**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

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**FORM 10-K/A**

**AmendmentNo. 2**

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**x**                               ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**ForThe Fiscal Year Ended December 31, 2006**

**OR**

**o**                                  TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**Forthe Transition PeriodFrom                              to                              .**

**COMMISSIONFILE NUMBER: 0-27644**

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**DGFastChannel, Inc.**

(Exact Name of Registrantas Specified in its Charter)

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

 

**750 West John CarpenterFreeway, Suite 700Irving, Texas 75039**

(Address Of PrincipalExecutive Offices, Including Zip Code)

**(972) 581-2000**

(Registrant’s TelephoneNumber, Including Area Code)

Securities registeredpursuant to Section 12(b) of the Act:

| **Title of Each Class**        |   | **Name of each exchange on which registered** |
|--------------------------------|--------|-----------------------------------------------|
| Common Stock, $0.001 par value |   | Nasdaq Global Market                          |

 

Securities registered pursuant to Section 12(g) ofthe Act: **None**

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Indicate by check mark if the Registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes o  No x

Indicate by check mark if the Registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Exchange Act.   Yes o  No x

Indicate by check mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months and (2) hasbeen subject to such filing requirements for the past 90 days.   Yes x  No o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, andwill not be contained, to the best of Registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III ofthis Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the Registrant is alarge accelerated filer, an accelerated filer or a non-accelerated filer. Seedefinition of “accelerated filer” and “large accelerated filer” in Rule 12b-2of the Exchange Act.

Large acceleratedfiler o                Acceleratedfiler o                Non-acceleratedfiler x

Indicate by check mark if the Registrant is a shellcompany (as defined in Rule 12b-2 of the Exchange Act).   Yes o  No x

The aggregate market value of the Common Stock held bynon-affiliates of the registrant, computed by reference to the closing priceand shares outstanding, was approximately $177.6 million as of December 31,2006, and approximately $52.9 million as of June 30, 2006, the lastbusiness day of the registrant’s most recently completed second quarter. Sharesof Common Stock held by each officer and director of the registrant and by eachperson who may be deemed to be an affiliate have been excluded. Thisdetermination of affiliate status is not necessarily a conclusive determinationfor other purposes.

As of March 31, 2007,the registrant had 15,849,796 shares of Common Stock outstanding.

**DOCUMENTSINCORPORATED BY REFERENCE**

**None**

 

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**DG FASTCHANNEL,INC.**

The discussion in thisReport contains forward-looking statements that involve risks anduncertainties. The statements contained in this Report that are not purelyhistorical are forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. Words such as “anticipates,” “believes,”“plans,” “expects,” “future,” “intends,” and similar expressions are used toidentify forward-looking statements. All forward-looking statements included inthis document are based on information available to the Company on the datehereof, and we assume no obligation to update any such forward-lookingstatements, except as required by law. The Company’s actual results coulddiffer materially from those anticipated in these forward-looking statements asa result of certain factors, including, but not limited to, those discussed in “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” and “RiskFactors” as well as those discussed elsewhere in this Report, and the risksdiscussed in the Company’s other filings with the United States Securities andExchange Commission.

**TABLE OF CONTENTS**

| **PART I**  |
|------------------|
| ITEM 1.          |   | BUSINESS |   | 4 |   |
|             |   | General |   | 4 |   |
|             |   | Available  Information |   | 5 |   |
|             |   | Industry  Background |   | 5 |   |
|             |   | Services |   | 6 |   |
|             |   | Markets and  Customers |   | 8 |   |
|             |   | Sales,  Marketing and Customer Service |   | 9 |   |
|             |   | Competition |   | 10 |   |
|             |   | Intellectual  Property and Proprietary Rights |   | 11 |   |
|             |   | Employees |   | 11 |   |
| ITEM 1A.         |   | RISK FACTORS |   | 11 |   |
| ITEM 1B.         |   | UNRESOLVED  STAFF COMMENTS |   | 23 |   |
| ITEM 2.          |   | PROPERTIES |   | 23 |   |
| ITEM 3.          |   | LEGAL  PROCEEDINGS |   | 23 |   |
| ITEM 4.          |   | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS |   | 24 |   |
| **PART II** |
| ITEM 5.          |   | MARKET  FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER  PURCHASES OF EQUITY SECURITIES |   | 25 |   |
| ITEM 6.          |   | SELECTED  FINANCIAL DATA |   | 27 |   |
| ITEM 7.          |   | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |   | 29 |   |
|             |   | Introduction |   | 29 |   |
|             |   | Cautionary  Note Regarding Forward-Looking Statements |   | 30 |   |
|             |   | Overview |   | 30 |   |
|             |   | Results of  Operations |   | 33 |   |
|             |   | Financial  Condition |   | 36 |   |
|             |   | Liquidity  and Capital Resources |   | 37 |   |
|             |   | Critical  Accounting Policies |   | 39 |   |   |
|             |   | New  Accounting Pronouncements |   | 41 |   |   |
|             |   | Contractual  Payment Obligations |   | 42 |   |   |
|             |   | Off-Balance  Sheet Arrangements |   | 42 |   |   |

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| ITEM 7A.          |   | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                      |   | 42 |   |
|-------------------|--------|--------------------------------------------------------------------------------------------------|--------|----|--------|
| ITEM 8.           |   | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                     |   | 43 |   |
| ITEM 9.           |   | CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE            |   | 43 |   |
| ITEM 9A.          |   | CONTROLS  AND PROCEDURES                                                                         |   | 43 |   |
| ITEM 9B.          |   | OTHER  INFORMATION                                                                               |   | 45 |   |
| **PART III** |
| ITEM 10.          |   | DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE  GOVERNANCE                                         |   | 46 |   |
| ITEM 11.          |   | EXECUTIVE  COMPENSATION                                                                          |   | 52 |   |
| ITEM 12.          |   | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS |   | 69 |   |
| ITEM 13.          |   | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE                       |   | 70 |   |
| ITEM 14.          |   | PRINCIPAL  ACCOUNTING FEES AND SERVICES                                                          |   | 71 |   |
| **PART IV**  |
| ITEM 15.          |   | EXHIBITS,  FINANCIAL STATEMENT SCHEDULES                                                         |   | 72 |   |
| SIGNATURES        |   | 73                                                                                               |   |

 

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**DG FASTCHANNEL,INC.**

**PART I**

**ITEM 1.**                BUSINESS

**General**

DG FastChannel, Inc. (the “Company” or “DGF”) isthe leading provider of digital technology services that enable the electronicdelivery of advertisements from advertising agencies to traditional broadcastersand other media outlets. We operate a nationwide digital network out of ourNetwork Operation Center (“NOC”), located in Irving, Texas, which links morethan 5,000 advertisers and advertising agencies with more than 21,000 radio,television, cable, network and print publishing destinations electronicallythroughout the United States and Canada. Through our NOC, we deliver video,audio, image and data content that comprise transactions among advertisers andvarious media outlets, including those in the broadcast industries.

For the year ended December 31, 2006, we provideddelivery services for 18 of the top 25 advertisers, as ranked by Ad Age. Themajority of our revenue is derived from multiple services relating toelectronic delivery of video and audio advertising content. Our primary sourceis the delivery of television and radio advertisements, or spots, which istypically performed digitally but sometimes physically. We offer a digitalalternative to dub and ship delivery of spot advertising. We generally bill ourservices on a per transaction basis.

Our services include online creative research, mediaproduction and duplication, distribution, management of existing advertisementsand broadcast verification. This suite of innovative services addresses theneeds of our customers at multiple stages along the value chain ofadvertisement creation and delivery in a cost-effective manner and helpssimplify the overall process of content delivery.

The Company was organizedin 1991 and is incorporated in Delaware. Over the past five years, the Companyhas completed several strategic transactions including the following:

·  On June 1, 2004, the Company acquired substantiallyall the broadcast distribution assets and certain liabilities from AppliedGraphics Technologies, Inc (“AGT”) for $15.0 million in cash. AGT distributesadvertising content to radio and television stations utilizing conventional andelectronic duplication technologies. The acquisition increased the Company’scustomer base and resulted in operating synergies. AGT has been included in theCompany’s results since the date of acquisition.

·  On August31, 2004, the Company acquired substantially all the assets and certainliabilities of SourceEcreative for $3.8 million in cash. SourceEcreative offers a complete online resource andsearchable database of over 350,000 television commercials, both on asubscription and per-transaction basis. The acquisition expanded the Company’smedia asset management services to advertising agencies. SourceEcreativehas been included in the Company’s results since the date of acquisition.

·  Between March 2005 and July 2005, the Companypurchased (i) a total of approximately 12.6 million shares of Series BConvertible Preferred Stock of Verance Corporation (“Verance”) and (ii) anagreement to license Verance products, for an aggregate purchase price ofapproximately $5.1 million. Verance develops and licenses certain audiowatermarking technologies. The Company has accounted for this long-term investment as an “available for sale”equity security in accordance with SFAS 115.

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InSeptember 2006, the Company determined that its investment in Verance wasimpaired and wrote the value down to zero.

·  On April 15, 2005, the Company acquiredsubstantially all the assets and certain liabilities of Media DVX, Inc. (“MDX”)for $10.0 million (excluding transaction costs) consisting of (i) $1.5 millionin cash, (ii) a $6.5 promissory note, and (iii) 155,039 shares of the Company’scommon stock valued at approximately $2.0 million. MDX distributes advertisingcontent to radio and television stations utilizing conventional and electronicduplication technologies. The acquisition increased the Company’s customer baseand resulted in operating synergies. MDX has been included in the Company’sresults since the date of acquisition.

·  On May 31, 2006, the Company entered into atax-free merger transaction with the shareholders of privately-held FastChannelNetwork, Inc. (“FastChannel”) whereby FastChannel became a wholly-ownedsubsidiary of the Company. The $28.8 million purchase price consisted of (i)approximately 5.2 million shares of the Company’s common stock valued at $27.4million, and (ii) approximately $1.4 million of transaction costs. Similar tothe Company, FastChannel operates a digital distribution network serving theadvertising and broadcast industries. The merger with FastChannel has expandedthe Company’s “footprint” (i.e., electronic network), increased our customerbase, and resulted in operating synergies. FastChannel has been included in theCompany’s results since the date of acquisition.

·  InDecember 2006, the Company purchased a total of approximately 1.44 millionshares, or 14.8%, of the outstanding common stock of publicly held Point.360for approximately $4.8 million in cash. The shares were purchased in (i) aprivate transaction, and (ii) the open market. Point.360 distributesadvertising content to radio and television stations utilizing conventional andelectronic duplication technologies. The Company accounts for this long-term investment as an “available for sale”equity security in accordance with SFAS 115.

**AvailableInformation**

We file annual reports, quarterly reports, proxystatements and other documents with the Securities and Exchange Commission (“SEC”)under the Securities Exchange Act of 1934 (the “Exchange Act”). The public mayread and copy any materials that we file with the SEC at the SEC’s PublicReference Room at 100 F Street N.E., Washington, D.C. 20549. The publicmay obtain information on the operation of the Public Reference Room bycalling the SEC at 1-800-SEC-0330. Also, the SEC maintains awebsite that contains reports, proxy and information statements, and otherinformation regarding issuers, including us, that file electronically with theSEC. The public can obtain any documents that we file with the SEC athttp://www.sec.gov.

We also make availablefree of charge through our website (www.dgfastchannel.com) our Annual Report onForm 10-K, Quarterly Reports on Form 10-Q, CurrentReports on Form 8-K, and, if applicable, amendments to those reportsfiled or furnished pursuant to the Exchange Act as soon as reasonablypracticable after we electronically file such material with, or furnish it to,the SEC.

**Industry Background**

We believe there areapproximately 11,000 commercial radio and 4,500 television, cable and networkbroadcast stations in the United States. These stations primarily generaterevenue by selling airtime to advertisers. In addition, there are approximately8,100 daily and weekly newspapers in circulation in the United States.Newspapers also primarily generate revenues from advertising. Advertising ismost frequently produced under the direction of advertising agencies for largenational or regional advertisers or by station personnel for local advertisers.Television advertising is characterized as network or spot, depending on how itis purchased and distributed. Network advertising typically is delivered tostations as 

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part ofa network feed (bundled with network programming), while spot advertising isdelivered to stations independently of other programming content. 

Advertising agencies andadvertisers use third-party service companies to ensure their media assets aredelivered to multiple broadcast destinations on a time-sensitive basis. Certainadvertising campaigns can be extremely complex and include dozens of commercialtelevision and radio spots which may require delivery to hundreds of discretemedia locations across the United States. Additionally, advertising agenciesand advertisers require certain quality control standards, web-based ordermanagement capabilities and certain tagging/editing functions by the thirdparty service provider. Finally, these service providers must offer immediateconfirmation of the delivery of the commercial content to the media outlet anddetailed billing services.

Spot advertising airtimeis typically purchased by advertising agencies or media buying firms on behalfof advertisers. Advertisers, their agencies and media buying firms selectindividual stations or groups of stations to support marketing objectives,which usually are based on the stations’ geographic and demographiccharacteristics. The actual commercials or spots are typically produced at adigital production studio and recorded on digital tape. Variations of the spotintended for specific demographic groups are also produced at this time. Thespots undergo a review of quality and content before being cleared fordistribution to broadcast stations, and can be delivered physically, via thetraditional dub and ship method, or electronically.

While many radio andtelevision broadcasters now embrace digital technology for much of theirproduction processes and in-station media management, current methods for thedistribution of audio and video advertising content still include manualduplication and physical delivery of analog tapes. Many companies, commonlyknown as dub and ship houses, duplicate audio and video tapes, assemble themaccording to agency specified bills of material and package them for airexpress delivery. Advertisers and their agencies can choose to have advertisingcontent delivered electronically via the Internet and satellite transmissions.Electronic transmission has several advantages over dub and ship delivery,including: cost, transmission time, labor, materials, quality of content andcontrol of distribution. The amount of advertising content transmittedelectronically has steadily increased, and we estimate that approximately 95%of radio spots and approximately 50% of video spots are now electronicallydistributed. We believe that these figures will continue to grow as advertiserscontinue to take advantage of the benefits of electronic distribution.

Radio and television continueto attract significant portions of the advertising dollars spent by advertisersand advertising agencies and represent powerful mediums for cost-effectivelyreaching large, targeted audiences and offer the accountability and returnsthat advertisers increasingly demand.

We believe there areseveral key drivers that are increasing the growth of digital delivery ofadvertising:

**Services**

Our suite of innovative services seek to address theneeds of advertisers at various stages along the value chain of advertisementcreation and delivery. These include idea generation, production andduplication, content distribution, media asset management and broadcastverification products. By offering services that encompass multiple stages ofcontent creation and delivery, we are able to simplify the workflow process foradvertisers. We believe our solutions offer advertisers tools essential to thecreation and strategic distribution of advertisements in a cost effectivemanner. Our services address our clients’ needs for efficient, accurate andreliable solutions for the development and delivery of advertising contentacross a wide spectrum of media, and include the following offerings:

*OnlineCreative Research.**  *Weown and maintain an online database of content and credits of U.S. televisioncommercials for the advertising and TV commercial production industry. Webelieve that this is 

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the most comprehensiveonline television commercial information service available to advertisingagencies and production companies. Our SourceEcreative (formerly known as“Source TV”) database includes information relating to commercials, individualsand companies. Customers can use our robust search engine specifically designedfor the advertising industry. SourceEcreative allows users to find out whichdirector, post house, composer or other production resource worked on specificspots, enabling advertising agencies to identify creative and productionresources, and to accelerate their creative development process. Informationcan be provided via fax, phone, e-mail or over the Internet. SourceEcreativeservices most of the major U.S. advertising agencies and production companies,as well as television networks, programs and industry associations.

*MediaProduction and Duplication.**  *Our production and duplication capabilities allow usto provide customers with ancillary services, which are offered in addition toour primary distribution service. Our services include storage of clientmasters or storyboards, editing of materials, tagging content, dubbing, videoduplication and copying of media onto various physical multimedia formats, suchas CD, DVD or tape. We believe these add-on service offerings allow us tobetter service our customers by reducing the number of vendors necessary tocreate and distribute advertisements.

*Distribution.**  *We provide primarily electronicand, to a lesser extent, physical distribution of broadcast advertising contentto broadcast stations throughout the United States and Canada. Through our NOC,we operate a digital network, currently connecting more than 5,000 advertisersand advertising agencies with more than 4,500 television, cable and networkbroadcast destinations, over 10,000 radio stations, and over 6,500 printpublishing destinations across the United States and Canada. Our networkenables the rapid, cost-effective and reliable electronic transmission of audioand video spots and other content and provides a high level of quality,accountability and flexibility to both advertisers and broadcasters. Ourtechnologically advanced digital network delivers near master quality audio orvideo to broadcasters, which is equal or superior to the content currentlydelivered on dub and ship analog tapes. Our network routes transmissions tostations through an automated online transaction and delivery system, enablingdelivery in as little as one hour after an order is received.

·       *Video.  *We receive video contentelectronically at our NOC primarily via our proprietary FTP software that isdeployed in video production studios. Video content also can be receivedthrough our various regional customer service locations and collection points throughoutthe United States. When video spots are received, our employees quality assurethe spots and release the video to the NOC, where it is combined with thecustomer’s electronic transaction to transmit the various combinations of videoto designated television stations. Video transmissions are sent via a high-speedfiber link to the digital satellite uplink facility over which they are thendelivered directly to DG FastChannel Spot Boxes that we have placedin television stations and cable interconnects.

·       *Audio.  *Audio content can be uploadedvia the Internet electronically. In addition, audio can be received using ourUpload Internet audio collection system. When audio spots are received, ouremployees quality assure the audio content and then initiate the electronictransaction to transmit various combinations of audio to designated radiostations. Audio transmissions are delivered over broadband connections toservers that we place in each radio station on the network, where the contentwill be available to the station on demand. Alternatively, these transmissionscan be downloaded from our website.

·       *Print.  *Print content can be uploadedvia the Internet electronically into our print media distribution system. Printtransmissions are delivered over the Internet to various newspaper locationsvia proprietary web-based software applications. The print transmissions aremodified to the specific format as required by the individual newspapers.

Video and audio transmissions are received atdesignated television and radio stations on DG FastChannel-owned servers,called DG FastChannel Spot Boxes, Receive Playback Terminals, Client 

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Workstations and DigitalMedia Managers. The servers enable stations to receive and play back materialdelivered through our digital distribution network. The units are owned by usand typically installed in the master control or production area of thestations. Upon receipt, station personnel generally review the content andtransfer the spot to a standardized internal station and format for subsequentbroadcast. Through our NOC, we monitor the spots stored in each of our serversand ensure that space is always available for new transmissions. We can quicklytransmit video or audio at the request of a station or in response to acustomer who wishes to alter an existing order, allowing us to effectivelyadapt to customer needs and to distribute to hundreds of locations in as littleas one hour, which would be impossible for traditional physical dub and shiphouses.

We offer various levels of digital video and audiodistribution services from our NOC to advertisers distributing content to broadcasters.These include the following: DGFC Priority, a service which guarantees arrivalof the first spot on an order within one hour; DGFC Express, which guaranteesarrival within four hours; DGFC Standard, which guarantees arrival by noon thenext day; and DGFC Economy, which guarantees arrival by noon on the second day.We also offer a set of premium services enabling advertisers to distributeaudio or video spots provided after normal business hours.

In addition to our standard services, we have developedunique products to service markets with particular time-sensitive deliveryneeds, including the delivery of political advertising during electioncampaigns, providing a rapid response mechanism for candidates and issuegroups.

*MediaAsset Management.**  *Ourdigital media asset management solution simplifies spot management, access,storage and collaboration for our customers. Our media asset managementsolution is integrated with our distribution system, enabling automaticarchiving of trafficked spots, online search, send-for-review andreview-and-approval capabilities, automated digital storyboarding, streamingpreviews, a comprehensive order and market data history for each spot, scriptattachment capability and online search, sort, retrieve and hardcopyfulfillment.

*BroadcastBusiness Intelligence Products.**  *Our broadcast verificationsolution, through various alternative detection networks, allows our customersto monitor and confirm accurate airplay of their broadcast commercials. Thisservice offering relies on remotely controlled tuners and servers operated byothers in secure locations to monitor the stations in each market.

During the fourth quarterof fiscal 2006, the Company’s Board of Directors authorized management to beginmarketing for sale certain assets of two subsidiaries: StarGuide Digital Networks, Inc.and Corporate Computer Systems, Inc. These subsidiaries made up ourpreviously reported Product Sales Segment. The Company determined that thesebusinesses were no longer consistent with our strategic business goals. Theseassets include inventories, property and equipment and certain intangibleassets. The Company completed the sale of the assets of Corporate ComputerSystems for a price of $425,000 in March 2007 and has recorded a loss onsale of $1,163,000 related to this subsidiary. The sale of StarGuide isexpected to result in a gain which will be recognized if the sale is completed.

**Markets andCustomers**

A large portion of DGF’srevenue is derived from the delivery of spot radio and television advertisingto broadcast stations, cable systems and networks. DGF derives revenue frombrand advertisers and advertising agencies, and from its marketing partners,which are typically dub and ship houses that have signed agreements with DGF toconsolidate and forward the deliveries of their advertising agency customers tobroadcast stations, cable systems and networks via DGF’s electronic deliveryservice in exchange for price discounts from DGF. The advertisementsdistributed by DGF are representative of the five leading national advertisingcategories of automotive, retail, business and consumer services, food andrelated products and entertainment. The volume of advertising from thesesegments is subject to seasonal and cyclical variations.

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**Sales, Marketingand Customer Service**

*BrandStrategy.**  *DGF’sbrand strategy is to position itself as the standard transaction method for theradio, television, cable, and network broadcast industries. DGF focuses itsmarketing messages and programs at multiple segments within the advertising andbroadcast industries. Each of the segments interacts with DGF for a differentreason. Agencies purchase services from DGF on behalf of their advertisers.Production studios facilitate the transmission of audio and video to DGF’s NOC.Production studios and dub and ship houses resell delivery services toagencies. Stations join the network to receive the content from theircustomers: the agencies and advertisers.

*Internet/E-CommerceStrategy.**  *TheSpotCentral online order entry and management system adds functionality to ouronline management tool that opens up our network so customers can see thestatus of their media asset as it moves from endpoint to endpoint—from the timeit leaves their possession until it arrives at the media outlet. With newsystem architecture and user-friendly applications, SpotCentral providesadvertisers and agencies with an intuitive web portal to visualize and managethe distribution of their valuable advertising content. Users can upload spots,choose or create new destination groups, attach traffic instructions, viewinvoices, distribute media electronically to thousands of destinations acrossDGF’s massive digital network and confirm delivery at the station level throughDGF’s powerful new media server, the DG Spot Box. Users have immediate access tokey statistics, order status and other data, while workflow automation toolshelp user groups save routing instructions and destination paths for repeatorders. Users can search billing history and view invoices from anyweb-connected location. Customized search features let users research orderhistory by brand, service level or transmission date. In addition, spots can bepreviewed at any time of the day or point in the order process. This designintroduces new levels of simplicity, transparency, accountability and customersatisfaction to the spot distribution process. SpotCentral was made availableto the entire advertising marketplace in February 2005.

*Sales.**  *DGF employs a direct sales forcethat calls on various departments at advertising agencies to communicate thecapabilities and comparative advantages of DGF’s electronic distribution systemand related products and services. In addition, DGF’s sales force calls oncorporate advertisers who are in a position to either direct or influenceagencies in directing deliveries to DGF. A separate staff sells to and servicesaudio and video dealers, who resell DGF’s distribution services. DGF currentlyhas regional sales offices in New York, Los Angeles and Chicago. DGF’s salesforce includes regional sales, inside sales, and telemarketing personnel.

*Marketing.**  *DGF’s marketing programs aredirected to stimulate demand with an emphasis on popularizing the benefits ofdigital delivery, including fast turnaround (same day services), increasedflexibility, higher quality, and greater reliability and accountability. Thesemarketing 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. DGFalso engages in public relations activities including trade show participation,the stimulation of articles in the trade and business press, press tours andadvertisements in advertising and broadcast oriented trade publications.

DGF markets to broadcast stations to arrange for the placementof its Digital Media Managers, and DG Spot Boxes for the receipt of audio andvideo advertisements.

*Customer Service.**  *DGF’s approach to customer serviceis based on a model designed to provide focused support from key marketcentered offices, located in Los Angeles, Dallas, Chicago, Detroit, New Yorkand San Francisco. Clients work with specific, assigned account coordinators toplace production service and distribution orders. National distribution ordersare electronically routed to the NOC for electronic distribution or, foroff-line destinations, to DGF’s national duplication center in Louisville,Kentucky. DGF’s distributed service approach provides direct support in keymarket cities enabling DGF to develop closer relationships with clients aswell as the ability to support client needs for local production services. DGFalso maintains a customer service team dedicated to supporting the needs 

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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, trafficinstructions or additional media. Providing direct support alleviates the needfor client traffic departments to deal with individual stations or thechallenges of staffing for off-hours support. DGF’s customer service operationcenters are linked to DGF’s order management and media storage systems, andnational distribution network. These resources enable DGF to manage thedistribution of client orders to the fulfillment location best suited to meetcritical customer requirements as well as providing order status andfulfillment confirmation. This distribution model also provides DGF withsignificant redundancy and re-route capability, enabling DGF to meet customerneeds when weather or other conditions prevent deliveries using traditionalcourier services.

**Competition**

DGF competes with a variety of dub and ship houses andproduction studios that have traditionally distributed taped advertising spotsvia physical delivery. As local distributors, these entities have long-standingties with advertising agencies that are often difficult for DGF to replace. Inaddition, these dub and ship houses and production studios often provide anarray of ancillary video services, including archival storage and retrieval,closed captioning and format conversions, enabling them to deliver to theiradvertiser and agency customers a full range of customizable, mediapostproduction, preparation, distribution and trafficking services. DGF plansto continue pursuing potential dub and ship house partners where suchpartnerships make strategic sense.

In the video marketplace, DGF competes with dub andship houses across the country but additionally with a satellite-based videodistribution network operated by Vyvx, an operating division of WilltelCommunications, which is a wholly-owned subsidiary of Level 3Communications, Inc. DGF also anticipates that certain common and/orvalue-added telecommunications carriers may develop and deploy high bandwidthnetwork services targeted at the advertising and broadcast industries, althoughDGF believes that no such carriers have yet entered the market for spotdistribution.

We are aware of other companies that are focusing ormay in the future focus significant resources on developing and marketingproducts and services that will compete with ours. We believe that our abilityto compete successfully depends on a number of factors, both within and outsideof our control, including: (1) the price, quality and performance of ourproducts and those of our competitors; (2) the timing and success of newproduct introductions; (3) the emergence of new technologies; (4) thenumber and nature of our competitors in a given market; (5) the protectionof intellectual property rights; and (6) general market and economicconditions.

DGF expects competition tocontinue to intensify as existing and new competitors begin to offer products,services, or systems that compete with our products. Our current or futurecompetitors, many of whom, individually or together with their affiliates, havesubstantially greater financial resources, research, and development resources,distribution, marketing, and other capabilities than us, may apply theseresources and capabilities to compete successfully against our products andservice. A number of the markets in which we sell our products and services arealso served by technologies that currently are more widely accepted than ours.Although we believe that our products and services are less expensive to useand more functional than competing products and services that rely on othertechnologies, it is uncertain whether our potential customers will be willingto make the initial capital investment that may be necessary to convert to ourproducts and services. The success of our systems against these competingtechnologies depends in part upon whether our systems can offer significantimprovements in productivity and sound and video quality in a cost-effectivemanner. It is uncertain whether our competitors will be able to develop systemscompatible with, or that are alternatives to, our proprietary technology orsystems. It is also not certain that we will be able to compete successfullyagainst current or future competitors or that competitive pressures faced by uswill not materially adversely affect our business, operating results, andfinancial condition.

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**IntellectualProperty and Proprietary Rights**

DGF primarily relies upona combination of copyright, trademark and trade secret laws and licenseagreements to establish and protect proprietary rights in its technologies. DGFcurrently has 27 patents issued with expiration dates ranging from June 2012to September 2022 and eight other patent applications pending. DGF alsohas eleven trademark registrations, eight trademark applications andapproximately 200 copyright registrations.

**Employees**

As of December 31, 2006, DGF had in itscontinuing operations a total of 376 employees, including 45 in research anddevelopment, 46 in sales and marketing, 242 in operations, and 43 in financeand administration. 372 of these employees are located in the United States and4 are located in the United Kingdom. DGF’s employees are not represented by acollective bargaining agreement and DGF has not experienced a work stoppage. DGFconsiders its relations with its employees to be good.

DGF’s business andprospects depend in significant part upon the continued service of its keymanagement, sales and marketing and administrative personnel. The loss of keymanagement or technical personnel could materially adversely affect DGF’soperating results and financial condition. DGF believes that its prospectsdepend in large part upon its ability to attract and retain highly skilledmanagerial, sales and marketing and administrative personnel. Competition forsuch personnel is intense, and DGF may not be successful in attracting andretaining such personnel. Failure to attract and retain key personnel couldhave a material adverse effect on DGF’s operating results and financialcondition.

**ITEM 1A.**        RISKFACTORS

In evaluating aninvestment in our Company, the following risk factors should be considered.

**Risks Relating tothe Industry**

***The mediadistribution products and services industry is divided into several distinctmarkets, some of which are relatively mature while others are growing rapidly.If the mature markets begin to decline at a time when the developing marketsfail to grow as anticipated, it will be increasingly difficult to achieve andmaintain profitability.***

To date, our design and marketing efforts for ourproducts and services have involved the identification and characterization ofthe broadcast market segments within the media distribution products andservices industry that will be the most receptive to our products and services.We may not have correctly identified and characterized such markets and ourplanned products and services may not address the needs of those markets.Furthermore, our current technologies may not be suitable for specificapplications within a particular market and further design modifications,beyond anticipated changes to accommodate different markets, may be necessary.

While the electronic distribution of media has beenavailable for several years and growth of this market is modest, many of theproducts and services now on the market are relatively new. It is difficult topredict the rate at which the market for these new products and services willgrow, if at all. Even if the market does grow, it will be necessary to quicklyconform our products and services to customer needs and emerging industrystandards in order to be a successful participant in those markets, such as themarket for HD spots. If the market fails to grow, or grows more slowly thananticipated, it will be difficult for any market participant to succeed and itwill be increasingly difficult for us to achieve and maintain profitability.

To achieve andsustain profitability and growth, we must expand our product and serviceofferings beyond the broadcast markets to include additional market segments withinthe media distribution 

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productsand services industry. Potential new applications for our existing products innew markets include distance learning and training, finance and retail. Whileour products and services could be among the first commercial products that maybe able to serve the convergence of several industry segments, includingdigital networking, telecommunications, compression products and Internetservices, our products and services may not be accepted by that market. Inaddition, it is possible that:

·       theconvergence of several industry segments may not continue;

·       themarkets may not develop as a result of such convergence; or

·       ifmarkets develop, such markets may not develop either in a direction beneficialto our products or product positioning or within the time frame in which weexpect to launch new products and product enhancements.

Because the convergence ofdigital networking, telecommunications, compression products and Internetservices is new and evolving, the growth rate, if any, and the size of thepotential market for our products cannot be predicted. If markets for theseproducts fail to develop, develop more slowly than expected or become served bynumerous competitors, or if our products do not achieve the anticipated levelof market acceptance, our future growth could be jeopardized. Broad adoption ofour products and services will require us to overcome significant marketdevelopment hurdles, many of which we cannot predict.

***The industry is in a state of rapid technologicalchange and we may not be able to keep up with that pace.***

The advertisementdistribution and asset management industry is characterized by extremely rapidtechnological change, frequent new products, service introductions and evolvingindustry standards. The introduction of products with new technologies and theemergence of new industry standards can render existing products obsolete andunmarketable. Our future success will depend upon our ability to enhanceexisting products and services, develop and introduce new products and servicesthat keep pace with technological developments and emerging industry standardsand address the increasingly sophisticated needs of our customers, includingthe need for HD spots. We may not succeed in developing and marketing productenhancements or new products and services that respond to technological changeor emerging industry standards. We may experience difficulties that could delayor prevent the successful development, introduction and marketing of theseproducts and services. Our products and services may not adequately meet therequirements of the marketplace and achieve market acceptance. If we cannot,for technological or other reasons, develop and introduce products and servicesin a timely manner in response to changing market conditions, industrystandards or other customer requirements, particularly if we have pre-announcedthe product and service releases, our business, financial condition, results ofoperations or cash flows will be harmed.

***The marketing andsale of our products and services involve lengthy sales cycles. This makesbusiness forecasting extremely difficult and can lead to significantfluctuations in quarterly results.***

Due to the complexity and substantial cost associatedwith providing integrated product and services to provide audio, video, dataand other information across a variety of media and platforms, licensing andselling products and services to our potential customers typically involves asignificant technical evaluation. In addition, there are frequently delaysassociated with educating customers as to the productive applications of ourproducts and services, complying with customers’ internal procedures forapproving large expenditures and evaluating and accepting new technologies thataffect key operations. In addition, certain customers have even longerpurchasing cycles that can greatly extend the amount of time it takes to placeour products and services with these customers. Because of the lengthy salescycle and the large size of our potential customers’ average orders, ifrevenues projected from a specific potential customer for a particular quarterare not realized in that quarter, product revenues and operating results forthat quarter 

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could be harmed. Revenueswill also vary significantly as a result of the timing of product and servicepurchases and introductions, fluctuations in the rate of development of newmarkets and new applications, the degree of market acceptance of new andenhanced versions of our products and services, and the level of use ofsatellite networking and other transmission systems. In addition, increasedcompetition and the general strength of domestic and international economicconditions also impact revenues.

Because expense levelssuch as personnel and facilities costs, are based, in part, on expectations offuture revenue levels, if revenue levels are below expectations, our business,financial condition, results of operations or cash flows will be harmed.

***Seasonality inbuying patterns also makes forecasting difficult and can result in widelyfluctuating quarterly results.***

On a historical basis, theindustry has experienced lower sales for services in the first quarter, whichis somewhat offset with higher sales in the fourth quarter due to increasedcustomer advertising volumes for the holiday selling season. In addition,product and service revenues are influenced by political advertising, whichgenerally occurs every two years. Nevertheless, in any single period, productand service revenues and delivery costs are subject to variation based onchanges in the volume and mix of deliveries performed during such period. Inaddition, we have historically operated with little or no backlog. The absenceof backlog and fluctuations in revenues and costs due to seasonality increasesthe difficulty of predicting our operating results.

***The markets inwhich we will operate are highly competitive, and competition may increasefurther as new participants enter the market and more established companieswith greater resource seek to expand their market share.***

Competition within the markets for media distributionis intense. Moreover, these markets have become increasingly concentrated inrecent years as a result of acquisitions. We believe that our ability to competesuccessfully depends on a number of factors, both within and outside of ourcontrol, including: (1) the price, quality and performance of our productsand those of our competitors; (2) the timing and success of new productintroductions; (3) the emergence of new technologies; (4) the numberand nature of our competitors in a given market; (5) the protection ofintellectual property rights; and (6) general market and economicconditions. In addition, the assertion of intellectual property rights by othersand general market and economic conditions factor into the ability to competesuccessfully. The competitive environment could result in price reductions thatcould result in lower profits and loss of our market share.

While we offer products and services focused on theelectronic distribution of media, we compete with dub and ship houses andproduction studios. Although many dub and ship houses and production studios,such as Point.360, generally do not offer electronic delivery, they often havelong-standing ties to local distributors that can be difficult to replace. Manyof these dub and ship houses and production studios also have greaterfinancial, distribution and marketing resources than we and have achieved ahigher level of brand recognition. Production studios, advertising agencies andmedia buying firms also could deliver directly through entities with packagedelivery expertise such as Federal Express, United Parcel Service, the UnitedStates Postal Service and DHL.

In addition, we compete with a satellite-based videodistribution network operated by Vyvx, an operating division of WilltelCommunications, which is a wholly-owned subsidiary of Level 3 Communications, Inc.We also anticipate that certain common and/or value-added telecommunications carriersand other companies, such as Pathfire, may develop and deploy high bandwidthnetwork services targeted at the advertising and broadcast industries, althoughwe believe that no such carriers have yet entered the market for spotdistribution in any significant way.

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With respect to new markets, such as the delivery ofother forms of content to radio and television stations, competition is likelyto come from companies in related communications markets and/or packagedelivery markets. Some of the companies capable of offering products andservices with superior functionality include telecommunications providers, suchas AT&T, MCI and other fiber and telecommunication companies, each of whichwould enjoy materially lower electronic delivery transportation costs. Radionetworks such as ABC Radio Networks or Westwood One could also becomecompetitors by selling and transmitting advertisements as a complement to theircontent programming.

Further, other companies may in the future focussignificant resources on developing and marketing products and services thatwill compete with ours.

We have identified videoadvertising on the Internet as a potential business opportunity. This businessis currently undergoing rapid change with many different companies providinginnovative technology and solutions to advertisers and advertising agencies.Some of these companies capable of providing these services have establishedtechnologies and customer bases. Additionally, there is no assurance we will beable to compete on this level. Additionally, we are unsure of the amount ofinvestment required to enter this new and quickly changing market.

**Risks Related tothe Company**

***We have a history of losses which must be consideredin assessing our future prospects.***

2003 was the first year wereported net income after having been unprofitable since our inception. Whilewe reported profit again in 2004, we experienced a loss in 2005 and 2006. In2002, we were profitable only after excluding the effect of a change inaccounting principle. We could continue to generate net losses in the future,which could depress our stock price. Decreases in revenues could occur, whichcould impair our ability to operate profitably in the future. Future successalso depends in part on obtaining reductions in delivery and service costs,particularly our ability to continue to automate order processing and to reducetelecommunications costs. Our prospects must be considered in light of therisks, expenses and difficulties frequently encountered by companies in new andrapidly evolving markets, such as risks that the market might fail to grow,expenses relating to modifying products and services to meet industry standardsas they change over time, and difficulties in gaining and maintaining marketshare. To address these risks, we must, among other things, respond tocompetitive developments, attract, retain and motivate qualified persons,continually upgrade our technologies and begin to commercialize productsincorporating such technologies. We may not be successful in addressing any orall of these risks and may not be able to achieve and sustain profitability.

***We may not be able to obtain additional financing tosatisfy our future capital needs.***

We intend to continuemaking capital expenditures to market, develop, produce and deploy at no costto our customer the various equipment required by the customers to receive ourservices and to introduce additional services. In addition, we will need tomake the investments necessary to maintain and improve our network. We alsoexpect to expend capital to consummate any mergers and acquisitions that weundertake in the future. We may require additional capital sooner thancurrently anticipated and may not be able to obtain additional funds adequatefor our capital needs. We cannot predict any of the factors affecting therevenues and costs of these activities with any degree of certainty.Accordingly, we cannot predict the precise amount of future capital that wewill 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 maynot be available on acceptable terms. Our inability to obtain the necessaryfinancing on acceptable terms may prevent us from deploying our products andservices effectively, maintaining and improving our products and network andcompleting advantageous acquisitions. Our inability to obtain the necessaryfinancing 

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could seriously harm our business, financialcondition, results of operations and prospects. Consequently, we could berequired to:

·       significantlyreduce or suspend our operations;

·       seekan additional merger partner; or

·       sell additional securitieson terms that are highly dilutive to our stockholders.

***Our business is highly dependent upon radio andtelevision advertising. If demand for, or margins from, our radio andtelevision advertising delivery services decline, our business results willdecline.***

Weexpect that a significant portion of our revenues will continue to be derivedfrom the delivery of radio and television advertising spots from advertisingagencies, production studios and dub and ship houses to radio and televisionstations in the United States. A decline in demand for, or average sellingprices of, our radio and television advertising delivery services for any ofthe following reasons, or otherwise, would seriously harm our business,financial condition, results of operations and prospects:

·       competitionfrom new advertising media;

·       newproduct introductions or price competition from competitors;

·       ashift in purchases by customers away from our premium services; and

·       achange in the technology used to deliver such services.

Additionally, we aredependent on our relationship with the radio and television stations in whichwe have installed communications equipment. Should a substantial number ofthese stations go out of business, experience a change in ownership ordiscontinue the use of our equipment in any way, our business, financialcondition, results of operations and prospects would be harmed.

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

Ourbusiness will depend on making cost-effective deliveries to broadcast stationswithin the time periods requested by our customers. If we are unsuccessful inmaking these deliveries, for whatever reason, a station might be prevented fromselling airtime that it otherwise could have sold. Our ability to makedeliveries to stations within the time periods requested by customers dependson a number of factors, some of which will be outside of our control,including:

·       equipmentfailure;

·       interruptionin services by telecommunications service providers; and

·       inabilityto maintain our installed base of audio and video units that will comprise ourdistribution network.

Stations may assert claims for lost air-time in thesecircumstances and dissatisfied advertisers may refuse to make furtherdeliveries through us in the event of a significant occurrence of lostdeliveries, which would result in a decrease in our revenues or an increase inour expenses, either of which could lead to a reduction in net income or anincrease in net loss. Although we expect that we will maintain insuranceagainst business interruption, such insurance may not be adequate to protect usfrom significant loss in these circumstances or from the effects of a majorcatastrophe (such as an earthquake or other natural disaster), which couldresult in a prolonged interruption of our business.

***Our business is highly dependent on electronic videoadvertising delivery service deployment.***

Our inability to maintain units necessary for thereceipt of electronically delivered video advertising content in an adequatenumber of television stations or to capture market share among content delivery

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customers, which may bethe result of price competition, new product introductions from competitors orotherwise, would be detrimental to our business objectives and deter futuregrowth. We have made a substantial investment in upgrading and expanding ourNOC and in populating television stations with the units necessary for thereceipt of electronically delivered video advertising content. However, wecannot assure you that the maintenance of these units will cause this serviceto achieve adequate market acceptance among customers that require videoadvertising content delivery.

In addition, we believe that to more fully address theneeds of video delivery customers we have developed a set of ancillary servicesthat typically are provided by dub and ship houses. These ancillary servicesinclude cataloging, physical archiving, closed-captioning, modification ofslates and format conversions. We will need to provide these services on alocalized basis in each of the major cities in which we provide servicesdirectly to agencies and advertisers. We currently provide certain of suchservices to a portion of our customers through our facilities in New York, LosAngeles, Detroit and Chicago. However, we may not be able to successfullyprovide these services to all customers in those markets or any other majormetropolitan area at competitive prices. Additionally, we may not be able toprovide competitive video distribution services in other U.S. markets becauseof the additional costs and expenses necessary to do so and because we may notbe able to achieve adequate market acceptance among current and potentialcustomers in those markets.

While we are taking the steps we believe are requiredto achieve the network capacity and scalability necessary to deliver videocontent, such as HDTV content, reliably and cost effectively as videoadvertising delivery volume grows, we may not achieve such goals because theyare highly dependent on the services provided by our telecommunicationproviders and the technological capabilities of both our customers and thedestinations to which content is delivered. If our telecommunication providersare unable or unwilling to provide the services necessary at a rate we are willingto pay or if our customers and/or our delivery destinations do not have thetechnological capabilities necessary to send and/or receive video content, ourgoals of adequate network capacity and scalability could be jeopardized.

In addition, we may be unableto retain current audio delivery customers or attract future audio deliverycustomers who may ultimately demand delivery of both media content unless wecan 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.

***We rely onbandwidth providers or other third parties for key aspects of the process ofproviding products and services to our customers, and any failure orinterruption in the services and products provided by these third parties couldharm our ability to operate our business and damage our reputation.***

We rely on third-partyvendors, including bandwidth providers. Any disruption in the network accessservices provided by these third-party providers or any failure of thesethird-party providers to handle current or higher volumes of use couldsignificantly harm our business. Any financial or other difficulties ourproviders face may have negative effects on our business, the nature and extentof which we cannot predict. We exercise little control over these third partyvendors, which increases our vulnerability to problems with the services theyprovide. We license technology from third parties to facilitate aspects of ourconnectivity operations. We have experienced and expect to continue toexperience interruptions and delays in service and availability for suchelements. Any errors, failures, interruptions or delays experienced in connectionwith these third-party technologies could negatively impact our relationshipwith users and adversely affect our business and could expose us to liabilitiesto third parties.

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***If we were nolonger able to rely on our existing providers of transmissions services, ourbusiness and results of operations could be harmed affected.***

We obtain our local accesstransmission services and long distance telephone access through contracts withSprint, which expires in November 2007, and MCI, which expired in March 2007.While our MCI service continues on a month-to-month basis with no contract, weare evaluating which service provider(s) we will select for future needs. Theagreement with Sprint provides for reduced pricing on various services providedin exchange for minimum purchases of $1.0 million for each year of theSprint contract and the MCI contract provided reduced pricing in exchange forminimum purchases of $0.5 million for 2006. The agreements provide forcertain achievement credits once specified purchase levels are met. Anyinterruption in the supply or a change in the price of either local access orlong distance carrier service could increase costs or cause a significant declinein revenues, thereby decreasing our operating results.

***We face various risks associated with purchasingsatellite capacity.***

As part of our strategy ofproviding transmittal of audio, video, data and other information usingsatellite technology, we periodically purchase satellite capacity from thirdparties owning satellite systems. Although our management attempts to matchthese expenditures against anticipated revenues from sales of products tocustomers, they may not be successful at estimating anticipated revenues, andactual revenues from sales of products may fall below expenditures forsatellite capacity. In addition, the purchases of satellite capacity require asignificant amount of capital. Any inability to purchase satellite capacity orto achieve revenues sufficient to offset the capital expended to purchasesatellite capacity may make our business more vulnerable and significantlyaffect financial condition and results of operations.

***If the existingrelationship with Clear Channel Satellite Services is terminated, or if ClearChannel Satellite Services fails to perform as required under its agreementwith us, our business could be interrupted.***

We have designed anddeveloped the necessary software to enable our current video delivery systemsto receive digital satellite transmissions over the AMC-9 satellitesystem. However, the Clear Channel satellite system may not have the capacityto meet our future delivery commitments and broadcast quality requirements on acost-effective basis, if at all. We have a non-exclusive agreement with ClearChannel that expires in June 2010. The agreement provides for fixedpricing on dedicated bandwidth and gives us access to satellite capacity forelectronic delivery of digital audio and video transmissions by satellite.Clear Channel is required to meet performance specifications as outlined in theagreement, and we are given a credit allowance for future fees if Clear Channeldoes not meet these requirements. The agreement states that Clear Channel canterminate the agreement if we do not make timely payments or become insolvent.

***Certain of ourproducts depend on satellites; any satellite failure could result ininterruptions of our service that could negatively impact our business andreputation.***

A reduction in the number of operating satellites oran extended disruption of satellite transmissions would impair the currentutility of the accessible satellite network and the growth of current andadditional market opportunities. Satellites and their ground support systemsare complex electronic systems subject to weather conditions, electronic andmechanical failures and possible sabotage. The satellites have limited designlives and are subject to damage by the hostile space environment in which theyoperate. The repair of damaged or malfunctioning satellites is nearlyimpossible. If a significant number of satellites were to become inoperable,there could be a substantial delay before they are replaced with newsatellites. In addition, satellite transmission can be disrupted by naturalphenomena causing atmospheric interference, such as sunspots.

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Certain of our productsrely on signals from satellites, including, but not limited to, satellitereceivers and head-end equipment. Any satellite failure could result in interruptionsof our service, negatively impacting our business. We attempt to mitigate thisrisk by having our customers procure their own agreements with satelliteproviders.

***Interruption orfailure of our information technology and communications systems could impairour ability to effectively provide our products and services, which coulddamage our reputation and harm our operating results.***

Our provision of our products and services depends onthe continuing operation of our information technology and communicationssystems. Any damage to or failure of our systems could result in interruptionsin our service. Interruptions in our service could reduce our revenues andprofits, and our brand could be damaged if people believe our system isunreliable. Our systems are vulnerable to damage or interruption fromearthquakes, terrorist attacks, floods, fires, power loss, telecommunicationsfailures, computer viruses, computer denial of service attacks or otherattempts to harm our systems, and similar events. Some of our systems are notfully redundant, and our disaster recovery planning cannot account for alleventualities. The occurrence of a natural disaster, a decision to close afacility we are using without adequate notice for financial reasons or otherunanticipated problems at our NOC could result in lengthy interruptions in ourservice.

We have experienced systemfailures in the past and may in the future. Any unscheduled interruption in ourservice puts a burden on our entire organization and may result in a loss ofrevenue. If we experience frequent or persistent system failures in our NOC orweb-based management systems, our reputation and brand could be permanentlyharmed. The steps we have taken to increase the reliability and redundancy ofour systems are expensive, reduce our operating margin and may not besuccessful in reducing the frequency or duration of unscheduled downtime.

***The market price of our common stock is likely tocontinue to be volatile.***

Some of the factorsthat may cause the market price of our common stock to fluctuate significantlyinclude:

·       theaddition or departure of key personnel;

·       variationsin our quarterly operating results;

·       announcementsby us or our competitors of significant contracts, new or enhanced products orservice offerings, acquisitions, distribution partnerships, joint ventures orcapital commitments;

·       changesin coverage and financial estimates by securities analysts;

·       changesin market valuations of networking, Internet and telecommunications companies;

·       fluctuationsin stock market prices and trading volumes, particularly fluctuations of stockprices quoted on the Nasdaq Global Market; and

·       sale of a significantnumber of shares of our common stock by us or our significant holders.

***Sales ofsubstantial amounts of our common stock in the public market could harm themarket price of our common stock.***

The sale of substantialamounts of our shares (including shares issuable upon exercise of outstandingoptions and warrants to purchase our common stock) may cause substantialfluctuations in the price of our common stock. Because investors would be morereluctant to purchase shares of our common stock following substantial sales,the sale of these shares also could impair its ability to raise capital throughthe sale of additional stock.

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***Our inability toenter into or develop strategic relationships in key market segments could harmour operating results.***

Our strategy depends inpart on the development of strategic relationships with leading companies inkey market segments, including media broadcasters and digital system providers.We may not be able to successfully form or enter into such relationships, whichmay jeopardize our ability to generate sales of our products or services inthose segments. Specific product lines are dependent to a significant degree onstrategic alliances and joint ventures formed with other companies. Variousfactors could limit our ability to enter into or develop strategicrelationships, including, but not limited to, our relatively short operatinghistory, history of losses and the resources available to our competitors.Moreover, the terms of strategic alliances and joint ventures may vest controlin a party other than us. Accordingly, the success of the strategic alliance orjoint venture may depend upon the actions of that party and not us.

***Insiders havesubstantial control over us which could limit others’ ability to influence theoutcome of key transactions, including changes in control.***

As of December 31,2006, our executive officers and directors and their respective affiliates ownedapproximately 17% of our common stock. As a result, these stockholders may beable to control or significantly influence all matters requiring stockholderapproval, including the election of directors and the approval of significantcorporate transactions. This concentration of ownership may have the effect ofdelaying or preventing a change in control of us even if a change of control isin the best interest of all stockholders.

***Our business may beharmed if we are not able to protect our intellectual property rights fromthird-party challenges.***

We cannot assure that our intellectual property doesnot infringe on the proprietary rights of third parties. The steps taken toprotect our proprietary information may not prevent misappropriation of suchinformation, and such protection may not preclude competitors from developingconfusingly similar brand names or promotional materials or developing productsand services similar to ours. We consider our trademarks, copyrights,advertising and promotion design and artwork to be of value and important toour businesses. We rely on a combination of trade secret, copyright andtrademark laws and nondisclosure and other arrangements to protect ourproprietary rights. We generally enter into confidentiality or licenseagreements with our distributors and customers and limit access to anddistribution of our software, documentation and other proprietary information.Despite our efforts to protect our proprietary rights, unauthorized parties mayattempt to copy or obtain and use information that we regard as proprietary. Inaddition, the laws of some foreign countries do not protect our proprietaryrights to the same extent as do the laws of the United States.

While we believe that ourtrademarks, copyrights, advertising and promotion design and artwork do notinfringe upon the proprietary rights of third parties, we may still receivefuture communications from third parties asserting that we are infringing, ormay be infringing, on the proprietary rights of third parties. Any such claims,with or without merit, could be time-consuming, require us to enter intoroyalty arrangements or result in costly litigation and diversion of managementattention. If such claims are successful, we may not be able to obtain licensesnecessary for the operation of our business, or, if obtainable, such licensesmay not be available on commercially reasonable terms, either of which couldprevent our ability to operate our business.

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***We may enter intoor seek to enter into business combinations and acquisitions that may bedifficult to integrate, disrupt our business, dilute stockholder value ordivert management attention.***

We recentlyacquired FastChannel Network Inc., Media DVX, Inc., SourceEcreativeand the Broadcast Division of Applied Graphics Technologies, Inc., each ofwhich became our wholly-owned subsidiary. Our business strategy will includethe acquisition of additional complementary businesses and product lines. Anysuch acquisitions would be accompanied by the risks commonly encountered insuch acquisitions, including:

·       thedifficulty of assimilating the operations and personnel of the acquiredcompanies;

·       thepotential disruption of our business;

·       theinability of our management to maximize our financial and strategic position bythe successful incorporation of acquired technology and rights into our productand service offerings;

·       difficultymaintaining uniform standards, controls, procedures and policies, with respectto accounting matters and otherwise;

·       thepotential loss of key employees of acquired companies; and

·       theimpairment of relationships with employees and customers as a result of changesin management and operational structure.

We may not be able tosuccessfully complete any acquisition or, if completed, the acquired businessor product line may not be successfully integrated with our operations,personnel or technologies. Any inability to successfully integrate theoperations, personnel and technologies associated with an acquired businessand/or product line may negatively affect our business and results ofoperation. We may dispose of any of our businesses or product lines in theevent that we are unable to successfully integrate them, or in the event thatmanagement determines that any such business or product line is no longer inour strategic interests.

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

Our personnel, systems,procedures and controls may not be adequate to support our existing as well asfuture operations. We will need to continue to implement and improve ouroperational, financial and management information systems, procedures andcontrols on a timely basis and to expand, train, motivate and manage our workforce. We must also continue to further develop our products and services whileimplementing effective planning and operating processes, such as continuing toimplement and improve operational, financial and management informationsystems; hiring and training additional qualified personnel; continuing toexpand and upgrade our core technologies; and effectively managing multiplerelationships with various customers, joint venture and technological partnersand other third parties.

***We will depend onkey personnel to manage the business effectively, and if we are unable toretain our key employees or hire additional qualified personnel, our ability tocompete could be harmed.***

Our future success will depend to a significant extentupon the services of Scott K. Ginsburg, Chairman of the Board and ChiefExecutive Officer; and Omar A. Choucair, Chief Financial Officer.Uncontrollable circumstances, such as the death or incapacity of any keyexecutive officer, could have a serious impact on our business.

Our future success willalso depend upon our ability to attract and retain highly qualified management,sales, operations, technical and marketing personnel. At the present time thereis, and will continue to be, intense competition for personnel with experiencein the markets applicable to our products and services. Because of this intensecompetition, we may not be able to retain key personnel or 

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attract,assimilate or retain other highly qualified technical and management personnelin the future. The inability to retain or to attract additional qualifiedpersonnel as needed could have a considerable impact on our business.

***Certain provisionsof our bylaws may have anti-takeover effects that could prevent a change incontrol even if the change would be beneficial to its shareholders.***

We have a classified boardwhich might, under certain circumstances, discourage the acquisition of acontrolling interest of its stock because such acquirer would not have theability to replace these directors except as the term of each class expires.The directors are divided into three classes with respect to the time for whichthey hold office. The term of office of one class of directors expires at eachannual meeting of stockholders. At each annual meeting of stockholders,directors elected to succeed those directors whose terms then expire areelected for a term of office to expire at the third succeeding annual meetingof stockholders after their election.

***Our board ofdirectors may issue, without stockholder approval, preferred stock with rightsand preferences superior to those applicable to the common stock.***

Our certificate ofincorporation includes a provision for the issuance of “blank check” preferredstock. This preferred stock may be issued in one or more series, with eachseries containing such rights and preferences as the board of directors maydetermine from time to time, without prior notice to or approval ofstockholders. Among others, such rights and preferences might include therights to dividends, superior voting rights, liquidation preferences and rightsto convert into common stock. The rights and preferences of any such series ofpreferred stock, if issued, may be superior to the rights and preferencesapplicable to the common stock and might result in a decrease in the price ofthe common stock.

***We depend upon anumber of single or limited-source suppliers, and our ability to produce audioand video distribution equipment could be harmed if those relationships werediscontinued.***

We rely on fewer than fivesingle or limited-source suppliers for integral components used in the assemblyof our audio and video units. If a supplier were to experience financial oroperational difficulties that resulted in a reduction or interruption incomponent supply to us, this would delay our deployment of audio and videounits. We rely on our suppliers to manufacture components for use in ourproducts. Some of our suppliers also sell products to our competitors and mayin the future become our competitors, possibly entering into exclusive arrangementswith our existing competitors. In addition, our suppliers may stop selling ourproducts or components to us at commercially reasonable prices or completelystop selling our products or components to us. If a reduction or interruptionof supply were to occur, it could take a significant period of time for us toqualify an alternative subcontractor, redesign our products as necessary andcontract for the manufacture of such products. This would have the effect ofdepressing our business until we was able to establish sufficient componentsupply through an alternative source. We believe that there are currentlyalternative component manufacturers that could supply the components requiredto produce our products, but based on the financial condition and servicelevels of our current suppliers, we do not feel the need to pursue agreementsor understandings with such alternative sources or pursue long-term contractswith our current suppliers. We have experienced component shortages in thepast, and material component shortages or production or delivery delays mayoccur in the future.

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***We determined thatthere was a material weakness in our disclosure controls and procedures relatedsuch that those controls and procedures were not effective as ofDecember 31, 2006 and December 31, 2004. In the event a materialweakness occurs again in the future, our financial statements and results ofoperations could be harmed and you may not be justified in relying on thosefinancial statements.***

For the year ended December 31,2006, we determined that our disclosure controls and procedures were noteffective, and we identified a material weakness in our internal controls overfinancial reporting for business combinations and stock compensation as ofDecember 31, 2006. For the year ended December 31, 2004, wedetermined that our disclosure controls and procedures were not effective, andwe identified a material weakness in our internal controls over financialreporting for income taxes as of December 31, 2004. In the event that thisor any other material weakness occurs in the future, our financial statementsand results of operations could be harmed and you may not be justified inrelying on those financial statements, either of which could result in adecrease in our stock price.

***The Public CompanyAccounting Oversight Board, or PCAOB, is conducting an annual inspection of ourexternal auditors and we cannot assure you that in the course of thisinspection, the PCAOB will not identify additional information in our financialstatements which it believes could have been reported differently.***

The PCAOB is conducting aninspection of our external auditors, KPMG LLP, and their audit of our financialstatements as of and for the year ended December 31, 2005. The PCAOB is aprivate agency established to oversee the auditors of publicly held companies,and the PCAOB conducts annual inspections on all large public accounting firmsthat audit the financial statements of publicly held companies. As part of thisinspection, the PCAOB has selected, among others, to review KPMG LLP’s audit ofour financial statements as of and for the year ended December 31, 2005.The PCAOB’s inspection of KPMG LLP is ongoing and there can be no assurance asto when it will be completed. In addition, we cannot assure you that in thecourse of this inspection, the PCAOB will not identify additional informationcontained in our historical financial statements which it believes could havebeen reported differently, or the prospective impact of any such items on ourfinancial statements.

***We are required toevaluate our internal control over financial reporting under Section 404of the Sarbanes Oxley Act of 2002, and any adverse results from such evaluationcould result in a loss of investor confidence in our financial reports and harmour stock price.***

Pursuant to Section 404 of the Sarbanes-Oxley Actof 2002, beginning with our Annual Report on Form 10-K for thefiscal year ending December 31, 2007, we will be required to furnish areport by our management on our internal control over financial reporting. Sucha report will contain, among other matters, an assessment of the effectivenessof our internal control over financial reporting as of the end of our fiscalyear, including a statement as to whether or not our internal control overfinancial reporting is effective. This assessment must include disclosure ofany material weaknesses in our internal control over financial reportingidentified by management. Such report must also contain a statement that ourauditors have issued an attestation report on management’s assessment of suchinternal controls.

The Committee of Sponsoring Organizations of theTreadway Commission (COSO) provides a framework for companies to assess andimprove their internal control systems. The Public Company Accounting OversightBoard’s Auditing Standard No. 2, or Standard No. 2 and proposedStandard No. 5, which is expected to replace Standard 2, provides theprofessional standards and related performance guidance for auditors to attestto, and report on, management’s assessment of the effectiveness of internalcontrol over financial reporting under Section 404. Management’sassessment of internal controls over financial reporting requires management tomake subjective judgments and some of the judgments will be in areas that maybe open to interpretation and therefore the report may be uniquely difficult toprepare, and our auditors may not agree with management’s assessments. We arestill performing the system and 

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process documentation andevaluation needed to comply with Section 404, which is both costly andchallenging.

During this process, if our management identifies oneor more material weaknesses in our internal control over financial reporting,we will be unable to assert such internal control is effective. If we areunable to assert that our internal control over financial reporting iseffective as of December 31, 2007 (or if our auditors are unable to attestthat our management’s report is fairly stated or they are unable to express anopinion on the effectiveness of our internal controls), we could lose investorconfidence in the accuracy and completeness of our financial reports, whichwould harm our stock price.

We have in the pastdiscovered, and may in the future discover, areas of our internal controls thatneed improvement. We cannot be certain as to the timing of completion of ourevaluation, testing and any required remediation due in large part to the factthat there is very little precedent available by which to measure compliancewith the new Auditing Standard No. 2. If we are not able to complete ourassessment under Section 404 in a timely manner, we and our auditors wouldbe unable to conclude that our internal control over financial reporting iseffective as of December 31, 2007.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

None

**ITEM 2.**                PROPERTIES

The Company’s principalexecutive offices are at 750 West John Carpenter Freeway in Irving, Texas. TheIrving offices include 26,000 square feet of leased space, for which the leaseexpires in 2011. In addition, the Company leases approximately 6,400 squarefeet in Dallas, TX which is occupied by production personnel and expires in2013; approximately 9,100 square feet in Louisville, Kentucky for its dub andship facility which expires in 2010; approximately 15,600 square feet in NewYork which is occupied by production service and sales personnel and expires in2011; approximately 15,300 square feet in Los Angeles occupied by productionservice and sales personnel which expires in 2011; approximately 1,900 squarefeet in San Francisco occupied by sales personnel which expires in 2008; 4,500square feet in Detroit, which is occupied by production service and salespersonnel which expires in July 2007; 19,200 square feet in Wilmington,Ohio that expires in 2009 which is being sublet to a lessee; 18,500 square feetin Chicago, which is occupied by production service and sales personnel whichexpires in 2011; 1,000 square feet near Boston, Massachusetts, which isoccupied by administrative personnel which expires in October 2007; and200 square feet in Austin, Texas, which is occupied by administrative personnelwhich expires in October 2007. In addition, the Company leases an officein Boca Raton, Florida that is approximately 2,600 square feet and includessales, operations and administrative staff for SourceEcreative, which expiresin 2009; and 800 square feet in London, England, which is occupied by salespersonnel which expires in 2009. 

**ITEM 3.**                LEGALPROCEEDINGS

On February 2, 2006, a subsidiary of the Companyinitiated an arbitration proceeding against Pathfire, Inc. Our subsidiary seeksunspecified damages suffered due to Pathfire’s alleged breach and wrongfultermination of a Technology License and Services Agreement between Pathfire andMedia DVX, Inc., which agreement was acquired by our subsidiary inApril 2005. Pathfire has asserted a breach of contract counterclaimagainst our subsidiary and seeks damages in the approximate amount of $387,000.A hearing is scheduled for May 2007, at which the arbitrator isexpected to decide whether Pathfire is liable for breaching an exclusivity andnon-competition clause in the agreement. Discovery is in progress.

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The Company is subject,from time to time, to various legal proceedings and claims, either asserted orunasserted, which arise in the ordinary course of business. While the outcomeof these claims cannot be predicted with certainty, management does not believethat the outcome of any of these legal matters asserted to date will have amaterial effect on the financial condition or results of operations of theCompany.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

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**PART II**

**ITEM 5.**                MARKET FORREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES

The Common Stock of the Company has been traded on theNasdaq Global Market (formerly known as the Nasdaq National Market) under thesymbol 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 CommonStock or other securities. On May 26, 2006 the Company’s common stock wasreverse split on a 1-for-10 basis.

Thefollowing table sets forth the high and low closing sales prices of our CommonStock from January 1, 2005 to December 31, 2006. Such pricesrepresent prices between dealers, do not include retail mark-ups, markdowns orcommissions and may not represent actual transactions. 

| ** **     | ** ** | **Fiscal Year Ended  2006** | ** ** | **Fiscal Year Ended  2005** | ** ** |
|----------------|------------|---------------------------------------|------------|---------------------------------------|------------|
| ** **     | ** ** | **High**                              | ** ** | **Low**                               | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $                                     | 7.40       |                                  | $          | 5.20 |   | $ | 15.80 |   | $ | 10.60 |   |
| Second Quarter |       | 5.75                                  |       | 5.30                                  |       | 13.50 |   | 9.60 |   |
| Third Quarter  |       | 10.64                                 |       | 5.50                                  |       | 9.80 |   | 6.00 |   |
| Fourth Quarter |       | 13.53                                 |       | 10.81                                 |       | 7.10 |   | 4.70 |   |
|                |            |                                       |            |                                       |            |  |  |  |  |  |  |  |  |

 

The prices shown are adjusted to give effect for the1-for-10 reverse split on May 26, 2006.

The following table sets forth the purchases of equitysecurities by the Company during the period January 1, 2005 to December 31,2005. No purchases were made during 2006. All purchases shown below were madeon the open market during the time periods specified. 

| ** **                                      | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average Price  Paid per Share** | ** ** | **Total Number  of Shares  Purchased as  Part of Publicly  Announced  Plans(1)** | ** ** | **Maximum Dollar  Value of Shares  that May Yet be  Purchased under  the Plan** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|
| January 1,  2005 to December 31, 2005 |       |                                             | 10,800     |                                             |       |                                                                                                      | $          | 14.60                                                                                                                   |       |   |   | 56,371 |   |   |   | $ | 2,747,827 |   |   |
|                                                 |            |                                                  |            |                                                  |            |                                                                                                           |            |                                                                                                                         |            |  |  |  |  |  |  |  |  |  |  |

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(1)          Theauthorization by the Board of Directors to repurchase of up to$3.5 million of its common stock was announced to the public via a pressrelease filing on Form 8-K on November 30, 2004. No expirationdate was specified.

As of February 28, 2007, the Company had issued15,899,235 and outstanding 15,842,865 shares of its common stock. As of February 28,2007, the Company’s common stock was held by approximately 312 stockholders ofrecord. The Company estimates that there are approximately 5,749 beneficialstockholders.

The Company has neverdeclared or paid cash dividends on its capital stock. The Company currentlyexpects to retain any future earnings for use in the operation and expansion ofits business and does not anticipate paying any cash dividends in theforeseeable future.

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**Stock Performance Table**

The table set forthbelow compares the cumulative total stockholder return on the Common Stockbetween December 31, 2001 and December 31, 2006 with the cumulativetotal return of (i) the Nasdaq Non-Financial Stocks Index and(ii) the Nasdaq Computer and Data Processing Stocks Index, over the sameperiod. This table assumes the investment of $100.00 on December 31, 2001in the Common Stock, the Nasdaq Non-Financial Stocks Index and the NasdaqComputer and Data Processing Stocks Index, and assumes the reinvestment ofdividends, if any.

The comparisons shown in the table below are basedupon historical data. The Company cautions that the stock price performanceshown in the table below is not indicative of, nor intended to forecast, thepotential future performance of the Common Stock. Information used in the graphwas obtained from information published by Nasdaq and Research DataGroup, Inc., sources believed to be reliable, but the Company is notresponsible for any errors or omissions in such information.

**COMPARISON OF 5YEAR CUMULATIVE TOTAL RETURN***Among DG Fastchannel, Inc., The NASDAQComposite IndexAnd The NASDAQ Computer & Data Processing Index

****

* $100 invested on12/31/01 in stock or index-including reinvestment of dividends.Fiscal year ending December 31.

| ** **                                               | ** ** | **Cumulative Total Return** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                               | ** ** | **12/01**                             | ** ** | **12/02** | ** ** | **12/03** | ** ** | **12/04** | ** ** | **12/05** | ** ** | **12/06** | ** ** |
| DG FASTCHANNEL, INC.                                     |       | 100.00                                |       | 96.40 |   | 201.80 |   | 112.61 |   | 48.65 |   | 121.44 |   |
| NASDAQ NON-FINANCIAL  STOCKS INDEX                       |       | 100.00                                |       | 71.97 |   | 107.18 |   | 117.07 |   | 120.50 |   | 137.02 |   |
| NASDAQ COMPUTER & DATA PROCESSING STOCKS  INDEX |       | 100.00                                |       | 72.13 |   | 91.67 |   | 104.54 |   | 107.98 |   | 122.16 |   |

 

Notwithstanding anything to the contrary set forth inany of the Company’s previous or future filings under the Securities Act or theExchange Act that might incorporate this report or future filings made by theCompany under those statutes, this Stock Performance Graph shall not be deemedfiled with the SEC and shall not be deemed incorporated by reference into anyof those prior filings or into any future filings made by the Company underthose statutes.

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**EQUITY COMPENSATIONPLAN INFORMATION**

The following tableprovides information about the securities authorized for issuance under theCompany’s equity compensation plans as of December 31, 2006: 

| ** **                                              | ** ** | **Number of securities to  be issued upon exercise  of outstanding options,  warrants and rights** (1) | ** ** | **Weighted average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance  (excluding securities  reflected in column** (a)) (2) | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity compensation  plans approved by security holders |       |                                                                                                                                                          | 790,974    |                                                                                                             |       |                                                                                                                                                                      | $          | 10.15 |   |   |   | 1,097,500 |   |   |
|                                                         |            |                                                                                                                                                               |            |                                                                                                                  |            |                                                                                                                                                                           |            |  |  |  |  |  |  |  |

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(1)          Thistable excludes an aggregate of 441,692 shares issuable upon exercise ofoutstanding options and warrants assumed by the Company in connection with theCompany’s merger with StarGuide Digital Networks, Inc. in January 2001.The weighted-average exercise price of the excluded options and warrants is$11.95 per share.

(2)          Excludes99,269 available for issue under the Employee Stock Purchase Plan.

**ITEM 6.**                SELECTED FINANCIALDATA

The following selectedhistorical consolidated financial data should be read in conjunction with theCompany’s consolidated financial statements and related notes and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”contained herein. The data below includes the results of acquired operationsfrom the respective dates of acquisition, namely (i) Applied GraphicsTechnologies, Inc. (“AGT”) from June 1, 2004, (ii) SourceEcreative, Inc.(“SourceEcreative”) from August 31, 2004, (iii) Media DVX, Inc. (“MDX”)from April 15, 2005, and (iv) FastChannel Network, Inc. (“FastChannel”) fromMay 31, 2006. See Note 3 to the Company’s consolidated financial statements. Asa result of the Company’s decision to sell the assets of StarGuide DigitalNetworks, Inc. (“StarGuide”) and Corporate Computer Systems, Inc. (“CCS”),their operating results for all periods presented have been reflected in discontinuedoperations in the Company’s consolidated financial statements and the selectedfinancial data below. See Note 4 to the Company’s consolidated financialstatements.

The consolidated statementsof operations data for the years ended December 31, 2006, 2005, 2004,2003, and 2002 and the consolidated balance sheet data at December 31,2006, 2005, 2004, 2003, and 2002 are derived from the consolidated financialstatements of the Company, which were audited by KPMG LLP, independentregistered public accounting firm.

Amounts are shown inthousands (except per share amounts):

**Statements of Operations Data:**

| ** **                    | ** ** | **For years ended December 31,** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|
| ** **                    | ** ** | **2006**                                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues:                     |       | $                                                    | 68,667     |   | $ | 51,824 |   | $ | 53,570 |   | $ | 47,928 |   | $ | 53,145 |   |
| Costs and expenses:           |       |                                                 |       |   |   |   |   |   |   |   |   |
| Cost of revenues              |       | 33,322                                               |       | 32,184 |   | 28,941 |   | 23,871 |   | 26,336 |   |
| Sales and marketing           |       | 4,240                                                |       | 3,915 |   | 4,264 |   | 3,970 |   | 4,011 |   |
| Research and development      |       | 1,779                                                |       | 1,107 |   | 1,520 |   | 1,958 |   | 2,449 |   |
| General and administrative    |       | 10,462                                               |       | 7,587 |   | 6,328 |   | 4,968 |   | 6,937 |   |
| Restructuring charges         |       | —                                               |       | 434 |   | — |   | — |   | 771 |   |
| Impairment charges            |       | —                                               |       | — |   | 1,048 |   | — |   | — |   |
| Depreciation and amortization |       | 8,563                                                |       | 6,348 |   | 5,143 |   | 5,685 |   | 6,476 |   |
| Total expenses                |       | 58,366                                               |       | 51,575 |   | 47,244 |   | 40,452 |   | 46,980 |   |
|                               |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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| Income from operations                                                                                                    |   | 10,301 |   | 249    |   | 6,326  |   | 7,476  |   | 6,165    |   |
|---------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|----------|--------|
| Other (income) expense:                                                                                                   |   |   |   |   |   |   |   |   |   |     |   |
| Reduction in fair value of long-term investments                                                                          |   | 4,758  |   | — |   | — |   | — |   | —   |   |
| Interest income and other (income) expense, net                                                                           |   | (58    | )      | — |   | — |   | — |   | —   |   |
| Interest expense                                                                                                          |   | 2,844  |   | 2,990  |   | 1,284  |   | 211    |   | 680      |   |
| Net income (loss) before income taxes and cumulative  effect of change in accounting principle from continuing operations |   | 2,757  |   | (2,741 | )      | 5,042  |   | 7,265  |   | 5,485    |   |
| Provision (benefit) for income taxes                                                                                      |   | 2,378  |   | (768   | )      | 1,728  |   | 1,469  |   | 2,114    |   |
| Net income (loss) before cumulative effect of change  in accounting principle from continuing  operations                 |   | 379    |   | (1,973 | )      | 3,314  |   | 5,796  |   | 3,371    |   |
| Cumulative effect of change in accounting principle                                                                       |   | — |   | — |   | — |   | — |   | (130,234 | )      |
| Net income (loss) after cumulative effect of change  in accounting principle from continuing operations                   |   | 379    |   | (1,973 | )      | 3,314  |   | 5,796  |   | (126,863 | )      |
| (Loss) income from operations of discontinued operations                                                                  |   | (539   | )      | 1,455  |   | (6,181 | )      | (2,575 | )      | (788     | )      |
| Income tax benefit (expense)                                                                                              |   | 209    |   | (572   | )      | 6,071  |   | 978    |   | 266      |   |
| Loss on disposal of discontinued operations, net of  tax benefit                                                          |   | (698   | )      | — |   | — |   | — |   | —   |   |
| Net (loss) income from discontinued operations                                                                            |   | (1,028 | )      | 883    |   | (110   | )      | (1,597 | )      | (522     | )      |
| Net income (loss) after cumulative effect of change  in accounting principle                                              |   | $      | (649   | )      | $      | (1,090 | )      | $      | 3,204  |     | $      | 4,199 |   | $ | (127,385 | ) |
| Basic net income (loss) per common share from  continuing operations                                                      |   | $      | 0.04   |   | $      | (0.27  | )      | $      | 0.46   |     | $      | 0.81 |   | $ | (17.94 | ) |
| Basic net income (loss) per common share from  discontinued operations                                                    |   | (0.10  | )      | 0.12   |   | (0.02  | )      | (0.22  | )      | (0.07    | )      |
| Basic net income (loss) per common share                                                                                  |   | $      | (0.06  | )      | $      | (0.15  | )      | $      | 0.44   |     | $      | 0.59 |   | $ | (18.01 | ) |
| Diluted net income (loss) per common share from  continuing operations                                                    |   | $      | 0.04   |   | $      | (0.27  | )      | $      | 0.46   |     | $      | 0.77 |   | $ | (17.92 | ) |
| Diluted net income (loss) per common share from  discontinued operations                                                  |   | (0.10  | )      | 0.12   |   | (0.02  | )      | (0.21  | )      | (0.07    | )      |
| Diluted net income (loss) per common share                                                                                |   | $      | (0.06  | )      | $      | (0.15  | )      | $      | 0.44   |     | $      | 0.56 |   | $ | (17.99 | ) |
| Basic weighted average common shares outstanding                                                                          |   | 10,568 |   | 7,378  |   | 7,277  |   | 7,137  |   | 7,072    |   |
| Diluted weighted average common  shares outstanding                                                                       |   | 10,568 |   | 7,378  |   | 7,330  |   | 7,489  |   | 7,081    |   |

 

**Balance Sheet Data (Continuing Operations):**

| ** **                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Cash and cash  equivalents                           |       | $                     | 24,474     |   | $ | 1,886 |   | $ | 8,059 |   | $ | 7,236 |   | $ | 2,527 |   |
| Working capital                                      |       | 25,106                |       | 1,722 |   | 9,054 |   | 9,206 |   | 2,150 |   |
| Property and  equipment, net                         |       | 12,829                |       | 11,494 |   | 10,692 |   | 9,471 |   | 12,212 |   |
| Total assets                                         |       | 172,997               |       | 110,065 |   | 102,027 |   | 78,357 |   | 80,070 |   |
| Long-term debt,  excluding current portion           |       | 15,650                |       | 20,834 |   | 8,447 |   | 2,400 |   | 4,548 |   |
| Net assets (liabilities)  of discontinued operations |       | 2,441                 |       | 3,242 |   | 1,928 |   | 7,097 |   | (17,495 | ) |
| Shareholders’ equity                            |       | 141,886               |       | 80,207 |   | 79,432 |   | 75,474 |   | 70,004 |   |
|                                                      |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’sDiscussion and Analysis of Financial Condition and Results of Operations shouldbe read in conjunction with our Consolidated Financial Statements and Notesthereto contained elsewhere in this Annual Report on Form 10-K.

**Introduction**

Management’sdiscussion and analysis of financial condition and results of operations (“MD&A”)is provided as a supplement to the accompanying consolidated financialstatements and notes to help provide an understanding of DG FastChannel Inc.’s(“DGF” or the “Company”) financial condition, changes in financial conditionand results of operations. MD&A is organized as follows:

*·** *CautionaryNote Regarding Forward-Looking Statements.   This section provides adescription of the use of forward-looking information appearing in this report,including in MD&A and the consolidated financial statements. Suchinformation is based on management’s current expectations about future events,which are inherently susceptible to uncertainty and changes in circumstances.Refer to “Risk Factors” above, for a discussion of the risk factors applicableto the Company.

*·** **Overview.*   This section provides a general descriptionof the Company’s business, as well as recent developments the Company believesare important in understanding the results of operations and financialcondition or in understanding anticipated future trends.

*·** **Results of Operations.*   This section provides an analysisof the Company’s results of operations for three years in the period endedDecember 31, 2006. In addition, a brief description is provided of significanttransactions and events that impact the comparability of the results beinganalyzed.

·  *Financial Condition.*   Thissection provides a summary of certain major balance sheet accounts and adiscussion of the factors that tend to cause these accounts to change, or thereasons for the change.

*·** **Liquidity and Capital Resources.*   This section providesan analysis of the Company’s cash flows for three years in the period endedDecember 31, 2006, as well as a discussion of the Company’s outstanding debtand commitments that existed as of December 31, 2006. Included in the analysisof outstanding debt is a discussion of the amount of financial capacityavailable to fund the Company’s future commitments, as well as a discussion ofother financing arrangements.

*·** **Critical Accounting Policies.*   This section discussesaccounting policies that are considered important to the Company’s results ofoperations and financial condition, require significant judgment and requireestimates on the part of management in application. The Company’s significantaccounting policies, including those considered to be critical accountingpolicies, are summarized in Note 2 to the accompanying consolidated financialstatements.

·  *New AccountingPronouncements.*   This section provides a discussion of recentlyissued accounting pronouncements that have been adopted or will be adopted inthe near future, including a discussion of the impact or potential impact ofsuch standards on our consolidated financial statements when applicable.

·  *Contractual PaymentObligations.*   This section provides a summary of the Company’scontractual payment obligations by major category in total and a breakdown byperiod.

·  *Off-Balance Sheet Arrangements.*   This section providesa summary of the Company’s off-balance sheet arrangements and the purpose fortheir use.

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**Cautionary NoteRegarding Forward-Looking Statements**

The Securities and Exchange Commission encouragescompanies to disclose forward-looking information so that investors can betterunderstand a company’s future prospects and make informed investment decisions.Certain statements contained herein may be deemed to constitute “forward-lookingstatements.”

Words such as “may,” “anticipate,” “estimate,” “expects,”“projects,” “intends,” “plans,” “believes” and words and terms of similarsubstance used in connection with any discussion of future operating orfinancial performance, identify forward-looking statements. All forward-lookingstatements are management’s present expectations of future events and aresubject to a number of risks and uncertainties that could cause actual resultsto differ materially from those described in the forward-looking statements.These risks and uncertainties include, among other things: our need foradditional capital to fund the current level of our technology developmentprograms, our inability to further identify, develop and achieve commercialsuccess for new products; the possibility of delays in product development; ourdependence upon a small number of large customers; the development of competingdistribution products; our ability to protect our proprietary technologies;patent-infringement claims; risks of new, changing and competitivetechnologies; and other factors discussed elsewhere herein under the heading “RiskFactors.”

In light of theseassumptions, risks and uncertainties, the results and events discussed in theforward-looking statements contained herein might not occur. You are cautionednot to place undue reliance on forward-looking statements, which speak only asof the date of this filing. We are not under any obligation, and we expresslydisclaim any obligation, to update or alter any forward-looking statements,whether as a result of new information, future events or otherwise, except asmay be required by applicable law. All subsequent forward-looking statementsattributable to management or to any person authorized to act on our behalf areexpressly qualified in their entirety by the cautionary statements contained orreferred to in this section.

**Overview**

DGF is the leading provider of digital technologyservices that enable the electronic delivery of advertisements from advertisingagencies to traditional broadcasters and other media outlets. Our business canbe impacted by several factors including the financial stability of ourcustomers, the overall advertising market, new emerging digital technologies,and the continued transition from analog to digital broadcast signaltransmission.

The Company faces several factors which impact thegrowth of digital delivery of advertising, including the following:

***Increasein demand for reliable and rapid means of content delivery***.*  *In recent years, technologicalinnovations in digital media have driven increasing demand for reliable andrapid means of information transfer, particularly in the broadcast andtelecommunications industries. Digital distribution technologies are increasinglyused for distributing media in forms such as audio, video, text and data.Digitized information has many advantages including ease and efficiency ofstorage, manipulation, transmission and reproduction, with less degradation andin greater volumes than traditional analog or hard copy formats.

***Governmentmandate to transition to digital broadcasting***.*  *On February 1, 2006, the U.S.Congress passed legislation, which was signed by the President onFebruary 8, 2006 establishing the deadline for the transition from analogto digital broadcasting by February 17, 2009. Most networks currentlybroadcast, and are expected to continue to broadcast, in both analog anddigital formats until February 17, 2009, when all analog broadcasting mustterminate. The shift to digital provides improved picture quality and preservesnetwork capacity by using various compression technologies. This governmentmandate has created strong momentum in the shift to high definition television(“HDTV”) broadcasting because of the 

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complementary aspectsbetween digital-only and HDTV broadcasting, which we believe will encourage thebroadcast industry to move to an entirely digital work stream, including theelectronic delivery of digital advertising.

***Increasein adoption and popularity of High Definition Television***.*  *Consumer demand for superiorquality, declining HDTV set prices and increasing availability of HDTV contentare driving the rapid growth in HDTV adoption, with the United States leadingthe charge. Currently, all major broadcasters are delivering prime time contentvia HD broadcasting and, though advertisements are still mainly delivered instandard definition, with the broadcast industry shifting towards HD, webelieve that advertising will soon follow. As local television stations worktowards upgrading their infrastructure to enable HDTV signals, advertisers areincreasing the number of HDTV commercials, which we believe will likely requiredigital distribution.

***Emergenceof video advertising content on the Internet***.*  *The confluence of a successfulonline advertising industry and the penetration of personal broadbandconnections creates a strong platform for the Internet to become a significantmedium with respect to video advertisements. The increase in broadbandsubscribers is fueling the accelerating growth in streaming media. Largely dueto this growth in broadband usage, the Internet has become a widely used mediumfor distributing and receiving audio and video content. As the volume andquality of dynamic content progresses, we believe that there will besignificant growth in video advertising over the Internet and that advertiserswill look to existing digital content distributors to provide the necessarycapabilities to successfully leverage this emerging medium.

The Company depends on several third party vendors tooperate our digital distribution network. Accordingly, we are highly dependenton satellite and high-speed connectivity vendors to properly operate ourdigital network. Additionally, DGF is highly dependent on the video advertisingaired on TV and cable networks, cable systems, and other broadcast mediaoutlets.

The distribution of incremental video and audioadvertising over DGF’s digital network in excess of the fixed costs necessaryto operate the network is one of the drivers of operating income. Historically,the Company has been able to secure sufficient video and audio advertising togenerate operate income.

***SignificantTransactions***.   Part of our business strategyis to acquire, or make investments in, similar and/or ancillary businesses thatwill increase our market penetration and, in some cases, result in operatingsynergies. Consistent with this business strategy:

·  On June 1, 2004, the Company acquired substantiallyall the broadcast distribution assets and certain liabilities of AGT for $15.0million in cash. AGT distributes advertising content to radio and televisionstations utilizing conventional and electronic duplication technologies. Theacquisition increased the Company’s customer base and resulted in operatingsynergies. AGT has been included in the Company’s results since the date ofacquisition.

·  On August31, 2004, the Company acquired substantially all the assets and certainliabilities of SourceEcreative for $3.8 million in cash. SourceEcreative offers a complete online resource andsearchable database of over 350,000 television commercials, both on asubscription and per-transaction basis. The acquisition expanded theCompany’s media asset management services to advertising agencies. SourceEcreativehas been included in the Company’s results since the date of acquisition, andrepresents a seperate business segment.

·  Between March 2005 and July 2005, the Companypurchased (i) a total of approximately 12.6 million shares of Series BConvertible Preferred Stock of Verance Corporation (“Verance”) and (ii) anagreement to license Verance products, for an aggregate purchase price ofapproximately $5.1 million. Verance develops and licenses certain audiowatermarking technologies. The Company has accounted for this long-term investment as an “available for sale”equity security in accordance with SFAS 115.

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InSeptember 2006, the Company determined that its investment in Verance wasimpaired and wrote the value down to zero.

·  On April 15, 2005, the Company acquiredsubstantially all the assets and certain liabilities of MDX for $10.0 million(excluding transaction costs) consisting of (i) $1.5 million in cash, (ii) a$6.5 promissory note, and (iii) 155,039 shares of the Company’s common stockvalued at approximately $2.0 million. MDX distributes advertising content toradio and television stations utilizing conventional and electronic duplicationtechnologies. The acquisition increased the Company’s customer base andresulted in operating synergies. MDX has been included in the Company’s resultssince the date of acquisition.

·  On May 31, 2006, the Company entered into atax-free merger transaction with the shareholders of privately-held FastChannelwhereby FastChannel became a wholly-owned subsidiary of the Company. The $28.8million purchase price consisted of (i) approximately 5.2 million shares of theCompany’s common stock valued at $27.4 million, and (ii) approximately $1.4million of transaction costs. Similar to the Company, FastChannel operates adigital distribution network serving the advertising and broadcast industries.The merger with FastChannel has expanded the Company’s “footprint” (i.e., electronicnetwork), increased our customer base and resulted in operating synergies.FastChannel has been included in the Company’s results since the date ofacquisition.

·  InDecember 2006, the Company purchased a total of approximately 1.44 millionshares, or 14.8%, of the outstanding common stock of publicly held Point.360for approximately $4.8 million in cash. The shares were purchased in (i) aprivate transaction, and (ii) the open market. Point.360 distributesadvertising content to radio and television stations utilizing conventional andelectronic duplication technologies. The Company accounts for this long-term investment as an “available for sale”equity security in accordance with SFAS 115.

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**Results ofOperations**

Thefollowing table sets forth certain historical financial data for the yearsended December 31, 2006, 2005, and 2004. Operating results for any periodare not necessarily indicative of results for any future period. Amounts areshown in thousands (except per share data). 

| ** **                                                               | ** ** | **For years ended December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                               | ** ** | **2006**                                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                                                |       | $                                                    | 68,667     |   | $ | 51,824 |   | $ | 53,570 |   |
| Costs and  expenses:                                                     |       |                                                 |       |   |   |   |   |
| Cost of revenues                                                         |       | 33,322                                               |       | 32,184 |   | 28,941 |   |
| Sales and marketing                                                      |       | 4,240                                                |       | 3,915 |   | 4,264 |   |
| Research and development                                                 |       | 1,779                                                |       | 1,107 |   | 1,520 |   |
| General and administrative                                               |       | 10,462                                               |       | 7,587 |   | 6,328 |   |
| Restructuring charges                                                    |       | —                                               |       | 434 |   | — |   |
| Impairment charges                                                       |       | —                                               |       | — |   | 1,048 |   |
| Depreciation and amortization                                            |       | 8,563                                                |       | 6,348 |   | 5,143 |   |
| Total expenses                                                           |       | 58,366                                               |       | 51,575 |   | 47,244 |   |
| Income from operations                                                   |       | 10,301                                               |       | 249 |   | 6,326 |   |
| Other (income)  expense:                                                 |       |                                                 |       |   |   |   |   |
| Reduction in fair value of long-term investments                         |       | 4,758                                                |       | — |   | — |   |
| Interest income and other (income) expense, net                          |       | (58                                                  | )          | — |   | — |   |
| Interest expense                                                         |       | 2,844                                                |       | 2,990 |   | 1,284 |   |
| Net income (loss) before income taxes from  continuing operations        |       | 2,757                                                |       | (2,741 | ) | 5,042 |   |
| Provision (benefit) for income taxes                                     |       | 2,378                                                |       | (768 | ) | 1,728 |   |
| Net income (loss) from continuing operations                             |       | 379                                                  |       | (1,973 | ) | 3,314 |   |
| Discontinued operations:                                                 |       |                                                 |       |   |   |   |   |
| (Loss) income from operations of discontinued operations                 |       | (539                                                 | )          | 1,455 |   | (6,181 | ) |
| Income tax benefit (expense)                                             |       | 209                                                  |       | (572 | ) | 6,071 |   |
| (Loss) on disposal of discontinued operations, net  of tax benefit       |       | (698                                                 | )          | — |   | — |   |
| Net (loss) income from discontinued operations                           |       | (1,028                                               | )          | 883 |   | (110 | ) |
| Net income (loss)                                                        |       | $                                                    | (649       | ) | $ | (1,090 | ) | $ | 3,204 |   |
| Basic net income (loss) per common share from continuing  operations     |       | $                                                    | 0.04       |   | $ | (0.27 | ) | $ | 0.46 |   |
| Basic net income (loss) per common share from  discontinued   operations |       | (0.10                                                | )          | 0.12 |   | (0.02 | ) |
| Basic net income (loss) per common share                                 |       | $                                                    | (0.06      | ) | $ | (0.15 | ) | $ | 0.44 |   |
| Diluted net income (loss) per common share from  continuing   operations |       | $                                                    | 0.04       |   | $ | (0.27 | ) | $ | 0.46 |   |
| Diluted net income (loss) per common share from  discontinued operations |       | (0.10                                                | )          | 0.12 |   | (0.02 | ) |
| Diluted net income (loss) per common share                               |       | $                                                    | (0.06      | ) | $ | (0.15 | ) | $ | 0.44 |   |
| Basic weighted average common shares outstanding                         |       | 10,568                                               |       | 7,378 |   | 7,277 |   |
| Diluted weighted average common shares outstanding                       |       | 10,568                                               |       | 7,378 |   | 7,330 |   |

 

***2006 versus 2005***

*Revenues.**  *For the year ended December 31,2006, revenues from continuing operations increased $16.8 million or32.5%, as compared to the prior year period. Revenues increased by$12.6 million due to the acquisition of FastChannel while the remainder ofthe increase was primarily from growth in the existing advertisementdistribution operations.

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*Costof Revenues.**  *Forthe year ended December 31, 2006, cost of revenues increased$1.1 million, or 3.5%, from the prior year. Increases in cost of revenuesoccurred at a lower rate than the increases in related revenues due to theelimination of redundant costs that would have otherwise occurred inFastChannel if it had not merged with the Company.

*Salesand Marketing.**  *Salesand marketing expense increased $0.3 million, or 8.3%, for the year ended December 31,2006 primarily due to incremental expenses related to sales support for theabove noted incremental revenues attributable to the operations of FastChannel.

*Researchand Development.**  *Forthe year ended December 31, 2006, research and development expenseincreased $0.7 million, or 60.7%, primarily due to certain costs incurredafter the FastChannel acquisition related to transitioning these duties frompersonnel in the FastChannel division to personnel in the Company’s existingengineering department.

*Generaland Administrative.**  *Forthe year ended December 31, 2006, general and administrative expensesincreased $2.9 million, or 37.9%, from the prior year due to increases inheadcount and office locations resulting from the acquisition of FastChannel. TheFastChannel division incurred $1.1 million of these costs during the year evenas attrition and lease terminations continued. Further, during 2005 we benefitedfrom a one-time expense reduction of $0.5 million from the renegotiationof an existing service agreement.

*Depreciationand Amortization.**  *Depreciationand amortization expense increased $2.2 million, or 34.9%, during the yearended December 31, 2006, primarily due to amortization of certainintangible assets of FastChannel which accounts for $1.9 million of theincrease. The remaining portion of the increase is from intangibles acquired inthe 2005 acquisition of MDX that incurred a full year’s amortization in 2006 ascompared to a partial year in 2005.

*Reductionin fair value of investments.*   During the yearended December 31, 2006, a loss from the reduction in fair value ofinvestments of $4.8 million occurred as the Company’s evaluation determinedthat its investment in Verance was other-than-temporarily impaired and theCompany fully impaired the investment value.

*Interest(income) expense and other (income) expense.**  *Interest and other expensedecreased $0.2 million, or 6.8%, for the year ended December 31,2006, as compared to the prior year period due to lower interest during periodslate in 2006 in which the Company paid off portions of the debt with proceedsfrom common stock issued.

*Provisionfor Income Taxes.**  *Forthe year ended December 31, 2006, the Company has recorded a valuationallowance on the deferred tax asset createdas a result of the write down of its investment in Verance. A valuationallowance was deemed necessary since the Company does not have adequate historyof generating capital gains to offset the capital loss when it occurs for taxpurposes, and therefore, ultimate realization of the benefit was not morelikely that not. Other than the aforementioned, the Company has no othervaluation allowance on the remainder of its deferred tax assets.

For the year ended December 31, 2006, income taxexpense related to continuing operations increased $3.1 million also as aresult of the increase in net income before taxes from continuing operations.In 2006, the Company recorded a valuation allowance of $0.9 millionrelated to the impairment charge recognized for its investment in Verance. Novaluation allowance was recorded in 2005.

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Incometax expense (benefit) differs from the amounts that would result from applyingthe federal statutory rate of 34% to the Company’s net income (loss) beforeincome taxes from continuing operations as follows (in thousands): 

| ** **                                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------|------------|----------|------------|----------|------------|
| Expected tax expense (benefit),  @ 34%                          |       | $        | 937        |     | $          | (932 | ) |
| State and foreign income  taxes, net of federal benefit         |       | 207      |       | (88      | )          |
| Other non-deductible  items (primarily meals and entertainment) |       | 358      |       | 252      |       |
| Change in valuation  allowance                                  |       | 876      |       | —   |       |
| Provision (benefit) for income taxes                            |       | $        | 2,378      |     | $          | (768 | ) |
| Effective tax rate                                              |       | 86       | %          | 28       | %          |

 

***Discontinued operations.  ******For the year ended December 31,2006, the StarGuide division, now classified as discontinued operations,generated a loss before taxes of $0.5 million as compared to income of $1.5million in 2005, which represents a reduction of $2.0 million or 137% inincome. The decrease is primarily attributable to certain revenue contractsthat expired during 2005 under which StarGuide was deferring profits over therelated contract period. Income taxes allocated to discontinued operationsresulted in an effective tax rate of 39% for 2006 and 2005, representing aFederal rate of 34% and a combined net state rate of 5%. As non-deductibleitems were insignificant, they had no impact on the effective rate.***

***2005 versus 2004***

*Revenues.**  *For the year ended December 31,2005, revenues decreased $1.7 million or 3.3%, as compared to the prioryear period. $5.2 million in revenue reductions are the result of a morecompetitive rate environment and a decrease in distribution volumes, especiallyby automobile manufacturers and movie studios. In addition, the year ended December 31,2004 contained $3.0 million in political revenues that did not recur in2005. This decrease was partially offset by revenues increases of$0.5 million, $1.7 million, and $1.3 million related theacquisition of MDX, Broadcast, and SourceEcreative, respectively.

*Cost of Revenues.**  *For the year ended December 31,2005, cost of revenues increased $3.2 million, or 11.2%, from the prioryear period. Increases in cost of revenues are attributable to the Company’sacquisition of MDX, Broadcast, and SourceEcreative, which account for increasesof $0.7 million, $1.3 million, and $0.5 million, respectively.

*Sales and Marketing.**  *Sales and marketing expensedecreased $0.3 million, or 8.2%, for the year ended December 31, 2005primarily due to the elimination of redundant expenses in acquired companies.

*Research and Development.**  *For the year ended December 31,2005, research and development expense decreased $0.4 million, or 27.2%,primarily due to increased capitalization of expenses related to internallydeveloped software.

*General and Administrative.**  *For the year ended December 31,2005, general and administrative expenses increased $1.3 million, or19.9%, from the prior year due to increases in headcount and office locationsresulting from the acquisitions of Broadcast and SourceEcreative, eachaccounting for $0.2 million of increase. The remaining portion of theincrease is due to increased professional fees of $0.5 million for audit, taxand legal costs related to acquired companies and higher costs of employeebenefit of $0.2 million.

*Depreciation andAmortization.**  *Depreciationand amortization expense increased $1.2 million, or 23.4%, during the yearended December 31, 2005, primarily due to depreciation and amortization of

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certain assetsacquired from Broadcast, which accounts for $0.5 million of the increase,from SourceEcreative, which accounts for $0.3 million and from MDX whichaccounts for $0.4 million.

*Restructuring charges.**  *DGF incurred restructuring chargesof $0.4 during the year ended December 31, 2005. Restructuring chargesrelate to lease termination costs for redundant facilities in New York andseverance benefits paid or accrued to employees hired in connection with theBroadcast acquisition, who were subsequently terminated.

*Interest (income) expenseand other (income) expense.**  *Interest and other expense increased$1.7 million, or 132.9%, for the year ended December 31, 2005, ascompared to the prior year. Interest expense increased $0.7 million, or56.7%, due to the debt incurred for acquisitions and working capital, as wellas $0.9 million recorded to write off certain deferred loan fees as aresult of DGF’s debt refinancing in April 2005 and debt covenant violationat December 31, 2005.

*Provision for Income Taxes.**  *For the year ended December 31,2005, as compared to the prior year, income tax benefit decreased $1.0 million,or 55.6%, due primarily to the reversal of DGF’s valuation allowance fordeferred tax assets which occurred in December 2004. At December 31,2005, DGF has no valuation allowance on its deferred tax assets. DGF consideredseveral factors in concluding that it was more likely than not that DGF wouldfully utilize its deferred tax assets including four consecutive years ofreporting taxable income and utilizing over $20 million of net operatingloss carryforwards and that DGF management expects to continue to generate theearnings necessary to utilize its deferred tax assets in future years.Accordingly, DGF has not recorded a valuation allowance on its deferred taxassets.

*Discontinued operations.  *For the year ended December 31, 2005, the StarGuide division, now classified asdiscontinued operations, generated income before taxes of $1.5 million ascompared to a loss of $6.2 million in 2004. 2004 contained a $8.1 million goodwillimpairment charge. Excluding the effect of the impairment charge, income beforetaxes would have been $1.9 million in 2004, representing a decrease of $0.4million or 21% in 2005. The reduction is related to certain revenue contractsthat expired during 2005 under which StarGuide was deferring profits over therelated contract period. Income taxes allocated to discontinued operationsresulted in an effective tax rate of 39% and 98% for 2005 and 2004,respectively. The effective tax rate in 2004 is impacted by the $8.1 milliongoodwill impairment charge, which was not deductible for tax purposes, and $6.7million of income tax benefit which was recognized when the Company reversedits valuation allowance on deferred tax assets. Excluding the effect of thoseitems, the effective tax rate would have been similar to the 2005 rate.

**Financial Condition**

Thefollowing table sets forth certain major balance sheet accounts of the Company asof December 31, 2006, 2005 and 2004 (in thousands): 

| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Assets:**                              | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash equivalents                |       | $                     | 24,474     |   | $ | 1,886 |   | $ | 8,059 |   |
| Accounts receivable, net                 |       | 15,433                |       | 10,363 |   | 12,022 |   |
| Property and equipment, net              |       | 12,829                |       | 11,494 |   | 10,692 |   |
| Long term investments                    |       | 5,180                 |       | 4,758 |   | — |   |
| Deferred income taxes, net               |       | 12,534                |       | 18,200 |   | 17,974 |   |
| Goodwill and intangible assets, net      |       | 100,657               |       | 61,639 |   | 51,388 |   |
| Liabilities:                             |       |                  |       |   |   |   |   |
| Accounts payable and accrued liabilities |       | 12,612                |       | 8,110 |   | 5,491 |   |
| Debt and capital leases                  |       | 19,840                |       | 24,532 |   | 18,103 |   |
| Stockholders’ Equity                |       | 141,886               |       | 80,207 |   | 79,432 |   |
|                                          |            |                       |            |  |  |  |  |  |  |  |

 

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Cash and cash equivalentsfluctuate with operating, investing and financing activities. In particular,cash and cash equivalents fluctuate with (i) operating results, (ii) the timingof payments, (iii) capital expenditures, (iv) acquisition and investment activity,(v) borrowings and repayments of debt, and (vi) capital raising activity.In December 2006, the Company raised $31.7 million through the issuance of commonstock, $4.8 million of which was used to invest in Point.360.

Accounts receivable generallyfluctuate with the level of revenues. As revenues increase, accounts receivabletend to increase. Days sales outstanding were 82 days, 73 days and 82 days asof December 31, 2006, 2005 and 2004, respectively.

Property and equipmenttend to grow with the level of revenues and with acquisition activity.Purchases of property and equipment have been approximately $3 million per yearfor each year presented.

Long term investmentsconsisted of (i) an investment in the common stock of Point.360 ($5.2 million),and (ii) an investment in the preferred stock of Verance ($4.8 million) atDecember 31, 2006 and 2005, respectively. The investment in Verance waswritten-down to zero during 2006 as a result of poor financial results andprospects.

Deferred income tax assets,net decreased in 2006 as a result of an increase in deferred income taxliabilities stemming from the purchase of FastChannel in May 2006. Thesedeferred tax liabilities primarily relate to the excess book basis over the taxbasis of certain identifiable intangibles ($3.5 million) and net operating losscarryforward utilization of $1.3 million.

Goodwill and intangibleassets increased as a result of the acquisitions of FastChannel in 2006 ($22million goodwill, $19 million intangible assets) and MDX in 2005 ($9 milliongoodwill, $1 million intangible assets), less amounts amortized. In connectionwith the acquisitions, the purchase price was allocated among the assetsacquired (including identifiable intangibles) and the liabilities assumed basedupon their estimated fair values, with any excess purchase price allocated togoodwill.

Accounts payable andaccrued liabilities increased as a result of the acquisitions of FastChannel in2006 ($13.0 million at acquisition date) and MDX in 2005 ($0.9 million atacquisition date). More particularly, a portion of the preacquisitionobligations of FastChannel and MDX remained unsettled at December 31, 2006. Inaddition, at December 31, 2006 the Company had an accrued liability of $1.1million for purchases of Point.360 common stock.

Debt and capital leases increasedin 2005 as a result of the issuance of a $6.5 million promissory note inconnection with the purchase of MDX. Debt and capital leases decreased and cashincreased in 2006 as a result of raising $31.7 million of net proceeds inconnection with a public equity offering in December 2006 and using a portionof such proceeds to retire debt.

Stockholders’ equityincreased in 2006 principally as a result of (i) issuing $27.4 million ofcommon stock in connection with the purchase of FastChannel in May 2006, and(ii) the sale of $31.7 million of common stock in connection with the publicequity offering in December 2006. 

**Liquidity and Capital Resources**

On a reported basis, netcash provided by operating activities for the year ended December 31, 2006was $9.6 million compared to $5.4 million for the year endedDecember 31, 2005. The increase of $4.2 million was primarily due to  (i) reductions in net loss ($.5 million) andfair value of long-term investments ($4.8 million), and (ii) increases innon-cash charges such as depreciation ($1.3 million), amortization ($1.2million) and deferred taxes ($1.5 million), partially offset by a net decreasein net operating assets and liabilities of $4.1 million.

The Company purchased propertyand equipment of $3.1 million during 2006, compared to $3.0 million in2005. In 2006, the Company used $4.8 million in cash to make an investment inthe common 

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stock ofPoint.360, Inc. The Company had used $5.1 million in 2005 to acquire anownership interest in Verance.

Net repayments of long-termdebt and capital leases was $10.4 million in 2006 versus ($0.5) millionfor 2005. This fluctuation was due to the new credit facility obtained by theCompany in February 2006, which was drawn against to payoff the priorcredit facility and provide working capital in addition to the funds receivedat the refinancing of the new credit facility in May 2006. Included in the2006 net repayments of $10.4 million was $3.5 million related to the MDX note.At December 31, 2005, the balance of the MDX note was $6.5 million. The MDXnote was repaid in 2006 from a combination of (i) $3.5 million cash drawn underthe Credit Agreement, and (ii) the issuance of 259,177 shares of the Company’scommon stock (valued at $3.0 million). In 2005, operating activities providedsufficient funds to reduce the line of credit in place at the time.

On February 10, 2006,the Company entered into a $25.0 million Credit Agreement with Wachovia Bank,N.A. This revolving credit facility replaced the prior credit facility. OnMay 31, 2006, the Company entered into an Amended and Restated CreditAgreement with Wachovia Bank, N.A. The facility, as amended, provides formaximum indebtedness of $35.0 million, made up of a term loan for $20.0million, and a revolving line of credit for $15.0 million. None of therevolving line of credit was drawn as of December 31, 2006. Borrowingsunder the facility bear interest at various rates over the applicable base rateor LIBOR. The facility, as amended, is not subject to any borrowing base,contains customary debt to EBITDA leverage tests (EBITDA is defined as earningsbefore interest, taxes, depreciation and amortization) and minimum EBITDAtests, provides for customary events of default, is guaranteed by all of theCompany’ subsidiaries, including FastChannel, and is secured by substantiallyall of the assets of the Company and its subsidiaries, including FastChannel,but excludes the stock and assets of its subsidiary that owns the assetsacquired from Media DVX. The term loan matures on May 31, 2009. Therevolving loans mature on June 30, 2011. At December 31, 2006, theinterest rate on the outstanding term loan was approximately 7.4%.

At December 31, 2006,the Company’s sources of liquidity included cash and cash equivalents of$24.5 million, while the Company’s debt consisted of (i) a term loan toWachovia Bank, N.A. totaling $19.6 million, (ii) the above referenced $15.0million undrawn revolving credit facility, and (iii) $0.2 million of capitallease obligations. The Company believes it has sufficient capital and capitalresources to sustain liquidity in the foreseeable future.

Effective on May 26,2006, the Company’s common stock was reverse split on a 1-for-10 basis.

The Company filed a shelfregistration statement with the SEC in October 2006. As a result of theshelf registration, the Company had the ability to offer, from time to time, upto 3,000,000 shares of its common stock and the selling stockholder namedtherein (the “Selling Stockholder”) had the ability to offer up to659,177 shares. On December 14, 2006, the Company entered into anunderwriting agreement (the “Underwriting Agreement”) withOppenheimer & Co., Inc., as representative of the severalunderwriters named therein (collectively, the “Underwriters”) and the sellingstockholder, related to a public offering of 2,556,000 shares of common stock,par value $0.001 per share, of the Company (the “Common Stock”) and 400,000shares of Common Stock of the Selling Stockholder at a price of $11.40 pershare. Under the terms of the Underwriting Agreement, the Company granted theUnderwriters an option, which they excercised in full, to purchase up to anadditional 443,400 shares of Common Stock to cover over-allotments, if any. Theoffering was made pursuant to the Company’s effective shelf registrationstatement on Form S-3, as amended and supplemented (Registration StatementNo. 333-137958) filed with the Securities and Exchange Commission.Net proceeds to the Company from the offering was $31.7 million.

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**Critical Accounting Policies**

The preparation offinancial statements in conformity with generally accepted accountingprinciples in the United States of America requires the Company to makeestimates and assumptions in determining the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from the Company’sestimates. The Company’s significant accounting policies and methods used inthe preparation of its Consolidated Financial Statements are discussed in Note2 of the Notes to Consolidated Financial Statements. Following is a discussionof our critical accounting policies.

***Business Combinations.******  ***The Company accounts forbusiness combinations under the purchase method of accounting. The total costof an acquisition is allocated to the underlying net assets, based on theirrespective estimated fair values. The excess of the purchase price over the estimatedfair values of the net assets acquired is recorded as goodwill. Determining thenature of identifiable intangible assets and the fair value of assets acquiredand liabilities assumed requires management’s judgment and often involves theuse of significant estimates and assumptions. The value assigned to a specificasset or liability, and the period over which an asset is depreciated oramortized can impact future earnings. Some of the more significant estimatesmade in business combinations relate to the values assigned to identifiableintangible assets, such as customer relationships and brand name, and theperiod over which these assets are amortized.

***Goodwill.******  ***On an annual basis, goodwill istested for impairment using a two-step process. The first step is to identify apotential impairment by comparing the fair value of a reporting unit with itscarrying amount. The estimated fair value of a reporting unit is determinedbased on a discounted cash flow analysis. A discounted cash flow analysisrequires us to make various assumptions, including assumptions about futurecash flows, growth rates and discount rates. The assumptions about future cashflows and growth rates are based on our long-term projections for each operatingsegment. The discount rate used reflects our average cost of funds. Ifnecessary, the second step of the goodwill impairment test compares the impliedfair value of the reporting unit’s goodwill with the carrying amount of thatgoodwill. To the extent the carrying amount of goodwill exceeds the impliedfair value a write-down of goodwill would be necessary. Both tests require the Companyto identify the reporting units to which goodwill is associated, a processwhich involves management judgment.

***Impairment of Long-Lived Assets.******  ***Long-lived assets principallyrelate to identifiable intangible assets, such as customer relationships andbrand name, and network equipment. In determining whether long-lived assets areimpaired, the accounting rules do not provide for an annual impairmenttest. Instead they require that a triggering event occur before testing anasset for impairment. Triggering events include poor operating performance,significant negative trends and significant changes in the use of such assets.Once a triggering event has occurred, the impairment test employed is based onwhether the intent is to hold the asset for continued use or to hold the assetfor sale. If the intent is to hold the asset for continued use, first acomparison of undiscounted future cash flows against the carrying value of theasset is performed. If the carrying value exceeds the undiscounted future cashflows, the asset would be written down to the discounted fair value. If theintent is to hold the asset for sale, then to the extent the asset’s carryingvalue is greater than its fair value less selling costs, an impairment loss isrecognized for the difference. The most significant assumption relates to theprojection of future cash flows.

***Allowance for Doubtful Accounts.******  ***Our allowance for doubtfulaccounts relates to trade accounts receivable. The allowance for doubtfulaccounts is an estimate prepared by management principally based on historicalcollection results by aging category (i.e., current, 1-30 days past due,31-60 days past due, etc.) with consideration given to specific customeraccounts and current economic conditions and trends. If the financial conditionof our customers were to deteriorate, additional allowances may be requiredwhich would adversely affect our earnings. Conversely, if the financialcondition of our customers were to 

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improve, we may berequired to reduce our allowance which would improve our earnings. As ofDecember 31, 2006, 2005 and 2004, our allowance for doubtful accounts was6.3%, 4.5% and 3.4% of gross accounts receivables, respectively. The increasein the allowance for doubtful accounts as a percentage of gross accountsreceivables is partially attributable to the acquisition of FastChannel in 2006and MDX in 2005.

***Income Taxes.******  ***Deferred taxes arise as aresult of temporary differences between amounts recognized in accordance withgenerally accepted accounting principles and amounts recognized for federalincome tax purposes. The Company has both deferred tax assets and deferred taxliabilities, which are shown on a net current and net non-current basis on theaccompanying consolidated balance sheets. Deferred tax assets relate primarilyto net operating loss (“NOL”) carryforwards. Deferred tax liabilities relateprimarily to intangible assets, such as customer relationships and brand namethat have little or no tax basis.

Valuation allowances are provided against deferred taxassets if a determination is made that their ultimate realization is not “morelikely than not” (i.e., not likely). Significant judgment is required in makingthese assessments, which generally relate to an acquired operation generatingfuture taxable income. At December 31, 2006, the Company had established avaluation allowance of approximately $13.1 million, the vast majority of whichrelates to NOL carryforwards acquired in the acquisition of FastChannel. TheCompany will maintain a full valuation allowance on these acquired NOLcarryforwards until a determination is made as to the extent to which theseacquired NOL carryforwards are limited under Section 382 of the InternalRevenue Code. Any future reduction in the valuation allowance of theFastChannel NOL’s will result in a decrease to goodwill.

***RevenueRecognition.  ***We derive revenue from services which consist primarily ofrevenue for digital and analog audio, video, videotape distribution and mediaresearch resources.

Our services revenue from digital distribution ofaudio and video advertising content is billed based on a rate per transmission,and we recognize revenue for these services upon notification of successfultransmission of the content at the broadcast destination. Revenue fordistribution of analog audio and video content by tape is recognized whendelivery has occurred, which is at the time the tapes are delivered to a commoncarrier.

Our online creative research revenue is generated on asubscription basis, where customers pay either monthly, quarterly,semi-annually, or annually in order to access our database. We recognizerevenue ratably over the subscription period.

Media production and duplication includes a variety ofancillary services such as storage of client masters or other physicalmaterial, for which revenue is recognized monthly, after the storage servicehas been performed. Revenue related to our other services is recognized on aper transaction basis after the service has been performed. If the serviceresults in a tape or other deliverable, revenue is recognized when delivery hasoccurred, which is at the time the tape or other deliverable is in thepossession of the common carrier.

Customers pay a fixed fee per month for our mediaasset management and broadcast verification services. We recognize revenueratably over the service period.

***Adoption of Staff Accounting Bulletin No. 108.  ***On September 13, 2006, the SECissued Staff Accounting Bulletin No. 108 (“SAB No. 108”). SAB No. 108 expressesthe SEC Staff’s views regarding the process of evaluating materiality of financialstatement misstatements. SAB No. 108 addresses the diversity in evaluatingmateriality of financial statement misstatements and the potential undercurrent practice used by the Company for the build up of improper amounts onthe balance sheet. SAB No. 108 is effective for the Company for the year endedDecember 31, 2006. As allowed by SAB No. 108, the cumulative effect of theinitial application of SAB No. 108 has been reported in the carrying amounts ofassets and liabilities as of the beginning of fiscal 2006, with the offsettingbalance to retained earnings. Upon adoption, the 

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Company recorded an increase to accrued liabilities of $0.1million, an increase in deferred tax liabilities of approximately $0.3 millionto record liabilities not previously identified and a decrease in retainedearnings of approximately $0.4 million to correct errors in previous years thatwere considered immaterial under the Company’s previous method of evaluatingmateriality.

**New Accounting Pronouncements**

In September 2006, the SECpublished SAB No. 108, “Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements.” SAB No.108 addresses quantifying the financial statement effects of misstatements,specifically, how the effects of prior year uncorrected errors must beconsidered in quantifying misstatements in the current year financialstatements. SAB No. 108 is effective for fiscal years ending after November 15,2006. The adoption of SAB No. 108 by the Company in the fourth quarter of 2006is discussed in Note 2 to the financial statements. 

In December 2004, the FASBissued SFAS No. 123R “Share Based Payment.” SFAS No. 123R is a revision to SFAS123 and supersedes APB Opinion No. 25 and amends FASB Statement No. 95,“Statement of Cash Flows.” SFAS No. 123R requires a public entity to expensethe cost of employee services received in exchange for an award of equityinstruments. It provides guidance on valuing and expensing these awards, aswell as disclosure requirements of these equity arrangements. SFAS No. 123Ralso requires the benefits of tax deductions in excess of recognizedcompensation cost to be reported as a financing cash flow, rather than as anoperating cash flow as required under previous literature. This requirement reducesnet operating cash flows and increases net financing cash flows in periodsafter adoption. SFAS No. 123R permits an issuer to use either a prospective orone of two modified versions of retrospective application under which financialstatements for prior periods are adjusted on a basis consistent with the proforma disclosures required for those periods by the original SFAS No. 123. Asmodified by the SEC on April 15, 2005, SFAS No. 123R is effective for the firstannual or interim reporting period of the registrant’s first fiscal year thatbegins after June 15, 2005. The Company has implemented this pronouncementeffective at the beginning of the fiscal year ended December 31, 2006.

In December 2004, the FASBissued SFAS No. 153, “Exchanges of Nonmonetary Assets, an amendment of APBOpinion No. 29.” SFAS No. 153 is based on the principle that exchanges ofnonmonetary assets should be measured based on the fair value of the assetsexchanged. APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” providedan exception to its basic measurement principle (fair value) for exchanges ofsimilar productive assets. Under APB Opinion No. 29, an exchange of aproductive asset for a similar productive asset was based on the recordedamount of the asset relinquished. SFAS No. 153 eliminates this exception andreplaces it with an exception for exchanges of nonmonetary assets that do nothave commercial substance. SFAS No. 153 became effective for the Company as ofJuly 2, 2005, and did not have a material impact on our consolidated financialstatements. 

In May 2005, the FASBissued SFAS No. 154, “Accounting Changes and Error Corrections, a replacementof Accounting Principles Board (“APB”) Opinion No. 20 and FASB Statement No. 3.”SFAS No. 154 requires retrospective application to prior periods' financialstatements of a voluntary change in accounting principle unless it isimpracticable. APB Opinion No. 20, “Accounting Changes,” previously requiredthat most voluntary changes in accounting principle be recognized by includingin net income of the period of the change the cumulative effect of changing tothe new accounting principle. SFAS No. 154 became effective for the Company onJanuary 1, 2006. The adoption of SFAS No. 154 did not have a material impact onour consolidated financial statements. 

In September 2006, theFASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fairvalue, establishes a framework for measuring fair value and expands disclosurerequirements about fair value measurements. SFAS No. 157 is effective for theCompany on January 1, 2008. We believe the adoption of SFAS No. 157 will nothave a material impact on our consolidated financial statements. 

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In February 2007, the FASBissued SFAS No. 159, “The Fair Value Option for Financial Assets and FinancialLiabilities—Including an amendment of FASB Statement No. 115.” SFAS No. 159permits entities to choose to measure many financial instruments and certainother items at fair value. Unrealized gains and losses on items for which thefair value option has been elected will be recognized in earnings at eachsubsequent reporting date. SFAS No. 159 is effective for the Company on January1, 2008. The Company is evaluating the impact the adoption of SFAS No. 159 willhave on our consolidated financial statements. 

In July 2006, the FASBissued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”(“Interpretation No. 48”). Interpretation No. 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with SFAS No. 109, “Accounting for Income Taxes.” InterpretationNo. 48 prescribes a recognition threshold and measurement attribute for thefinancial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. Interpretation No. 48 also providesguidance on derecognition, classification, interest and penalties, accountingin interim periods, disclosure and transition. For the Company, Interpretation No.48 was effective beginning January 1, 2007, and the cumulative effectadjustment, if any, will be recorded in the first quarter of 2007. We believe theadoption of Interpretation No. 48 will not have a material impact on ourconsolidated financial statements.

**Contractual Payment Obligations**

Thetable below summarizes the Company’s contractual obligations, includingestimated interest, at December 31, 2006 (in thousands): 

| ** **                            | ** ** | ** ** | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------------|------------|------------|------------|-------------------------------------------|------------|
| **Contractual Obligation**       | ** ** | ** ** | ** ** | **Total**                                 | ** ** | **Less Than  1 Year** | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **After 5  Years** | ** ** |
| Long-Term Debt                        |       | $          | 23,217     |                                      |       | $ | 5,258 |   |   | $ | 15,313 |   | $ | 2,646 |   |   | $ | — |   |   |
| Capital Leases                        |       | 240        |       |                                      | 240        |   |   | — |   | — |   |   |   |   |   |
| Operating Leases                      |       | 11,685     |       |                                      | 2,810      |   |   | 7,300 |   | 1,575 |   |   | — |   |   |
| Employment Contracts                  |       | 2,126      |       |                                      | 1,004      |   |   | 1,122 |   | — |   |   | — |   |   |
| Unconditional Purchase  Obligations   |       | 5,947      |       |                                      | 2,246      |   |   | 3,701 |   | — |   |   | — |   |   |
| Total Contractual Payment Obligations |       | $          | 43,215     |                                      |       | $ | 11,558 |   |   | $ | 27,436 |   | $ | 4,221 |   |   | $ | — |   |   |
|                                       |            |            |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Off-Balance Sheet Arrangements**

The Company has enteredinto operating leases for all of its office facilities and certain equipmentrentals. Generally these leases are for periods of three to five years andusually contain one or more renewal options. The Company uses leasingarrangements to preserve capital. The Company expects to continue to leasethe majority of its office facilities under arrangements substantiallyconsistent with the past. For the years ended December 31, 2006, 2005 and2004 rent expense for all operating leases amounted to approximately $3.4million, $2.7 million and $2.4 million, respectively. 

Other than its operatingleases, the Company is not a party to any off-balance sheet arrangement thatmanagement believes is reasonably likely to have a current or future effect onthe Company’s financial condition, revenues or expenses, results of operations,liquidity, capital expenditures or capital resources that is material toinvestors. 

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is thepotential loss arising from adverse changes in market rates and prices, such asinterest rates and changes in the market value of financial instruments.

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***Foreign Currency Exchange Risk***

The Company provides verylimited services to entities located outside of the United States and,therefore, believes that the risk that changes in exchange rates will adverselyimpact its results of operations is remote. Historically, our foreign currencyexchange gains and losses have been immaterial.

**Interest Rate Risk**

DGF has issuedvariable-rate debt that, at December 31, 2006, had an outstanding balance of$19.6 million. Based on DGF’s variable-rate obligations outstanding at December31, 2006, each 25 basis point increase or decrease in the level of interestrates would, respectively, increase or decrease DGF’s annual interestexpense and related cash payments by approximately $0.1 million. Suchpotential increases or decreases are based on certain simplifying assumptions,including a constant level of variable-rate debt for all maturities and animmediate, across-the-board increase or decrease in the level of interest rateswith no other subsequent changes for the remainder of the period. Conversely,since almost all of the Company’s cash balances of approximately $ 24.5million is invested in variable-rate interest earning assets, the Company wouldalso earn more (less) interest income due to such an increase (decrease) in interestrates.

**Equity Risk**

The Company is exposed tomarket risk as it relates to changes in the market value of its investments.The Company invests in equity instruments of private companies for operationaland strategic business purposes. These securities are subject to significantfluctuations in fair market value due to the volatility of the stock market andthe industries in which the companies operate. These securities, which areclassified in Long-term Investments, including available-for-sale securities onthe accompanying consolidated balance sheet, include equity-method investments,investments in private securities, available-for-sale securities, restrictedsecurities and equity derivative instruments. As of December 31, 2006, theCompany’s investment in Verance was reduced to $0.

**ITEM8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

The information requiredby this Item is set forth in the Company’s Consolidated Financial Statementsand the Notes thereto beginning at Page F-1 of this report.

**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM9A.**        CONTROLS AND PROCEDURES

**Evaluation of Disclosure Controls and Procedures**

We maintain disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in our Exchange Act reports is recorded, processed, summarizedand reported within the time periods specified by the SEC’s rules andforms, and that such information is accumulated and communicated to ourmanagement team, including our Chief Executive Officer (our principal executiveofficer) and Chief Financial Officer (our principal financial officer), orpersons performing similar functions, as appropriate, to allow for timelydecisions regarding required disclosure. In designing and evaluating theCompany’s disclosure controls and procedures, management recognizes that anycontrols and procedures, no matter how well designed and operated, can provideonly reasonable assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating andimplementing possible controls and procedures.

We carried out anevaluation, under the supervision and with participation of our management,including our Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and 

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operationof our disclosure controls and procedures as of December 31, 2006. Basedupon that evaluation, our Chief Executive Officer and Chief Financial Officerconcluded the disclosure controls and procedures were not effective at areasonable assurance level as of December 31, 2006 due to a materialweakness in our internal control over financial reporting described below.

**Internal Control over Financial Reporting**

Internalcontrol over financial reporting refers to a process designed by, or under thesupervision of, our Chief Executive Officer and Chief Financial Officer andeffected by our board of directors, management and other personnel, to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles and includes those policies andprocedures that:

·       pertainto the maintenance of records that in reasonable detail accurately and fairlyreflect the transactions and dispositions of our assets;

·       providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that our receipts and expenditures are being madeonly in accordance with authorizations of our management and members of ourboard of directors; and

·       providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of our assets that could have a materialeffect on our financial statements.

In connection with thepreparation of our financial statements for the year ended December 31,2006 and the related audit by our independent registered public accountingfirm, KPMG LLP, management identified a material weakness in our internalcontrol over financial reporting related to certain deficiencies in thecontrols surrounding monitoring and oversight of accounting and financialreporting related to business combinations and stock compensation. The PublicCompany Accounting Oversight Board’s Auditing Standard No. 2 defines amaterial weakness as a significant deficiency, or combination of significantdeficiencies, that results in a more than a remote likelihood that a materialmisstatement of the annual or interim financial statements will not beprevented or detected.

Specifically, we did nothave sufficient personnel with adequate knowledge regarding accounting for businesscombinations and stock compensation expense to ensure that these transactionsare accounted for in accordance with generally accepted accounting principles.In addition, we did not have adequate policies and procedures regarding ouraccounting related to completed business combinations and stock compensation.These control deficiencies required us to make audit adjustments related ouraccounting for the FastChannel acquisition and related to our recordation ofstock compensation expense.

**Limitations on Internal Control Over FinancialReporting**

Internal control overfinancial reporting cannot provide absolute assurance of achieving financialreporting objectives because of its inherent limitations. Internal control overfinancial reporting is a process that involves human diligence and complianceand is subject to lapses in judgment and breakdowns resulting from humanfailures. Internal control over financial reporting also can be circumvented bycollusion or improper override. Because of such limitations, there is a riskthat material misstatements may not be prevented or detected on a timely basisby internal control over financial reporting. However, these inherentlimitations are known features of the financial reporting process, and it ispossible to design into the process safeguards to reduce, though not eliminate,this risk.

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**RemediationEfforts**

Toremediate the material weakness described above and enhance our internalcontrol over financial reporting, we made the following plans to accomplish theremediation. The progress we made to implement these remediation plans isdescribed below.

·       Werequired members of our corporate accounting staff to receive training on businesscombinations and stock compensation on an ongoing basis.

Two senior levelaccounting personnel have received formal training related to businesscombinations. These seminars were attended in the months of May and September2007.

·       Wedetermined to add at least one senior level controller with significantaccounting and financial reporting experience to strengthen the corporateaccounting staff.

This person washired and began employment with the Company in April 2007.

·       Werevised our internal control over financial reporting for non-routine businesscombinations transactions and stock compensation to require our accountingstaff to take prescribed steps for such transactions, including: engaging externalaccounting advisors, establishing work groups, action plans, or monitoringmeetings based on the nature of the event, in each case in an effort to ensurethat individuals from the appropriate departments are involved, communicationis thorough, and action items are addressed.

The Company had atDecember 31, 2006 and continues to have a relationship with an externalaccounting advisor. This advisor was consulted with respect to the businesscombinations that occurred in the Company’s second and third quarters of 2007. Specifically,the advisor has been and continues to consult with the Company on tax mattersrelating to business combinations.

·       Werevised our internal control over financial reporting to require the completionof a detailed business combinations checklist when acquisitions are completedin order to ensure purchase price consideration is complete and adequatelyrecorded and the performance of ongoing reviews of existing acquisition accrualbalances and accounting procedures designed to ensure proper accounting forbusiness combination activities.

In July 2007, theCompany completed the preparation of its business combination checklist. Thechecklist was utilized in connection with the business combinations thatoccurred in the Company’s second and third quarters. While the Companyroutinely reviews accrual balances, including acquisition related accrualbalances, the Company has added a step on its quarterly close checklist tospecifically address the ongoing review of acquisition related accrualbalances.

Although we have implementedremediation efforts, the existence of the material weaknesses described aboveindicates that there is a more than remote likelihood that a materialmisstatement of our financial statements will not be prevented or detected in afuture period. In addition, we cannot assure you that we will not in the futureidentify additional material weaknesses or significant deficiencies in ourinternal control over financial reporting that we have not discovered to date.The remediation efforts we commenced in the first quarter of 2007 are subjectto continued management review supported by confirmation and testing bymanagement and audit committee oversight. As a result, additional changes areexpected to be made to our internal control over financial reporting.

There has been no changein our internal control over financial reporting during the quarter endedDecember 31, 2006 that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

**ITEM9B.**       OTHER INFORMATION

Not applicable.

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**PART III**

**Item10.**                 DIRECTORS,EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

**Executive Officers and Directors**

Thefollowing table sets forth certain information concerning our executiveofficers and directors as of March 31, 2007: 

| **Name**                | ** ** | ** ** | ** ** | **Age**                                           | ** ** | **Title(s)** | ** ** | **Expiration  of Term as  Director** |
|-------------------------|------------|------------|------------|---------------------------------------------------|------------|--------------|------------|------------------------------------------------|
| Scott K. Ginsburg(1)    |       | 54         |       | Chief Executive Officer and Chairman of the Board |       | 2007         |
| Omar A. Choucair(1)     |       | 45         |       | Chief Financial Officer and Director              |       | 2009         |
| William Donner(2)       |       | 54         |       | Director                                          |       | 2008         |
| Lisa C. Gallagher(3)    |       | 50         |       | Director                                          |       | 2009         |
| Kevin C. Howe(2),(3)    |       | 58         |       | Director                                          |       | 2008         |
| David M. Kantor(3)      |       | 50         |       | Director                                          |       | 2009         |
| Anthony J. LeVecchio(2) |       | 60         |       | Director                                          |       | 2008         |
| Neil H. Nguyen          |       | 33         |       | Executive Vice President of Sales and Operations  |       | N/A          |
| Pamela Maythenyi        |       | 51         |       | Senior  Vice President of SourceEcreative         |       | N/A          |

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(1)          Memberof the Executive Committee

(2)          Memberof the Audit Committee

(3)          Memberof the Compensation Committee

*Scott K. Ginsburg*joined the Company in December 1998 as Chief Executive Officer andChairman of the Board. In July 1999, Matthew E. Devine assumed theresponsibilities as Chief Executive Officer, but Mr. Ginsburg remained theCompany’s Chairman. Mr. Ginsburg reassumed the responsibilities as ChiefExecutive Officer of the Company in November 2003 following Mr. Devine’sresignation. Mr. Ginsburg founded the Boardwalk Auto Group in 1998, whichconsists of several car dealerships located in the Dallas area. From 1997 to1998, Mr. Ginsburg served as Chief Executive Officer and Director ofChancellor Media Corporation (now part of Clear ChannelCommunications, Inc.). Mr. Ginsburg founded Evergreen MediaCorporation in 1988, and was the co-founder of StatewideBroadcasting, Inc. and H&G Communications, Inc. Mr. Ginsburgearned a B.A. from George Washington University in 1974 and a J.D. fromGeorgetown University in 1978.

*Omar A. Choucair***joined the Company as Chief FinancialOfficer in July 1999 and has been a member of the Board of Directors ofthe Company since November 2000. Prior to joining the Company,Mr. Choucair served as Vice President of Finance for AMFM, Inc.(formerly Chancellor Media Corporation) and served as Vice President of Financefor Evergreen Media Corporation before it was acquired by Chancellor MediaCorporation in 1997. Prior to entering the media industry, Mr. Choucairwas a Senior Manager at KPMG LLP, where he specialized in media andtelecommunications clients. Mr. Choucair received a B.B.A. from BaylorUniversity.

*William Donner*has been a member of the Board of Directors of the Company since May 2006after having served as a director of FastChannel Network, Inc. Since 2004,Mr. Donner has served as CEO of MedCommons, a personal health recordstorage and transport company. In the early 1980s, Mr. Donner built andran Precision Business Systems, a Wall Street based systems integrator.Precision Business Systems was sold to Bank of America in 1988 andsubsequently, a division was sold to Reuters, PLC, where Mr. Donner ranthe Reuters Dealing 2001 and 2002 Trading Services. In 1994, Mr. Donnerwas named Chief Architect of Reuters where he ran the central research group.Mr. Donner joined the Greenhouse Group, Reuters’ corporate venture capitalarm, in 1996. In 1999, Mr. Donner joined Fenway Partners, a private equityfund, where he led the technology investment group. Mr. Donner holds aB.S.E.E. from Massachusetts Institute of Technology.

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*Lisa C. Gallagher***has been a member of the Board ofDirectors of the Company since May 2006 after having served first as adirector, and most recently as Chairman of the Board of Directors, ofFastChannel Network, Inc. since 2002. Since 2003, Ms. Gallagher hasserved as the Senior Vice President and Chief Operating Officer of HawtanLeathers, a privately held international manufacturer of specialty leathers forthe garment industry. She previously spent over 20 years as both a commercialas well as investment banker specializing in media transactions. She startedher banking career in the early 1980s at the Bank of Boston and in 1997 movedto its investment bank, BancBoston Securities as Managing Director to run theirMedia &Communications Group. In 1998 she became Managing Director andGroup head of the Internet/Media Convergence Group of Robertson Stephens, aleading high technology investment banking firm, upon the BancBoston Securitiesacquisition of Robertson Stephens. After leaving Robertson Stephens in 2001,she worked for Remy Capital Partners, a small investment banking boutique,before joining Hawtan Leathers. Ms. Gallagher holds a B.A. from MountHolyoke College and an M.B.A. from the Simmons Graduate School of Management inBoston.

*Kevin C. Howe*has been a member of the Board of Directors of the Company sinceFebruary 2001. Since 1999, he has been the Managing Partner of MercuryVentures. Mercury Ventures manages six different funds that invest in emergingtechnology companies that focus on Internet applications. Mr. Howe serveson the board of The Sage Group, plc. which is traded on the London StockExchange. Mr. Howe also sits on the boards of seven privately held technologyfirms. In 1985, he co-founded DacEasy, an early leader in packaged applicationsoftware. In 1987, Mr. Howe led the sale of DacEasy to Insilco (a Fortune500 company). In 1991, Mr. Howe led the carve-out of DacEasy from Insilcoand subsequent sale to The Sage Group, plc. which had market capitalization ofover $7 billion. He was Chief Executive Officer of the US operations of TheSage Group, plc. responsible for operations and acquisitions until 1999. In1993, Mr. Howe also co-founded Martin Howe Associates, which was an earlyleader in the merchant credit card processing industry and a pioneer inwireless solutions. The company was sold in 1997 to PMT Services, Inc., aNasdaq listed company. Mr. Howe received his MBA from Southern MethodistUniversity in 1976.

*David M. Kantor***has been a member of the Board ofDirectors of the Company since August 1999. Since 2003, Mr. Kantorhas been Vice Chairperson and Chief Executive Officer of Reach Media, a companythat develops, acquires and partners in quality media and marketingopportunities targeting the African-American population. Formerly, he wasSenior Vice President for Network Operations of AMFM, Inc. (formerlyChancellor Media Corporation) and President of ABC Radio Network, havingpreviously served as Executive Vice President. Prior to joining ABC RadioNetwork, he held executive positions with Cox Cable and Satellite MusicNetwork. Mr. Kantor holds a B.S. from the University of Massachusetts andan MBA from Harvard Business School.

*Anthony J. LeVecchio*has been a member of the Board of Directors of the Company sinceAugust 2004. Since its formation in 1988, he has been the President of TheJames Group, a general business consulting firm that has advised clients acrossa range of high-tech industries. Prior to forming The James Group in 1988,Mr. LeVecchio was the Senior Vice President and Chief Financial Officerfor VHA Southwest, Inc., a regional healthcare system. He currently serveson the Board of Directors of Microtune, Inc., a company that is listed onthe Nasdaq Global Market, and serves as the Chairman of its Audit Committee. Hecurrently serves on the Board of Directors of Ascendent Solutions, Inc., acompany that is tracked on the OTC Bulletin Board and serves as the Chairman ofits Audit Committee. He also serves on the Board of Directors of ViewpointFinancial Group, a Plano, Texas based bank holding group traded on the NasdaqGlobal Select Market and is on their audit and compensation committees.

*Neil H. Nguyen***joined the Company as Executive VicePresident of Sales and Operations in March 2005. Prior to joining theCompany, from 1998 to 2002, Mr. Nguyen served as President of Point.360’sMultiMedia Group and also served in various senior management roles atFastChannel Network including Executive Vice President, Strategic Planning andVice President Global Sales and 

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BusinessDevelopment from 2003 to 2005. Mr. Nguyen received a B.S. from CaliforniaState University, Northridge.

*Pamela Maythenyi***joined the Company as Senor VicePresident of SourceEcreative in August 2004. Prior to joining the Company,Ms. Maythenyi owned The Source Maythenyi (also known as Source TV),which she formed in 1988 and sold to the Company in 2004, at which time she washired by the Company to oversee that division, now known as SourceEcreative.Formerly, she was a producer for BBDO and executive producer for J. WalterThomson. Ms. Maythenyi received a B.A. from the University of Florida.

**Corporate Governance**

***Independence***

The Board of Directors hasdetermined, after considering all of the relevant facts and circumstances, thateach of Mr. Howe, Mr. Kantor, Mr. LeVecchio, Mr. Donner andMs. Gallagher is independent from our management, and is an “independentdirector” as defined under the Nasdaq Marketplace Rules. This means that noneof those directors (1) is an officer or employee of the Company or itssubsidiaries or (2) has any direct or indirect relationship with theCompany that would interfere with the exercise of his or her independentjudgment in carrying out the responsibilities of a director. As a result, theCompany has a majority of independent directors as required by the NasdaqMarketplace Rules.

***Code of BusinessConduct and Ethics***

The Company has adopted aCode of Business Conduct and Ethics that applies to its directors, officers andemployees. A copy of the Company’s Code of Business Conduct and Ethics isavailable on its website at *www.dgfastchannel.com*by clicking first on “Who We Are,” then on “Careers & Ethics.”  The Company will also provide a copy of itsCode of Business Conduct and Ethics, without charge, to any stockholder who sorequests in writing.

***Executive Sessionsof Independent Directors***

The Company’s independentdirectors have executive sessions at which only independent directors arepresent after every regularly scheduled meeting of the Board of Directors.Mr. Howe presides over these executive sessions.

***Communications withthe Board of Directors***

Stockholders maycommunicate with the Board of Directors by writing to the Board in care of theCompany’s Secretary, DG FastChannel, Inc., 750 West John CarpenterFreeway, Suite 700, Irving, Texas 75039. The Board of Directors hasdelegated responsibility for initial review of stockholder communications tothe Company’s Secretary. In accordance with the Board’s instructions, theSecretary will forward the communication to the director or directors to whomit is addressed, except for communications that are (1) advertisements orpromotional communications, (2) solely related to complaints by users withrespect to ordinary course of business customer service and satisfaction issuesor (3) clearly unrelated to our business, industry, management or Board orcommittee matters. In addition, the Secretary will make all communicationsavailable to each member of the Board, at the Board’s next regularly scheduledmeeting.

**Board Committees**

The Board of Directors ofthe Company has three standing committees: the Audit Committee, theCompensation Committee and the Executive Committee. None of the directors whoserve as members of the Audit Committee or the Compensation Committee areemployees of the Company or any of its subsidiaries. The Company has nonominating committee or committee that recommends qualified candidates to theBoard of Directors for nomination or election as directors.

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***Audit Committee***

The Audit Committeeoperates under an Amended and Restated Charter of the Audit Committee adoptedby the Company’s Board of Directors, a copy of which was attached as *Appendix A* to the Company’s 2004 Proxy Statement.

TheAudit Committee’s functions include:

·       engagingindependent auditors and determining their compensation;

·       makingrecommendations to the Board of Directors for reviewing the completed audit andaudit report with the independent auditors, the conduct of the audit,significant accounting adjustments, recommendations for improving internalcontrols, and all other significant findings during the audit;

·       meetingat least quarterly with the Company’s management and auditors to discussinternal accounting and financial controls, as well as results of operationsreviews performed by the auditors;

·       determiningthe scope of and authorizing or approving any permitted nonaudit servicesprovided by the independent auditors and the compensation for those services;and

·       initiatingand supervising any special investigation it deems necessary regarding theCompany’s accounting and financial policies and controls.

The Audit Committee iscomposed solely of directors who are not officers or employees of the Companyand who, the Company believes, have the requisite financial literacy to serveon the Audit Committee, have no relationship to the Company that mightinterfere with the exercise of their independent judgment, and meet thestandards of independence for members of an audit committee under therules of the Securities and Exchange Commission (the “SEC”) and under theNasdaq Marketplace Rules.

In accordance with therules and regulations of the SEC, the preceding paragraph regarding theindependence of the members of the Audit Committee shall not be deemed to be“soliciting material” or to be “filed” with the SEC or subject to Regulations14A or 14C of the Securities Exchange Act of 1934, as amended (the “ExchangeAct”), or to the liabilities of Section 18 of the Exchange Act and shallnot be deemed to be incorporated by reference into any filing under theSecurities Act of 1933, as amended (the “Securities Act”), or the Exchange Act,notwithstanding any general incorporation by reference of this section of thisProxy Statement into any other filed document.

Messrs. LeVecchio(Chairman), Donner and Howe are the current members of the Audit Committee. TheBoard of Directors, after reviewing all of the relevant facts, circumstancesand attributes, has determined that Mr. LeVecchio, the Chairman of theAudit Committee, is the sole “audit committee financial expert” on the AuditCommittee.

***CompensationCommittee***

TheCompensation Committee’s functions include:

·       establishingand administering the Company’s compensation policies;

·       determining,or recommending to the Board, the compensation of the Company’s executiveofficers;

·       administeringthe Company’s equity compensation plans; and

·       overseeingthe administration of other employee benefit plans and fringe benefits paid to orprovided for the Company’s officers.

See “ExecutiveCompensation—Compensation Committee Report” below. Messrs. Howe (Chairman)and Kantor and Ms. Gallagher are the current members of the CompensationCommittee. All current members of the Compensation Committee are “independentdirectors” as defined under the Nasdaq Marketplace Rules.

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***Executive Committee***

The Executive Committeewas established in January 2001. The Executive Committee has theauthority, between meetings of the Board of Directors, to take all actions withrespect to the management of the Company’s business that require action by theBoard of Directors, except with respect to certain specified matters that bylaw must be approved by the entire Board of Directors. Messrs. Ginsburgand Choucair are the current members of the Executive Committee.

**Attendance at Meetings of the Board of Directors and Committees**

During 2006, the Board ofDirectors held five meetings. The Audit Committee held five meetings during2006, and the Compensation Committee did not have any meetings during 2006.Instead, all issues normally considered by the Compensation Committee wereconsidered by the entire Board of Directors. All persons who were directorsduring 2006 attended at least 75% of the total of the Board meetings and themeetings of committees on which they served that were held while such personserved as a director.

**Nominations to the Board of Directors**

The Board of Directorsdoes not have a nominating committee or other committee that recommendsqualified candidates to the Board for nomination or election as directors. TheBoard of Directors believes that, because of its relatively small size, it issufficient for the independent directors to select or recommend directornominees. The Board of Directors has adopted a nominations process thatprovides that the Company’s independent directors (as defined under the NasdaqMarketplace Rules), acting by a majority, are authorized to recommendindividuals to the Board of Directors for the Board’s selection as directornominees. Under the rules promulgated by the SEC, the independentdirectors are, therefore, treated as a “nominating committee” for the purposeof the disclosures in this section.

With respect to thenominations process, the independent directors do not operate under a writtencharter, but under resolutions adopted by the Board of Directors.

Theindependent directors are responsible for reviewing and interviewing qualifiedcandidates to serve on the Board of Directors, for making recommendations tothe full Board for nominations to fill vacancies on the Board, and forselecting the management nominees for the directors to be elected by theCompany’s stockholders at each annual meeting. The independent directors havenot established specific minimum age, education, experience or skillrequirements for potential directors. The independent directors have, however,been authorized by the Board of Directors to take into account all factors theyconsider appropriate in fulfilling their responsibilities to identify andrecommend individuals to the Board as director nominees. Those factors mayinclude, without limitation, the following:

·       anindividual’s business or professional experience, accomplishments, education,judgment, understanding of the business and the industry in which the Companyoperates, specific skills and talents, independence, time commitments,reputation, general business acumen and personal and professional integrity orcharacter;

·       thesize and composition of the Board and the interaction of its members, in eachcase with respect to the needs of the Company and its stockholders; and

·       regardingany individual who has served as a director of the Company, his pastpreparation for, attendance at, and participation in meetings and otheractivities of the Board or its committees and his overall contributions to theBoard and the Company.

The independent directors may use multiple sources foridentifying and evaluating nominees for directors, including referrals from theCompany’s current directors and management as well as input from third parties,including executive search firms retained by the Board. The independentdirectors will obtain background information about candidates, which mayinclude information from directors’ and officers’ 

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questionnaires andbackground and reference checks, and will then interview qualified candidates.The Company’s other directors will also have an opportunity to meet andinterview qualified candidates. The independent directors will then determine,based on the background information and the information obtained in theinterviews, whether to recommend to the Board of Directors that a candidate benominated to the Board.

The independent directorswill consider qualified nominees recommended by stockholders, who may submitrecommendations to the independent directors in care of the Company’s Board ofDirectors through a written notice as described under “—Corporate Governance—Communicationswith the Board of Directors” above. To be considered by the independentdirectors, a stockholder nomination (1) must be submitted by May 1,2008, (2) must contain a statement by the stockholder that suchstockholder holds, and has continuously held for at least a year before thenomination, at least $2,000 in market value or 1% of the shares of Common Stockand that such stockholder will continue to hold at least that number of sharesthrough the date of the annual meeting of stockholders, and (3) must beaccompanied by a description of the qualifications of the proposed candidateand a written statement from the proposed candidate that he or she is willingto be nominated and desires to serve, if elected. Nominees for director who arerecommended by the Company’s stockholders will be evaluated in the same manneras any other nominee for director.

**DirectorCompensation**

Directors of the Companyreceive compensation for services provided as a director as well asreimbursement for documented reasonable expenses incurred in connection withattendance at meetings of the Board and the committees thereof. Other than Mr. LeVecchio,the Company pays its directors $2,500 per Board meeting attended, plus $1,000per meeting of each committee or special assignments of the Board. Mr. LeVecchiois paid $25,000 as an annual retainer, $1,000 for each meeting of the Boardattended, and $750 for each meeting of the Audit Committee attended. Directorsof the Company are also eligible to receive stock-based compensation in theform of stock options.

**Section 16(a) Beneficial Ownership ReportingCompliance**

The members of the Boardof Directors, the officers of the Company and persons who hold more than 10% ofthe Company’s outstanding common stock are subject to the reportingrequirements of Section 16(a) of the Securities Exchange Act of 1934, asamended, which require them to file reports with respect to their ownership ofthe Company’s common stock and their transactions in such common stock. Basedupon (i) the copies of Section 16(a) reports that the Companyreceived from such persons for their 2006 fiscal year transactions in thecommon stock and their common stock holdings and (ii) the writtenrepresentation received from one or more of such persons that no annual Form 5reports were required to be filed by them for the 2006 fiscal year, the Companybelieves that all reporting requirements under Section 16(a) for suchfiscal year were met in a timely manner by its officers, Board members andgreater than 10% shareholders at all times during the 2006 fiscal year.

**Other Information**

In September 1999, a civil lawsuit was filed bythe SEC in the United States District Court for the Southern District ofFlorida against Scott K. Ginsburg, the Chairman of the Board of theCompany, his brother and his father. The lawsuit alleged that Mr. Ginsburghad violated the insider trading provisions of the federal securities laws bycommunicating material, non-public information to his brother in 1996 regardingthe securities of EZ Communications, Inc. (“EZ”) and in 1997 regarding thesecurities of Katz Media, Inc. (“Katz”). The lawsuit further alleged thatMr. Ginsburg’s father and brother, relying upon the information allegedlyfurnished by Mr. Ginsburg, purchased securities in EZ and Katz, andsubsequently profited from the sale of such securities.

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In April 2002,a jury found that Mr. Ginsburg did make these communications, known as“tipping,” and therefore concluded that he had violated Sections 10(b) and14(e) of the Exchange Act and Rules 10b-5 and 14e-3thereunder. In July 2002, the United States District Court imposed a$1,000,000 civil penalty against Mr. Ginsburg.

Mr. Ginsburg filed a motion asking the Court to setaside its ruling and the verdict of the jury. On December 19, 2002, theUnited States District Court granted Mr. Ginsburg’s motion for judgmentnotwithstanding the verdict. The Court overturned the jury verdict in itsentirety and set aside the civil penalty.

On February 13, 2003,the SEC filed a Notice of Appeal, seeking to reverse the Court’s decision andchallenging the Court’s earlier refusal to impose an injunction againstMr. Ginsburg. On March 19, 2004 a decision of a three-judge panel ofthe Eleventh Circuit U.S. Court of Appeals reversed the decision by the U.S.District Court for the Southern District of Florida on December 19, 2002.The Court of Appeals (i) reinstated the jury verdict thatMr. Ginsburg had, in matters unrelated to the Company, violated Sections10(b) and 14(e) of the Exchange Act and Rules 10b-5 and14e-3 thereunder, (i) reinstated a $1 million civil penalty againstMr. Ginsburg and (iii) remanded the case to the District Court withinstructions to enjoin Mr. Ginsburg from violations of the federalsecurities laws and regulations. The Court of Appeals did not barMr. Ginsburg from serving as an officer or director of a public companyand the Company’s Board immediately and unanimously moved to affirmMr. Ginsburg in his capacity as Chairman of the Board of Directors.

**Item 11.**                 EXECUTIVE COMPENSATION

**CompensationDiscussion and Analysis**

***Compensation Philosophy and Objectives***

The Compensation Committeebelieves that the most effective executive compensation program is one that isdesigned to reward the achievement of specific annual, long-term and strategicgoals by the Company, and which aligns executives’ interests with those of thestockholders by rewarding performance at or above established goals, with theultimate objective of improving stockholder value. The philosophy of theCompensation Committee is to evaluate both performance and compensation toensure that we maintain our ability to attract and retain superior employees inkey positions and that compensation provided to key employees remainscompetitive relative to the compensation paid to similarly situated executivesof our peer companies. Additionally, the Compensation Committee maintainsflexibility, enabling management and the Board to make decisions based on theneeds of the business and to recognize different levels of individualcontribution and value creation. To that end, the Compensation Committeebelieves executive compensation packages should include both cash andequity-based compensation that reward performance as measured againstestablished goals.

***Setting Executive Compensation***

Management develops our compensation plans byutilizing publicly available compensation data in the media services andtechnology industries. We believe that the practices of these groups ofcompanies provide us with appropriate compensation benchmarks, because thesegroups of companies are in similar businesses and tend to compete with us forexecutives and other employees. For benchmarking executive compensation, wetypically review the compensation data we have collected from these groups ofcompanies, as well as a subset of the data from those companies that have asimilar number of employees as the Company. For purposes of determiningexecutive compensation, we have not engaged consultants to help us analyze thisdata or to compare our compensation programs with the practices of thecompanies represented in the compensation data we review.

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As the basis for its 2006comparative review, the Compensation Committee determined the appropriatecompanies to include in the executive compensation peer group. The CompensationCommittee believes that the Company’s most direct competitors for executivetalent include a broader range of large capitalization companies than thosefirms with which the Company might be compared for stock performance purposes.As a result, the Compensation Committee included companies in the compensationcomparison group beyond those included in the Company’s peer group index thatappears in the stock performance graph contained in Item 5. For 2006, theCommittee compared the Company’s executive compensation levels with availableinformation for similar executive positions at companies in a broadindustry group of ten technology, media, and telecommunications companiescomparable in size to the Company (the “industry group”). The 10 companiesincluded in the industry group were Point.360, MediaLink, Avid, LodgeNet,ValueClick, Akamai, Viewpoint Corporation, National Cinemedia, Getty Images,and Access IT. With respect to the Company’s executive officers, becauseinformation for each position being reviewed was not available for comparablepositions at each company in the industry group, the companies included in themarket competitive data used by the Committee in its review varied for each position.

Based on management’s analyses and recommendations,the Compensation Committee has approved a pay-for-performance compensationphilosophy, which is intended to establish base salaries and total executivecompensation (taking into consideration the executive’s experience andabilities) that are competitive with those companies with a similar number ofemployees represented in the compensation data we review.

We work within theframework of this pay-for-performance compensation philosophy to determine eachcomponent of an executive’s initial compensation package based on numerousfactors, including:

·       theindividual’s particular background, track record and circumstances, includingtraining and prior relevant work experience;

·       theindividual’s role with us and the compensation paid to similar persons in thecompanies represented in the compensation data that we review;

·       thedemand for individuals with the individual’s specific expertise and experience;

·       performancegoals and other expectations for the position; and

·       uniqueness of industryskills.

**EmploymentAgreements**

We have entered intoemployment agreements with all executive officers, the key terms of which aredescribed in the narrative following the Summary Compensation Table. We believethat having employment agreements with our executives is often beneficial to usbecause it provides retentive value and generally gives us a competitiveadvantage in the recruiting process over a company that does not offer anemployment agreement. Our employment agreements set forth the terms andconditions of employment and establish the components of an executive’scompensation, which generally include the following:

·       Basesalary;

·       Atarget annual cash bonus with the actual amount determined based on whetherperformance criteria are met;

·       Benefits,including participation in our retirement plans and health, life insurance anddisability insurance plans.

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Our employment agreements,also contain key provisions in the event of an executive’s termination orresignation, setting forth the circumstances under which an executive mayresign for “good reason” or that we may terminate the agreement “for cause,”and formalizing restrictive covenants such as commitments not to join acompetitor within a set time frame, not to solicit our employees to leave ourcompany, and to protect our confidential information, among others. The eventsthat constitute a termination for “good reason” are negotiated in connectionwith the employment agreement and generally include such events as substantialchanges in the executive’s duties or reporting structure, relocationrequirements, reductions in compensation and any breach by us of the agreement.Mr. Ginsburg’s employment agreement provides that it may be terminated byeither party at any time. There are change-in-control provisions in ouremployment agreements.

**Key Considerationsin Determining Executive Compensation**

In general, the terms of our executive employmentagreements are initially negotiated by our CEO and CFO, as appropriate, and legalcounsel. The agreements for our executives over whose compensation the CompensationCommittee has authority are presented to the Compensation Committee forconsideration. When appropriate, such as in the case of the agreements for Messrs.Ginsburg and Choucair the Compensation Committee takes an active role in thenegotiation process. The Compensation Committee also establishes from time totime the general compensation principles set forth in our executive employmentagreements.

During the review and approval process for theemployment agreements for executives under its purview, the Compensation Committeeconsiders the appropriate amounts for each component of compensation and thecompensation design appropriate for the individual executive. In its analysis,the Compensation Committee considers the individual’s credentials, and ifapplicable, performance at the Company, the compensation history of theexecutive, data on the compensation of individuals in comparable positions atour Company and the total projected value of the compensation package to theexecutive.

The Compensation Committee does exercise thediscretion to increase or decrease awards or payouts, except for base salary,which has an established minimum set forth in the respective employmentagreements.

The Compensation Committee does not use rigidguidelines in determining the mix of compensation elements (i.e., long-termversus currently paid out compensation and cash versus non-cash compensation)for each senior executive.

***2006 Executive Compensation Components***

For the fiscal yearended December 31, 2006, the principal components of compensation that ournamed executive officers were eligible to receive were:

·       Basesalary;

·       Performance-basedincentive compensation (annual bonus);

·       Long-termequity incentive compensation;

·       Participationin the Company’s 401(k) Plan; and

·       Perquisites and otherpersonal benefits.

***Base Salary***

Base salaries for our executives are established basedon the scope of their responsibilities and their prior relevant background,track record, training and experience, taking into account competitive market 

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compensation paid by thecompanies represented in the compensation data we review for similar positionsand the overall market demand for such executives at the time the respectiveemployment agreements are negotiated. As with total executive compensation, webelieve that executive base salaries should be competitive with the range ofsalaries for executives in similar positions and with similar responsibilitiesin the companies of similar size to us represented in the compensation data wereview. An executive’s base salary is also evaluated together with componentsof the executive’s other compensation to ensure that the executive’s totalcompensation is consistent with our overall compensation philosophy.

The base salaries were established in arms-lengthnegotiations between the executive and the Company, taking into account theirextensive experience, knowledge of the industry, track record, and achievementson behalf of the Company. Although the Company considered the same factors inestablishing the base salaries of each of the executives, due to the differentlevels of satisfaction of such factors by each executive, the base salariesare, in certain cases, substantially different. Specifically, due to hisextensive experience, responsibilities and significant market demand, theCompany believes that it is appropriate that Mr. Ginsburg’s base salary issubstantially higher than the Company’s other executives.

Base salaries are adjusted annually in accordance withthe terms of the executive’s employment contract.

With respect to the Chairman and our other executiveofficers, the Compensation Committee believes that using the industry groupprovides comparative data on the companies that are most likely to competedirectly with the Company for senior executive talent.

Consistentwith the Company’s financial performance expectations, its size and complexity,and each executive’s position relative to similarly situated executives in eachof the peer groups noted above, the Committee generally targets total directcompensation, which is composed of base salary, target annual cash bonus, andthe estimated value of stock-based awards.

***Annual Bonus***

Our compensation program includes eligibility for anannual performance-based cash bonus. The amount of the cash bonus is generallyconsistent with the targeted bonus established in the executive’s employmentcontract and may be adjusted on a discretionary basis, in accordance with theemployment contract. All executives are eligible for annual performance-basedcash bonuses as set forth in their employment agreements and in accordance withCompany policies. As provided in their employment agreements, our ChiefExecutive Officer and Chief Financial Officer are eligible for annualperformance-based cash bonuses of up to $187,500 and $75,500, respectively (whichamounts are adjusted upward during the term of the agreement). In itsdiscretion, the Compensation Committee and Board of Directors may, however,award a bonus payment above or below this target amount.

In the CompensationCommittee’s view, the use of annual cash bonuses that are based on performancecreates a direct link between executive compensation and individual andbusiness performance.

The Compensation Committeeestablishes specific criteria to assist it in determining the annual bonusesfor the Chief Executive Officer and other executives. The CompensationCommittee established bonuses pursuant to the target contractual bonusesdetailed in the executive’s employment agreement, which represent the amountthe Company would expect to pay the executive each year for satisfactoryperformance. Thus, if the Company achieves its financial objectives and theexecutive performs in a satisfactory manner in light of his or her individualgoals, receipt of at least the target bonus amount by each executive is likely.While these goals are used as a guide by the Compensation Committee indetermining the bonuses to be paid to the executives, the CompensationCommittee has the discretion in making its bonus determinations and it has doneso in individual bonus determinations.

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Inevaluating the Company’s performance and each individual executive’s 2006performance, the Compensation Committee determined that the Company and itsexecutives generally met or exceeded the financial and individual goals thatwere established for 2006.

These metrics are usedbecause they encourage executives to achieve superior operating results usingappropriate levels of capital. In its assessment of whether the goals are met,the Committee may consider the nature of unusual expenses or contributors tofinancial results, and authorize adjustments in its sole discretion.

The individualgoals established for Mr. Ginsburg and the other named executives at thebeginning of 2006 included strategic and leadership goals tailored to theindividual’s position, and focused on the Company’s strategic initiatives. Thefollowing is a summary of the individual goals for Mr. Ginsburg, all ofwhich were achieved during 2006:

·       Achievingrevenue and margin improvements;

·       Completingthe merger with FastChannel Network, Inc.;

·       Raisingadditional capital through the issuance of additional common stock, subject tomarket conditions;

·       Achievingsignificant cost reductions through streamlined organizational structures; and

·       Undertakingsignificant cost synergies to reduce its cost base resulting from theFastChannel merger.

The Committee established these goals with theobjective that they would help to enhance stockholder value. The CompensationCommittee did not establish specific quantitative targets for the financialgoals described above. These accomplishments, in addition to the Company’sfinancial performance as a whole, served as a basis for the Committee’sdetermination of the bonus to approve for Mr. Ginsburg and the otherexecutive officers.

**Mr. Ginsburg’sAnnual Bonus.****  **Asdiscussed above, the Compensation Committee believes that Mr. Ginsburg’sannual cash bonus should be clearly linked to the Company’s financialperformance and his individual performance to further the compensationphilosophy regarding accountability. In determining and approvingMr. Ginsburg’s bonus, the Committee evaluated the Company’s financialperformance against Mr. Ginsburg’s individual performance covering hisroles as both the Chairman of the Board and the Chief Executive Officer of theCompany, which focused on major business initiatives and objectives of theCompany. The Committee also retained the discretion to consider other factorsin setting Mr. Ginsburg’s bonus. As a result, in recognition ofMr. Ginsburg’s and the Company’s significant accomplishments in 2006, theCompensation Committee approved a 2006 bonus for him of $175,000.

In considering theindividual performance of Mr. Ginsburg, the Compensation Committee noted,among other things, Mr. Ginsburg’s outstanding financial, strategic andleadership accomplishments. To strengthen the portfolio of businesses,Mr. Ginsburg oversaw the merger with FastChannel. Mr. Ginsburg also pursuedseveral initiatives to streamline and grow the Company’s business.

**Annual Bonuses for ExecutivesOther than the Chief Executive Officer.  **The Compensation Committee established the2006 cash bonuses for other executives in a similar manner as forMr. Ginsburg. In establishing the 2006 bonuses, the Committee reviewed theCompany’s financial performance and the individual performance of each executive.In light of their and the Company’s achievements, the Company’s executives wereawarded 2006 annual cash bonuses (set forth in the Summary Compensation Table).

During 2006, Mr. Ginsburgwas awarded a cash bonus of $175,000. Mr. Choucair was awarded a cash bonusof $75,000. In addition, the Compensation Committee approved a supplementalbonus in 

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February 2006for Mr. Choucair in the amount of $30,000, in accordance with hisemployment agreement in effect at the time, due to the achievement of certainCompany objectives, including refinancing the Company’s credit facilities.Mr. Nguyen’s annual bonus of $75,000 was paid in accordance with the termsof his current employment agreement. In addition, Mr. Nguyen received abonus in February 2006 in the amount of $40,000, as provided for in hisemployment agreement in effect at the time which expired in 2006, Ms. Maythenyireceived bonuses totaling $60,000 in 2006, in accordance with the terms of heremployment agreement.

***Long-Term Equity Incentive Compensation***

We believe that long-term performance is achievedthrough an ownership culture that encourages long-term participation by ourexecutives in equity-based awards. Our 2006 Long-term Stock Incentive Plan (the“2006 Plan”) allows us to grant stock options to employees. We currently makeinitial equity awards of stock options to new executive and certainnon-executive employees in connection with their employment with the Company. Annualgrants of options, if any, are approved by the Compensation Committee*.*

*InitialEquity Incentives.**  *Executivesand certain non-executive employees who join us are awarded initial stockoption grants. These grants have an exercise price equal to the fair marketvalue of our common stock on the later of the grant date or the date theemployee joins us, and they typically vest ratably over four years. The initialstock option awards are intended to provide the executive with incentive tobuild value in the organization over an extended period of time. The size ofthe initial stock option award is also reviewed in light of the executive’strack record, base salary, other compensation and other factors to ensure thatthe executive’s total compensation is in line with our overall compensationphilosophy.

*Subsequent EquityIncentives.**  *Wemay make annual stock option awards as part of our overall annual reviewprocess. The Compensation Committee believes that stock options providemanagement with a strong link to long-term corporate performance and thecreation of stockholder value. We expect that the annual aggregate value ofthese awards would be set near competitive median levels for companiesrepresented in the compensation data we review. As is the case when the amountsof base salary and initial equity awards are determined, a review of allcomponents of compensation is conducted when determining equity awards toensure that total compensation conforms to our overall philosophy andobjectives.

***Perquisites and Other Personal Benefits***

We provide named executive officers with perquisitesand other personal benefits that we and the Compensation Committee believe arereasonable and consistent with our overall compensation program to betterenable the Company to attract and retain superior employees for key positions. TheCompensation Committee periodically reviews the levels of perquisites and otherpersonal benefits provided to executive officers.

We maintain benefits andperquisites that are offered to all employees, including health insurance, lifeand disability insurance, dental insurance and a 401(k) plan**,** including Company matching contributions.

***Termination Based Compensation***

Upon termination ofemployment, all executive officers are entitled to receive severance paymentsunder their employment agreements. In determining whether to approve and aspart of the process of setting the terms of such severance arrangements, theCompensation Committee recognizes that executives and officers often facechallenges securing new employment following termination. Our Chief ExecutiveOfficer’s employment agreement provides, if his employment is terminatedwithout cause, he is entitled to (a) all remaining salary in lump sumpayments to the end of the employment term, plus salary in 

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lump sumpayments from the end of the employment term through the end of the firstanniversary of the Date of Termination, and (b) the continuation by theCompany of medical and dental insurance coverage for him and his family untilthe end of the employment term. Our Chief Financial Officer’s employmentagreement provides, if his employment is terminated without cause, he isentitled to (a) all remaining salary in lump sum payments to the end ofthe employment term, plus salary in lump sum payments from the end of theemployment term through the end of the third anniversary of the Date ofTermination, and (b) the continuation by the Company of medical and dentalinsurance coverage for him and his family until the end of the employment term.Following the end of the employment term, upon termination for any reason otherthan cause, our Chief Executive Officer and Chief Financial Officer each areentitled to continuation of his salary in effect at that time for a period ofsix months.

**Tax and AccountingImplications**

***Deductibility of Executive Compensation***

As part of its role, theCompensation Committee reviews and considers the deductibility of executivecompensation under Section 162(m) of the Internal Revenue Code, whichprovides that we may not deduct compensation of more than $1,000,000 that ispaid to certain individuals. We believe that compensation paid under themanagement incentive plans are generally fully deductible for federal incometax purposes.

***Accounting for Stock-Based Compensation***

Beginning on January 1,2006, we began accounting for stock-based payments, including awards under the 2006Plan, in accordance with the requirements of Statement of Financial AccountingStandards No. 123 (revised 2004), *Share-BasedPayment,*or SFAS 123(R).

**CompensationCommittee Report**

The Compensation Committeeof the Board of Directors of the Company has reviewed and discussed theCompensation Discussion and Analysis required by Item 402(b) ofRegulation S-K with management and, based on such review and discussions, theCompensation Committee recommended to the Board of Directors of the Companythat the Compensation Discussion and Analysis be included in this Amendment No. 2to the Annual Report on Form 10-K/A.

THE COMPENSATION COMMITTEE

Kevin C. Howe, Chairman

Lisa C. Gallagher

David M. Kantor

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**SummaryCompensation Table**

Thefollowing table shows the compensation for the fiscal year ended December 31,2006 earned by our Chairman and Chief Executive Officer, our Chief FinancialOfficer who is our Principal Financial and Accounting Officer, and othersconsidered to be executive officers of the Company.
| Name and Principal Position        | ** ** | ** ** | ** ** | **Year** | ** ** | **Salary  ($)** | ** ** | **Bonus  ($)** | ** ** | **Option  Awards  ($)(1)** | ** ** | **All Other  Compensation  ($)** | ** ** | **Total  ($)** | ** ** |
|---------------------------------------------------|------------|------------|------------|----------|------------|-----------------|------------|----------------|------------|----------------------------|------------|---------------------------------------|------------|----------------|------------|
| Scott K. Ginsburg                                 |       | 2006       |       | 323,077  |       | 175,000         |       | 42,482         | (2)        |                       | 230,085    | (3)                                   |       | 770,644        |       |
| Chairman and Chief  Executive Officer             |       |       |       |     |       |            |       |           |       |                       |       |                                  |       |           |       |
| Omar A. Choucair                                  |       | 2006       |       | 229,230  |       | 105,000         |       | 22,942         | (4)        |                       | 20,660     | (5)                                   |       | 377,832        |       |
| Chief Financial Officer                           |       |       |       |     |       |            |       |           |       |                       |       |                                  |       |           |       |
| Neil H. Nguyen                                    |       | 2006       |       | 192,500  |       | 115,000         |       | 22,558         | (6)        |                       | 58,051     | (7)                                   |       | 388,109        |       |
| Executive Vice President of  Sales and Operations |       |       |       |     |       |            |       |           |       |                       |       |                                  |       |           |       |
| Pamela Maythenyi                                  |       | 2006       |       | 173,308  |       | 60,000          |       | 16,902         | (8)        |                       | 7,647      | (9)                                   |       | 257,857        |       |
| Sr.  Vice President of  SourceEcreative           |       |       |       |     |       |            |       |           |       |                       |       |                                  |       |           |       |

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(1)          SeeNote 2 to our Consolidated Financial Statements included in our Annual Reporton Form 10-K for our fiscal year ended December 31, 2006 fordetails as to the assumptions used to determine the fair value of stock awards.

(2)          Representscompensation expense incurred by us in fiscal year 2006 in connection with thegrant of options to purchase 100,000 shares of common stock to Mr. Ginsburgon July 12, 2006, calculated in accordance with SFAS 123(R).

(3)          Consistsof $12,000 paid for automobile allowance, $203,425 which represents the amountpaid for Mr. Ginsburg’s personal guarantee of a portion of the Company’sdebt, and $14,660 which represents the costs of insurance premiums paid by theCompany for participation in the health insurance program.

(4)          Consistsof $16,891, $3,496, and $2,555 representing compensation expense incurred by usin fiscal year 2006 in connection with the grant of options to purchase 40,000,2,500, and 25,000 shares of common stock to Mr. Choucair on July 12,2006, May 16, 2003, and February 20, 2002, respectively, calculatedin accordance with SFAS 123(R).

(5)          Consistsof $6,000 paid for automobile allowance, and $14,660 which represents the costsof insurance premiums paid by the Company for participation in the healthinsurance program.

(6)          Consistsof $16,891 and $5,667 representing compensation expense incurred by us infiscal year 2006 in connection with the grant of options to purchase 40,000 and3,000 shares of common stock to Mr. Nguyen on July 12, 2006 and March 30,2005, respectively, calculated in accordance with SFAS 123(R).

(7)          Consistsof $3,000 paid for automobile allowance, $40,391 for sales commissions, and$14,660 which represents the costs of insurance premiums paid by the Companyfor participation in the health insurance program.

(8)          Consistsof $1,373, $8,445, $3,113,  and $3,971representing compensation expense incurred by us in fiscal year 2006 inconnection with the grant of options to purchase 2,500, 20,000, 2,500, and2,500 shares of common stock to Ms. Maythenyi on August 31, 2006, July 12,2006, August 31, 2005, and August 31, 2004, respectively, calculatedin accordance with SFAS 123(R).

(9)          Representsthe costs of insurance premiums paid by the Company for participation in thehealth insurance program.

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**Grants ofPlan-Based Awards**

Thefollowing table shows information regarding grants of equity awards that wemade during the fiscal year ended December 31, 2006 to each of theindividuals named in the Summary Compensation Table.
| Name              | ** ** | ** **           | ** ** | **Grant  Date**         | ** ** | **Approval  Date** | ** ** | **All Other  Stock  Awards:  Number of  Shares of  Stock or  Units  (#)** | ** ** | **All Other  Option  Awards:  Number of  Securities  Underlying  Options  (#)** | ** ** | **Exercise  or Base  Price of  Option  Awards  ($/Sh)** | ** ** | **Closing  Market  Price on  Grant  Date  ($/Sh)(1)** | ** ** | **Grant Date  Fair Value  of Stock  and Option  Awards  ($)** | ** ** |
|-------------------|------------|----------------------|------------|-------------------------|------------|--------------------|------------|-----------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| Scott K. Ginsburg |       | July 12,  2006  |       | July 12,  2006     |       |               | —     |                                                                                          |       |                                                                                      | 100,000    |                                                              |       |                                                       | 5.88       |                                                                              |       |   | 5.89 |   |   |   | 400,877 |   |   |
| Omar A. Choucair  |       | July 12,  2006  |       | July 12,  2006     |       |               | —     |                                                                                          |       |                                                                                      | 40,000     |                                                              |       |                                                       | 5.88       |                                                                              |       |   | 5.89 |   |   |   | 160,351 |   |   |
| Neil H. Nguyen    |       | July 12,  2006  |       | July 12,  2006     |       |               | —     |                                                                                          |       |                                                                                      | 40,000     |                                                              |       |                                                       | 5.88       |                                                                              |       |   | 5.89 |   |   |   | 160,351 |   |   |
| Pamela Maythenyi  |       | July 12,  2006  |       | July 12,  2006     |       |               | —     |                                                                                          |       |                                                                                      | 20,000     |                                                              |       |                                                       | 5.88       |                                                                              |       |   | 5.89 |   |   |   | 80,175 |   |   |
|              |       | August 31, 2006 |       | August 31, 2004(2) |       |               | —     |                                                                                          |       |                                                                                      | 2,500      |                                                              |       |                                                       | 8.14       |                                                                              |       |   | 7.99 |   |   |   | 16,316 |   |   |

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(1)             Our 1992 Plan and 2006 Plan, under which these optionswere granted, provide that the exercise price shall be determined by using thefair market value of our common stock, which is defined under the Plans as theclosing price of our common stock on the Nasdaq Global Market on the day priorto the grant date.

(2)             Represents the commencement date of Ms. Maythenyi’semployment agreement. According to the terms of such agreement, she is to beissued 2,500 stock options on the first and second anniversaries of heragreement at the then-current market price.

**Discussion ofSummary Compensation Table and Grants of Plan-Based Awards**

The terms of our executive officers’ compensation arederived from our employment agreement with them and the annual performancereview by our Compensation Committee. The terms of Mr. Ginsburg’semployment agreement with us were the result of negotiations between us and Mr. Ginsburgand were approved by our Board of Directors. The terms of Mr. Choucair’semployment agreement with us were the result of negotiations between our ChiefExecutive Officer and Mr. Choucair and were approved by our Board ofDirectors. The terms of Ms. Maythenyi’s employment agreement with us werethe result of negotiations between our Chief Executive Officer and Ms. Maythenyiand were approved by our Board of Directors in conjunction with their approvalof the acquisition of The Source Maythenyi in 2004. The terms of Mr. Nguyen’semployment agreement with us were the result of negotiations between our ChiefExecutive Officer and Mr. Nguyen and were approved by our CompensationCommittee.

All of the equity awardsdisclosed in the Grants of Plan-Based Awards table were issued under our 2006Plan or 1992 Plan. All option awards were granted with an exercise price pershare equal to the closing price of our common stock on the Nasdaq GlobalMarket on the day prior to the grant date of each award. Subject to the termsand conditions of the 2006 Plan or 1992 Plan and the option agreements issuedin connection with these grants, all of the options granted in 2006 vest 25% onthe first anniversary of the date of grant, and the remainder vests ratablyover each of the 36 months thereafter.

***Employment Agreement with Scott K. Ginsburg***

On June 22, 2006, the Company entered into anEmployment Agreement with our Chief Executive Officer, Scott K. Ginsburg. Pursuantto the Employment Agreement between Mr. Ginsburg and the Company (the “CEOAgreement”), the Company agreed to employ Mr. Ginsburg as its ChiefExecutive Officer from the date of the Agreement through May 31, 2008. Underthe CEO Agreement, Mr. Ginsburg is entitled to an annualized base salaryof $375,000 and is eligible for an annual bonus of up to $187,500 for the termof the Agreement. The Company retained the right to increase the basecompensation as it deems necessary. In addition, Mr. Ginsburg is entitledto participate in the Company’s stock option plans, is entitled to four weeksof paid vacation per calendar year and is to receive a car allowance totaling$1,000 

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per month for the term ofthe Agreement. Finally, during the term of the Agreement, the Company shall paythe amount of premiums or other costs incurred for the coverage of Mr. Ginsburgand his spouse and dependent family members under the Company’s health plan.

The CEO Agreement also includes provisions respectingseverance, non-solicitation, non-competition, and confidentiality obligations.Pursuant to the CEO Agreement, if he terminates his employment for Good Reason(as described below), or, is terminated prior to the end of the Employment Termby the Company other than for Cause (as described below) or death, he shall beentitled to all remaining salary to the end of the Employment Term, plus salaryfrom the end of the Employment Term through the end of the first anniversary ofthe Date of Termination, at the rate of salary in effect on the Date ofTermination in a lump sum payment. He shall have no obligation to seek otheremployment and any income so earned shall not reduce the foregoing amounts. Ifhe is terminated by the Company for Cause (as described below), or at the endof the Employment Term, he shall not be entitled to further compensation.Following the end of the Employment Term, upon termination of his employmentwith the Company for any reason other than Cause, but upon ninety days priorwritten notice if such termination is by him, the Company shall pay to theemployee his salary as then in effect for a period of six months. Under theAgreement, Good Reason includes the assignment of duties inconsistent with histitle, a material reduction in salary and perquisites, the relocation of theCompany’s principal office by 20 miles, the transfer to an office other thanthe principal office or a material breach of the CEO Agreement by theCompany. Under the CEO Agreement, Cause includes conviction of or a plea ofguilty or *nolo contendre* by Mr. Ginsburg to afelony or certain criminal conduct against the Company, habitual neglect of orfailure to perform his duties to the Company or any material breach of the CEOAgreement by Mr. Ginsburg.

The above summary of theCEO Agreement is qualified in its entirety by reference to the full text of theAgreement, a copy of which was filed as an exhibit to the Current Report on Form 8-Kfiled by the Company on June 27, 2006.

***Employment Agreement with Omar A. Choucair***

On June 22, 2006, the Company entered into anAmended and Restated Employment Agreement with our Chief Financial Officer,Omar A. Choucair. Pursuant to the Amended and Restated Employment Agreementbetween Mr. Choucair and the Company (the “CFO Agreement”), the Companyagreed to employ Mr. Choucair as its Chief Financial Officer from the dateof the Agreement through May 31, 2009. Under the CFO Agreement, Mr. Choucairis entitled to an annualized base salary of $250,000 for the period June 1,2006 through May 31, 2007 (increasing to $260,000 and $270,000 on theanniversaries of the CFO Agreement during its term), and is eligible for anannual bonus of $75,500 for the term of the Agreement. The Company retained theright to increase the base compensation as it deems necessary. In addition, Mr. Choucairis entitled to participate in the Company’s stock option plans, is entitled tofour weeks of paid vacation per calendar year and is to receive a car allowancetotaling $500 per month for the term of the CFO Agreement. Finally, duringthe term of the Agreement, the Company shall pay the amount of premiums orother costs incurred for the coverage of Mr. Choucair and his spouse anddependent family members under the Company’s health plan.

The CFO Agreement also includes provisions respectingseverance, non-solicitation, non-competition, and confidentiality obligations.Pursuant to the CFO Agreement, if he terminates his employment for Good Reason(as described below), or, is terminated prior to the end of the Employment Termby the Company other than for Cause (as described below) or death, he shall beentitled to all remaining salary to the end of the Employment Term, plus salaryfrom the end of the Employment Term through the end of the third anniversary ofthe Date of Termination, at the rate of salary in effect on the Date ofTermination in a lump sum payment. He shall have no obligation to seek other employmentand any income so earned shall not reduce the foregoing amounts. If he isterminated by the Company for Cause (as described below), or at the end of theEmployment Term, he shall not be entitled to further compensation. Following 

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the end of the EmploymentTerm, upon termination of his employment with the Company for any reason otherthan Cause, but upon ninety days prior written notice if such termination is byhim, the Company shall pay to him his salary as then in effect for a period ofsix months. Under the CFO Agreement, Good Reason includes the assignmentof duties inconsistent with his title, a material reduction in salary andperquisites, the relocation of the Company’s principal office by 20 miles, thetransfer to an office other than the principal office or a material breach ofthe Agreement by the Company. Under the CFO Agreement, Cause includesconviction of or a plea of guilty or *nolo contendre*by Mr. Choucair to a felony or certain criminal conduct against theCompany, habitual neglect of or failure to perform his duties to the Company orany material breach of the CFO Agreement by Mr. Choucair.

The above summary of theCFO Agreement is qualified in its entirety by reference to the full text of theAgreement, a copy of which was filed as an exhibit to the Current Report on Form 8-Kfiled by the Company on June 27, 2006.

***Employment Agreement with Neil H. Nguyen***

On August 30, 2006, the Company entered into anAmended and Restated Employment Agreement with our Executive Vice President ofSales and Operations, Neil H. Nguyen. Pursuant to the Amended and RestatedEmployment Agreement between Mr. Nguyen and the Company (the “NguyenAgreement”), the Company agreed to employ Mr. Nguyen as its Executive VicePresident of Sales and Operations from the date of the Agreement through July 1,2009. Under his agreement, Mr. Nguyen is entitled to an annualized basesalary of $210,000 for the period July 1, 2006 through June 30, 2007(increasing to $230,000 and $240,000 on the anniversaries of the Nguyen Agreementduring its term), and is eligible for an annual bonus of $75,000 each year forthe term of the Nguyen Agreement. Half of the annual bonus is based onacquiring new customers and existing customer retention. The remaining 50% ofthe annual bonus is determined in the sole discretion of the CompensationCommittee. The Company retained the right to increase the base compensation asit deems necessary. Mr. Nguyen earns a commission which is based on theamount of revenue recognized by the Company. Sales commissions are paidmonthly, and are increased if revenues exceed certain budgeted targets. Duringfiscal 2006, Mr. Nguyen earned and was paid $40,391 in sales commissions. Inaddition, Mr. Nguyen is entitled to participate in the Company’s stockoption plans, is entitled to four weeks of paid vacation per calendar year andis to receive a car allowance totaling $500 per month for the term of the Nguyen Agreement.Finally, during the term of the Agreement, the Company shall pay the amount ofpremiums or other costs incurred for the coverage of Mr. Nguyen and hisspouse and dependent family members under the Company’s health plan.

The Nguyen Agreement alsoincludes provisions respecting severance and confidentiality obligations.Pursuant to the Nguyen Agreement, if he terminates his employment for GoodReason (as described below), or, is terminated prior to the end of theEmployment Term by the Company other than for Cause (as described below), heshall be entitled to all remaining salary to the end of the Employment Term. Ifhe is terminated by the Company for Just Cause (as described below), or at theend of the Employment Term, he shall not be entitled to further compensation. Underthe Nguyen Agreement, Good Reason includes the assignment of duties inconsistentwith his title, a material reduction in salary and perquisites, the requirementby the Company for Mr. Nguyen to move out of the State of California, areduction in title below “Executive Vice President,” a material breach of the Nguyen Agreementby the Company, or in the event of a change in control of the Company in whichthe successor does not assume the Nguyen Agreement or the surviving entityterminates the employment of Mr. Nguyen within one year of the change incontrol, other than for Just Cause. Under the Nguyen Agreement, Just Causeincludes conviction of or a plea of guilty or *nolocontendre* by the employee to a felony or certain criminal conductagainst the Company, habitual neglect of or failure to perform his duties tothe Company or any material breach of the Nguyen Agreement by the employee.

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***EmploymentAgreement with Pamela Maythenyi***

On August 31, 2004,the Company entered into an Employment Agreement with our Senior Vice Presidentof SourceEcreative. Pursuant to the Employment Agreement betweenMs. Maythenyi and the Company (the “Maythenyi Agreement”), the Companyagreed to employ Ms. Maythenyi to be in charge of SourceEcreative, one ofits principal business units from the date of the Maythenyi Agreement throughAugust 31, 2007. Under her agreement, Ms. Maythenyi is entitled to anannualized base salary of $160,000 for the period August 31, 2004 throughAugust 31, 2005 (increasing to $170,000 and $180,000 on the anniversariesof the Maythenyi Agreement during its term), and is eligible for an annualbonus of $30,000 each year for the term of the Maythenyi Agreement. Payment ofthe annual bonus is dependent upon the business unit achieving certainbudgeting revenue targets. In addition, Ms. Maythenyi is entitled toparticipate in the Company’s stock option plans and receive a 2,500 employeestock options at the commencement of the Maythenyi Agreement at an exerciseprice per share equal to the fair market value of the stock on the respectivedate of grant, and if she has not terminated prior to such time, is entitled toreceive an equal number on each of the first two anniversaries of the MaythenyiAgreement. Furthermore, she is entitled to four weeks of paid vacation percalendar year. The Maythenyi Agreement also includes provisions respectingseverance, covenants against competition, and confidentiality obligations. Pursuant to the Maythenyi Agreement, ifshe is terminated prior to the end of the term by the Company other than forJust Cause (as described below), she shall be entitled to all remaining salaryto the end of the Employment Term. If she is terminated by the Company for JustCause (as described below), or at the end of the Employment Term, she shall notbe entitled to further compensation. Under the Maythenyi Agreement, Just Causeincludes conviction of or a plea of guilty or *nolo contendre*by the employee to a felony or certain criminal conduct against the Company,habitual neglect of or failure to perform her duties to the Company or anymaterial breach of the Maythenyi Agreement by the employee.

**Outstanding Equity Awards at Fiscal Year-End**

Thefollowing table shows grants of stock options and grants of unvested stockawards outstanding on December 31, 2006, the last day of our fiscal year,to each of the individuals named in the Summary Compensation Table.
| Name              | ** ** | ** ** | ** ** | **Number of  Securities  Underlying  Unexercised  Options  (#)  Exercisable** | ** ** | **Number of  Securities  Underlying  Unexercised  Options  (#)(1)  Unexercisable** | ** ** | **Option  Exercise  Price  ($)** | ** ** | **Option  Expiration  Date** | ** ** |
|-------------------|------------|------------|------------|------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|----------------------------------|------------|------------------------------|------------|
| Scott K. Ginsburg |       |       | 43,330     |                                                                               |       |                                                                                    | —     |                             |       |                         | 21.60      |   |   | November 29, 2009 |   |
|                   |       |       | 5,000      |                                                                               |       |                                                                                    | —     |                             |       |                         | 33.10      |   |   | January 18, 2008 |   |
|                   |       |       | 2,500      |                                                                               |       |                                                                                    | —     |                             |       |                         | 12.90      |   |   | February 20, 2009 |   |
|                   |       |       | —     |                                                                               |       |                                                                                    | 100,000    |                             |       |                         | 5.88       |   |   | July 12, 2013 |   |
| Omar A. Choucair  |       |       | 17,332     |                                                                               |       |                                                                                    | —     |                             |       |                         | 21.60      |   |   | November 29,  2009 |   |
|              |       |       | 5,000      |                                                                               |       |                                                                                    | —     |                             |       |                         | 33.10      |   |   | January, 18, 2008 |   |
|              |       |       | 25,000     |                                                                               |       |                                                                                    | —     |                             |       |                         | 12.90      |   |   | February 20, 2009 |   |
|              |       |       | 2,240      |                                                                               |       |                                                                                    | 260        |                             |       |                         | 26.00      |   |   | May 16, 2010 |   |
|              |       |       | —     |                                                                               |       |                                                                                    | 40,000     |                             |       |                         | 5.88       |   |   | July 12, 2013 |   |
| Neil H. Nguyen    |       |       | 1,313      |                                                                               |       |                                                                                    | 1,687      |                             |       |                         | 12.60      |   |   | March 30,  2012 |   |
|                   |       |       | —     |                                                                               |       |                                                                                    | 40,000     |                             |       |                         | 5.88       |   |   | July 12, 2013 |   |
| Pamela Maythenyi  |       |       | 1,458      |                                                                               |       |                                                                                    | 1,042      |                             |       |                         | 13.00      |   |   | August, 31, 2011 |   |
|              |       |       | 833        |                                                                               |       |                                                                                    | 1,667      |                             |       |                         | 6.50       |   |   | August 31, 2012 |   |
|              |       |       | —     |                                                                               |       |                                                                                    | 20,000     |                             |       |                         | 5.88       |   |   | July 12, 2013 |   |
|              |       |       | —     |                                                                               |       |                                                                                    | 2,500      |                             |       |                         | 8.14       |   |   | August 31, 2013 |   |

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(1)          Optionswill vest 25% on the first anniversary of the date of grant, and the remaindervests ratably over each of the 36 months thereafter.

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**Option Exercisesand Stock Vested**

None of the individualsnamed in the Summary Compensation Table have ever exercised stock options. Furthermore,the Company has never issued restricted stock awards to the individuals namedin the Summary Compensation Table.

**Pension Benefits**

We do not have anyqualified or non-qualified defined benefit pans.

**Potential Paymentsupon Termination or Change of Control**

Generally,regardless of the manner in which a named executive officer’s employmentterminates, he is entitled to receive amounts earned during his term ofemployment. Such amounts include:

·       theportion of the executive’s base salary that has accrued prior to anytermination and not yet been paid;

·       unusedvacation pay; and

·       distributionfrom the Company’s 401(k) plan (assuming the executive participated in theplan).

In addition, we arerequired to make the additional payments and/or provide additional benefits tothe individuals named in the Summary Compensation Table in the event of atermination of employment or a change of control, as set forth below.

**2006 Long-TermStock Incentive Plan**

The 2006 Plan has beenadopted to replace the Company’s 1992 Stock Option Plan. In addition, becausethe Director Plan has expired recently, the 2006 Plan has been prepared in amanner to enable stock awards to be granted to members of our Board ofDirectors. When the 2006 Plan was approved by our stockholders, the 1992 Planterminated and the shares identified above as remaining for future grants underthe 1992 Plan ceased to be available for grants under the 1992 Plan. The numberof shares subject to the 2006 Plan is 1,100,000 shares.

**Termination orChange-in-Control Payments**

Set forth below is a discussionof the payments and benefits payable to our executive officers upon theirrespective terminations under various circumstances. The multiples ofcompensation that are payable under these circumstances were determined by the CompensationCommittee to be appropriate and consistent with arrangements for executives insimilar positions in the industry group. The potential payments and benefitsunder these arrangements were considered by the Compensation Committee inconnection with the other elements of compensation in order to achieve apackage of benefits that is appropriate for each executive officer.

***Scott K. Ginsburg, Chairman and Chief ExecutiveOfficer***

Pursuant to terms of the 1992 Plan, under which Mr. Ginsburg’soptions are issued, in the event of a change of control, 50% of the unvestedportion of stock options held by Mr. Ginsburg which have not previouslyvested shall immediately and fully vest and shall remain exercisable for atleast 15 days. If Mr. Ginsburg’s employment is terminated by us or by Mr. Ginsburgfor any reason, any unvested portion of his stock options will be immediatelycancelled, and any vested portion thereof shall remain exercisable by Mr. Ginsburgfor a period of up to three months from the date of termination. If Mr. Ginsburg’semployment is terminated as a result of his death or disability, thenimmediately upon the date of Mr. Ginsburg’s termination, any unvested portionof his stock options will be immediately cancelled, and 

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any vested portion thereofshall remain exercisable by Mr. Ginsburg for a period of six months fromthe date of termination.

Thefollowing table summarizes the potential payments to Mr. Ginsburg assuminghis employment with us was terminated or a change of control occurred on December 31,2006, the last day of our most recently completed fiscal year.

| **Benefits and Payments**   | ** ** | ** ** | ** ** | **Change  of Control** | ** ** | **Termination  upon Death  or Disability** | ** ** | **Termination by us  without Cause or  by Mr. Ginsburg  for Good Reason** | ** ** |
|---------------------------------------|------------|------------|------------|-----------------------------|------------|------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|
| Base Salary                           |       | $          | 531,250    |                        |       | $                                                    | —     |                                                                                                              |       |   | $ | 531,250 |   |   |
| Bonus                                 |       | $          | —     |                        |       | $                                                    | —     |                                                                                                              |       |   | $ | — |   |   |
| Acceleration of Vesting  of Options:  |       |       |       |                        |       |                                                 |       |                                                                                                              |       |   |   |
| Number of Stock  Options and Value(1) |       | 50,000     |       |                        | $          | —                                               |       |                                                                                                              |       | $ | — |   |   |
|                                  |       | $          | 380,000    |                        |       | $                                                    | —     |                                                                                                              |       |   | $ | — |   |   |
| Total                                 |       | $          | 911,250    |                        |       |                                                 |       |                                                                                                              |       | $ | 531,250 |   |   |

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(1)          Valueupon change of control is calculated using a value of our common stock of$13.48 per share, the closing price of our common stock on December 29,2006, the last trading day in the fiscal year ended December 31, 2006,less the exercise price of the option of $5.88 per share.

***Omar A. Choucair, Chief Financial Officer***

Pursuant to terms of the 1992 Plan, under which Mr. Choucair’soptions are issued, in the event of a change of control, 50% of the unvestedportion of stock options held by Mr. Choucair which have not previouslyvested shall immediately and fully vest and shall remain exercisable for atleast 15 days. If Mr. Choucair’s employment is terminated by us or by Mr. Choucairfor any reason, any unvested portion of his stock options will be immediatelycancelled, and any vested portion thereof shall remain exercisable by Mr. Choucairfor a period of up to three months from the date of termination. If Mr. Choucair’semployment is terminated as a result of his death or disability, thenimmediately upon the date of Mr. Choucair’s termination, any unvestedportion of his stock options will be immediately cancelled, and any vestedportion thereof shall remain exercisable by Mr. Choucair for a period of sixmonths from the date of termination.

Thefollowing table summarizes the potential payments to Mr. Choucair assuminghis employment with us was terminated or a change of control occurred on December 31,2006, the last day of our most recently completed fiscal year. 

| **Benefits and Payments**   | ** ** | ** ** | ** ** | **Change of  Control** | ** ** | **Termination  upon Death  or Disability** | ** ** | **Termination by us  without Cause or  by Mr. Choucair  for Good Reason** | ** ** |
|---------------------------------------|------------|------------|------------|-----------------------------|------------|------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|
| Base Salary                           |       | $          | 774,167    |                        |       | $                                                    | —     |                                                                                                              |       |   | $ | 774,167 |   |   |
| Bonus                                 |       | $          | —     |                        |       | $                                                    | —     |                                                                                                              |       |   | $ | — |   |   |
| Acceleration of Vesting  of Options:  |       |       |       |                        |       |                                                 |       |                                                                                                              |       |   |   |
| Number of Stock  Options and Value(1) |       | 20,130     |       |                        | —     |                                                 |       |                                                                                                              | —     |   |   |
|                                  |       | $          | 152,000    |                        |       | $                                                    | —     |                                                                                                              |       |   | $ | — |   |   |
| Total                                 |       | $          | 926,167    |                        |       | $                                                    | —     |                                                                                                              |       |   | $ | 774,167 |   |   |

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(1)          Valueupon change of control is calculated using a value of our common stock of$13.48 per share, the closing price of our common stock on December 29,2006, the last trading day in the fiscal year ended December 31, 2006,less the exercise price of the option of $5.88 per share.

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***Neil H. Nguyen, Executive Vice President of Sales andOperations***

Pursuant to terms of the 1992 Plan, under which Mr. Nguyen’soptions are issued, in the event of a change of control, 50% of the unvestedportion of stock options held by Mr. Nguyen which have not previouslyvested shall immediately and fully vest and shall remain exercisable for atleast 15 days. If Mr. Nguyen’s employment is terminated by us or by himfor any reason, any unvested portion of his stock options will be immediatelycancelled, and any vested portion thereof shall remain exercisable by Mr. Nguyenfor a period of up to three months from the date of termination. If hisemployment is terminated as a result of his death or disability, thenimmediately upon the date of Mr. Nguyen’s termination, any unvestedportion of his stock options will be immediately cancelled, and any vestedportion thereof shall remain exercisable by Mr. Nguyen for a period of sixmonths from the date of termination.

Thefollowing table summarizes the potential payments to Mr. Nguyen assuminghis employment with us was terminated or a change of control occurred on December 31,2006, the last day of our most recently completed fiscal year. 

| **Benefits and Payments**   | ** ** | ** ** | ** ** | **Change of  Control** | ** ** | **Termination  upon Death  or Disability** | ** ** | **Termination by us  without Just Cause  or by Mr. Nguyen  for Good Reason** | ** ** |
|---------------------------------------|------------|------------|------------|-----------------------------|------------|------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------|------------|
| Base Salary                           |       | $          | —     |                        |       | $                                                    | —     |                                                                                                                      |       |   | $ | 575,000 |   |   |
| Bonus                                 |       | $          | —     |                        |       | $                                                    | —     |                                                                                                                      |       |   | $ | — |   |   |
| Acceleration of Vesting  of Options:  |       |       |       |                        |       |                                                 |       |                                                                                                                      |       |   |   |
| Number of Stock  Options and Value(1) |       | 20,843     |       |                        | —     |                                                 |       |                                                                                                                      | —     |   |   |
|                                  |       | $          | 152,742    |                        |       | $                                                    | —     |                                                                                                                      |       |   | $ | — |   |   |
| Total                                 |       | $          | 152,742    |                        |       | $                                                    | —     |                                                                                                                      |       |   | $ | 575,000 |   |   |

----

(1)          Valueupon change of control is calculated using a value of our common stock of$13.48 per share, the closing price of our common stock on December 29,2006, the last trading day in the fiscal year ended December 31, 2006,less the exercise price of the option of $5.88 per share.

***Pamela Maythenyi, Senior Vice President,SourceEcreative***

Pursuant to terms of the 1992 Plan and 2006 Plan,under which Ms. Maythenyi’s options are issued, in the event of a changeof control, 50% of the unvested portion of stock options held by Ms. Maythenyiwhich have not previously vested shall immediately and fully vest and shallremain exercisable for at least 15 days. If Ms. Maythenyi’s employment isterminated by us or by her for any reason, any unvested portion of her stockoptions will be immediately cancelled, and any vested portion thereof shallremain exercisable by Ms. Maythenyi for a period of three months from thedate of termination. If her employment is terminated as a result of her deathor disability, then immediately upon the date of Ms. Maythenyi’stermination, any unvested portion of her stock options will be immediatelycancelled, and any vested portion thereof shall remain exercisable by her for aperiod of six months from the date of termination.

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Thefollowing table summarizes the potential payments to Ms. Maythenyiassuming her employment with us was terminated or a change of control occurredon December 31, 2006, the last day of our most recently completed fiscalyear. 

| **Benefits and Payments**   | ** ** | ** ** | ** ** | **Change of  Control** | ** ** | **Termination  upon Death  or Disability** | ** ** | **Termination by us  without Just Cause  or by Ms. Maythenyi  for Good Reason** | ** ** |
|---------------------------------------|------------|------------|------------|-----------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|
| Base Salary                           |       |       | $          | —                      |       |                                                 |       | $                                                                                                                            | —     |   |   |   | $ | 120,000 |   |   |
| Bonus                                 |       |       | $          | —                      |       |                                                 |       | $                                                                                                                            | —     |   |   |   | $ | — |   |   |
| Acceleration of Vesting  of Options:  |       |       |       |                        |       |                                                 |       |                                                                                                                         |       |   |   |   |   |
| Number of Stock  Options and Value(1) |       |       | 12,605     |                        |       |                                                 | —     |                                                                                                                         |       |   | — |   |   |
|                                  |       |       | $          | 88,743                      |       |                                                 |       | $                                                                                                                            | —     |   |   |   | $ | — |   |   |
| Total                                 |       |       | $          | 88,743                      |       |                                                 |       | $                                                                                                                            | —     |   |   |   | $ | 120,000 |   |   |

----

(1)          Valueupon change of control is calculated using a value of our common stock of$13.48 per share, the closing price of our common stock on December 29,2006, the last trading day in the fiscal year ended December 31, 2006,less the exercise price of the option of $5.88 per share.

**DirectorCompensation**

***Director Compensation Table***

Thefollowing table sets forth a summary of the compensation earned by ourDirectors and/or paid to certain of our Directors pursuant to the Company’scompensation policies for the fiscal year ended December 31, 2006, otherthan Scott K. Ginsburg, our Chairman and Chief Executive Officer, andOmar A. Choucair, our Chief Financial Officer and Director.

| **Name**              | ** ** | ** ** | ** ** | **Fees Earned or  Paid in Cash  ($)** | ** ** | **Option Awards  ($)(1)(2)** | ** ** | **Total  ($)** | ** ** |
|-----------------------|------------|------------|------------|-----------------------------------------------------------|------------|-----------------------------------|------------|----------------|------------|
| William Donner        |       |       | 7,000      |                                                      |       |                              | —     |           |       | 7,000 |   |
| Lisa Gallagher        |       |       | 2,500      |                                                      |       |                              | —     |           |       | 2,500 |   |
| Kevin C. Howe         |       |       | 12,000     |                                                      |       |                              | 9,198      |           |       | 21,198 |   |
| David M. Kantor       |       |       | 5,000      |                                                      |       |                              | 9,198      |           |       | 14,198 |   |
| Anthony J.  LeVecchio |       |       | 32,000     |                                                      |       |                              | 9,198      |           |       | 41,198 |   |
| Cappy R. McGarr(3)    |       |       | 8,500      |                                                      |       |                              | 23,921     |           |       | 32,421 |   |

----

(1)          SeeNote 2 to our Consolidated Financial Statements included in our Annual Reporton Form 10-K for our fiscal year ended December 31, 2006 fordetails as to the assumptions used to determine the fair value of optionawards.

(2)          Representsthe compensation expense incurred by us in fiscal year 2006 in connection withgrants of options to purchase 10,000 shares of common stock on May 26,2006 at an exercise price of $5.30, calculated in accordance with SFAS 123(R).

(3)          Mr. McGarrresigned from our Board of Directors effective May 26, 2006.

***Director Compensation Policy***

Messrs. Ginsburg and Choucair, our Chairman andChief Executive Officer, and Chief Financial Officer and Director,respectively, are not paid any fees or other compensation for services as amember of our Board of Directors or of any committee of our Board of Directors.

67

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The non-employee members of our Board of Directorsreceive compensation for services provided as a director as well asreimbursement for documented reasonable expenses incurred in connection withattendance at meetings of our Board of Directors and the committees thereof. Otherthan Mr. LeVecchio, the Company pays its directors $2,500 per Board ofDirectors meeting attended, plus $1,000 per meeting of each committee orspecial assignments of the Board of Directors. Mr. LeVecchio is paid$25,000 as an annual retainer, $1,000 for each meeting of the Board attended,and $750 for each meeting of the Audit Committee attended.

Members of our Board ofDirectors are also eligible to receive stock option grants both upon joiningthe Board of Directors and on an annual basis in line with recommendations bythe Compensation Committee, which grants are non-qualified stock options underour 2006 Plan, and which typically vest ratably over four years.

**Guarantor Agreementwith Scott K. Ginsburg**

In connection with theCompany’s acquisition of Media DVX, a $6.5 million promissory note wasissued to the seller of Media DVX, payable over three years with an interestrate of the one month LIBOR rate for the applicable period with principal andthen accrued interest due as follows: $1.5 million due on April 15, 2006,$2.0 million due on April 15, 2007, and $3.0 million due on April 15,2008. However, during the fourth quarter of 2006, the Company retired theentire remaining balance of this obligation through a combination of issuingcommon stock and cash. The Company paid accrued interest on the promissory noteon a quarterly basis. The promissory note was personally guaranteed byScott K. Ginsburg, the Company’s Chief Executive Officer and Chairman ofthe Board. Mr. Ginsburg’s personal guarantee of the Company’s debt wasevaluated for the purpose of determining an amount to compensate him for suchguarantee. The Company obtained an independent valuation which determined thatthe improved interest rate obtained by the Company as a direct result of thepersonal guarantee was worth approximately $0.6 million over the term ofthe loan. For the years ended December 31, 2006 and 2005 respectively, theCompany has recognized additional interest expense of $0.3 million and$0.1 million associated with the guarantee. Amounts paid to Mr. Ginsburgassociated with this guarantee were $0.2 million and $0, for the years ended December 31,2006 and 2005, respectively.

**Employee BenefitPlans**

We sponsor a 401(k) plancovering employees who meet certain defined requirements. Under the terms ofour 401(k) plan, participants may elect to make contributions on a pre-taxand after-tax basis, subject to certain limitations under the Internal RevenueCode and we may match a percentage of employee contributions, on adiscretionary basis, as determined by our Board of Directors. We currentlymatch 1% of the participating employees’ salary who contribute at least 3% oftheir salary. We may make other discretionary contributions to the 401(k) planpursuant to a determination by our Board of Directors, although, to date, nosuch other discretionary contributions have been made.

**CompensationCommittee Interlocks and Insider Participation**

The current members of the Compensation Committee are Messrs. Howe(Chairman) and Kantor, and Ms. Gallagher. There were no other members ofthe committee during 2006. All current members of the Compensation Committeeare “independent directors” as defined under the Nasdaq Marketplace Rules. Noneof these individuals were at any time during 2006, or at any other time, anofficer or employee of the Company.

No executive officer ofthe Company serves as a member of the board of directors or compensationcommittee of any entity that has one or more executive officers serving as amember of the Company’s Board of Directors or Compensation Committee.

68

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**Item12.**                 SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

**Security Ownership of Directors and Executive Officers**

Thefollowing table sets forth the beneficial ownership of our common stock as of March 31,2007, except as noted, for (a) each stockholder known by us to ownbeneficially more than 5% of our common stock; (b) each of our Directors; (c) eachexecutive officer named in the Summary Compensation Table; (d) and allof our current Directors and executive officers as a group. Beneficialownership is determined in accordance with the rules of the Securities andExchange Commission and includes voting or investment power with respect to thesecurities.

|                                                                      | ** ** | **Shares Beneficially Owned  as of March 31, 2007** (1) (2) | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|
| **Beneficial Owner**                                            | ** ** | ** **                                                                                          | ** ** | **Number of  Shares** | ** ** | **Percentage  of Class** | ** ** |
| Scott K. Ginsburg(3)                                                 |       | 3,298,199                                                                                           |       |   | 19.9 | % |   |
| Moon Doggie Family Partnership                                       |       |                                                                                                |       |   |   |   |   |
| Omar A. Choucair(4)                                                  |       | 61,884                                                                                              |       |   | * |   |   |
| Pamela Maythenyi(5)                                                  |       | 2,812                                                                                               |       |   | * |   |   |
| Neil H. Nguyen(6)                                                    |       | 1,625                                                                                               |       |   | * |   |   |
| David M Kantor(7)                                                    |       | 17,416                                                                                              |       |   | * |   |   |
| Kevin C. Howe(8)                                                     |       | 28,616                                                                                              |       |   | * |   |   |
| Anthony J. LeVecchio(9)                                              |       | 11,721                                                                                              |       |   | * |   |   |
| Lisa C. Gallagher                                                    |       | 14,664                                                                                              |       |   | * |   |   |
| William Donner                                                       |       | 1,745                                                                                               |       |   | * |   |   |
| Kinderhook Partners, LP                                              |       | 1,376,885                                                                                           |       |   | 8.7 | % |   |
| 1 Executive Dr., Suite 160  Fort Lee, NJ 07024                  |       |                                                                                                |       |   |   |   |   |
| William Blair &  Company, L.L.C.                            |       | 1,100,000                                                                                           |       |   | 6.9 | % |   |
| 222 West Adam Street  Chicago, IL 60606                              |       |                                                                                                |       |   |   |   |   |
| Costa Brava Partnership  III, LP                                     |       | 1,001,089                                                                                           |       |   | 6.3 | % |   |
| 420 Boylston St.  Boston, MA 02116                                   |       |                                                                                                |       |   |   |   |   |
| CrossPoint Venture Partners                                          |       | 846,701                                                                                             |       |   | 5.3 | % |   |
| The Pioneer Hotel Building  2925 Woodside Road  Woodside, CA 94062   |       |                                                                                                |       |   |   |   |   |
| All directors and executive officers as a group (9 persons)(10) |       | 3,438,682                                                                                           |       |   | 20.7 | % |   |
|                                                                      |            |                                                                                                     |            |  |  |  |  |  |  |

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*                    Lessthan 1% of the Company’s common stock.

(1)          Exceptas indicated in the footnotes to this table and pursuant to applicablecommunity property laws, to the Company’s knowledge, the persons and entitiesnamed in the table have sole voting and investment power with respect to allshares of common stock shown as beneficially owned by them. Unless otherwiseindicated, the business address of each beneficial owner listed is750 West John Carpenter Freeway, Suite 700, Irving, TX 75039

69

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(2)          Thenumber of shares of common stock outstanding as of March 31, 2007 was15,849,796. The number of beneficially owned shares includes shares issuablepursuant to stock options and warrants that may be exercised withinsixty days after March 31, 2007.

(3)          Basedon filings with the Securities and Exchange Commission indicating beneficialownership. Includes 2,303,531 shares held of record by Scott K. Ginsburg and292,013 shares held in the name of Moon Doggie Family Partnership, L.P. ScottK. Ginsburg is the sole general partner of Moon Doggie Family Partnership, L.P.Includes options exercisable into 50,830 shares of common stock, warrantsissued to Moon Doggie Family Partnership, L.P. exercisable into 300,852 sharesof common stock and warrants issued to Scott K. Ginsburg exercisable into350,973 shares of common stock.

(4)          Includesoptions exercisable into 49,832 shares of common stock and warrants exercisableinto 8,666 shares of common stock.

(5)          Representsoptions exercisable into 2,812 shares of common stock.

(6)          Representsoptions exercisable into 1,625 shares of common stock.

(7)          Includesoptions exercisable into 16,416 shares of common stock.

(8)          Includesoptions exercisable into 15,416 shares of common stock.

(9)          Includesoptions exercisable into 4,221 shares of common stock.

(10)   Includesoptions exercisable into 141,152 shares of common stock and warrantsexercisable into 660,491 shares of common stock.

**Equity Compensation Plan Information**

Thefollowing table provides certain aggregate information with respect to all ofthe Company’s equity compensation plans in effect as of December 31, 2006.
| Plan category    | ** ** | ** ** | ** ** | **Number of  Securities to be issued  upon exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding securities  reflected in first column)** | ** ** |
|-----------------------|------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Common stock options  |       |       | 572,176    |                                                                                                                                             |       |                                                                                                        | $          | 11.71                                                                                                                                                                                                              |       |   |   | 1,097,500 |   |   |
| Common stock warrants |       |       | 660,491    |                                                                                                                                             |       |                                                                                                        | $          | 10.00                                                                                                                                                                                                              |       |   |   | — |   |   |
| Total                 |       |       | 1,232,667  |                                                                                                                                             |       |                                                                                                        | $          | 10.79                                                                                                                                                                                                              |       |   |   | 1,097,500 |   |   |

 

**Item13.**                 CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

**Certain Relationships and Related Transactions**

Our Audit Committeereviews and approves in advance all related party transactions in accordancewith its written charter in order to determine whether or not the proposedtransaction is fair to, and in the best interests of the Company. None of theCompany’s directors or executive officers (1) has entered into anytransaction or series of similar transactions with the Company except asdescribed below, (2) has any relationship, or has had any relationshipwith the Company except as described below, or (3) has outstandingindebtedness to the Company, which (in any case) requires disclosure under Item404 of the SEC’s Regulation S-K.

Prior to its execution anddelivery, the Board of Directors and the Audit Committee reviewed the Media DVXtransaction in detail and determined it was in the best interest of the Companyto move forward with the acquisition of the Media DVX assets.

70

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However, the Company didnot have the borrowing capacity to fully finance the $10 million purchase pricethrough the Company’s existing credit facility in April 2005. Accordingly, theBoard of Directors, Audit Committee and the Media DVX selling shareholdernegotiated a $6.5 million promissory note as part of the purchase price. TheMedia DVX selling shareholder demanded a personal guarantee from Mr. Ginsburgas security on the three year $6.5 million promissory note.

Consistent with itswritten charter, the Audit Committee and the Board of Directors approved andratified the asset purchase agreement, the promissory note and the personalguarantor agreement in connection with the purchase of the Media DVX assets.Mr. Ginsburg’s personal guarantee of the Company’s debt was evaluated forthe purpose of determining an amount to compensate him for such guarantee. TheCompany obtained an independent valuation which determined that the improvedinterest rate obtained by the Company as a direct result of the personalguarantee was worth approximately $0.6 million over the term of the loan.The Audit Committee and the Board of Directors each determined that thecompensation payable to Mr. Ginsburg was fair to, and in the best interests ofthe Company and its stockholders.

In connection with theCompany’s acquisition of Media DVX, the $6.5 million promissory note wasissued to the seller of Media DVX and was payable over three years with aninterest rate of the one month LIBOR rate for the applicable period withprincipal and then accrued interest due as follows: $1.5 million due on April 15,2006, $2.0 million due on April 15, 2007, and $3.0 million dueon April 15, 2008. However, during the fourth quarter of 2006, the Companyretired the entire remaining balance of this obligation through a combinationof issuing common stock and cash. The Company paid accrued interest on thepromissory note on a quarterly basis. For the years ended December 31,2006 and 2005 respectively, the Company has recognized additional interestexpense of $0.3 million and $0.1 million associated with the guarantee. Amountspaid to Mr. Ginsburg associated with this guarantee were $0.2 million and 0,for the years ended December 31, 2006 and 2005, respectively.

**Director Independence**

The Board of Directors hasdetermined, after considering all of the relevant facts and circumstances, thateach of Mr. Howe, Mr. Kantor, Mr. LeVecchio, Mr. Donner andMs. Gallagher are independent from our management, as an “independentdirector” as defined under the Nasdaq Marketplace Rules. This means that noneof those directors (1) is an officer or employee of the Company or its subsidiariesor (2) has any direct or indirect relationship with the Company that wouldinterfere with the exercise of his or her independent judgment in carrying outthe responsibilities of a director. As a result, the Company has a majority ofindependent directors as required by the Nasdaq Marketplace Rules.

**Item14.**                 PRINCIPALACCOUNTANT FEES AND SERVICES

Thefollowing is a summary of the fees billed to the Company by KPMG forprofessional services rendered for the fiscal years ended December 31,2006 and December 31, 2005:

| ** **         | ** ** | **Years Ended December 31,** | ** ** |
|--------------------|------------|---------------------------------------------|------------|
| ** **         | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| Audit Fees         |       | $                                           | 1,169,000  |   | $ | 924,000 |   |
| Audit Related Fees |       | 25,408                                      |       | 25,000 |   |
| Tax Fees           |       | 197,500                                     |       | 110,000 |   |
| All Other Fees     |       | —                                      |       | — |   |
| Total              |       | $                                           | 1,391,908  |   | $ | 1,059,000 |   |

 

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The Audit Committee has considered whether (and hasdetermined that) the provision by KPMG of the services described under Tax Feesis compatible with maintaining KPMG’s independence from management and theCompany. In addition, all of the services rendered to the Company by KPMG werepre-approved by the Audit Committee.

***Audit Fees***

These are fees forprofessional services for the audit of the Company’s annual financialstatements, and for the review of the financial statements included in theCompany’s filings on Form 10-Q, and for services that are normallyprovided in connection with statutory and regulatory filings or engagements,including fees relating to compliance with the provisions of the Sarbanes-OxleyAct, Section 404, and audits of acquired entities. The amount for 2006includes approximately $172,000 for the Registration Statements on Forms S-3,S-4, and S-8.

***Audit-Related Fees***

We paid KPMG $25,408 and$25,000 in 2006 and 2005, respectively, for services related to auditing our401(k) plan.

***Tax Fees***

The amounts shown are feespaid to KPMG associated with tax compliance and tax consultation.

***All Other Fees***

We paid no other fees toKPMG in 2006 or 2005.

**Policy on Audit Committee Pre-Approval of Audit andPermissible Non-Audit Services of Independent Registered Public Accounting Firm**

Consistent with thepolicies of the Securities and Exchange Commission regarding auditorindependence, the Audit Committee has responsibility, pursuant to its writtencharter, for appointing, setting compensation and overseeing the work of ourindependent registered public accounting firm. In recognition of thisresponsibility, the Audit Committee has established a policy to pre-approve allaudit and permissible non-audit services provided by our independent registeredpublic accounting firm. The Audit Committee’s policy is to approve all auditand non-audit services provided by our independent registered public accountingfirm prior to the commencement of the services using a combination ofpre-approvals for certain engagements up to predetermined dollar thresholds inaccordance with the pre-approval policy and specific approvals for certainengagements on a case-by-case basis. The Audit Committee has delegatedauthority to the committee chair to pre-approve between committee meetingsthose services that have not already been pre-approved by the committee. Thechair is required to report any such pre-approval decisions to the fullcommittee at its next scheduled meeting.

**PART IV**

**Item 15.**                 EXHIBITS,FINANCIAL STATEMENT SCHEDULES.

| (a)(1) |   | See Index to  Financial Statements on page F-1 of this Amendment No. 2 for a list of  financial statements filed herewith              |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|
| (a)(2) |   | See Schedule  II-Valuation and Qualifying Accounts on page S-1 of this Amendment No. 2                                                 |
| (a)(3) |   | See Index to Exhibits on  page 74 of this Amendment No. 2 for a list of exhibits filed as  part of this Amendment No. 2 |

 

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**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.
|                               | **DG  FASTCHANNEL, INC.** |
|-------------------------------|---------------------------|
| Date:  November 27, 2007 | By:                       | /s/ SCOTT K. GINSBURG |
|                          |                      | Scott K. Ginsburg |
|                          |                      | Chairman of the Board of  Directors and  Chief Executive Officer |

 

Pursuantto the requirements of the Securities Act of 1934, this report has been signedby the following persons on behalf of the registrant and in the capacities andon the dates indicated.

|                       | **Name**                                                                                 | ** **                                    | ** ** | ** **        | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|-----------------------|------------------------------------------------------------------------------------------|-----------------------------------------------|------------|-------------------|-----------|------------|------------|------------|----------|------------|
| *                     |                                                                                     | Chairman of the Board of Directors            |       | November 27, 2007 |
| Scott  K. Ginsburg    |                                                                                     | and Chief  Executive Officer                  |       |              |
| *                     |                                                                                     | Chief Financial Officer and Director          |       | November 27, 2007 |
| Omar  A. Choucair     |                                                                                     | (Principal  Financial and Accounting Officer) |       |              |
| *                     |                                                                                     | Director                                      |       | November 27, 2007 |
| William  Donner       |                                                                                     |                                          |       |              |
| *                     |                                                                                     | Director                                      |       | November 27, 2007 |
| David  M. Kantor      |                                                                                     |                                          |       |              |
| *                     |                                                                                     | Director                                      |       | November 27, 2007 |
| Lisa  C. Gallagher    |                                                                                     |                                          |       |              |
| *                     |                                                                                     | Director                                      |       | November 27, 2007 |
| Kevin  C. Howe        |                                                                                     |                                          |       |              |
| *                     |                                                                                     | Director                                      |       | November 27, 2007 |
| Anthony  J. LeVecchio |                                                                                     |                                          |       |              |
| *By                   | /s/ SCOTT K. GINSBURG                                                                    |                                          |       |              |      |
|                  | Scott K. Ginsburg  As Attorney-in-Fact  Pursuant to Powers of  Attorney Previously Filed |                                          |       |              |      |
|                       |                                                                                          |                                               |            |                   |           |            |            |            |          |            |  |

 

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**INDEXTO FINANCIAL STATEMENTS**

|                                                                                                                                  | ** ** | **Page** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Report of Independent  Registered Public Accounting Firm                                                                         |       | F-2      |   |
| Consolidated Balance Sheets  as of December 31, 2006 and 2005                                                               |       | F-3      |   |
| Consolidated Statements of  Operations for the Three Years Ended December 31, 2006                                          |       | F-4      |   |
| Consolidated Statements of  Stockholders’ Equity and Comprehensive Income for the Three Years Ended  December 31, 2006 |       | F-5      |   |
| Consolidated Statements of  Cash Flows for the Three Years Ended December 31, 2006                                          |       | F-6      |   |
| Notes  to Consolidated Financial Statements                                                                                      |       | F-7      |   |

 

F-1

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**DGFASTCHANNEL, INC. AND SUBSIDIARIES**

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

The Board of Directors and StockholdersDG FastChannel, Inc. f/k/a Digital Generation Systems, Inc.:

We have audited the accompanying consolidated balance sheets of DGFastChannel, Inc. and subsidiaries (f/k/a Digital Generation Systems, Inc.) asof December 31, 2006 and 2005, and the related consolidated statements ofoperations, stockholders’ equity and comprehensive income, and cash flows for each of the years in thethree-year period ended December 31, 2006. In connection with our audits of theconsolidated financial statements, we also have audited financial statementschedule II.  These consolidatedfinancial statements and financial statement schedule are the responsibility ofthe Company’s management. Our responsibility is to express an opinion on theseconsolidated financial statements and financial statement schedule based on ouraudits.

We conducted our auditsin accordance with the standards of thePublic Company Accounting Oversight Board (United States).  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit also includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of DG FastChannel, Inc. and subsidiaries (f/k/a Digital Generation Systems, Inc.) asof December 31, 2006 and 2005, and the results of their operations and theircash flows for each of the years in the three-year period ended December 31,2006, in conformity with U.S. generally accepted accounting principles.  Also in our opinion, the related financialstatement schedule, when considered in relation to the basic consolidatedfinancial statements taken as a whole, present fairly, in all materialrespects, the information set forth therein.

As discussed in Note 2 to the consolidated financialstatements, effective January 1, 2006, the Company adopted Statement ofFinancial Accounting Standards No. 123 (revised 2004), *Share-Based Payment*, and effectiveJanuary 1, 2006, the Company adopted the provision of Securities andExchange Commission Staff Accounting Bulletin No. 108, *Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in the Current Year Financial Statements*.

KPMG LLP

Dallas, TexasMarch 30, 2007

F-2

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**DG FASTCHANNEL, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(In thousands, except par value amounts)**

| ** **                                                                                                                                                                                          | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ***Assets***                                                                                                                                                                                        |       |                        |       |                        |       |   |   |   |   |
| CURRENT ASSETS:                                                                                                                                                                                     |       |                        |       |                        |       |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                                                          |       |                        | $          | 24,474                      |       |   |   | $ | 1,886 |   |   |
| Accounts receivable  (less allowance for doubtful accounts of $1,046 in 2006 and $491 in 2005)                                                                                                      |       |                        | 15,433     |                        |       |   | 10,363 |   |   |
| Current deferred income  taxes                                                                                                                                                                      |       |                        | 2,290      |                        |       |   | 829 |   |   |
| Other current assets                                                                                                                                                                                |       |                        | 811        |                        |       |   | 910 |   |   |
| Current assets held for  sale from discontinued operations                                                                                                                                          |       |                        | 711        |                        |       |   | 1,928 |   |   |
| Total current assets                                                                                                                                                                                |       |                        | 43,719     |                        |       |   | 15,916 |   |   |
| Property and equipment  (net of accumulated depreciation of $20,163 in 2006 and $16,245 in 2005)                                                                                                    |       |                        | 12,829     |                        |       |   | 11,494 |   |   |
| Long term investments                                                                                                                                                                               |       |                        | 5,180      |                        |       |   | 4,758 |   |   |
| Goodwill                                                                                                                                                                                            |       |                        | 65,545     |                        |       |   | 43,397 |   |   |
| Deferred income taxes,  net                                                                                                                                                                         |       |                        | 10,244     |                        |       |   | 17,371 |   |   |
| Intangible assets (net  of accumulated amortization of $9,210 in 2006 and $5,638 in 2005)                                                                                                           |       |                        | 35,112     |                        |       |   | 18,242 |   |   |
| Restricted cash                                                                                                                                                                                     |       |                        | 425        |                        |       |   | — |   |   |
| Other noncurrent assets                                                                                                                                                                             |       |                        | 654        |                        |       |   | 815 |   |   |
| Noncurrent assets held  for sale from discontinued operations                                                                                                                                       |       |                        | 1,875      |                        |       |   | 2,340 |   |   |
| TOTAL ASSETS                                                                                                                                                                                        |       |                        | $          | 175,583                     |       |   |   | $ | 114,333 |   |   |
| ***Liabilities and Stockholders’  Equity***                                                                                                                                                    |       |                        |       |                        |       |   |   |   |   |
| CURRENT LIABILITIES                                                                                                                                                                                 |       |                        |       |                        |       |   |   |   |   |
| Accounts payable                                                                                                                                                                                    |       |                        | $          | 4,112                       |       |   |   | $ | 4,870 |   |   |
| Accrued liabilities  (includes amounts owed to related party of $332 in 2006, and $103 in 2005—see  Notes 7 and 19)                                                                       |       |                        | 8,500      |                        |       |   | 3,240 |   |   |
| Deferred revenue, net                                                                                                                                                                               |       |                        | 1,100      |                        |       |   | 458 |   |   |
| Current portion of  long-term debt and capital leases                                                                                                                                               |       |                        | 4,190      |                        |       |   | 3,698 |   |   |
| Short-term obligations  of discontinued operations                                                                                                                                                  |       |                        | 145        |                        |       |   | 1,026 |   |   |
| Total current  liabilities                                                                                                                                                                          |       |                        | 18,047     |                        |       |   | 13,292 |   |   |
| Long-term debt and  capital leases, net of current portion                                                                                                                                          |       |                        | 15,650     |                        |       |   | 20,834 |   |   |
| TOTAL LIABILITIES                                                                                                                                                                                   |       |                        | 33,697     |                        |       |   | 34,126 |   |   |
| Commitments and contingencies (see Note 14)                                                                                                                                                         |       |                        |       |                        |       |   |   |   |   |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                          |       |                        |       |                        |       |   |   |   |   |
| Preferred stock, $0.001  par value—Authorized 15,000 shares; Issued and outstanding—none                                                                                                  |       |                        | —     |                        |       |   | — |   |   |
| Common stock, $0.001 par  value—Authorized—200,000 shares; 15,900 issued and 15,844 outstanding at  December 31, 2006; 7,479 issued and 7,423 outstanding at  December 31, 2005 |       |                        | 16         |                        |       |   | 8 |   |   |
| Additional paid-in  capital                                                                                                                                                                         |       |                        | 333,821    |                        |       |   | 271,320 |   |   |
| Accumulated deficit                                                                                                                                                                                 |       |                        | (191,358   | )                           |       |   | (190,268 | ) |   |
| Other comprehensive  income                                                                                                                                                                         |       |                        | 260        |                        |       |   | — |   |   |
| Treasury stock, at cost                                                                                                                                                                             |       |                        | (853       | )                           |       |   | (853 | ) |   |
| TOTAL STOCKHOLDERS’  EQUITY                                                                                                                                                                    |       |                        | 141,886    |                        |       |   | 80,207 |   |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                     |       |                        | $          | 175,583                     |       |   |   | $ | 114,333 |   |   |

 

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

F-3

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts)**

| ** **                                                                | ** ** | **For years ended December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                | ** ** | **2006**                                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                                                 |       |                                                 |       |   |   |   |   |
| Audio and video content distribution                                      |       | $                                                    | 64,911     |   | $ | 49,971 |   | $ | 52,970 |   |
| Other                                                                     |       | 3,756                                                |       | 1,853 |   | 600 |   |
| Total revenues                                                            |       | 68,667                                               |       | 51,824 |   | 53,570 |   |
| Cost of revenues:                                                         |       |                                                 |       |   |   |   |   |
| Audio and video content distribution                                      |       | 32,919                                               |       | 31,578 |   | 28,806 |   |
| Other                                                                     |       | 403                                                  |       | 606 |   | 135 |   |
| Total cost of revenues                                                    |       | 33,322                                               |       | 32,184 |   | 28,941 |   |
| Operating  expenses:                                                      |       |                                                 |       |   |   |   |   |
| Sales and marketing                                                       |       | 4,240                                                |       | 3,915 |   | 4,264 |   |
| Research and development                                                  |       | 1,779                                                |       | 1,107 |   | 1,520 |   |
| General and administrative                                                |       | 10,462                                               |       | 7,587 |   | 6,328 |   |
| Restructuring charges                                                     |       | —                                               |       | 434 |   | — |   |
| Impairment charges                                                        |       | —                                               |       | — |   | 1,048 |   |
| Depreciation and amortization                                             |       | 8,563                                                |       | 6,348 |   | 5,143 |   |
| Total operating  expenses                                                 |       | 25,044                                               |       | 19,391 |   | 18,303 |   |
| Income from  operations                                                   |       | 10,301                                               |       | 249 |   | 6,326 |   |
| Other (income) expense:                                                   |       |                                                 |       |   |   |   |   |
| Reduction in fair value of long-term investments                          |       | 4,758                                                |       | — |   | — |   |
| Interest income and other (income) expense, net                           |       | (58                                                  | )          | — |   | — |   |
| Interest expense                                                          |       | 2,844                                                |       | 2,990 |   | 1,284 |   |
| Net income (loss)  before income taxes from continuing operations         |       | 2,757                                                |       | (2,741 | ) | 5,042 |   |
| Provision  (benefit) for income taxes                                     |       | 2,378                                                |       | (768 | ) | 1,728 |   |
| Net income (loss)  from continuing operations                             |       | 379                                                  |       | (1,973 | ) | 3,314 |   |
| Discontinued  operations:                                                 |       |                                                 |       |   |   |   |   |
| (Loss) income from operations of discontinued operations                  |       | (539                                                 | )          | 1,455 |   | (6,181 | ) |
| Income tax benefit (expense)                                              |       | 209                                                  |       | (572 | ) | 6,071 |   |
| (Loss) on disposal of discontinued operations, net  of tax benefit        |       | (698                                                 | )          | — |   | — |   |
| Net (loss) income  from discontinued operations                           |       | (1,028                                               | )          | 883 |   | (110 | ) |
| Net income (loss)                                                         |       | $                                                    | (649       | ) | $ | (1,090 | ) | $ | 3,204 |   |
| Basic net income (loss) per common share from  continuing operations      |       | $                                                    | 0.04       |   | $ | (0.27 | ) | $ | 0.46 |   |
| Basic net income  (loss) per common share from discontinued operations    |       | (0.10                                                | )          | 0.12 |   | (0.02 | ) |
| Basic net income  (loss) per common share                                 |       | $                                                    | (0.06      | ) | $ | (0.15 | ) | $ | 0.44 |   |
| Diluted net income (loss) per common share from  continuing operations    |       | $                                                    | 0.04       |   | $ | (0.27 | ) | $ | 0.46 |   |
| Diluted net  income (loss) per common share from discontinued  operations |       | (0.10                                                | )          | 0.12 |   | (0.02 | ) |
| Diluted net  income (loss) per common share                               |       | $                                                    | (0.06      | ) | $ | (0.15 | ) | $ | 0.44 |   |
| Basic weighted average common shares outstanding                          |       | 10,568                                               |       | 7,378 |   | 7,277 |   |
| Diluted weighted average  common shares outstanding                       |       | 10,568                                               |       | 7,378 |   | 7,330 |   |

 

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

F-4

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME(In thousands)**

| ** **                                                                 | ** ** | ** **            | ** ** | ** **              | ** ** | ** **  | ** ** | ** **        | ** ** | **Additional**  | ** ** | **Other**              | ** ** | ** **  | ** ** | **Total**  | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|-------------|------------|-------------------|------------|-----------------|------------|------------------------|------------|-------------|------------|------------|------------|
| ** **                                                                 | ** ** | **Common Stock** | ** ** | **Treasury Stock** | ** ** | **Paid-in** | ** ** | **Comprehensive** | ** ** | **Accumulated** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                 | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Shares**  | ** ** | **Amount**        | ** ** | **Capital**     | ** ** | **Income**             | ** ** | **Deficit** | ** ** | **Equity** | ** ** |
| Balance at December 31, 2003                                          |       |                  | 7,209      |                    |       |        | $          | 7                 |       |            |       | (1                     | )          |        |       | $          | (101       | ) |   |   | $ | 267,950 |   |   |   | $ | — |   |   |   | $ | (192,382 | ) |   |   | $ | 75,474 |   |   |
| Exercise of stock options                                                  |       |                  | 109        |                    |       |        | 0          |              |       |            | —     |                   |       |        | —     |       |       |   | 1,254 |   |   |   | — |   |   |   | — |   |   |   | 1,254 |   |   |
| Issuance of common stock under employee stock  purchase plan               |       |                  | 2          |                    |       |        | —     |              |       |            | —     |                   |       |        | —     |       |       |   | 19 |   |   |   | — |   |   |   | — |   |   |   | 19 |   |   |
| Tax benefits from employee stock option plans                              |       |                  | —     |                    |       |        | —     |              |       |            | —     |                   |       |        | —     |       |       |   | 75 |   |   |   | — |   |   |   | — |   |   |   | 75 |   |   |
| Repurchase of common stock                                                 |       |                  | —     |                    |       |        | —     |              |       |            | (45        | )                      |       |        | (594       | )          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (594 | ) |   |
| Net income                                                                 |       |                  | —     |                    |       |        | —     |              |       |            | —     |                   |       |        | —     |       |       |   | — |   |   |   | — |   |   |   | 3,204 |   |   |   | 3,204 |   |   |
| Balance at December 31, 2004                                          |       |                  | 7,320      |                    |       |        | $          | 7                 |       |            |       | (46                    | )          |        |       | $          | (695       | ) |   |   | $ | 269,298 |   |   |   | $ | — |   |   |   | $ | (189,178 | ) |   |   | $ | 79,432 |   |   |
| Exercise of stock options                                                  |       |                  | 1          |                    |       |        | —     |              |       |            | —     |                   |       |        | —     |       |       |   | 5 |   |   |   | — |   |   |   | — |   |   |   | 5 |   |   |
| Issuance of common stock for acquisition                                   |       |                  | 155        |                    |       |        | 1          |              |       |            | —     |                   |       |        | —     |       |       |   | 1,999 |   |   |   | — |   |   |   | — |   |   |   | 2,000 |   |   |
| Issuance of common stock under employee stock  purchase plan               |       |                  | 3          |                    |       |        | —     |              |       |            | —     |                   |       |        | —     |       |       |   | 18 |   |   |   | — |   |   |   | — |   |   |   | 18 |   |   |
| Repurchase of common stock                                                 |       |                  | —     |                    |       |        | —     |              |       |            | (10        | )                      |       |        | (158       | )          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (158 | ) |   |
| Net loss                                                                   |       |                  | —     |                    |       |        | —     |              |       |            | —     |                   |       |        | —     |       |       |   | — |   |   |   | — |   |   |   | (1,090 | ) |   |   | (1,090 | ) |   |
| Balance at December 31, 2005                                          |       |                  | 7,479      |                    |       |        | $          | 8                 |       |            |       | (56                    | )          |        |       | $          | (853       | ) |   |   | $ | 271,320 |   |   |   | $ | — |   |   |   | $ | (190,268 | ) |   |   | $ | 80,207 |   |   |
| SAB 108 adoption                                                           |       |                  | —     |                    |       |        | —     |              |       |            | —     |                   |       |        | —     |       |       |   | — |   |   |   | — |   |   |   | (441 | ) |   |   | (441 | ) |   |
| Exercise of stock options                                                  |       |                  | 2          |                    |       |        | —     |              |       |            | —     |                   |       |        | —     |       |       |   | 23 |   |   |   | — |   |   |   | — |   |   |   | 23 |   |   |
| Common stock issued to acquire FastChannel  Networks, Inc.            |       |                  | 5,160      |                    |       |        | 5          |              |       |            | —     |                   |       |        | —     |       |       |   | 27,444 |   |   |   | — |   |   |   | — |   |   |   | 27,449 |   |   |
| Issuance of common stock to retire debt                                    |       |                  | 259        |                    |       |        | —     |              |       |            | —     |                   |       |        | —     |       |       |   | 3,000 |   |   |   | — |   |   |   | — |   |   |   | 3,000 |   |   |
| Issuance of common stock under employee stock  purchase plan               |       |                  | 1          |                    |       |        | —     |              |       |            | —     |                   |       |        | —     |       |       |   | 9 |   |   |   | — |   |   |   | — |   |   |   | 9 |   |   |
| Proceeds from issuance of common stock                                     |       |                  | 2,999      |                    |       |        | 3          |              |       |            | —     |                   |       |        | —     |       |       |   | 31,717 |   |   |   | — |   |   |   | — |   |   |   | 31,720 |   |   |
| Share based compensation                                                   |       |                  | —     |                    |       |        | —     |              |       |            | —     |                   |       |        | —     |       |       |   | 308 |   |   |   | — |   |   |   | — |   |   |   | 308 |   |   |
| Comprehensive  income:                                                     |       |                  |       |                    |       |        |       |              |       |            |       |                   |       |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Currency translation adjustment                                            |       |                  | —     |                    |       |        | —     |              |       |            | —     |                   |       |        | —     |       |       |   | — |   |   |   | (2 | ) |   |   | — |   |   |   | (2 | ) |   |
| Unrealized gain on long-term investment (net of tax  expense of $166) |       |                  | —     |                    |       |        | —     |              |       |            | —     |                   |       |        | —     |       |       |   | — |   |   |   | 262 |   |   |   | — |   |   |   | 262 |   |   |
| Net loss                                                                   |       |                  | —     |                    |       |        | —     |              |       |            | —     |                   |       |        | —     |       |       |   | — |   |   |   | — |   |   |   | (649 | ) |   |   | (649 | ) |   |
| Total comprehensive income                                                 |       |                  |       |                    |       |        |       |              |       |            |       |                   |       |        |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   | (389 | ) |   |
| Balance at  December 31, 2006                                         |       |                  | 15,900     |                    |       |        | $          | 16                |       |            |       | (56                    | )          |        |       | $          | (853       | ) |   |   | $ | 333,821 |   |   |   | $ | 260 |   |   |   | $ | (191,358 | ) |   |   | $ | 141,886 |   |   |

 

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

F-5

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)**

| ** **                                                                                | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Cash flows from operating activities:                                                     |       |                                        |       |   |   |   |   |
| Net income (loss)                                                                         |       | $                                           | (649       | ) | $ | (1,090 | ) | $ | 3,204 |   |
| Adjustments to reconcile  net income (loss) to net cash provided by operating activities: |       |                                        |       |   |   |   |   |
| Depreciation of  property and equipment                                                   |       | 4,861                                       |       | 3,594 |   | 3,864 |   |
| Amortization of  intangibles                                                              |       | 4,285                                       |       | 3,052 |   | 1,933 |   |
| Impairment of  fixed assets                                                               |       | —                                      |       | — |   | 1,048 |   |
| Impairment of  goodwill                                                                   |       | —                                      |       | 655 |   | 8,083 |   |
| Deferred income  taxes                                                                    |       | 1,297                                       |       | (226 | ) | (4,678 | ) |
| Tax benefits from  employee stock options                                                 |       | —                                      |       | — |   | 75 |   |
| Loss on  extinguishment of debt                                                           |       | —                                      |       | 949 |   | — |   |
| Reduction in fair  value of long-term investment                                          |       | 4,758                                       |       | — |   | — |   |
| Provision for  doubtful accounts                                                          |       | 806                                         |       | 330 |   | 275 |   |
| Loss on disposal  of fixed assets                                                         |       | —                                      |       | 8 |   | — |   |
| Share based  compensation                                                                 |       | 308                                         |       | — |   | — |   |
| Changes in operating  assets and liabilities, net of working capital from acquisitions:   |       |                                        |       |   |   |   |   |
| Accounts  receivable                                                                      |       | (1,769                                      | )          | 1,510 |   | 1,051 |   |
| Other assets                                                                              |       | 874                                         |       | (2,310 | ) | (380 | ) |
| Accounts payable  and accrued liabilities                                                 |       | (4,188                                      | )          | 517 |   | (568 | ) |
| Deferred revenue,  net                                                                    |       | (938                                        | )          | (1,635 | ) | (2,537 | ) |
| Net cash provided  by operating activities                                                |       | 9,645                                       |       | 5,354 |   | 11,370 |   |
| Cash flows from investing  activities:                                                    |       |                                        |       |   |   |   |   |
| Purchases of  property and equipment                                                      |       | (3,054                                      | )          | (3,044 | ) | (3,342 | ) |
| Long-term  investments                                                                    |       | (4,752                                      | )          | (5,116 | ) | — |   |
| Acquisitions, net  of cash acquired                                                       |       | (257                                        | )          | (1,809 | ) | (18,251 | ) |
| Net cash used in  investing activities                                                    |       | (8,063                                      | )          | (9,969 | ) | (21,593 | ) |
| Cash flows from financing  activities:                                                    |       |                                        |       |   |   |   |   |
| Proceeds from  issuance of common stock                                                   |       | 31,753                                      |       | 23 |   | 1,273 |   |
| Purchases of  treasury stock                                                              |       | —                                      |       | (158 | ) | (594 | ) |
| Payments to secure  financing                                                             |       | (341                                        | )          | (885 | ) | (78 | ) |
| Borrowings under  long-term debt                                                          |       | 51,850                                      |       | 19,500 |   | 16,500 |   |
| Payments on  long-term debt                                                               |       | (62,254                                     | )          | (20,038 | ) | (6,055 | ) |
| Net cash provided  by (used in) financing activities                                      |       | 21,008                                      |       | (1,558 | ) | 11,046 |   |
| Effect of exchange  rate changes on cash and cash equivalents                             |       | (2                                          | )          | — |   | — |   |
| Net increase  (decrease) in cash and cash equivalents                                     |       | 22,588                                      |       | (6,173 | ) | 823 |   |
| Cash and cash  equivalents at beginning of year including discontinued operations         |       | 1,886                                       |       | 8,059 |   | 7,236 |   |
| Cash and cash  equivalents at end of year including discontinued operations               |       | $                                           | 24,474     |   | $ | 1,886 |   | $ | 8,059 |   |
| Cash paid for  interest                                                                   |       | $                                           | 2,349      |   | $ | 1,209 |   | $ | 991 |   |
| Cash paid for  income taxes                                                               |       | $                                           | 264        |   | $ | 195 |   | $ | 183 |   |
| Noncash financing  activities:                                                            |       |                                        |       |   |   |   |   |
| Vendor financed  acquisition of software                                                  |       | $                                           | —     |   | $ | 468 |   | $ | 1,544 |   |
| Equipment  purchased under capital lease                                                  |       | $                                           | —     |   | $ | — |   | $ | 757 |   |
| Non-cash component  of purchase price to acquire a business                               |       | $                                           | 49,048     |   | $ | 8,500 |   | $ | — |   |
| Debt extinguished  with the issuance of common stock                                      |       | $                                           | 3,000      |   | $ | — |   | $ | — |   |

 

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

F-6

----

**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1.   The Company:**

DG FastChannel, Inc.(the “Company”) owns a nationwide digital network that beneficially links morethan 5,000 advertisers and advertising agencies with more than 21,000 radio,television, cable, network and print publishing destinations electronicallythroughout the United States and Canada. The Company has a Network OperationCenter located in Irving, Texas that delivers audio, video, image and datacontent that comprise transactions among advertisers and various media outlets,including those in the broadcast industries.

**2.   Summary of Significant Accounting Policies:**

**Consolidation**

The consolidated financialstatements include the accounts of the Company and its subsidiaries. Allsignificant intercompany balances and transactions have been eliminated inconsolidation.

Certain prior year amountshave been reclassified to conform to current year presentations.

**Cash and Cash Equivalents**

Cash and cash equivalentsconsist of liquid investments with original maturities of three months or less.The Company maintains substantially all of its cash and cash equivalents withina few major financial institutions in the United States. As of December 31,2006 and 2005, cash equivalents consisted primarily of investments in U.S.money market funds and/or certificates of deposit at U.S. financialinstitutions.

**Allowance for Doubtful Accounts**

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

**Property and Equipment**

Property and equipment arestated at cost. Depreciation is computed over the estimated useful lives ofassets using the straight-line method. Equipment held under capital leases andleasehold improvements are amortized straight-line over the shorter of thelease term or estimated useful life of the asset. Estimated useful livesgenerally range from 2 to 7 years for network equipment, 3 to 5 yearsfor office equipment and furniture and 3 to 6 years for leaseholdimprovements.

**Impairment of Long-Lived Assets**

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

F-7

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Goodwill**

Goodwill, which representsthe excess of purchase price over the fair value of net identifiable assetsacquired, is assessed annually for recoverability based on the fair value ofthe reporting unit to which it relates.

**Identifiable Intangible Assets**

TheCompany assesses the impairment of long-lived assets whenever events or changesin circumstances indicate that the carrying value may not be recoverable.Factors that the Company considers important which could trigger an impairmentreview include the following:

·       significantunderperformance relative to expected historical or projected future operatingresults;

·       significantchanges in the manner or use of the acquired assets or the strategy for theCompany’s overall business;

·       significantnegative industry or economic trends;

·       significantdecline in its stock price for a sustained period; and

·       theCompany’s market capitalization relative to net book value.

If the Company determinesthat the carrying value of long-lived or intangible assets may not berecoverable based upon the existence of one or more of the above indicators ofimpairment, the Company assesses the recoverability of the long-lived orintangible asset by determining whether the amortization of the asset balanceover its remaining life can be recovered through undiscounted future operatingcash flow of the acquired operations. Any impairment is measured based on aprojected discounted cash flow method using a discount rate reflecting theCompany’s average cost of funds.

The Company determines theuseful lives of identifiable intangible assets after considering the specificfacts and circumstances related to each intangible asset. Factors consideredwhen determining useful lives include the contractual term of any agreement,the history of the asset, the Company’s long-term strategy for the use of theasset, any laws or other local regulations which could impact the useful lifeof the asset, and other economic factors, including competition and specificmarket conditions. Intangible assets that are deemed to have definite lives areamortized, generally on a straight-line basis, over their useful lives, rangingfrom 3 to 20 years. Refer to Note 6.

**Restricted Cash**

Restricted cash consistsof real estate security deposits totaling $0.4 million at December 31,2006. These security deposits are carried at fair value and are restricted asto withdrawal. The security deposits are held in the name of one of the Company’ssubsidiaries with major financial institutions to collateralize certain of theCompany’s office leases. Deposits expected to be returned beyond one year areclassified as non-current on the accompanying consolidated balance sheets.

**Use of Estimates**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. On an ongoing basis, the Company evaluates its estimates,including those related to the allowance for 

F-8

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

doubtfulaccounts, inventories, intangible assets and income taxes. The Company basesits estimates on historical experience and on other relevant assumptions thatare believed to be reasonable under the circumstances, the results of whichform the basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual resultscould differ from those estimates.

**Revenue Recognition**

The Company’s servicesrevenue from digital distribution of audio and video advertising content isbilled based on a rate per transmission, and the Company recognizes revenue forthese services upon notification of successful transmission of the content atthe broadcast destination. Revenue for distribution of analog audio and videocontent by tape is recognized when delivery has occurred, which is at the timethe tapes are delivered to a common carrier.

Our online creative research revenue is generated on asubscription basis, where customers pay either monthly, quarterly,semi-annually, or annually in order to access our database. We recognizerevenue ratably over the subscription period.

Media production and duplication includes a variety ofancillary services such as storage of client masters or other physicalmaterial, for which revenue is recognized monthly, after the storage servicehas been performed. Revenue related to our other services is recognized on aper transaction basis after the service has been performed. If the serviceresults in a tape or other deliverable, revenue is recognized when delivery hasoccurred, which is at the time the tape or other deliverable is in thepossession of the common carrier.

Customers pay a fixed fee per month for our mediaasset management and broadcast verification services. We recognize revenue ratablyover the service period.

The Company recognizesproduct revenue, now classified within discontinued operations, when persuasiveevidence of an arrangement exists, delivery has occurred, the sales price isfixed and determinable and collectibility is probable. Generally for productsales, these criteria are met at the time of delivery to a common carrier, as ourshipping terms are FOB shipping point. Provision is made at the time therelated revenue is recognized for estimated product returns, which historicallyhave been immaterial. The Company analyzes historical returns, current economictrends, and changes in customer demand when evaluating the adequacy ofprovisions for sales returns. At the time of the transaction, the Companyassesses whether the fee associated with revenue transactions is fixed anddeterminable and whether or not collection is reasonably assured. The Companyassesses whether the fee is fixed and determinable based on the payment termsassociated with the transaction. The Company assesses collectibility based on anumber of factors, including past transaction history with the customer and thecredit-worthiness of the customer. For all sales, the Company uses either abinding purchase order or signed sales agreement as evidence of an arrangement.Shipping and handling revenues are included in product revenues and costs areincluded in product costs.

**Operating Leases**

***The Company leases certain properties under terms thatinclude both rent holidays and escalations of rent. Rent expense on all leasesis recorded on a straight-line basis over the term of the lease.***

F-9

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Research and Development and Software DevelopmentCosts**

Research and developmentand other costs incurred to establish the technological feasibility of asoftware product to be sold are expensed as incurred. Costs of producingproduct masters incurred subsequent to establishing technological feasibilityare capitalized. Capitalized software development costs are amortized on aproduct-by-product basis over the estimated economic life of the product(generally 3-5 years). Amortization is computed by using either theratio that current gross revenues for a product bear to the total of currentand anticipated gross revenues for that product or the straight-line method,whichever results in a greater annual amortization.

Research and developmentand other costs incurred for the creation of internal use software arecapitalized when the preliminary project stage is completed and only costsincurred during the application development stage are capitalized. Uponcompletion of the project, amortization is initiated and capitalized softwaredevelopment costs are amortized over their estimated useful lives, generallyexpected to be 3 years.

**Income Taxes**

Income taxes are accountedfor under the asset and liability method. Deferred tax assets and liabilitiesare recognized for the future tax consequences attributable to differencesbetween financial statement carrying amounts of existing assets and liabilitiesand its respective tax basis and operating loss and tax credit carryforwards.Deferred tax assets and liabilities are measured using enacted tax ratesexpected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. The effect on deferred taxassets and liabilities of a change in tax rates is recognized in income in theperiod that includes the enactment date.

**Foreign Currencies**

The Company providesservices to certain entities located outside of the United States of America.Gains or losses on foreign currency transactions for the years ended December 31,2006, 2005 and 2004, were not material.

**Stock Option Plans**

Effective for the first quarter of 2006, the Companyadopted SFAS No. 123R, “Share-Based Payment,” which is a revision toSFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123Rfocuses primarily on accounting for transactions in which an entity obtainsemployee services in exchange for share-based payments. Under SFAS No. 123R,share-based awards that do not require future service (i.e., vested awards) areexpensed immediately. Share-based employee awards that require future serviceare amortized over the relevant service period. The Company adopted SFAS No. 123Runder the modified prospective adoption method. Accordingly, beginning January 1,2006, the Company recognizes compensation cost from share-based paymentarrangements based on grant date fair value. Under the modified prospectivetransition method, compensation cost recognized in 2006 includes: (i) compensationcost for all share-based payments granted prior to, but not vested as of, January 1,2006, based on the grant date fair value estimated in accordance with theoriginal provisions of SFAS No.123, and (ii) compensation cost for allshare-based payments granted subsequent to January 1, 2006, based on thegrant date fair value estimated in accordance with the provisions of SFAS No.123R.The Company recognized approximately $308,000 in share-based compensationexpense related to employee stock options in the year ended December 31,2006, which reduced our income from continuing operations by $185,000, or $0.01per common share (basic and diluted) and increased our net loss by 

F-10

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

$185,000, or ($0.02) percommon share (basic and diluted). SFAS No. 123R had no impact on our reportedcash flows.

Share-basedemployee awards granted for the year ended December 31, 2005 and prioryears were accounted for under the intrinsic-value-based method prescribed byAPB Opinion No. 25, “Accounting for Stock Issued to Employees,” aspermitted by SFAS No. 123. Therefore, no compensation expense wasrecognized for unmodified stock options issued for years prior to fiscal 2003that had no intrinsic value on the date of grant. If the Company were torecognize compensation expense over the relevant service period, generally fouryears, under the fair value method per SFAS No. 123 with respect tostock options granted for the years ended December 31, 2005 and 2004, netearnings would have decreased, resulting in proforma net gain (loss) andearning (loss) per common share (EPS) as set forth below (in thousands,except per share amounts):

| ** **                                                                                                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net income (loss):                                                                                                                         |       |     |       |     |       |
| As reported                                                                                                                                |       | $        | (1,090     | )        | $          | 3,204 |   |
| Total stock-based  employee compensation expense determined under fair value-based method  for all awards, net of related tax effects |       | (1,528   | )          | (2,999   | )          |
| Pro forma                                                                                                                                  |       | $        | (2,618     | )        | $          | 205 |   |
| Basic earnings per share of common stock:                                                                                                  |       |     |       |     |       |
| As reported                                                                                                                                |       | $        | (0.15      | )        | $          | 0.44 |   |
| Pro forma                                                                                                                                  |       | $        | (0.35      | )        | $          | 0.03 |   |
| Diluted earnings per share of common stock:                                                                                                |       |     |       |     |       |
| As reported                                                                                                                                |       | $        | (0.15      | )        | $          | 0.44 |   |
| Pro forma                                                                                                                                  |       | $        | (0.35      | )        | $          | 0.03 |   |

 

On January 17, 2006, the Company amended thetotal stock-based employee compensation expense determined under fairvalue-based method for all awards, net of related tax effects, pro forma netincome, and pro forma basic and diluted earnings per share of common stock forthe year ended December 31, 2004 to reflect the fair value of themodification of certain warrants during 2004.

**Financial Instruments and Concentration of Credit Risk**

Financial instruments thatpotentially subject the Company to a concentration of credit risk consistprimarily of cash and cash equivalents and accounts receivable. The Companyperforms ongoing credit evaluations of its customers, generally does notrequire collateral from its customers and maintains a reserve for potentialcredit losses. The Company believes that a concentration of credit risk withrespect to accounts receivable related to audio and video content distribution(the primary source of revenues and related accounts receivable) is limitedbecause its customers are geographically dispersed and the end users (thecustomers’ clients) are diversified across industries. The Company’sreceivables are principally from advertising agencies, dub and ship houses, andsyndicated programmers. The Company’s revenues are not contingent on itscustomers’ sales or collections. However, the timing of collections from itscustomers is affected by the billing cycle in which the customer bills itsend-users (the customers’ clients). The Company provides reserves for creditlosses.

F-11

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

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

During the years ended December 31,2006, 2005 and 2004, the Company had no customers that accounted for more than10% of the Company’s total revenue.

**Adoption of SAB 108**

On September 13,2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”). SAB108 expresses the SEC Staff’s views regarding the process of evaluatingmateriality of financial statement misstatements. SAB 108 addresses the diversityin evaluating materiality of financial statement misstatements and thepotential under current practice used by the Company for the build up ofimproper amounts on the balance sheet. SAB 108 is effective for the Company forthe year ended December 31, 2006. As allowed by SAB 108, the cumulativeeffect of the initial application of SAB 108 has been reported in the carryingamounts of assets and liabilities as of the beginning of fiscal 2006, with theoffsetting balance to retained earnings. Upon adoption, the Company recorded anincrease to accrued liabilities of $0.1 million, originally related to2005, and an increase in deferred tax liabilities of approximately $0.3 millionoriginally related to 2001 or earlier to record liabilities not previouslyidentified and a decrease in retained earnings of approximately $0.4 millionto correct errors in previous years that were considered immaterial under theCompany’s previous method of evaluating materiality.

**Reclassifications**

Certain amounts within theoperating activities section of the statement of cash flows have beenreclassified to properly reflect the nature of changes in balances during 2006.

**3.   Investments and Acquisitions:**

*Investment in Point.360*

On December 22, 2006,the Company entered into a Securities Purchase Agreement (the “Agreement”)with Midwood Capital Management LLC, Midwood Capital Partners, L.P. andMidwood Capital Partners QP, L.P., related to the purchase by the Companyof 1,108,674 shares (the “Shares”) of common stock, no par value, ofPoint.360 (symbol “PTSX” on the NASDAQ Global Market), a Californiacorporation, which were held by such entities.

At December 31, 2006the Company owned 1,442,974 shares of common stock or approximately 14.8% ofPoint.360 and accounts for the long-term investment as an ‘available for sale’equity security in accordance with SFAS 115. The Company has reported theinvestment at its fair market value as of December 31, 2006 ($5.2 million)and has reported an unrealized gain of $0.3 million, net of taxes, in othercomprehensive income. Other than a nondisclosure agreement and the SecuritiesPurchase Agreement, the Company and its affiliates do not have a materialrelationship with Point.360. The Company has determined that these agreementsare not “material contracts” for purposes of Item 601(b)(10) ofRegulation S-K.

*Merger with FastChannel Network*

On December 15, 2005,the Company and privately-held FastChannel Network, Inc. (“FastChannel”)entered into a definitive agreement to merge in a tax-free, stock-for-stocktransaction. The purpose of the merger was (i) to expand the Company’selectronic distribution network, thereby offering our customers 

F-12

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

greaterdistribution capabilities, (ii) to attract new customers as a result of thelarger and more capable electronic distribution network, and (iii) theexpectation of realizing significant operating synergies, thereby improving ourprofitability and ultimately shareholder value. On May 31, 2006, themerger was consummated, pursuant to which FastChannel became a wholly ownedsubsidiary of the Company. The results of operations of FastChannel have beenincluded from June 1, 2006. As consideration for the transaction, theCompany issued to holders of FastChannel common and preferred stockapproximately 5.2 million shares of the Company’s common stock (giving effectto the 1-for-10 share reverse stock split that was effective as of May 30,2006) valued at $27.4 million. The Company determined a value of the commonstock issued based on the average closing prices of its stock on December 15,2006, the date the plan of merger was announced, plus two days prior andsubsequent to that date, for an average price of $5.32 (giving effect for thereverse split). Additionally, the Company refinanced approximately $8.0 millionof FastChannel debt. The net purchase price was allocated based on thecurrent estimated fair values of the assets deemed acquired and liabilities deemedassumed at the date of acquisition, $14.6 million to customer relationships and$4.4 million to the trade name. Both intangibles are being amortized over 10years. The remaining excess of the purchase price over the net assets deemed acquiredwas allocated to Goodwill. Goodwill created as a result of the acquisitiontotaled $22.0 million, none of which will be deductible for tax purposes.

*Investment in Verance Corporation*

Effective March 21,2005, the Company purchased 6,286,146 shares of Series B ConvertiblePreferred Stock, $0.0001 par value per share (the “Series B PreferredStock”), from Verance Corporation, a Delaware corporation (“Verance”), for$2.5 million pursuant to that certain Series B Convertible PreferredStock Purchase Agreement, dated March 16, 2005 (the “Verance Agreement”)between Verance and the Company. As required by the Verance Agreement, theCompany purchased an additional 6,286,146 shares of Series B PreferredStock from Verance for $2.5 million in July 2005. The Series BPreferred Stock is convertible into common stock, $0.0001 par value per share(the “Common Stock”), and will be automatically converted into Common Stock (1) uponthe election of the holders of 662¤3% of the Series A Preferred Stockand Series B Preferred Stock acting together, or (2) immediatelyprior to a qualified public offering by Verance. The holders of Series BPreferred Stock are entitled to cumulative cash dividends of 7% per annum pershare. Verance has the option to pay such dividends in kind with shares of Series BPreferred Stock. For purposes of liquidation or in connection with a sale ormerger by Verance, the Series B Preferred Stock is senior to the Series APreferred Stock and Common Stock of Verance, but is junior to the Series CPreferred Stock of Verance. Holders of Verance’s preferred stock vote togetherwith holders of its Common Stock on an as-converted basis.

The Company ownsapproximately 8% of Verance on an as-converted basis and accounts for thelong-term investment using the cost method of accounting. Other than theVerance Agreement, the Company and its affiliates do not have a materialrelationship with Verance. However, the Company and Verance have simultaneouslyentered into other agreements that enable the Company to add certain servicesprovided by Verance to its products. The Company has determined that theseother existing agreements are not “material contracts” for purposes ofItem 601(b)(10) of Regulation S-K.

TheCompany regularly evaluates the carrying value of its investments. When thecarrying value of an investment exceeds the fair value and the decline in fairvalue is deemed to be other-than-temporary, the Company writes down the valueof the investment to its fair value. As of September 30, 2006, the Company’sevaluation of its investment in Verance determined that it had sustained another-than-temporary reduction in fair value and reduced the carrying value ofthe investment down to zero. A license 

F-13

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

related to this investment was also deemed to have nofurther value and the Company recorded additional amortization expense toreduce the carrying value to zero. Details of the other-than-temporaryreduction are as follows (in thousands):

| ** **                             | ** ** | **Year ended**             | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **December 31, 2006** | ** ** |
| Long-term investments:                 |       |                            |       |   |   |
| Verance Series B  Preferred Stock |       |                            | $          | 4,758 |   |   |
| Intangible assets:                     |       |                            |       |   |   |
| Verance license                        |       |                            | 329        |   |   |
|                                   |       |                            | $          | 5,087 |   |   |

 

*Media DVX*

On April 15, 2005, the Company completed theacquisition of substantially all of the assets of Media DVX, Inc. (“MDX”).Accordingly, the results of MDX’s operations have been included in theconsolidated financial statements since that date. Based in Pennsylvania, MDX’score services are the distribution of program and/or advertising content totelevision stations throughout the country utilizing conventional andelectronic duplication technology. The purpose of the acquisition was to expandthe Company’s electronic distribution network. The Company paid$1.5 million in cash, issued a $6.5 million promissory note and issued155,039 shares of its common stock, worth approximately $2.0 million atthe time of issuance, as consideration for the assets of MDX. The net purchaseprice was allocated based on the current estimated fair values of the assetsacquired and liabilities assumed at the date of acquisition. Subsequent to theacquisition date, the Company obtained a third-party valuation of certainintangible assets of MDX and, accordingly, allocated $1.0 million tocustomer relationships and $0.1 million to the trade name. Both intangibleassets are being amortized over 10 years. The remaining excess of the purchaseprice over the net assets acquired was allocated to Goodwill. Goodwill createdas a result of the acquisition totaled $8.9 million, all of which isdeductible for tax purposes.

Thefollowing table summarizes the estimated fair values of the assets acquired andthe liabilities assumed at the date of the acquisition for each of theaforementioned acquisitions other than Point.360 and Verance. The Company is inthe process of finalizing the fair values of the assets required andliabilities assumed and will complete the process in the first quarter of 2007.The purchase price allocations for the acquisitions are currently as follows(in thousands): 

| ** **                      | ** ** | **FastChannel** | ** ** | **MDX** | ** ** |
|---------------------------------|------------|-----------------|------------|---------|------------|
| Current assets                  |       |            | $          | 5,303   |       |   | $ | — |   |
| Property, plant and  equipment  |       |            | 2,950      |    |       | 1,004 |   |
| Other non-current assets        |       |            | 1,052      |    |       | — |   |
| Identifiable intangible  assets |       |            | 19,010     |    |       | 1,103 |   |
| Goodwill                        |       |            | 22,038     |    |       | 8,940 |   |
| Total assets acquired           |       |            | 50,353     |    |       | 11,047 |   |
| Liabilities assumed             |       |            | 21,597     |    |       | 890 |   |
| Net assets acquired             |       |            | $          | 28,756  |       |   | $ | 10,157 |   |

 

F-14

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Thefollowing pro forma information details the results of continuing operations asif the acquisitions of MDX and FastChannel had taken place on January 1,2005 (in thousands). A table of actual amounts is provided for reference:

| ** **                                                  | ** ** | **As Reported**  | ** ** | **Proforma**          | ** ** |
|-------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **Year ended**   | ** ** | **Year ended**   | ** ** |
| ** **                                                  | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                  | ** ** | **2006**              | ** ** | **2005**              | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenue                                                     |       | $                     | 68,667     |                  | $          | 51,824 |   | $ | 78,148 |   | $ | 77,194 |   |
| Income (loss) from  operations                              |       | $                     | 10,301     |                  | $          | 249 |   | $ | 7,175 |   | $ | (12,415 | ) |
| Net income (loss) from  continuing operations:              |       | $                     | 379        |                  | $          | (1,973 | ) | $ | (3,585 | ) | $ | (15,567 | ) |
| Basic and Diluted income (loss) per share of common  stock: |       | $                     | 0.04       |                  | $          | (0.27 | ) | $ | (0.28 | ) | $ | (1.23 | ) |

 

**4.   Discontinued Operations**

During the fourth quarterof fiscal 2006, the Company’s Board of Directors authorized management to beginmarketing for sale certain assets of two subsidiaries: StarGuide Digital Networks, Inc.and Corporate Computer Systems, Inc. These subsidiaries made up ourpreviously reported Product Sales Segment. The Company determined that thesebusinesses were no longer consistent with our strategic business goals. Theseassets include inventories, property and equipment and certain intangibleassets. The Company completed the sale of the assets of Corporate ComputerSystems for a price of $425,000 in March 2007 and as of December 31,2006 has recorded a loss on sale of $1,163,000 ($698,000 net of tax benefit) relatedto this subsidiary. The sale of StarGuide is expected to result in a gain whichwill be recognized if the sale is completed.

In accordance with the provisions of SFAS No. 144“Accounting for the Impairment or Disposal of Long-Lived Assets,” the financialdata for these businesses have been presented as discontinued operations. Theassets and liabilities of the discontinued operations are presented in theconsolidated balance sheet under the captions “Assets held for sale from discontinuedoperations” and “Obligations of Discontinued Operations.”

F-15

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Theunderlying assets and liabilities of the discontinued operations as ofDecember 31, 2006 and 2005 are as follows:

| ** **                        | ** ** | **December 31,**   | ** ** |
|-----------------------------------|------------|-------------------------|------------|
| ** **                        | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **(In thousands)** | ** ** |
| **Assets**                        |       |                    |       |   |   |
| Accounts receivable               |       | $                       | 376        |   | $ | 357 |   |
| Inventories                       |       | 316                     |       | 1,548 |   |
| Other current assets              |       | 19                      |       | 23 |   |
| Total current assets              |       | 711                     |       | 1,928 |   |
| Property and equipment,  net      |       | 7                       |       | 147 |   |
| Goodwill, net                     |       | 1,750                   |       | 1,750 |   |
| Intangible and other  assets, net |       | 118                     |       | 443 |   |
| Total noncurrent assets           |       | 1,875                   |       | 2,340 |   |
| **Liabilities**                   |       |                    |       |   |   |
| Accounts payable                  |       | $                       | 102        |   | $ | 197 |   |
| Accrued liabilities               |       | 43                      |       | 100 |   |
| Deferred revenue, net             |       | —                  |       | 729 |   |
| Total current liabilities         |       | 145                     |       | 1,026 |   |

 

Operatingresults of the discontinued operations for the years ended December 31,2006, 2005 and 2004 were as follows:

| ** **                                                | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                | ** ** | **(in Thousands)**                     | ** ** |
| Revenues                                                  |       | $                                           | 3,983      |   | $ | 6,528 |   | $ | 8,796 |   |
| Cost of revenues                                          |       | (2,448                                      | )          | (3,159 | ) | (4,414 | ) |
| Depreciation and  amortization                            |       | (583                                        | )          | (298 | ) | (654 | ) |
| Impairment of goodwill                                    |       | —                                      |       | (655 | ) | (8,083 | ) |
| Other operating expenses                                  |       | (1,491                                      | )          | (961 | ) | (1,826 | ) |
| Income/(loss) from  operations of discontinued operations |       | (539                                        | )          | 1,455 |   | (6,181 | ) |
| Income tax benefit  (expense)                             |       | 209                                         |       | (572 | ) | 6,071 |   |
| (Loss) from disposition  net of tax benefit               |       | (698                                        | )          | — |   | — |   |
| Income/(loss) from discontinued operations                |       | $                                           | (1,028     | ) | $ | 883 |   | $ | (110 | ) |

 

F-16

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**5.   Propertyand Equipment:**

Propertyand equipment as of December 31, 2006 and 2005 are summarized as follows(in thousands): 

| ** **                                      | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Network equipment                               |       |                        | $          | 25,862                      |       |   |   | $ | 20,397 |   |   |
| Office furniture  and equipment                 |       |                        | 6,581      |                        |       |   | 6,352 |   |   |
| Leasehold  improvements                         |       |                        | 549        |                        |       |   | 990 |   |   |
|                                            |       |                        | 32,992     |                        |       |   | 27,739 |   |   |
| Less accumulated  depreciation and amortization |       |                        | (20,163    | )                           |       |   | (16,245 | ) |   |
|                                            |       |                        | $          | 12,829                      |       |   |   | $ | 11,494 |   |   |

 

The Company incurred restructuring charges of$0.4 million during the year ended December 31, 2005. Restructuringcharges relate to lease termination costs for redundant facilities in New Yorkand severance benefits paid or accrued to employees hired in connection withthe Broadcast acquisition, who were subsequently terminated.

The Company upgraded itsdistribution network during 2004 and, as a result, removed certain oldernetwork assets from service. In accordance with Statement of FinancialAccounting Standards No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets” (“SFAS 144”), at December 31, 2004, the Company recorded animpairment charge of $1.0 million related to these assets. The fair value ofthe assets removed from service was determined to be zero.

**6.   Intangibleand Other Assets:**

In accordance with SFAS No. 142, the Companyperforms an annual impairment test of its goodwill. A two-step impairment testis used to first identify potential goodwill impairment and then measure theamount of goodwill impairment loss, if any.

The Company has identified two reporting units, asdefined in SFAS No. 142, with goodwill, a digital distribution unit andSourceEcreative.

Goodwill totaled $65.5 million at December 31,2006 and $43.4 million at December 31, 2005. The changes in thecarrying value of goodwill by segment for the years ended December 31,2006 and 2005 are as follows (in thousands): 

| ** **                                      | ** ** | **Digital  Distribution** | ** ** | **SourceEcreative** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|---------------------------|------------|---------------------|------------|-----------|------------|
| Balance at  December 31, 2004              |       |                      | $          | 32,569              |       |      |       | $ | — |   |   | $ | 32,569 |   |
| Finalization of  SourceEcreative acquisition    |       |                      | —     |                |       |      | 1,998      |   |   | 1,998 |   |
| Goodwill created by  acquisition of MDX         |       |                      | 8,830      |                |       |      | —     |   |   | 8,830 |   |
| Balance at  December 31, 2005              |       |                      | 41,399     |                |       |      | 1,998      |   |   | 43,397 |   |
| Finalization of MDX  acquisition                |       |                      | 110        |                |       |      | —     |   |   | 110 |   |
| Goodwill created  by acquisition of FastChannel |       |                      | 22,038     |                |       |      | —     |   |   | 22,038 |   |
| Balance at  December 31, 2006              |       |                      | $          | 63,547              |       |      |       | $ | 1,998 |   |   | $ | 65,545 |   |

 

F-17

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Intangible assets as of December 31,2006, and December 31, 2005 are as follows (in thousands): 

| ** **                         | ** ** | **Amortization  Period** | ** ** | **Gross  Assets** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Assets** | ** ** |
|------------------------------------|------------|--------------------------|------------|-------------------|------------|-------------------------------|------------|-----------------|------------|
| ***December 31, 2006***       |       |                     |       |              |       |                          |       |            |       |   |   |   |   |
| Customer relationships             |       |                     | 10 years   |              |       | $                             | 21,902     |            |       | $ | (2,596 | ) |   | $ | 19,306 |   |
| Brand name                         |       |                     | 20 years   |              |       | 13,304                        |       |            | (2,907     | ) |   | 10,397 |   |
| On-line resource and  database     |       |                     | 3 years    |              |       | 724                           |       |            | (560       | ) |   | 164 |   |
| Software development  costs        |       |                     | 3-5 years  |              |       | 8,392                         |       |            | (3,147     | ) |   | 5,245 |   |
| Total Intangible Assets            |       |                     |       |              |       | 44,322                        |       |            | (9,210     | ) |   | 35,112 |   |
| Other assets                       |       |                     |       |              |       | 654                           |       |            | —     |   |   | 654 |   |
| Total Intangible and  Other Assets |       |                     |       |              |       | $                             | 44,976     |            |       | $ | (9,210 | ) |   | $ | 35,766 |   |
| ***December 31, 2005***       |       |                     |       |              |       |                          |       |            |       |   |   |   |   |
| Customer relationships             |       |                     | 10 years   |              |       | $                             | 7,393      |            |       | $ | (979 | ) |   | $ | 6,414 |   |
| Brand name                         |       |                     | 20 years   |              |       | 8,954                         |       |            | (2,351     | ) |   | 6,603 |   |
| On-line resource and  database     |       |                     | 3 years    |              |       | 724                           |       |            | (315       | ) |   | 409 |   |
| Software development  costs        |       |                     | 3-5 years  |              |       | 6,450                         |       |            | (1,993     | ) |   | 4,457 |   |
| Other licenses                     |       |                     | 9 years    |              |       | 359                           |       |            | —     |   |   | 359 |   |
| Total Intangible Assets            |       |                     |       |              |       | 23,880                        |       |            | (5,638     | ) |   | 18,242 |   |
| Other assets                       |       |                     |       |              |       | 815                           |       |            | —     |   |   | 815 |   |
| Total Intangible and Other Assets  |       |                     |       |              |       | $                             | 24,695     |            |       | $ | (5,638 | ) |   | $ | 19,057 |   |

 

Intangibleassets are amortized using the straight line method over the periods shownabove. Amortization expense related to intangible assets totaled $3.8, $2.3,and $1.0 million during the years ended December 31, 2006, 2005 and2004, respectively. The estimated aggregate future amortization expense forintangible assets remaining as of December 31, 2006 is as follows (inthousands): 

| 2007       |   | 4,860  |   |
|------------|--------|--------|--------|
| 2008       |   | 4,582  |   |
| 2009       |   | 4,284  |   |
| 2010       |   | 3,682  |   |
| 2011       |   | 3,575  |   |
| Thereafter |   | 14,129 |   |
|       |   | $      | 35,112 |   |
|            |        |        |        |  |

 

F-18

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**7.   AccruedLiabilities:**

Accruedliabilities consist of the following (in thousands): 

| ** **                                                            | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                            | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Interest payable                                                      |       | $                     | 507        |   | $ | 220 |   |
| Interest payable  to guarantor of MDX note payable (see Note 19) |       | 332                   |       | 103 |   |
| Lease obligations                                                     |       | 615                   |       | 147 |   |
| Telecommunications  liabilities                                       |       | 78                    |       | 109 |   |
| Employee  compensation                                                |       | 432                   |       | 329 |   |
| Royalties  obligations                                                |       | 935                   |       | 823 |   |
| Property tax  liabilities                                             |       | 148                   |       | 363 |   |
| Merger  liabilities                                                   |       | 2,220                 |       | — |   |
| Due to broker for  unsettled Point.360 trades                         |       | 1,149                 |       | — |   |
| Other                                                                 |       | 2,084                 |       | 1,146 |   |
|                                                                  |       | $                     | 8,500      |   | $ | 3,240 |   |

 

**8.   DeferredRevenue:**

Deferred revenue isprimarily from payments received for subscriptions and memberships withinSourceEcreative for which revenue is recognized ratably over the membership orsubscription period, generally less than one year. Deferred revenue was $1.1million and $0.5 at December 31, 2006 and 2005, respectively all of whichwas classified as current. Cash received from customers in 2006 forsubscriptions and memberships was $3.5 million. Amounts recognized asrevenue during 2006 was $3.7 million. The Company acquired $0.9 millionin deferred revenue from FastChannel.

**9.   Long-TermDebt:**

Long-termdebt as of December 31, 2006 and 2005 is summarized as follows (inthousands): 

| ** **                                         | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Term loan                                          |       |                        | $          | 19,600                      |       |   |   | $ | 12,500 |   |   |
| Revolving credit  facility                         |       |                        | —     |                        |       |   | 4,276 |   |   |
| Note Payable  issued to Seller for MDX acquisition |       |                        | —     |                        |       |   | 6,500 |   |   |
| Capital lease  obligations                         |       |                        | 240        |                        |       |   | 1,256 |   |   |
|                                               |       |                        | 19,840     |                        |       |   | 24,532 |   |   |
| Less current  portion                              |       |                        | (4,190     | )                           |       |   | (3,698 | ) |   |
|                                               |       |                        | $          | 15,650                      |       |   |   | $ | 20,834 |   |   |

 

In conjunction with the purchase of MDX, on April 15,2005, the Company amended its credit facility. As a result of this amendment,the Company wrote off approximately $0.3 million in previously deferredloan origination fees incurred during the three months ended June 30,2005. The amended credit facility provided for a $15.0 million revolvingline of credit as well as a $15.0 million term loan. All previousoutstanding debt was consolidated into the term loan effective as of theclosing date of the transaction. The amended term loan was scheduled to matureon March 31, 2008 and required quarterly principal payments of$1.25 million. The Company paid interest on borrowings at a variable ratebased on the lender’s 

F-19

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Prime Rate or LIBOR,plus an applicable margin. The applicable margin fluctuated based on theCompany’s leverage ratios as defined in the amended long-term credit agreement.At December 31, 2005, the loan interest rate was approximately 8.6%.

Under the amended long-term credit agreement, theCompany was required to maintain certain fixed charge coverage ratios, certainleverage ratios and minimum tangible net worth on a quarterly basis and wassubject to limitations on capital expenditures for a rolling twelve-monthperiod and limitations on capital lease borrowings on an annual basis. Otherthan its fixed charge coverage ratio, the Company was in compliance with thesecovenants for the period ended June 30, 2005. As of September 30,2005, the Company was not in compliance with one of its covenants related toits leverage ratio. On November 9, 2005, the Company received a waiverfrom its lenders as of September 30, 2005. In connection with securingthis waiver, certain other changes were made to the credit facility which,among other things, reduced the amount that could be borrowed under the Company’srevolving line of credit from $15.0 million to $4.5 million. As such,no additional amounts were available to be borrowed under the revolving line ofcredit at December 31, 2005. As of December 31, 2005, the Company wasnot in compliance with its loan covenants. Upon making this determination, theCompany agreed to seek a new lender.

On February 10, 2006, the Company entered into a$25.0 million Credit Agreement with Wachovia Bank, N.A. This revolving creditfacility replaced the Company’s prior senior secured credit facility. The newfacility provides that borrowings under the facility will bear interest atvarious rates, over the applicable base rate or over LIBOR. The new facility isnot subject to any borrowing base, contains customary debt to EBITDA leveragetests (EBITDA is defined as earnings before interest, taxes, depreciation andamortization) and minimum EBITDA tests, provides for customary events ofdefault, is guaranteed by all of the Company’s subsidiaries and is secured bysubstantially all of the assets of the Company and its subsidiaries other thanthe stock and assets of its subsidiary that owns the assets acquired from MDX.This loan was originally set to mature on February 10, 2008. In addition,in 2005, the Company wrote off approximately $0.7 million in previouslydeferred loan origination fees incurred for the prior credit facility.

On May 31, 2006, the Company entered into anAmended and Restated Credit Agreement with Wachovia Bank, N.A. The facility, asamended, provides for maximum indebtedness of $35.0 million made up of a termloan for $20.0 million, and a revolving line of credit for $15.0 million, ofwhich none is drawn as of December 31, 2006. Borrowings under the facilitywill continue to bear interest at various rates, over the applicable base rateor over LIBOR. The facility, as amended, is not subject to any borrowing base,contains customary debt to EBITDA leverage tests and minimum EBITDA tests, containsa variety of restrictive covenants, such as limitations on borrowings,investments and dividends, provides for customary events of default, isguaranteed by all of the Company’s subsidiaries, including FastChannel, and issecured by substantially all of the assets of the Company and its subsidiaries,including FastChannel, but other than the stock and assets of its subsidiarythat owns the assets acquired from MDX. Dividends are permissible afterDecember 31, 2006, provided that (i) no default or event of default exists orwould result therefrom, and (ii) the Consolidated Fixed Charge Coverage Ratio ona pro forma basis is greater than or equal to 1.20 to 1.00. Based upon theConsolidated Fixed Charge Coverage Ratio at December 31, 2006, the Company waseligible to pay cash dividends after December 31, 2006 of approximately $8.5million.

F-20

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

At December 31, 2006,the loan interest rate was approximately 7.4%. The Company pays quarterly anominal commitment fee for the unused portion of the revolving line of credit. TheCompany is currently in compliance with its covenants as ofDecember 31, 2006.

The aggregate amounts ofprincipal payments due in each of the succeeding five years, beginning with 2007will be $4.2 million, $3.7 million, $4.4 million, $5.0 million, and $2.6million.

**10.   Income Taxes:**

Thecomponents of income from continuing operations before income taxes were: 

| ** **             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------|------------|----------|------------|----------|------------|----------|------------|
| United States          |       | $        | 2,040      |     | $          | (2,741   | )          | $ | 5,042 |   |
| Outside United  States |       | 717      |       | —   |       | —   |       |
| Total                  |       | $        | 2,757      |     | $          | (2,741   | )          | $ | 5,042 |   |

 

Componentsof deferred tax assets at December 31, 2006 and 2005 are as follows (inthousands): 

| ** **                                             | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred Tax Assets                                    |       |     |       |     |       |
| Federal and State net operating  loss carryforwards    |       | $        | 32,006     |     | $          | 21,983 |   |
| Current temporary differences                          |       |     |       |     |       |
| Allowance for doubtful accounts                        |       | 424      |       | 216      |       |
| Unearned revenue                                       |       | 427      |       | 180      |       |
| Accrued liabilities not yet deductible                 |       | 1,108    |       | 121      |       |
| Other                                                  |       | 331      |       | 312      |       |
|                                                   |       | 2,290    |       | 829      |       |
| Impairment of Verance investment                       |       | 1,845    |       | —   |       |
| Tax credit  carryforwards                              |       | 511      |       | 236      |       |
| Basis differences  in deductible purchased intangibles |       | 463      |       | —   |       |
| Basis differences  of fixed assets                     |       | 145      |       | —   |       |
| Other                                                  |       | 335      |       | 58       |       |
|                                                   |       | 3,299    |       | 294      |       |
| Total gross deferred tax  assets                       |       | 37,595   |       | 23,106   |       |
| Less valuation allowance                               |       | (13,141  | )          | —   |       |
| Net deferred tax assets  after valuation allowance     |       | 24,454   |       | 23,106   |       |
| Deferred Tax Liabilities                               |       |     |       |     |       |
| Purchased intangibles with no tax basis                |       | (9,332   | )          | (2,602   | )          |
| Basis differences of fixed assets                      |       | —   |       | (1,102   | )          |
| Deductible goodwill                                    |       | (722     | )          | (343     | )          |
| Other                                                  |       | (1,866   | )          | (859     | )          |
|                                                   |       | (11,920  | )          | (4,906   | )          |
| Net deferred tax  assets                               |       | $        | 12,534     |     | $          | 18,200 |   |

 

F-21

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Componentsof the provision for income taxes are as follows (in thousands): 

| ** **          | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------|------------|----------|------------|----------|------------|----------|------------|
| Current:            |       |     |       |     |       |     |       |
| US Federal          |       | $        | 92         |     | $          | 18       |       | $ | 138 |   |
| State               |       | 197      |       | 11       |       | 85       |       |
| Foreign             |       | 82       |       |     |       |     |       |
|                |       | 371      |       | 29       |       | 223      |       |
| Deferred:           |       |     |       |     |       |     |       |
| US Federal          |       | 1,063    |       | (697     | )          | 1,335    |       |
| State               |       | 68       |       | (100     | )          | 170      |       |
|                |       | 1,131    |       | (797     | )          | 1,505    |       |
| Valuation allowance |       | 876      |       | —   |       | —   |       |
|                |       | $        | 2,378      |     | $          | (768     | )          | $ | 1,728 |   |

 

As of December 31, 2006, the Company’s currenttax liability was $0.1 million, primarily related to amounts due inforeign jurisdictions.

Incometax expense (benefit) differs from the amounts that would result from applyingthe federal statutory rate of 34% to the Company’s net income (loss) beforeincome taxes from continuing operations as follows (in thousands): 

| ** **                                                                     | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected tax expense  (benefit)                                                |       | $        | 937        |     | $          | (932     | )          | $ | 1,714 |   |
| State and foreign income  taxes, net of federal benefit                        |       | 207      |       | (88      | )          | 227      |       |
| Other non-deductible  items                                                    |       | 358      |       | 252      |       | (212     | )          |
| Utilization of acquired  deferred tax assets recorded as reduction to goodwill |       | —   |       | —   |       | 8,971    |       |
| Valuation allowance                                                            |       | 876      |       | —   |       | (8,971   | )          |
| Provision (benefit) for income taxes                                           |       | $        | 2,378      |     | $          | (768     | )          | $ | 1,729 |   |

 

Net operating loss (NOL)carryforwards of approximately $88.0 million will expire on various datesranging from 2011 to 2025. Utilization of these carryforwards will be limitedon an annual basis as a result of previous business combinations, pursuant to Section 382of the Internal Revenue Code.

Generally acceptedaccounting principles require the Company to record a valuation allowanceagainst its deferred tax assets if it is “more likely than not” that theCompany will not be able to utilize them in the future. For the period from2001 through 2004, the Company has utilized $20.0 million in NOL carryforwardsto offset its current tax liability. During 2004, the Company concluded thatrealization of all tax benefits from NOL carryforwards and other deferred taxassets was more likely than not. As a result, $9.0 million of thevaluation allowance for deferred tax assets was reversed related to acquireddeferred tax assets and was recorded as a reduction to goodwill.

F-22

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

During 2006, the Companyhas recorded a valuation allowance of $0.9 million related to the deferred taxasset created as a result of the impairment charge recorded for its investmentin Verance. Additionally, the Company acquired approximately $33.7 million inNOL carryforwards in its acquisition of FastChannel and has maintained a full valuationallowance related to those NOL carryforwards. The Company will maintain a fullvaluation allowance on its acquired NOL carryforward until the Company’s taxposition can be completely assessed. In accordance with FAS 109, any futurereduction in the valuation allowance related to acquired deferred tax assetswill be recorded as a reduction to goodwill. Management believes that theresults of future operations will generate sufficient taxable income to realizethe benefits of all of its net deferred tax assets.

**11.   Employee Benefit Plan:**

The Company has a401(k) retirement plan for all U.S. based employees. Employees maycontribute up to a maximum dollar limit for 2006 of $15,000. In September 2006,the Company began matching 1% of gross pay for those employees contributing atleast 3% of their gross pay into the plan. Employees vest in the matchedcontribution after two years of employment. Employer contributions are fundedconcurrent with the employee contributions they matched. The Company madeapproximately$27,500 in matching contributions in 2006 to the plan and nomatching contributions in 2005 or 2004.

**12.   Stockholders’Equity:**

On May 30, 2006 theCompany’s common stock was reverse split on a 1-for-10 basis. All references toshare and per share data in these consolidated financial statements have beenadjusted to reflect the reverse stock split.

**Warrants**

The Company hasissued warrants in connection with certain financing and leasing transactionsas well as through common stock offerings. All outstanding warrants areconvertible into common stock. The warrants outstanding at December 31,2006 expire on December 31, 2010. A summary of outstanding warrants at December 31,2006, 2005 and 2004 and changes during the years then ended follows (inthousands, except per share amounts): 

| ** **                            | ** ** | **2006**     | ** ** | **2005**                            | ** ** | **2004**     | ** ** |
|---------------------------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **                            | ** ** | **Warrants** | ** ** | **Wtd. Avg.  Exercise  Price** | ** ** | **Warrants** | ** ** | **Wtd. Avg.  Exercise  Price** | ** ** | **Warrants** | ** ** | **Wtd. Avg.  Exercise  Price** | ** ** |
| Outstanding at beginning  of the year |       |         | 708        |                                |       |         | $          | 11.56 |   |   |   | 738 |   |   |   | $ | 23.00 |   |   |   | 738 |   |   |   | $ | 23.00 |   |   |
| Canceled                              |       |         | (47        | )                                   |       |         | $          | 33.45 |   |   |   | (30 | ) |   |   | $ | 14.40 |   |   |   | — |   |   |   | $ | — |   |   |
| Outstanding at end of the year        |       |         | 661        |                                |       |         | $          | 10.00 |   |   |   | 708 |   |   |   | $ | 11.56 |   |   |   | 738 |   |   |   | $ | 23.00 |   |   |

 

On June 24, 2004, the Company approved a proposalto extend the expiration date of certain fully-vested, outstanding warrants topurchase Common Stock of the Company held by Scott K. Ginsburg, Chairman andChief Executive Officer, and Omar A. Choucair, Chief Financial Officer, from March 31,2005 until March 20, 2008. The modification had no effect on the Company’sconsolidated financial statements but was included in the Company’s disclosureof pro forma net income (loss) and earnings (loss) per share under SFAS No. 123in Note 2 to these financial statements.

On December 21, 2005,Company approved a proposal to (i) extend the expiration date of certainfully-vested, outstanding warrants to purchase Common Stock of the Company heldby Scott K. Ginsburg, 

F-23

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Chairmanand Chief Executive Officer, and Omar A. Choucair, Chief Financial Officer,until December 31, 2010, and (ii) reduce the strike price of thewarrants to $10.00 per share (split adjusted). Prior to these modifications, Mr. Ginsburgheld fully vested warrants as follows: (i) warrant to purchase 146,007shares of Common Stock, strike price $32.50, with an expiration date of December 20,2006; (ii) warrant to purchase 154,846 shares of Common Stock, strikeprice $32.50, with an expiration date of February 20, 2008: and (iii) warrantto purchase 350,973 shares of Common Stock, strike price $14.40, with anexpiration date of March 20, 2008. Prior to the approved modifications, Mr. Choucairheld a fully vested warrant to purchase 8,666 shares of Common Stock, strikeprice $14.40 and an expiration date of March 20, 2008. The modificationhad no effect on the Company’s consolidated financial statements but wasincluded in the Company’s disclosure of pro forma net income (loss) andearnings (loss) per share under SFAS No. 123 in Note 2 to thesefinancial statements.

**13.   StockPlans:**

The Company has three stockincentive plans:

**1992 Stock OptionPlan**

Under the Company’s 1992Stock Option Plan, (the “1992 Plan”), the Company was permitted to issue up to14,950,000 shares of common stock to employees, officers, directors andconsultants. The exercise price and terms of the options granted were determinedby the Board of Directors, provided that such price could not be less than thefair value of the common stock on the date of grant for incentive stock optionsor, in the case of non-statutory options, less than 85 percent of the fairvalue of the common stock on the date of grant. The options generally vest overfour years. The 1992 Plan provided that, in the event of a change in control ofthe Company, executive officers of the Company would receive acceleratedvesting for a portion of its unvested option shares. The term of the optionsgranted is seven years. No options have been granted at less than fair valueunder this plan. As of December 31, 2006, the 1992 Plan has expired. Assuch, no shares are available for future grants.

**1996 SupplementalOption Plan**

Under the Company’s 1996Supplemental Option Plan, the Company may issue up to 750,000 shares of commonstock to employees, officers, directors and consultants. The exercise price andterms of the options granted are determined by the Board of Directors. Theoptions generally vest over four years. The term of the options granted isseven years.

**1995 DirectorOption Plan**

Under the Company’s 1995Director Option Plan (the “Director Plan”), the Company could issue up to800,000 shares of common stock to non-employee directors. The Director Plan providedthat each future non-employee director of the Company would be automaticallygranted an option to purchase 10,000 shares of common stock (the “First Option”)on the date on which the optionee first became a non-employee director of theCompany and an additional option to purchase 2,500 shares of common stock (the “SubsequentOption”) on each anniversary date thereafter. The exercise price per share ofall options granted under the Director Plan would be equal to the fair marketvalue of a share of the Company’s common stock on the date of grant. Sharessubject to the First Option vest over 36 months, and the Subsequent Optionshares vest over 12 months beginning with the month following the secondanniversary of its date of grant. The term of the options granted is ten years.As of December 31, 2006, the Director Plan has expired and no shares areavailable for future grants.

F-24

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**2006 Long-TermStock Incentive Plan**

The 2006 Long-Term Stock Incentive Plan (the “2006Plan”) has been adopted to replace the Company’s 1992 Stock Option Plan. Inaddition, because the Director Plan has expired recently, the 2006 Plan hasbeen prepared in a manner to enable stock awards to be granted to members ofour Board of Directors. When the 2006 Plan was approved by our stockholders,the 1992 Plan terminated and the shares identified above as remaining forfuture grants under the 1992 Plan ceased to be available for grants under the1992 Plan. The number of shares subject to the 2006 Plan is 1,100,000 shares.

A summary of theCompany’s fixed plan stock options at December 31, 2006 and the year thenended is presented below: 

| ** **                               | ** ** | **2006**   | ** ** |
|------------------------------------------|------------|------------|------------|
| ** **                               | ** ** | **Shares** | ** ** | **Wtd. Avg.  Exercise  Price** | ** ** |
| Outstanding at  beginning of the year    |       | 318,216    |       |   | $ | 22.46 |   |   |
| Granted                                  |       | 306,000    |       |   | $ | 5.82 |   |   |
| Exercised                                |       | (2,404     | )          |   | $ | 9.67 |   |   |
| Canceled                                 |       | (49,636    | )          |   | $ | 43.75 |   |   |
| Outstanding at end  of the year          |       | 572,176    |       |   | $ | 11.71 |   |   |
| Exercisable at end  of the year (vested) |       | 268,488    |       |   | $ | 17.93 |   |   |

 

The following tablesummarizes information about stock options outstanding at December 31,2006: 

| **Options Outstanding**                | ** ** | **Options Exercisable** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|
| **Range of Exercise Prices** | ** ** | ** **                   | ** ** | **Number  Outstanding** | ** ** | **Weighted-  Average  Remaining  Contractual Life** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| $5.00   -  $9.99                  |       |                         | 326,755    |   |   |   | 3.10 years |   |   |   | $ | 6.01 |   |   |   | 34,922 |   |   |   | $ | 7.34 |   |   |
| $10.00 - $12.49                             |       |                         | 61,853     |   |   |   | 2.87 years |   |   |   | $ | 11.33 |   |   |   | 56,175 |   |   |   | $ | 11.24 |   |   |
| $12.50 - $15.00                             |       |                         | 48,500     |   |   |   | 2.36 years |   |   |   | $ | 12.92 |   |   |   | 45,255 |   |   |   | $ | 12.92 |   |   |
| $20.00 - $50.00                             |       |                         | 135,068    |   |   |   | 2.44 years |   |   |   | $ | 25.26 |   |   |   | 132,136 |   |   |   | $ | 25.28 |   |   |
| $5.30   - $43.80                  |       |                         | 572,176    |   |   |   |   |   |   |   |   |   |   |   | 268,488 |   |   |   |   |   |   |

 

As of December 31, 2006, there were 1,097,500shares available for future grant under the stock option plans.

The weighted average fair value per share of optionsgranted during the year was $4.03, $5.10 and $6.40 for the years endedDecember 31, 2006, 2005 and 2004, respectively.

The total intrinsic value of options exercised wasapproximately $7,000, $1,000, and $407,000 during the years endedDecember 31, 2006, 2005 and 2004, respectively.

The aggregate intrinsic value of options outstandingat December 31, 2006 was approximately $2,600,000. The aggregate intrinsicvalue of options vested at December 31, 2006 was approximately $366,000.

Compensation costs related to options issued, but notyet vested, and therefore not yet recognized, is $1.1 million, which willbe recognized over the weighted-average remaining vesting period of 3.5 years.

F-25

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**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

The fair value ofeach option was estimated on the date of grant using the Black-Scholes optionpricing model with the following weighted average assumptions:

| ** **                                          | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Number of options  granted                          |       | 306,000  |       | 9,000    |       | 22,250   |       |
| Weighted average  exercise price of options granted |       | $        | 5.82       |     | $          | 10.87    |       | $ | 12.79 |   |
| Volatility(1)                                       |       | 86       | %          | 76       | %          | 83       | %          |
| Risk free interest  rate(2)                         |       | 4.4      | %          | 4.0      | %          | 3.5      | %          |
| Expected term (years)(3)(4)                         |       | 4.8      |       | 5.5      |       | 4.8      |       |
| Expected annual dividends                           |       | None     |       | None     |       | None     |       |
|                                                     |            |          |            |          |            |          |            |  |  |  |

----

(1)   Expectedvolatility is based on historical volatility of our stock over a precedingperiod commensurate with the expected term of the award.

(2)   The riskfree rate for periods within the contractual term of the stock is based on theU.S. Treasury yield curve in effect at the time of grant.

(3)   Theexpected term for 2006 is calculated as the average between the vesting termand the contractual term, weighted by tranche, pursuant to SAB No. 107.

(4)   The Company assumes a forfeiture rate of zero in its fair valuecalculations due to minimal turnover in holders of options in its workforce.

**14.   Commitmentsand Contingencies:**

The Company leases its facilities and certainequipment under non-cancelable capital and operating leases.

The table belowsummarizes the Company’s contractual obligations, including estimated interest,at December 31, 2006 (in thousands): 

| ** **                          | ** ** | ** ** | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------------|------------|------------|------------|-------------------------------------------|------------|
| **Contractual Obligation**     | ** ** | **Total**  | ** ** | **Less Than  1 Year**           | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **After 5  Years** | ** ** |
| Long-Term Debt                      |       | $          | 23,217     |                                      |       | $ | 5,258 |   |   | $ | 15,313 |   | $ | 2,646 |   |   | $ | — |   |   |
| Capital Leases                      |       | 240        |       |                                      | 240        |   |   | — |   | — |   |   | — |   |   |
| Operating Leases                    |       | 11,685     |       |                                      | 2,810      |   |   | 7,300 |   | 1,575 |   |   | — |   |   |
| Employment contracts                |       | 2,126      |       |                                      | 1,004      |   |   | 1,122 |   | — |   |   | — |   |   |
| Unconditional Purchase  Obligations |       | 5,947      |       |                                      | 2,246      |   |   | 3,701 |   | — |   |   | — |   |   |
| Total Contractual Cash Obligations  |       | $          | 43,215     |                                      |       | $ | 11,558 |   |   | $ | 27,436 |   | $ | 4,221 |   |   | $ | — |   |   |

 

The present value of obligations under capital leasewas $227 of which $240 is classified as a current liability.

Rent expense totaled $3,411, $2,675 and $2,422 in2006, 2005 and 2004, respectively.

As of December 31, 2006, the Company hasnon-cancelable future minimum purchase commitments with its telephone andsatellite service providers of approximately $2,246 for 2007, $1,247 for 2008,$1,534 for 2009, and $920 for 2010.

On February 2, 2006, asubsidiary of the Company initiated an arbitration proceeding againstPathfire, Inc. Our subsidiary seeks unspecified damages suffered due toPathfire’s alleged breach and wrongful termination of a Technology License andServices Agreement (the “Pathfire Agreement”) 

F-26

----

**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

betweenPathfire and Media DVX, Inc., which agreement was acquired by oursubsidiary in April 2005. Pathfire has asserted a breach of contractcounterclaim against our subsidiary and seeks damages in the approximate amountof $0.4 million. The Company has maintained its liability of $0.9 million, asof December 31, 2006, representing all amounts due under the PathfireAgreement, as the Company is seeking to enforce the Pathfire Agreement. A hearingis scheduled for May 2007, at which the arbitrator is expected to decidewhether Pathfire is liable for breaching an exclusivity and non-competitionclause in the agreement. Discovery is in progress.

The Company is involved invarious legal actions arising from the ordinary course of business. Managementdoes not believe the ultimate resolution of these matters will have a materialeffect on the Company’s financial position.

**15.   Net Income (Loss) Per Share:**

Under SFAS No. 128, “Earningsper Share,” the Company is required to compute earnings per share under twodifferent methods (basic and diluted). Basic earnings per share is calculatedby dividing net income (loss) attributable to common shareholders by theweighted average shares of common stock outstanding during the period. Dilutedearnings per share is calculated by dividing net income attributable to commonshareholders by the weighted average shares of outstanding common stock andcommon stock equivalents during the period.

Areconciliation of net income (loss) per basic and diluted share for the threeyears ended December 31, 2006 follows (in thousands, except per shareamounts): 

| ** **                                                               | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                               | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Basic:                                                                   |       |                  |       |   |   |   |   |
| Net income (loss) from  continuing operations                            |       | $                     | 379        |   | $ | (1,973 | ) | $ | 3,314 |   |
| Net income (loss) from  discontinued operations                          |       | (1,028                | )          | 883 |   | (110 | ) |
| Net income (loss)                                                        |       | $                     | (649       | ) | $ | (1,090 | ) | $ | 3,204 |   |
| Weighted average shares  outstanding                                     |       | 10,568                |       | 7,378 |   | 7,277 |   |
| Basic net income (loss)  from continuing operations per   common share   |       | $                     | 0.04       |   | $ | (0.27 | ) | $ | .46 |   |
| Basic net income (loss)  from discontinued operations per common share   |       | (0.10                 | )          | 0.12 |   | (0.02 | ) |
| Basic net income (loss)  per common share                                |       | $                     | (0.06      | ) | $ | (0.15 | ) | $ | 0.44 |   |
| Diluted:                                                                 |       |                  |       |   |   |   |   |
| Weighted average shares  outstanding                                     |       | 10,568                |       | 7,378 |   | 7,277 |   |
| Add: Net effect of  potentially dilutive shares                          |       | —                |       | — |   | 53 |   |
| Total shares                                                             |       | 10,568                |       | 7,378 |   | 7,330 |   |
| Diluted net income  (loss) from continuing operations per common share   |       | $                     | 0.04       |   | $ | (0.27 | ) | $ | 0.46 |   |
| Diluted net income  (loss) from discontinued operations per common share |       | (0.10                 | )          | 0.12 |   | (0.02 | ) |
| Diluted net income (loss) per common share                               |       | $                     | (0.06      | ) | $ | (0.15 | ) | $ | 0.44 |   |
| Antidilutive securities not  included:                                   |       |                  |       |   |   |   |   |
| Options and warrants                                                     |       | 1,176                 |       | 1,226 |   | 1,124 |   |

 

F-27

----

**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**16.   Unaudited Quarterly Financial Information(in thousands, expect per share amounts)**

| ** **                                                      | ** ** | **Quarter Ended**   | ** ** |
|-----------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                      | ** ** | **March 31,  2006** | ** ** | **June 30,  2006(1)** | ** ** | **September 30,  2006(2)** | ** ** | **December 31,  2006** | ** ** |
| Revenues                                                        |       |                     | $          | 13,034 |   |   | $ | 15,124 |   |   | $ | 18,769 |   |   |   | $ | 21,740 |   |   |
| Gross profit                                                    |       |                     | 6,312      |   |   | 7,578 |   |   | 9,394 |   |   |   | 12,061 |   |   |
| Net income (loss) from  continuing operations                   |       |                     | 632        |   |   | 1,060 |   |   | (4,426 | ) |   |   | 3,113 |   |   |
| Net income (loss) from  discontinued operations                 |       |                     | 118        |   |   | 32 |   |   | (54 | ) |   |   | (1,124 | ) |   |
| Net income (loss)                                               |       |                     | $          | 750 |   |   | $ | 1,092 |   |   | $ | (4,480 | ) |   |   | $ | 1,989 |   |   |
| Basic earnings (loss)  per share from continuing operations     |       |                     | $          | 0.08 |   |   | $ | 0.12 |   |   | $ | (0.35 | ) |   |   | $ | 0.24 |   |   |
| Basic earnings (loss)  per share from discontinued operations   |       |                     | 0.02       |   |   | 0.00 |   |   | (0.00 | ) |   |   | (0.09 | ) |   |
| Basic earnings (loss)  per share                                |       |                     | $          | 0.10 |   |   | $ | 0.12 |   |   | $ | (0.35 | ) |   |   | $ | 0.15 |   |   |
| Diluted earnings (loss)  per share from continuing operations   |       |                     | $          | 0.08 |   |   | $ | 0.12 |   |   | $ | (0.35 | ) |   |   | $ | 0.24 |   |   |
| Diluted earnings (loss)  per share from discontinued operations |       |                     | 0.02       |   |   | 0.00 |   |   | (0.00 | ) |   |   | (0.09 | ) |   |
| Diluted earnings (loss) per share                               |       |                     | $          | 0.10 |   |   | $ | 0.12 |   |   | $ | (0.35 | ) |   |   | $ | 0.15 |   |   |

 

| ** **                                                      | ** ** | **Quarter Ended**   | ** ** |
|-----------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                      | ** ** | **March 31,  2005** | ** ** | **June 30,  2005(3)** | ** ** | **September 30,  2005** | ** ** | **December 31,  2005(4)** | ** ** |
| Revenues                                                        |       |                     | $          | 13,638 |   |   | $ | 13,555 |   |   | $ | 11,591 |   |   |   | $ | 13,040 |   |   |
| Gross profit                                                    |       |                     | 5,611      |   |   | 5,018 |   |   | 3,648 |   |   |   | 5,363 |   |   |
| Net income (loss) from  continuing operations                   |       |                     | 471        |   |   | (577 | ) |   | (1,059 | ) |   |   | (808 | ) |   |
| Net income (loss) from  discontinued operations                 |       |                     | 652        |   |   | 227 |   |   | 218 |   |   |   | (214 | ) |   |
| Net income (loss)                                               |       |                     | $          | 1,125 |   |   | $ | (350 | ) |   | $ | (841 | ) |   |   | $ | (1,024 | ) |   |
| Basic earnings (loss)  per share from continuing operations     |       |                     | $          | 0.06 |   |   | $ | (0.08 | ) |   | $ | (0.14 | ) |   |   | $ | (0.11 | ) |   |
| Basic earnings (loss) per  share from discontinued operations   |       |                     | $          | 0.09 |   |   | $ | 0.03 |   |   | $ | 0.03 |   |   |   | $ | (0.03 | ) |   |
| Basic earnings (loss)  per share                                |       |                     | $          | 0.15 |   |   | $ | (0.05 | ) |   | $ | (0.11 | ) |   |   | $ | (0.14 | ) |   |
| Diluted earnings (loss)  per share from continuing operations   |       |                     | $          | 0.06 |   |   | $ | (0.08 | ) |   | $ | (0.14 | ) |   |   | $ | (0.11 | ) |   |
| Diluted earnings (loss)  per share from discontinued operations |       |                     | $          | 0.09 |   |   | $ | 0.03 |   |   | $ | 0.03 |   |   |   | $ | (0.03 | ) |   |
| Diluted earnings (loss) per share                               |       |                     | $          | 0.15 |   |   | $ | (0.05 | ) |   | $ | (0.11 | ) |   |   | $ | (0.14 | ) |   |

----

(1)   OnMay 31, 2006, the Company acquired FastChannel in tax-free stocktransaction. Accordingly, FastChannel has been included in the Company’sconsolidated results of operations from the date of acquisition.

(2)   InSeptember 2006, the Company determined that its investment in Verance wasimpaired. Accordingly, the Company wrote-down the value of its $4.8 millioninvestment to zero and recorded additional amortization expense of $.3 millionto fully amortize the value of a license agreement it had with Verance.

F-28

----

**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

(3)   OnApril 15, 2005, the Company acquired the assets and operations of MDX.Accordingly, MDX has been included in the Company’s consolidated results ofoperations from the date of acquisition.

(4)   In December 2005, the Company wrote off approximately $.9million of deferred loan fees in connection with a debt covenant violation atDecember 31, 2005.

**17.   Segment Information:**

The Companyoperates predominantly in two industry segments: digital and physicaldistribution of audio and video content and broadcast business intelligence andcreative research services (“SourceEcreative”). The Company has defined itsreportable segments based on internal financial reporting used for corporatemanagement and decision-making purposes. The information in the followingtables is derived directly from the segments’ internal financial reporting usedfor corporate management purposes (in thousands). 

| ** **                             | ** ** | **Year ended December 31, 2006** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|
| ** **                             | ** ** | **Audio and Video**                        | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Content  Distribution**                            | ** ** | **SourceEcreative** | ** ** | **Consolidated  Totals** | ** ** |
| Revenues                               |       |                                                 | $          | 64,911 |   |   |   | $ | 3,756 |   |   |   | $ | 68,667 |   |   |
| Depreciation and  amortization expense |       |                                                 | 8,162      |   |   |   | 401 |   |   |   | 8,563 |   |   |
| Operating income                       |       |                                                 | 8,624      |   |   |   | 1,677 |   |   |   | 10,301 |   |   |
| Total assets                           |       |                                                 | $          | 171,091 | (a) |   |   | $ | 4,492 |   |   |   | $ | 175,583 |   |   |

 

| ** **                             | ** ** | **Year ended December 31, 2005** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|
| ** **                             | ** ** | **Audio and Video **                  | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Content   Distribution**                      | ** ** | **SourceEcreative** | ** ** | **Consolidated  Totals** | ** ** |
| Revenues                               |       |                                                 | $          | 49,971 |   |   |   | $ | 1,853 |   |   |   | $ | 51,824 |   |   |
| Depreciation and  amortization expense |       |                                                 | 5,954      |   |   |   | 394 |   |   |   | 6,348 |   |   |
| Operating income (loss)                |       |                                                 | (37        | ) |   |   | 286 |   |   |   | 249 |   |   |
| Total assets                           |       |                                                 | $          | 110,643 | (a) |   |   | $ | 3,690 |   |   |   | $ | 114,333 |   |   |

 

| ** **                             | ** ** | **Year ended December 31, 2004** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|
| ** **                             | ** ** | **Audio and Video**                        | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Content   Distribution**                      | ** ** | **SourceEcreative** | ** ** | **Consolidated   Totals** | ** ** |
| Revenues                               |       |                                                 | $          | 52,970 |   |   |   | $ | 600 |   |   |   | $ | 53,570 |   |   |
| Depreciation and  amortization expense |       |                                                 | 5,019      |   |   |   | 124 |   |   |   | 5,143 |   |   |
| Operating income (loss)                |       |                                                 | 6,245      |   |   |   | 81 |   |   |   | 6,326 |   |   |
| Total assets                           |       |                                                 | $          | 102,694 | (a) |   |   | $ | 4,533 |   |   |   | $ | 107,227 |   |   |

----

(a)    Net of intersegment elimination which relateto intercompany receivables and payables that occur when one operating segmentpays costs that are related to another operating segment.

**18.   New Accounting Pronouncements:**

In September 2006, the SEC staff published StaffAccounting Bulletin (“SAB”) No. 108, *“*Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements.” SAB No. 108 addresses quantifying thefinancial statement effects of misstatements, specifically, how the effects ofprior year uncorrected errors must be considered in quantifying misstatementsin the current year financial statements. SAB No. 108 is effective forfiscal years ending 

F-29

----

**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

after November 15,2006. The adoption of SAB No. 108 by the Company in the fourth quarter of2006 is discussed in Note 2 to the financial statements.

In December 2004, the FASB issued SFASNo. 123R “Share Based Payment.” SFAS No. 123R is a revision to SFAS123 and supersedes APB Opinion No. 25 and amends FASB StatementNo. 95, “Statement of Cash Flows.” SFAS No. 123R requires a publicentity to expense the cost of employee services received in exchange for anaward of equity instruments. It provides guidance on valuing and expensingthese awards, as well as disclosure requirements of these equity arrangements.SFAS No. 123R also requires the benefits of tax deductions in excess ofrecognized compensation cost to be reported as a financing cash flow, ratherthan as an operating cash flow as required under current literature. Thisrequirement reduces net operating cash flows and increases net financing cashflows in periods after adoption. SFAS No. 123R permits an issuer to useeither a prospective or one of two modified versions of retrospectiveapplication under which financial statements for prior periods are adjusted ona basis consistent with the pro forma disclosures required for those periods bythe original SFAS No. 123. As modified by the SEC on April 15, 2005,SFAS No. 123R is effective for the first annual or interim reportingperiod of the registrant’s first fiscal year that begins after June 15,2005. The Company has implemented this pronouncement effective at the beginningof the fiscal year ended December 31, 2006.

In December 2004, the FASB issued SFASNo. 153, “Exchanges of Nonmonetary Assets, an amendment of APB OpinionNo. 29.” SFAS No. 153 is based on the principle that exchanges ofnonmonetary assets should be measured based on the fair value of the assetsexchanged. APB Opinion No. 29, “Accounting for Nonmonetary Transactions,”provided an exception to its basic measurement principle (fair value) forexchanges of similar productive assets. Under APB Opinion No. 29, anexchange of a productive asset for a similar productive asset was based on therecorded amount of the asset relinquished. SFAS No. 153 eliminates thisexception and replaces it with an exception for exchanges of nonmonetary assetsthat do not have commercial substance. SFAS No. 153 became effective forthe Company as of July 2, 2005, and did not have a material impact on ourconsolidated financial statements.

In May 2005, the FASB issued SFAS No. 154,“Accounting Changes and Error Corrections, a replacement of AccountingPrinciples Board (“APB”) Opinion No. 20 and FASB Statement No. 3.”SFAS No. 154 requires retrospective application to prior periods’financial statements of a voluntary change in accounting principle unless it isimpracticable. APB Opinion No. 20, “Accounting Changes,” previouslyrequired that most voluntary changes in accounting principle be recognized byincluding in net income of the period of the change the cumulative effect ofchanging to the new accounting principle. SFAS No. 154 became effectivefor the Company on January 1, 2006. The adoption of SFAS No. 154 didnot have a material impact on our consolidated financial statements.

In September 2006, the FASB issued SFASNo. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value,establishes a framework for measuring fair value and expands disclosurerequirements about fair value measurements. SFAS No. 157 is effective forthe Company on January 1, 2008. We believe that the adoption of SFASNo. 157 will not have a material impact on our consolidated financialstatements.

In February 2007, the FASB issued SFASNo. 159, “The Fair Value Option for Financial Assets and FinancialLiabilities—Including an amendment of FASB Statement No. 115.” SFASNo. 159 permits entities to choose to measure many financial instrumentsand certain other items at fair value. Unrealized gains and losses on items forwhich the fair value option has been elected will be recognized in earnings ateach subsequent reporting date. SFAS No. 159 is effective for the Company onJanuary 1, 2008. The 

F-30

----

**DG FASTCHANNEL, INC. AND SUBSIDIARIES  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Company is evaluating theimpact that the adoption of SFAS No. 159 will have on our consolidatedfinancial statements.

In July 2006, theFASB issued FASB Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes” (“Interpretation No. 48”). Interpretation No. 48clarifies the accounting for uncertainty in income taxes recognized in anenterprise’s financial statements in accordance with SFAS No. 109,“Accounting for Income Taxes.” Interpretation No. 48 prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. Interpretation No. 48 also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition. For the Company, Interpretation No. 48was effective beginning January 1, 2007, and the cumulative effectadjustment, if any, will be recorded in the first quarter of 2007. We believethat the adoption of Interpretation No. 48 will not have a material impacton our consolidated financial statements.

**19.   RelatedParty Transaction**

In connection with theCompany’s acquisition of MDX, a $6.5 million promissory note was issued tothe seller of Media DVX and was payable over three years with an interest rateof the one month LIBOR rate for the applicable period with principal and thenaccrued interest due as follows: $1.5 million due on April 15, 2006,$2.0 million due on April 15, 2007, and $3.0 million due on April 15,2008. However, during the fourth quarter of 2006, the Company retired theentire remaining balance of this obligation of $5.0 million through acombination of issuing common stock valued of $3.0 million and cash of $2.0million. We issued 259,177 shares valued at $11.58 per share, the closing priceof our stock on November 30, 2006, the date the promissory note was retired. TheCompany paid accrued interest on the promissory note on a quarterly basis. Thepromissory note was personally guaranteed by Scott K. Ginsburg, theCompany’s Chief Executive Officer and Chairman of the Board. Mr. Ginsburg’spersonal guarantee of the Company’s debt was evaluated for the purpose ofdetermining an amount to compensate him for such guarantee. The Company determinedthat the improved interest rate obtained as a direct result of the personalguarantee was worth approximately $0.6 million over the term of the loan.For the years ended December 31, 2006 and 2005 respectively, the Companyhas recognized additional interest expense of $0.3 million and $0.1 millionassociated with the guarantee.

**20.   SubsequentEvent**

On March 1, 2007, the Company completed its saleof Corporate Computer Systems, Inc. and proceeds of $425,000 were receivedin cash. Note 4 describes how this subsidiary is reflected in these financialstatements as discontinued operations.

F-31

----

**DG FASTCHANNEL, INC. AND SUBSIDIARIES SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS(in thousands)**

| **Classification**               | ** ** | ** ** | ** ** | **Balance at  Beginning of  Period** | ** ** | **Additions  Charged to  Operations(1)** | ** ** | **Acquired** | ** ** | **Write-offs** | ** ** | **Balance at  End of Period** | ** ** |
|----------------------------------|------------|------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|----------------------------------------------|------------|
| *Allowance for Doubful Accounts* |       |       |       |                                           |       |                                          |       |         |       |           |       |                                         |       |   |   |   |   |   |   |   |   |
| Year Ended:                      |       |       |       |                                           |       |                                          |       |         |       |           |       |                                         |       |   |   |   |   |   |   |   |   |
| December 31,  2004          |       |       | $          | 507                                            |       |                                          |       | 262          |       |           |       | 157                                          |       |   |   | (504 | ) |   |   | $ | 422 |   |   |
| December 31,  2005          |       |       | $          | 422                                            |       |                                          |       | 343          |       |           |       | —                                       |       |   |   | (274 | ) |   |   | $ | 491 |   |   |
| December 31, 2006           |       |       | $          | 491                                            |       |                                          |       | 789          |       |           |       | 199                                          |       |   |   | (433 | ) |   |   | $ | 1,046 |   |   |

----

(1)          Excludes amounts chargedto discontinued operations of $17, ($13), and, $13, in 2006, 2005, and 2004,respectively.

S-1

----

| Exhibit   Number | ** ** | ** **                                                                                                                                                              | ** ** | **Exhibit Title** |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|
| 3.1(a)           |       | Certificate of  Incorporation of registrant.                                                                                                                            |
| 3.2(b)           |       | Certificate of  Amendment to the Certificate of Incorporation of registrant.                                                                                            |
| 3.3(b)           |       | Certificate of  Amendment to the Certificate of Incorporation of registrant                                                                                             |
| 3.4(a)           |       | Bylaws of  registrant, as amended to date.                                                                                                                              |
| 4.1(c)           |       | Form of  Common Stock Certificate.                                                                                                                                 |
| 10.1(c)          |       | 1992 Stock Option  Plan (as amended) and forms of Incentive Stock Option Agreement and  Non-statutory Stock Option Agreement.*                                          |
| 10.2(c)          |       | Form of  Directors’ and Officers’ Indemnification Agreement.                                                                                             |
| 10.3(c)          |       | 1995 Director  Option Plan and form of Incentive Stock Option Agreement thereto.*                                                                                       |
| 10.4(c)          |       | Form of  Restricted Stock Agreement.*                                                                                                                              |
| 10.5(d)          |       | Content Delivery  Agreement between the Company and Hughes Network Systems, Inc., dated November 28,  1995.                                                   |
| 10.6(d)          |       | Equipment  Reseller Agreement between the Company and Hughes Network Systems, Inc.,  dated November 28, 1995.                                                 |
| 10.7(f)          |       | Special Customer  Agreement between the Company and MCI Telecommunications Corporation, dated May 5,  1997.                                                        |
| 10.8(g)          |       | 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. |
| 10.9(g)          |       | Amended and  Restated Registration Rights Agreement, dated December 9, 1998, by and  among the Registrant and certain of its security holders                      |
| 10.10(g)         |       | Registration  Rights Agreement, dated December 9, 1998, by and among the Registrant  and certain of its security holders.                                          |
| 10.11(h)         |       | Common Stock and  Warrant Purchase Agreement dated December 9, 1998 by and among the  Registrant and investors listed in Schedule A thereto.                       |
| 10.12(h)         |       | Common Stock  Subscription Agreement dated December 9, 1998 by and among the  Registrant and Scott Ginsburg.                                                       |
| 10.13(h)         |       | Warrant Purchase  Agreement dated December 9, 1998 by and among the Registrant and Scott  Ginsburg.                                                                |
| 10.14(h)         |       | Warrant No. 1  to Purchase Common Stock dated December 9, 1998 by and among Registrant  and Scott K. Ginsburg.                                           |
| 10.15(h)         |       | Warrant No. 2  to Purchase Common Stock dated December 9, 1998 by and among Registrant  and Scott K. Ginsburg                                            |
| 10.16(i)         |       | Registration  Rights Agreement, dated December 17, 1999, by and among the Registrant  and certain of its security holders.                                         |
| 10.17(i)         |       | Common Stock  Purchase Agreement dated December 17, 1999 by and among the Registrant  and investors listed in Schedule A thereto.                             |
| 10.18(j)         |       | Customer Service  Agreement, dated September 12, 2002 between Digital Generation Systems, Inc.  and Sprint Communications Company L.P.                   |
| 10.19(k)         |       | Employment  Agreement, dated December 10, 2003, between Digital Generation Systems, Inc.  and Omar Choucair, Chief Financial Officer.*                        |

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| 10.20(l) |   | Amendment to Employment  Agreement between Digital Generation Systems and Omar Choucair dated March 24,  2005.*                                                                                                          |
|----------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.21(m) |   | First Amended and  Restated Agreement and Plan of Merger by and among Digital Generation Systems, Inc.,  DG Acquisition Corp. IV and FastChannel Network, Inc. Dated as  of January 13, 2006.        |
| 10.22(m) |   | Credit Agreement  dated as of February 10, 2006 by and among Digital Generation Systems, Inc.  and Wachovia Bank, NA as Administrative Agent and Issuing Lender.                                               |
| 10.23(m) |   | Amendment No. 1  to Common Stock Purchase Warrant by and among Registrant and Scott K.  Ginsburg.*                                                                                                                  |
| 10.24(m) |   | Amendment No. 2  to Warrant No. 1 by and among Registrant and Scott K. Ginsburg.*                                                                                                                              |
| 10.25(m) |   | Amendment No. 2  to Warrant No. 2 by and among Registrant and Scott K. Ginsburg.*                                                                                                                              |
| 10.26(m) |   | Amendment No. 1  to Common Stock Purchase Warrant by and among Registrant and Omar A.  Choucair.*                                                                                                                   |
| 10.27(m) |   | Amendment No. 2  to Warrant by and among Registrant and Omar A. Choucair.*                                                                                                                                          |
| 10.28(n) |   | Employment  Agreement, dated June 22, 2006, between the Company and Scott K.  Ginsburg*                                                                                                                                  |
| 10.29(n) |   | Amended and  Restated Employment Agreement, dated June 22, 2006, between the Company  and Omar A. Choucair*                                                                                                         |
| 10.30(o) |   | Form of DG  FastChannel, Inc. 2006 Employee Stock Purchase Plan*                                                                                                                                                    |
| 10.31(o) |   | Form of DG  FastChannel, Inc. 2006 Long-term Stock Incentive Plan*                                                                                                                                                  |
| 10.32(p) |   | Amended and  Restated Credit Agreement dated as of May 31, 2006 by and among DG  FastChannel, Inc. and Wachovia Bank, NA as Administrative Agent and  Issuing Lender                                           |
| 10.33(q) |   | Debt Settlement  and Exchange Agreement dated November 20, 2006 by and among DG  FastChannel, Inc., DG Systems Acquisition III Corporation and MDVX, Inc.                                                      |
| 10.34(r) |   | Underwriting  Agreement, dated December 14, 2006 by and among DG FastChannel, Inc.,  a selling stockholder and Oppenheimer & Co., Inc., as  representative of the several underwriters named therein. |
| 10.35(s) |   | Securities  Purchase Agreement dated December 22, 2006, between DG FastChannel, Inc.  and Midwood Capital Management, LLC, Midwood Capital Partners, L.P., and  Midwood Capital Partners QP, L.P.                   |
| 10.36(t) |   | Employment  Agreement by and between Digital Generation Systems, Inc., and Pamela Maythenyi  entered into as of the 31st day of August 2004.                                                                                  |
| 10.37(t) |   | Amended and  Restated Employment Agreement by and between Digital Generation Systems,  Inc., and Neil Nguyen, entered into as of the 30th day of August 2006, but  effective as of the 1st day of July 2006.                  |
| 21.1(u)  |   | Subsidiaries of  the Registrant.                                                                                                                                                                                              |
| 23.1**   |   | Consent of  Independent Registered Public Accounting Firm                                                                                                                                                                     |
| 24.1(v)  |   | Power of Attorney                                                                                                                                                                                                             |
| 31.1**   |   | Rule 13a-14(a)/15d-14(a) Certifications                                                                                                                                                                             |
| 31.2**   |   | Rule 13a-14(a)/15d-14(a) Certifications                                                                                                                                                                             |
| 32.1**   |   | Section 1350  Certifications                                                                                                                                                                                             |

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(a)           Incorporated byreference to exhibit bearing the same title filed with registrant’s AnnualReport on Form 10-K filed March 27, 2003.

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(b)          Incorporated byreference to the exhibit bearing the same title filed with registrant’sQuarterly Report on Form 10-Q filed November 14, 2006.

(c)           Incorporated byreference to the exhibit bearing the same title filed with registrant’sRegistration Statement on Form S-1 (Registration No. 33-80203).

(d)          Incorporated byreference to the exhibit bearing the same title filed with registrant’sRegistration Statement on Form S-1 (Registration No. 33-80203).The registrant has received confidential treatment with respect to certainportions of this exhibit. Such portions have been omitted from this exhibit andhave been filed separately with the SEC.

(e)           Incorporated byreference to the exhibit bearing the same title filed with registrant’sQuarterly Report on Form 10-Q filed November 13, 1996.

(f)             Incorporated by referenceto the exhibit bearing the same title filed with registrant’s Quarterly reporton Form 10-Q filed August 14, 1997. Confidential treatment hasbeen requested with respect to certain portions of this exhibit pursuant to arequest for confidential treatment filed with the SEC, which request wasgranted. Omitted portions have been filed separately with the SEC.

(g)           Incorporated byreference to the exhibit bearing the same title filed with registrant’sRegistration Statement on Form S-3 filed on December 31, 1998.

(h)          Incorporated byreference to the exhibit bearing the same title filed with registrant’s AnnualReport on Form 10-K filed March 29, 1999.

(i)             Incorporated byreference to the exhibit bearing the same title filed with registrant’sQuarterly Report on Form 10-Q filed May 11, 2000.

(j)              Incorporated byreference to the exhibits bearing the same title filed with registrant’s AnnualReport on Form 10-K filed on March 27, 2003. The registrant hasrequested confidential treatment with respect to certain portions of thisexhibit.

(k)          Incorporated byreference to the exhibit bearing the same title filed with registrant’s AnnualReport on Form 10-K filed on March 12, 2004.

(l)             Incorporated byreference to the exhibit bearing the same title filed with registrant’s CurrentReport on Form 8-K filed March 29, 2005.

(m)      Incorporated by reference tothe exhibit bearing the same title filed with registrant’s Annual Report on Form 10-Kfiled on March 28, 2006.

(n)          Incorporated byreference to the exhibit bearing the same title filed with registrant’s CurrentReport on Form 8-K filed June 27, 2006.

(o)          Incorporated byreference to the exhibit bearing the same title filed with registrant’sDefinitive Proxy filed July 24, 1996

(p)          Incorporated byreference to the exhibit bearing the same title filed with registrant’sQuarterly Report on Form 10-Q filed August 14, 1996.

(q)          Incorporated byreference to the exhibit bearing the same title filed with registrant’s CurrentReport on Form 8-K filed November 22, 2006.

(r)            Incorporated byreference to the exhibit bearing the same title filed with registrant’s CurrentReport on Form 8-K filed December 19, 2006

(s)            Incorporated byreference to the exhibit bearing the same title filed with registrant’s CurrentReport on Form 8-K filed December 28, 2006

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(t)             Incorporated byreference to the exhibit bearing the same title filed with registrant’s AnnualReport on Form 10-K/A filed April 27, 2007.

(u)          Incorporated byreference to the exhibit bearing the same title filed with registrant’s AnnualReport on Form 10-K filed April 2, 2007

(v)           Previously filed onsignature page to registrant’s Annual Report on Form 10-K filed April 2, 2007

*                    Managementcontract or compensatory plan or arrangement.

**             Filed herewith.

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