
million for 2002.

(B) LITIGATION

     Westwood One, Inc. and Westwood One Radio Networks, Inc. (collectively,
"Westwood One") produce radio programming that is distributed using
satellite-based data distribution equipment marketed and sold by StarGuide. On
October 12, 2001, Westwood One filed a complaint against StarGuide in the
United States District Court for the District of Columbia alleging that
StarGuide has attempted unlawfully to compel Westwood One to replace existing
StarGuide equipment with later models. The complaint alleges violations of
federal antitrust laws, breach of contract, breach of the duties of good faith
and fair dealing, indemnification and tortuous interference with contracts.
Westwood One has requested an injunction, as well as the award of unspecified
general damages (trebled in accordance with applicable antitrust statutes),
costs and punitive damages. StarGuide has filed a motion to dismiss the
complaint. The court has not entered a decision on StarGuide's motion.

     On March 20, 2002, StarGuide filed a complaint against Westwood One in the
United States District Court for the District of Nevada alleging that Westwood
One has willfully infringed upon various StarGuide patents, copyrights and
trademarks, intentionally interfered with contracts to which StarGuide is a
party, and engaged in various deceptive and unfair trade practices. StarGuide
requests injunctive relief, unspecified damages (including treble damages in
accordance with applicable statute), and punitive and exemplary damages.

                                     F-17

<PAGE>

               DIGITAL GENERATION SYSTEM, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (in thousands, except share and per share data)

     On October 12, 2001, StarGuide filed a complaint against Williams
Communications Group, Inc. in the United States District Court for the District
of Nevada alleging that Williams has infringed on three patents of StarGuide.
StarGuide has requested preliminary and permanent injunctive relief, damages,
trebling of damages and costs and expenses. Williams has denied all material
allegations in the complaint and has asserted that the patents that are the
subject of the complaint are invalid and not infringed by Williams. On February
8, 2002, a subsidiary of Williams, Williams Communications LLC, filed suit
against StarGuide in the Northern District of Oklahoma alleging that the same
three StarGuide patents are invalid and not infringed. StarGuide has moved to
add this subsidiary as a party to the Nevada litigation and has moved to
dismiss or stay the Oklahoma litigation.

     In addition to the matters discussed above, the Company is subject, from
time to time, to various legal proceedings and claims, either asserted or
unasserted, which arise in the ordinary course of business. While the outcome
of these claims cannot be predicted with certainty, management does not believe
that the outcome of any of these legal matters asserted to date will have a
material effect on the consolidated financial position, liquidity or results of
operations of the Company.

16. NET INCOME (LOSS) PER SHARE:

     Under SFAS No. 128 "Earnings per Share," the Company is required to
compute earnings per share under two different methods (basic and diluted).
Basic earnings per share is calculated by dividing net income (loss)
attributable to common shareholders by the weighted average shares of common
stock outstanding during the period. Diluted earnings per share is calculated
by dividing net income attributable to common shareholders by the weighted
average shares of outstanding common stock and common stock equivalents during
the period. Due to losses for all years presented, inclusion of common stock
equivalents would be anti-dilutive. Therefore, basic and diluted loss per share
for the Company are the same.

     A reconciliation of net loss per basic and diluted share for the three
years ended December 31, 2001 follows:

<TABLE>
<CAPTION>
                                                  2001            2000             1999
                                                  ----            ----             ----
<S>                                           <C>             <C>              <C>
Basic:
   Net loss applicable to common shareholders  $   (9,029)     $  (27,866)      $   (9,000)
   Weighted average shares outstanding             70,443          40,912           39,183
                                              -----------     -----------      -----------
   Net loss per share                          $    (0.13)     $    (0.68)      $    (0.23)
                                              ===========     ===========      ===========

Diluted:
   Net loss applicable to common shareholders  $   (9,029)     $  (27,866)      $   (9,000)
                                              -----------     -----------      -----------

   Weighted average shares outstanding             70,443          40,912           39,183
   Add:  Common stock equivalents                       -               -                -
                                              -----------     -----------      -----------
   Total shares                                    70,443          40,912           39,183
                                              -----------     -----------      -----------
   Net loss per share                          $    (0.13)     $    (0.68)      $    (0.23)
                                              ===========     ===========      ===========
</TABLE>

17. RELATED PARTY TRANSACTIONS:

     Prior to the merger between StarGuide and DG Systems, the companies shared
certain management personnel and had certain common shareholders, thus the two
companies were related parties. During 2000, StarGuide charged approximately
$658 to DG Systems for payroll, insurance and travel costs related to shared
employees and was charged $342 by DG Systems for shared office space, commons
utilities and equipment. At December 31, 2001, all intercompany balances and
transactions for 2001 have been eliminated.

                                      F-18

<PAGE>

               DIGITAL GENERATION SYSTEM, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (in thousands, except share and per share data)

18. UNAUDITED QUARTERLY FINANCIAL INFORMATION

<TABLE>
<CAPTION>
                                                    Quarter Ended
                    ------------------------------------------------------------------------
                      March 31, 2001  June 30, 2001  September 30, 2001  December 31, 2001
                     ---------------  -------------  ------------------  -----------------
<S>                  <C>              <C>              <C>                 <C>
Revenues             $     18,931     $     18,588     $       15,919      $       17,262

Gross profit                8,904            8,964              7,071               8,348

Net loss                   (1,430)          (2,867)            (2,459)             (2,273)

Earnings per share   $      (0.02)    $      (0.04)    $        (0.04)     $        (0.03)
</TABLE>

<TABLE>
<CAPTION>
                                                    Quarter Ended
                    -------------------------------------------------------------------------
                      March 31, 2000  June 30, 2000   September 30, 2000   December 31, 2000
                     --------------   -------------   ------------------   -----------------
<S>                 <C>             <C>              <C>                  <C>
Revenues            $     3,130     $     3,470      $      4,104         $      3,715

Gross profit              1,322             913             1,393                  989

Net loss                (20,028)         (1,857)           (2,403)              (3,578)

Earnings per share  $     (0.50)    $     (0.05)     $      (0.06)        $      (0.09)
</TABLE>

19. SEGMENT INFORMATION:

     The Company operates predominantly in two industry segments: digital and
physical distribution of audio and video content and transmission and
compression technology and consulting. The Company has defined its reportable
segments based on internal financial reporting used for corporate management
and decision-making purposes. The information in the following tables is
derived directly from the segments' internal financial reporting used for
corporate management purposes.

<TABLE>
<CAPTION>
                                                             Year ended December 31, 2001
                                       -----------------------------------------------------------------------
                                           Audio and Video                      Intersegment     Consolidated
                                        Content Distribution   Other (a)      Eliminations (b)       Totals
                                       --------------------- -------------  ------------------ ---------------
<S>                                    <C>                   <C>              <C>                <C>
Revenues                               $       65,228        $       5,472    $          -       $     70,700
Interest income                                   130                    2               -                132
Interest expense                               (1,772)                   -               -             (1,772)
Depreciation and amortization expense         (16,984)                 (81)              -            (17,065)
Net income (loss)                      $       (9,175)       $         146    $          -       $     (9,029)
                                       ==============        =============    ============       ============
Purchases of property and equipment    $        3,191        $          28    $          -       $      3,219
                                       ==============        =============    ============       ============
Total assets                           $      243,864        $       2,819    $    (11,226)      $    235,457
                                       ==============        =============    ============       ============
</TABLE>

                                      F-19

<PAGE>

               DIGITAL GENERATION SYSTEM, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (in thousands, except share and per share data)

<TABLE>
<CAPTION>
                                                             Year ended December 31, 2000
                                       -----------------------------------------------------------------------
                                           Audio and Video                    Intersegment     Consolidated
                                        Content Distribution   Other (a)    Eliminations (b)       Totals
                                       --------------------- ------------- ------------------ ----------------
<S>                                     <C>                   <C>              <C>             <C>
Revenues                                $       6,924         $      7,539     $     (44)      $       14,419
Interest income                                   300                    -              -                 300
Interest expense                                 (11)                 (10)              -                (21)
Depreciation expense                            (763)                 (61)              -               (824)
Equity in losses of joint venture             (1,125)                    -              -             (1,125)
Noncash stock award charges                  (19,630)                    -              -            (19,630)
Net income (loss)                       $    (27,960)         $         71     $       23      $     (27,866)
                                        =============         ============     ==========      ==============
Investment in joint venture             $     (2,586)         $          -     $        -      $      (2,586)
                                        =============         ============     ==========      ==============
Purchases of property and equipment     $         647         $         17     $        -      $          664
                                        =============         ============     ==========      ==============
Total assets                            $      22,165         $      3,123     $ (14,186)      $       11,102
                                        =============         ============     ==========      ==============
</TABLE>

<TABLE>
<CAPTION>
                                                             Year ended December 31, 1999
                                       -----------------------------------------------------------------------
                                          Audio and Video
                                              Content                         Intersegment     Consolidated
                                           Distribution        Other (a)    Eliminations (b)       Totals
                                       --------------------- ------------- ------------------ ----------------
<S>                                     <C>                   <C>              <C>             <C>
Revenues                                $       7,160         $      6,024    $       (116)   $        13,068
Interest income                                    85                  204                -               289
Interest expense                                (531)                 (16)                -             (547)
Depreciation expense                            (749)                (224)                -             (973)
Equity in losses of joint venture             (3,030)                    -                -           (3,030)
Net loss                                $     (8,573)         $      (471)    $          44   $       (9,000)
                                        =============         ============    =============   ===============

Investment in joint venture             $     (5,739)         $          -    $           -   $       (5,739)
                                        =============         ============    =============   ===============
Purchases of property and equipment     $         502         $         45    $           -   $           547
                                        =============         ============    =============   ===============
</TABLE>

     (a)  Other includes operations of Corporate Computer Systems, Inc. (CCS),
          responsible for the Company's digital compression technology and
          consulting.

     (b)  Intersegment eliminations relate to intercompany receivables and
          payables that occur when one operating segment pays costs that are
          related to another operating segment.

20. NEW ACCOUNTING PRONOUNCEMENTS:

     SFAS 141 - In June 2001, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 141, "Business Combinations," which requires that the purchase
method of accounting be used for all business combinations initiated or
completed after June 30, 2001. Statement 141 also establishes the criteria for
the separate recognition of intangible assets acquired in a purchase method
business combination must meet to be recognized and reported apart from
goodwill, noting that any purchase price allocable to an assembled workforce
may not be accounted for separately. The Company adopted this statement in
fiscal 2001. The adoption of this statement had no effect on the Company's 2001
financial statements.

                                      F-20

<PAGE>

               DIGITAL GENERATION SYSTEM, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                (in thousands, except share and per share data)

     SFAS 142 - In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets," which will require that goodwill and certain other
intangible assets having indefinite useful lives no longer be amortized to
earnings, but instead be subject to periodic testing for impairment at least
annually. Intangible assets with determinable useful lives will continue to be
amortized over their respective estimated useful lives and reviewed for
impairment in accordance with SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of". The
Company will adopt SFAS 142 beginning January 1, 2002. Unamortized goodwill was
$183.2 million at December 31, 2001. Amortization expense related to goodwill
was $9.5 million for the twelve months ended December 31, 2001.

     Upon adoption of SFAS No. 142, the Company will be required to reassess the
useful lives and residual values of all intangible assets with determinable
useful lives acquired in purchase business combinations, and make any necessary
amortization period adjustments by the end of the first interim period after
adoption. In addition, to the extent an intangible asset is identified as having
an indefinite useful life, the Company will be required to test the intangible
asset for impairment in accordance with the provisions of SFAS No. 142 within
the first interim period. The impairment loss, which the Company expects to be
significant, will be measured as of the date of adoption and recognized as the
cumulative effect of a change in accounting principle. Because of the extensive
effort needed to adopt SFAS No. 142, it is not practicable to reasonably
estimate the impact of adopting these pronouncements on the Company's financial
statements at the date of this report, including the extent to which
transitional impairment losses will be required to be recognized as the
cumulative effect of a change in accounting principle.

     SFAS 143 - In August 2001, the FASB issued SFAS No. 143, "Accounting for
Asset Retirement Obligations." which requires entities to record the fair value
of a liability for an asset retirement obligation in the period in which it is
incurred. The Company will adopt SFAS No. 143 in fiscal year 2003. The Company
does not expect the provisions of SFAS No. 143 to have any significant impact
on its financial condition or results of operations.

     SFAS 144 - In October 2001, the FASB issued SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets," which replaces SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of." The Company will adopt SFAS No. 144 in fiscal year 2002.
The Company does not expect the provisions of SFAS No. 144 to have any
significant impact on its financial condition or results of operations.

                                      F-21

<PAGE>

                DIGITAL GENERATION SYSTEMS, INC. AND SUBSIDIARIES
                SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                                 (in thousands)

<TABLE>
<CAPTION>
                        Balance at    Additions
                        Beginning of  Charged to                        Balance at
Classification            Period      Operations  Other    Write-offs  End of Period
--------------            ------      ----------  -----    ----------  -------------
<S>                     <C>           <C>         <C>        <C>        <C>
Allowance for Doubtful
Accounts Year Ended:

December 31, 1999       $     142        93                             $        235

December 31, 2000       $     235       531          81                 $        847

December 31, 2001       $     847     1,954       2,907 (a)  (2,825)    $      2,883
</TABLE>

(a)  Represents allowance assumed as a result of the merger between DG Systems
     and StarGuide in January 2001.

                                      S-1