Security Capital Trading, Inc.
520 Madison Avenue, 10th Floor Phone: (212) 339-2000
New York, New York 10022-4213 (888) 305-0050
Member NASD · Member SIPC Fax: (212) 339-2020
March 17, 1999 Raymond L. Dirks, Research Director
Initiating Coverage Joseph Vaini , Internet Consultant
DIGITAL LAVA INC.
(AMEX:DGV)
Rating: Buy
Recent Price (common) $5 1/16 Sales 1999(E) $4.1M
Recent Price (warrants) 1 13/16 Sales 2000 (E) $18.7M
Shares Outstanding 4.36M Sales 2001 (E) $36.7M
Warrants Outstanding 1.2M EPS FY2000 (E) $0.72
Market Capitalization 22.25M EPS FY2001 (E) $1.52
Website:www.digitallava.com
Introduction:
Digital Lava Inc. is a provider of video publishing software products and services. Digital Lava's products allow users to organize and manage video content, link video to other types of files and stream the interactive video over the Internet, Intranets or Extranets, or publish the video on CD-ROM or DVD. We are initiating coverage of Digital Lava with a buy recommendation in consideration of the following factors:
Digital Lava has a unique product line which transforms digital video from a passive linear experience into a highly interactive multimedia experience. Digital Lava's products enable users to navigate, manipulate and integrate video with any other relevant information in digital format as well as permitting collaboration by several users.
We project revenues of $4.1M for FY99 (an increase of 170% over FY98) , $18.7M for FY2000 (+350%), and $36M for FY2001(+96%). Under this scenario, Digital Lava will be profitable in 2000, earning approximately $0.72 per share.
In terms of projected revenues, Digital Lava has a low valuation in comparison to other companies involved in digital video software. Macromedia currently trades at approximately 11X sales and Real Networks trades at approximately 52X sales. In contrast, Digital Lava currently trades at approximately 5X projected 1999 sales and 1X projected 2000 Sales.
Recent developments in broadband technology, such as DSL (Digital Subscriber Line) and projects in development such as the Internet 2 Digital Video Network (I2-DVN), which are expected to facilitate a national, higher education video service network to provide capabilities to support scalable and easy to use applications to deliver live or stored streaming and interactive high quality digital video, should positively impact the quality and speed of video streamed over the Internet. According to industry sources, streaming audio and video is expected to account for 5% of all Net traffic by the year 2000 and 6% of all Net traffic by the year 2003. Digital Lava is well positioned to take advantage of these factors.
The distance learning market, a prime market for Digital Lava's products and services, is projected to approach $1.5 billion by the year 2000. The number of students enrolled in distance learning courses is expected to increase from 710,000 in 1998 (representing 5% of all students) to 2.2 million by 2002 (representing 15% of all students). In 1998, 62% of higher education institutions offered distance learning programs. In 1999, that number should grow to 84%. The corporate training market is estimated at $55 billion in 1998. Of that amount, only $500 million was spent on web based training programs. That number should increase dramatically as businesses realize the cost benefits of Web based distance learning as opposed to other more traditional methods (CCTV, etc.) According to a Training Magazine study, today video is the third most popular medium for training after live classroom training and workbooks.
Industry leaders such as Len Jordan, Senior Vice President of Real Networks and Gary Schare, Lead Product Manager of Microsoft have praised Digital Lava's products. Both RealNetworks and Microsoft are technology partners of the company.
Digital Lava's open architecture is compatible with all major digital video formats and video servers.
Digital Lava has an impressive customer list which includes Fortune 1000 companies and major universities.
Digital Lava may become an acquisition target. There are several precedents in the technology industries for larger, more established companies making significant investments or acquiring smaller companies with an innovative product or concept at extremely high valuations. One example is Compaq Computer's recently completed $181 million cash acquisition of Shopping.com, a small OTC bulletin board company with trailing 12 month revenues of approximately $1 million. Compaq acquired the company in order to obtain its proprietary software.
The Company and its Products and Services:
Digital Lava Inc. was founded in 1995. On February 17,1999, Digital Lava completed its initial public offering of 1,200,000 units at 15.10 per unit. Each unit consisted of two shares of common stock and one purchase warrant exercisable at $9.00 per share commencing February 17, 2000 and expiring February 17, 2004. Net proceeds to the company from the IPO were approximately $11 million.
Digital Lava's software products are vPrism, and VideoVisor Professional.
vPrism is the publishing tool that creates the VideoCapsule (see below). It allows the user to assimilate and manage video and other digital information from diverse sources, organize its content, link the video to important data (like files, text, programs, etc.) and then rapidly publish the "video capsule”. It is simple to use, providing users with “drag and drop” tools to link text, transcripts, annotations images and other digital files, programs and web applications. vPrism is extremely powerful and capable of handling thousands of hours of video content.
VideoVisor empowers end users to manage the flow of information on a video capsule supporting a variety of standard video formats. With unprecedented simplicity, users can quickly analyze and re-arrange content, subtitle text and transcripts, annotate video, access notes, and easily link to desktop files, web sites and applications.
What is a VideoCapsule?
When published by vPrism, video integrated with other useful information is transformed into a file called a VideoCapsule, which is actually two files where one file is the video and another contains the Metadata. A VideoCapsule contains high quality digitized video with a full text transcription of the video. The system highlights the text as it is being spoken so that the viewer can understand precisely what is being said. In addition, because there are two text tracks available, you can have multilingual capability with the video speaking in English and the text in another language . Text is indexed to the video clip so that by clicking with a mouse on the required text transcript the video will be repositioned to that point. This gets the viewer to the information required in the minimal time. The language translation can also be shown at the same time. A typical VideoCapsule may contain video transcripts, foreign language translations, a hierarchically organized ClipList, video clip annotations, and links to a variety of websites, files, and programs.
A VideoCapsule can run from an Intranet or the Internet, a CD, DVD or on a LAN or WAN. This offers a wide choice of deployment options. Users can beam it by satellite into international markets or even deliver it on a “user pays” basis over the Internet. Advanced streaming technologies can deliver Internet based video in a range of modem speed formats including 28.8kps, 33.6kps, 55.6kps, DSL, cable or dual ISDN dedicated lines.
As an example, an organization can deploy the video content on a server in New York, the supporting Macromedia Director presentations on a server in Detroit, supporting electronic documentation on a server in Sydney, a PowerPoint slide presentation on a server in Rome and so on to maximize organizational bandwidth resources. VideoCapsules are programmed to retrieve the files it needs from any network, Intranet or Internet site. VideoCapsules can be played, edited and manipulated by the user with Video Visor.
VIDEO VISOR SCREENSHOT:
The Digital LavaVideo Visor Event Service:
Digital Lava offers a turnkey video streaming, publishing and hosting service aimed at corporate, educational and government institutions called VideoVisor Event. This service provides on demand Web access to interactive video events, in VideoVisor format, for training, education and communications purposes. In addition to transforming the video into VideoVisor format, it includes:
E-mail notification to target users that VideoVisor events are available for viewing including initial passwords and hot-linked URLs to the log in page.
Customization to match the look and feel of the client's website and image.
Video encoding in either Microsoft NetShow or RealNetworks G2 format with options to upgrade to both formats for increased hosting alternatives.
Encoding in three data rates for a variety of bandwidth options, with options to upgrade to faster rates
Online user registration and controlled access.
Around the clock technical support.
Detailed summary reports by event title or user, with options to upgrade for customized reporting capabilities.
In accessing a VideoVisor event, the user requires no plug-in or software except for the readily available Microsoft Netshow or RealNetworks G2 player.
VideoVisor Event can provide an additional marketing channel for the company's products since VideoVisor Event clients will have gotten a chance to familiarize themselves with the technology and its capabilities.
Digital Lava also has the capability to provide services on a contract basis ranging from simple video encoding to the complete set up of a customer's video publishing facility including, among other things, hardware acquisition, design, LAN setup and training.
Technology Partners:
Real Networks:
Under a licensing and distribution agreement with Real Networks, Digital Lava is a Real Networks Architecture Partner and licenses Real Networks client player software for integration with Video Visor. Digital Lava is also authorized to resell Real Networks server software products.The agreement gives Digital Lava the opportunity to be included in RealNetworks user conferences, tradeshows, and other events.
Microsoft:
Digital Lava is a MicrosoftNetShow independent software vendor. Besides the additional exposure such association gives Digital Lava, it gives the company access to mailing lists of Microsoft registered product users. Digital Lava also licenses Microsoft's Internet Explorer Administration Kit pursuant to a royalty free license and distribution agreement, permitting Digital Lava to customize the Internet Explorer browser for integration with VideoVisor and distribute the bundled product to its end users.
FVC.COM:
Pursuant to a worldwide distribution agreement with FVC.COM, FVC.COM bundles VideoVisor with its video networking and NGI access applications to create Virtual Classroom. Virtual Classroom enables students to access course content and complementary resources twenty-four hours a day. Using the VideoVisor interface, users can view a class as delivered by the instructor, search by topic or keyword across classes, access research documents and web URLs, access linked PowerPoint files and other class presentations and view search results in context of related materials and discussions by the instructor. Virtual Classroom is currently being implemented in two pilot programs in Hong Kong.
Agreements with companies such as Apple, Xing, RealNetworks, and Microsoft Corporation will ensure Digital Lava's continued compatibility with future generations of major video publishing formats.
Distribution Channels:
The company distributes its products and services through its own sales force, integration with other products (such as Virtual Classroom) and through various reseller agreements with system integrators, video software resellers and training companies. Of the proceeds received through its IPO, Digital Lava has earmarked $5,000,000 towards sales and marketing expenditures and will increase its direct sales force from one salesman to six.
Customers:
Within the past 18 months, Digital Lava has assembled the following customers.
American General Corp.
AR&D (Audience Research And Development)
Ardent Software
ASI Entertainment
Bellcore Corporation
Cal State - Long Beach
Campos Group
Cisco
COMAP, Inc.
Compact Data, Calgary
Dian Fossey Gorilla Fund
Diedrich Coffee
Digital Equipment Corp. (DEC)
DocuVideo Productions
Ernst & Young
ETS (Educational Testing Service)
Far West Laboratory
First Virtual Corporation
George Washington Univ.
Greenville School District
Hitachi Corporation
IRM Training Company, Australia
Legal Media Systems
Los Angeles Unified School District
Lotus
Max Planck Institute, Berlin
N'tl Center for Education Stats
Nanyang Technological Univ., Singapore
Nortel
Northwestern University
Primedia Workplace Learning
Rand Corporation
San Diego State University
SatCom Media Corp.
Shell Chemical Company
Smithsonian Institute
Stanford University
SUNY University
TERC
The Maya Group
Toyota
UCLA
Univ. of North Carolina
Univ. of Wisconsin - Madison
University of Colorado - Denver
University of Dortmund, Germany
University of Melborne, Australia
University of Michigan - Ann Arbor
University of Oregon - Eugene
University of Pittsburgh
University of Zuerich, Zurich
Vital Source Technology
Vox Pops International, London
Wild Dolphin Project
Wisconsin Center for Educational Resources
Reorders:
Repeat business by several high profile customers has validated Digital Lava's products. Customers that have placed reorders include:
Cisco
Lotus
Ardent Software
UCLA
Diedrich Coffee
LA Unified School District
Selected Case Studies:
(from Digital Lava's Website)
Shell Chemical:
“When Shell Chemical Company decided to upgrade its desktop PCs and migrate to a new suite of desktop applications, including the latest version of Microsoft's Office Suite™, the Fortune 1000 company sought a business solution to quickly and economically train and communicate with employees. The global company turned to Digital Lava's VideoVisor™ software application, a turnkey business solution that delivers on-demand interactive video IT training and communications directly to employee desktops. The initial roll-out will incorporate the software in 4,500 PCs throughout the United States.”
University of California (Los Angeles) UCLA
“Approximately half of all first marriages end in separation or divorce. Most of these failed relationships end within five years. To understand how once happy newlyweds often become unhappy in their relationships, UCLA Professor of Psychology Tom Bradbury is videotaping the interactions of 172 married couples over a five year period and studying the patterns that emerge. With more than 600 hours of taped sessions, Bradbury required a solution beyond a simple TV-VCR hook-up that could manage and categorize his video data. Bradbury chose Digital Lava's VideoVisor, a desktop application that expands video functionality beyond simple playback, rewind and advance, to quickly and easily search and annotate his video, re-arrange and organize video content, subtitle text and transcripts, access notes, and link to other files, Web sites and applications.To produce scientifically valid results, Bradbury views each couple's interaction and codes their behaviors moment by moment from a list of 60 unique emotional expressions and relationship skills.Through this process of quantification, Bradbury is able to uncover and study the patterns of interaction that lead to both enduring and failed relationships. Digital Lava's vPrism allows Bradbury to analyze the video second by second, note his observations directly to the video and organize the clips in any order he likes. Using Digital Lava's VideoVisor software, he can then type in a keyword such as "anger" and Digital Lava will search the entire 600-hour archive for every incidence of "anger" and present the results clip by clip.”
Can the Digital Lava Website become a Portal?
Both RealNetworks and Macromedia operate portal sites of sorts, which enable these companies to obtain advertisement revenues. Real Networks Real Guide operates as a portal for audio and video on the Net. Real Guide is comprised of channels which allow the user to search for audio and video content (in RealNetwork's format) by category. Macromedia's Shockrave showcases cartoons, games, and other features created with different Macromedia products.
Portals are valued by their number of unique visitors, the actual number of total unduplicated users to visit a website within a given month. These valuations can reach as high as $1,000 per unique visitor as in the case of YAHOO! Inc.
Although currently aimed at corporate, educational and government users, it is conceivable that, with advances in broadband technology, VideoCapsules published for the mass market (catalogs, movies, encyclopaedia type VideoCapsules), could be put on the Internet and be searched for and accessed through a portal.
Balance Sheet Data (September 30,1998):
(Pro forma as adjusted for the IPO)
Cash and Cash Equivalents $11,251,382
Working Capital 10,316,202
Total Assets 11,530,324
Total Liabilities 1,122,079
Stockholders Equity 10,408,245
Financial Projections:
1998 1999 2000 2001
Full Year Q1 Q2 Q3 Q4 Full Year Full Year Full Year
Revenue $1,500 $150 $550 $1,200 $2,200 $4,100 $18,700 $36,700
Cost of Revenues (277) (75) (120) (150) (300) (645) (2,050) (4,400)
Operating Expenses:
SG&A (5,618) (600) (1,100) (1,845) (2,615) (6,160) (11,220) (16,500)
R&D (584) (215) (290) (300) (300) (1,105) (1,600) (2,400)
Total Operating Expenses (6,102) (815) (1,390) (2,145) (2,915) (7,265) (12,820) (18,900)
Operating Income (Loss) (4,879) (740) (960) (1,095) (1,015) (3,810) 3,850 13,400
Other Income and Expenses:
Interest Income (Expense) (1,200) 40 140 120 60 360 400 600
Income before Taxes (6,079) (700) (820) (975) (955) (3,450) 4,250 14,000
Taxes (1,063) (5,600)
Net Income (6,079) (700) (820) (975) (955) (3,450) 3,187 8,400
EPS (1) $(1.38) $(0.15) $(0.19) $(0.22) $(0.21) $(0.78) $0.72 $1.91
EPS (2) $0.57 $1.52
(1) Based on 4,396,092 shares outstanding
(2) Based on fully diluted shares
Selected Accolades:
“We are excited by the powerful applications and tools that Digital Lava will bring to the training and enterprise communications markets based on the RealSystem 5.0 solution platform. We believe that Digital Lava's solution will ease the process of creating content and increase the usability of information on the desktop.”
Len Jordan, Senior VP, RealNetworks, Inc.
“Windows Media Technologies combined with Digital Lava's Video Publishing provides our customers with powerful solutions ideally suited for corporate communication and learning on-demand applications.”
Gary Schare, Lead Product Manager, Microsoft Corporation
“As Multimedia begins to proliferate in financial services companies, becoming a standard platform for communications in the enterprise, users will need these kinds of tools to work with the applications. Digital Lava's software is user friendly, and integrates well with current office applications. Digital Lava has no true competitors in this market. This is potentially a very important product.”
Greg Tapper, Analyst, Giga Research
Awards:
Best New Streaming/Broadcasting Product
MultiMedia.Com Conference, (formerly the Desktop Video Communications Conference) Spring '99
Best New Streaming Product
Networked MultiMedia Award
Desktop Video Communications Conference, Spring ‘98
People's Choice Award
Desktop Video Communications Conference, Fall '98
Silver Winner
NewMedia Invision 98 Awards
Conclusion:
We view Digital Lava as an attractive vehicle with which to participate in the emergence of a new growth sector of Internet technology.
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