**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

**FORM 10-Q**

** **

**(Mark One)**

** **

**                                               ****ý        QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

** **

**                                                                                               ****For The Quarterly PeriodEnded:    August 31, 2002**

** **

**                                               ****o        TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

** **

**                                                                                               ****For The TransitionPeriod From            To          **

** **

**                                                                                               ****Commission File Number:0-14779**

** **

**MEDIA 100 INC.**

**(Exactname of registrant as specified in its charter)**

** **

| **DELAWARE**                                  |   | **04-2532613**                           |
|-----------------------------------------------|--------|------------------------------------------|
| (State or other  jurisdiction of organization |   | (I.R.S. Employer  Identification Number) |
| or incorporation)                             |   |                                     |

 

**450 DONALD LYNCH BOULEVARD**

**MARLBOROUGH, MASSACHUSETTS**

(Address of principalexecutive offices)

 

**01752-4748**

(Zip code)

 

**(508)460-1600**

(Registrant’s telephonenumber, including area code)

 

 

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

                                                                Yes  ý                   No           o

 

                                                                                                Indicate the number of shares outstandingof each of the issuer’s classes of common stock, as of the latest practicabledate.

 

| **Common  Stock, par value $.01 per share** |   | **12,947,643  shares**          |
|---------------------------------------------|--------|---------------------------------|
| Class                                       |   | Outstanding at October  1, 2002 |

 

 

 

----

 

MEDIA 100 INC.

INDEX TO FORM 10-Q
|                                 |                                                                                                                  |   |
|--------------------------------------|-----------------------------------------------------------------------------------------------------------------------|--------|
|                                 |                                                                                                                  |   |
| PART I — FINANCIAL  INFORMATION |                                                                                                                  |
| ITEM 1                               | Consolidated Financial Statements:                                                                                    |   |
|                                 | Consolidated Balance Sheets  as of August 31, 2002 and November 30, 2001                                              |   |
|                                 |                                                                                                                  |   |
|                                 | Consolidated  Statements of Operations for the three and nine months ended August 31, 2002  and  August 31, 2001 |   |
|                                 |                                                                                                                  |   |
|                                 | Consolidated  Statements of Cash Flows for the nine months ended August 31, 2002 and August  31, 2001                 |   |
|                                 |                                                                                                                  |   |
|                                 | Notes to  Consolidated Financial Statements                                                                           |   |
|                                 |                                                                                                                  |   |
| ITEM  2                              | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                           |   |
|                                 |                                                                                                                  |   |
| ITEM  3                              | Quantitative  and Qualitative Disclosures About Market Risk                                                           |   |
|                                 |                                                                                                                  |   |
| ITEM 4                               | Controls And Procedures                                                                                               |   |
|                                 |                                                                                                                  |   |
| PART II — OTHER INFORMATION     |                                                                                                                  |
| ITEM  1                              | Legal Proceedings                                                                                                     |   |
| ITEM 6                               | Exhibits and  Reports on Form 8-K                                                                                     |   |
|                                 |                                                                                                                  |   |
| SIGNATURES                           |                                                                                                                  |
|                                 |                                                                                                                  |   |
| EXHIBIT INDEX                        |                                                                                                                  |

 

 

2

----

 

PART I - FINANCIAL INFORMATION

 

MEDIA 100 INC.

CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)

 
|                                                                                           |   | **August 31,** |   | **November  30,** |   |
|------------------------------------------------------------------------------------------------|--------|----------------|--------|-------------------|--------|
|                                                                                           |   | **2002**       |   | **2001**          |   |
| ASSETS                                                                                         |   |           |   |              |   |
| Current assets:                                                                                |   |           |   |              |   |
| Cash and cash  equivalents                                                                     |   | $              | 3,858  |              | $      | 17,369 |   |
| Available for  sale securities, at fair value                                                  |   | 161            |   | 241               |   |
| Restricted cash  (Notes 4 and 9)                                                               |   | 3,174          |   | —            |   |
| Due from escrow  (Notes 4 and 14)                                                              |   | 2,000          |   | 2,000             |   |
| Accounts  receivable, net of allowance for doubtful accounts of $394 in 2002 and $512  in 2001 |   | 2,452          |   | 2,907             |   |
| Inventories, net                                                                               |   | 2,086          |   | 1,220             |   |
| Prepaid expenses  and other current assets                                                     |   | 725            |   | 706               |   |
| Total current  assets                                                                          |   | 14,456         |   | 24,443            |   |
|                                                                                           |   |           |   |              |   |
| Property and  equipment, net                                                                   |   | 2,147          |   | 3,843             |   |
| Intangible  assets, net                                                                        |   | 158            |   | 1,880             |   |
|                                                                                           |   |           |   |              |   |
| Total assets                                                                                   |   | $              | 16,761 |              | $      | 30,166 |   |
|                                                                                           |   |           |   |              |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                     |   |           |   |              |   |
| Current  liabilities:                                                                          |   |           |   |              |   |
| Accounts payable                                                                               |   | $              | 1,019  |              | $      | 1,490 |   |
| Accrued expenses                                                                               |   | 6,723          |   | 8,000             |   |
| Deferred revenue                                                                               |   | 3,441          |   | 3,812             |   |
| Total current  liabilities                                                                     |   | 11,183         |   | 13,302            |   |
|                                                                                           |   |           |   |              |   |
| Contingencies  (Note 9)                                                                        |   |           |   |              |   |
|                                                                                           |   |           |   |              |   |
| Stockholders’  equity:                                                                    |   |           |   |              |   |
| Preferred stock,  $.01 par value                                                               |   |           |   |              |   |
| Authorized —  1,000 shares, none issued                                                   |   | —         |   | —            |   |
| Common stock,  $.01 par value,                                                                 |   |           |   |              |   |
| Authorized —  25,000 shares                                                               |   |           |   |              |   |
| Issued  — 12,978 shares and 12,575 shares at  August 31, 2002 and November 30, 2001  |   | 130            |   | 126               |   |
| Capital in  excess of par value                                                                |   | 218,300        |   | 217,683           |   |
| Accumulated  deficit                                                                           |   | (212,645       | )      | (200,836          | )      |
| Treasury stock,  30 shares at cost                                                             |   | (78            | )      | (78               | )      |
| Accumulated  other comprehensive loss                                                          |   | (129           | )      | (31               | )      |
| Total  stockholders’ equity                                                               |   | 5,578          |   | 16,864            |   |
|                                                                                           |   |           |   |              |   |
| Total liabilities  and stockholders’ equity                                               |   | $              | 16,761 |              | $      | 30,166 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

3

----

 

MEDIA 100 INC. 

CONSOLIDATED STATEMENTSOF OPERATIONS

(in thousands, except pershare data)

(unaudited)

 
|                                                                |   | **Three  Months Ended August 31,** |   | **Nine  Months Ended August 31,** |   |
|---------------------------------------------------------------------|--------|------------------------------------|--------|-----------------------------------|--------|
|                                                                |   | **2002**                           |   | **2001**                          |   | **2002** |   | **2001** |   |
| Net sales:                                                          |   |                               |   |                              |   |   |   |   |   |
| Products                                                            |   | $                                  | 3,931  |                              | $      | 5,485 |   | $ | 11,862 |   | $ | 18,264 |   |
| Services                                                            |   | 1,437                              |   | 2,066                             |   | 4,583 |   | 6,906 |   |
| Total net sales                                                     |   | 5,368                              |   | 7,551                             |   | 16,445 |   | 25,170 |   |
|                                                                |   |                               |   |                              |   |   |   |   |   |
| Cost of sales                                                       |   | 2,734                              |   | 4,465                             |   | 8,275 |   | 13,364 |   |
| Accelerated  depreciation and amortization of fixed assets (Note 6) |   | —                             |   | —                            |   | 331 |   | — |   |
| Gross profit                                                        |   | 2,634                              |   | 3,086                             |   | 7,839 |   | 11,806 |   |
|                                                                |   |                               |   |                              |   |   |   |   |   |
| Operating  expenses:                                                |   |                               |   |                              |   |   |   |   |   |
| Research and  development                                           |   | 2,101                              |   | 2,690                             |   | 7,227 |   | 8,056 |   |
| Selling and  marketing                                              |   | 1,650                              |   | 2,312                             |   | 6,614 |   | 9,402 |   |
| General and  administrative                                         |   | 796                                |   | 1,923                             |   | 3,329 |   | 4,594 |   |
| Amortization and  write-off of intangible assets                    |   | 279                                |   | 480                               |   | 1,044 |   | 2,420 |   |
| Accelerated  depreciation and amortization of fixed assets (Note 6) |   | —                             |   | —                            |   | 849 |   | — |   |
| Settlement of  litigation (Notes 7 and 9)                           |   | —                             |   | —                            |   | 924 |   | — |   |
| Restructuring  charge                                               |   | 299                                |   | 310                               |   | 299 |   | 878 |   |
| Total operating  expenses                                           |   | 5,125                              |   | 7,715                             |   | 20,286 |   | 25,350 |   |
| Operating loss                                                      |   | (2,491                             | )      | (4,629                            | )      | (12,447 | ) | (13,544 | ) |
|                                                                |   |                               |   |                              |   |   |   |   |   |
| Interest income,  net                                               |   | 31                                 |   | 50                                |   | 146 |   | 221 |   |
| Other income,  net                                                  |   | 204                                |   | 464                               |   | 390 |   | 200 |   |
| Loss from  continuing operations before benefit from income taxes   |   | (2,256                             | )      | (4,115                            | )      | (11,911 | ) | (13,123 | ) |
| Benefit from  income taxes                                          |   | —                             |   | —                            |   | (102 | ) | — |   |
| Loss from  continuing operations                                    |   | (2,256                             | )      | (4,115                            | )      | (11,809 | ) | (13,123 | ) |
| Loss from  discontinued operations                                  |   | —                             |   | (903                              | )      | — |   | (2,700 | ) |
| Net loss                                                            |   | $                                  | (2,256 | )                                 | $      | (5,018 | ) | $ | (11,809 | ) | $ | (15,823 | ) |
|                                                                |   |                               |   |                              |   |   |   |   |   |
| Loss per share:                                                     |   |                               |   |                              |   |   |   |   |   |
| Basic                                                               |   |                               |   |                              |   |   |   |   |   |
| Continuing  operations                                              |   | $                                  | (0.17  | )                                 | $      | (0.33 | ) | $ | (0.92 | ) | $ | (1.06 | ) |
| Discontinued  operations                                            |   | $                                  | — |                              | $      | (0.07 | ) | $ | — |   | $ | (0.22 | ) |
| Total                                                               |   | $                                  | (0.17  | )                                 | $      | (0.40 | ) | $ | (0.92 | ) | $ | (1.28 | ) |
| Diluted                                                             |   |                               |   |                              |   |   |   |   |   |
| Continuing  operations                                              |   | $                                  | (0.17  | )                                 | $      | (0.33 | ) | $ | (0.92 | ) | $ | (1.06 | ) |
| Discontinued  operations                                            |   | $                                  | — |                              | $      | (0.07 | ) | $ | — |   | $ | (0.22 | ) |
| Total                                                               |   | $                                  | (0.17  | )                                 | $      | (0.40 | ) | $ | (0.92 | ) | $ | (1.28 | ) |
| Weighted average  common shares outstanding:                        |   |                               |   |                              |   |   |   |   |   |
| Basic                                                               |   | 12,910                             |   | 12,415                            |   | 12,777 |   | 12,369 |   |
| Diluted                                                             |   | 12,910                             |   | 12,415                            |   | 12,777 |   | 12,369 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

 

4

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MEDIA 100 INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 
|                                                                                                     |   | **Nine  Months Ended** |    |
|----------------------------------------------------------------------------------------------------------|--------|------------------------|---------|
|                                                                                                     |   | **August 31,  2002**   |    | **August 31,  2001** |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                                   |   |                   |    |   |   |
| Net loss                                                                                                 |   | $                      | (11,809 | ) | $ | (15,823 | ) |
| Net loss from  discontinued operations                                                                   |   | —                 |    | 2,700 |   |
| (Loss) from continuing  operations                                                                       |   | (11,809                | )       | (13,123 | ) |
| Adjustments to  reconcile net loss from continuing operations to net cash used in operating  activities: |   |                   |    |   |   |
| Depreciation and  amortization                                                                           |   | 2,771                  |    | 2,067 |   |
| Non-cash  settlement of litigation                                                                       |   | 924                    |    | — |   |
| Amortization and  write-off of intangible assets                                                         |   | 1,044                  |    | 2,420 |   |
| Loss on sale of  marketable securities                                                                   |   | —                 |    | 9 |   |
| Changes in  assets and liabilities:                                                                      |   |                   |    |   |   |
| Restricted cash                                                                                          |   | (3,174                 | )       | — |   |
| Accounts  receivable, net                                                                                |   | 455                    |    | 2,546 |   |
| Inventories, net                                                                                         |   | (957                   | )       | 2,140 |   |
| Prepaid expenses  and other current assets                                                               |   | (19                    | )       | 350 |   |
| Accounts payable                                                                                         |   | (478                   | )       | (2,862 | ) |
| Accrued expenses                                                                                         |   | (1,451                 | )       | (741 | ) |
| Deferred revenue                                                                                         |   | (371                   | )       | (968 | ) |
| Net cash used in  operating activities                                                                   |   | (13,065                | )       | (8,162 | ) |
|                                                                                                     |   |                   |    |   |   |
| Net cash used in  discontinued operations                                                                |   | —                 |    | (1,006 | ) |
|                                                                                                     |   |                   |    |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                                   |   |                   |    |   |   |
| Net purchases of  equipment                                                                              |   | (972                   | )       | (768 | ) |
| Other assets                                                                                             |   | —                 |    | 114 |   |
| Purchase of  intangible assets                                                                           |   | (77                    | )       | (91 | ) |
| Net proceeds  from sales of marketable securities                                                        |   | 80                     |    | 5,419 |   |
| Net cash  provided by (used in) investing activities                                                     |   | (969                   | )       | 4,674 |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                                   |   |                   |    |   |   |
| Payment on note  payable                                                                                 |   | —                 |    | (1,492 | ) |
| Purchase of  treasury stock                                                                              |   | —                 |    | (78 | ) |
| Proceeds from  issuance of common stock                                                                  |   | 621                    |    | 504 |   |
| Net cash provided  by (used in) financing activities                                                     |   | 621                    |    | (1,066 | ) |
| EFFECT OF  EXCHANGE RATE CHANGES ON CASH                                                                 |   | (98                    | )       | 11 |   |
| NET DECREASE IN  CASH AND CASH EQUIVALENTS                                                               |   | (13,511                | )       | (5,549 | ) |
| CASH AND CASH  EQUIVALENTS, beginning of period                                                          |   | 17,369                 |    | 11,987 |   |
| CASH AND CASH  EQUIVALENTS, end of period                                                                |   | $                      | 3,858   |   | $ | 6,438 |   |
|                                                                                                     |   |                   |    |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                                                       |   |                   |    |   |   |
| Income tax  refunds                                                                                      |   | $                      | (118    | ) | $ | (42 | ) |
| OTHER  TRANSACTIONS NOT USING CASH:                                                                      |   |                   |    |   |   |
| Change in value  of marketable securities                                                                |   | $                      | —  |   | $ | (44 | ) |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

 

5

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MEDIA 100 INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED, EXCEPT FORNOVEMBER 30, 2001 AMOUNTS)

1.         Basisof Presentation

 

The accompanyinginterim consolidated financial statements include the accounts of Media 100Inc. (“the Company”), a Delaware corporation, and its wholly ownedsubsidiaries.  The interim financialstatements are unaudited.  However, inthe opinion of management, the interim consolidated financial statements anddisclosures reflect all adjustments necessary for a fair presentation. Interimresults are not necessarily indicative of results expected for a full year orfor any other interim period.  Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with accounting principles generally accepted in theUnited States have been condensed or omitted pursuant to the rules andregulations of the Securities and Exchange Commission. These consolidatedcondensed financial statements should be read in conjunction with theconsolidated financial statements and the notes thereto included in theCompany’s latest audited financial statements, which are included in theCompany’s Annual Report on Form 10-K for the fiscal year ended November 30,2001, filed with the Securities and Exchange Commission.

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions 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.  Actual results coulddiffer from those estimates.

We design and selladvanced media systems for content design. Our products are personal computer-based workstations configured withproprietary software and hardware that we engineer and manufacture.  In some cases, particularly with our recently-introducedproduct—844/XTM—we sell our products as “turnkey” systems, meaning we configureand ship the system to an end user, or reseller, with a host personal computer,our software and hardware, and disk storage; in other cases, we deliver only oursoftware and hardware (“unbundled”), typically to an independent value-addedreseller that configures the turnkey system themselves on behalf of an enduser.

2.         Principlesof Consolidation

 

The accompanyingconsolidated financial statements include the accounts of the Company and itswholly owned subsidiaries after elimination of significant intercompanytransactions and balances.  Theseconsolidated financial statements reflect the use of the following significant accountingpolicies, as described below and elsewhere in the notes to the consolidatedfinancial statements.  Theseconsolidated financial statements are prepared in accordance with accountingprinciples generally accepted in the United States.

3.         Reclassifications

 

Certain amounts inthe prior period’s financial statements have been reclassified to conform tothe current period’s presentation.

4.         Cash,Cash Equivalents and Available for Sale Securities

 

Cash equivalents arecarried at cost, which approximates fair market value, and have original maturitiesof less than ninety days.  Cashequivalents include money market accounts and repurchase agreements withovernight maturities.  Approximately$388,000 of the cash and cash equivalents is restricted under various lettersof credit and is classified as restricted cash in the accompanying balancesheet at August 31, 2002.

As part of the McRoberts litigation discussed in Note9, the Company has placed approximately $2.8 million in an escrow account whilethe case is on appeal. This amount is included as restricted cash in theaccompanying balance sheet at August 31, 2002.

 

On October 5,2001, the Company sold its streaming media software product line to Autodesk,Inc. for $16.0 million in cash, of which $2.0 million was deposited into anescrow account for a period of one year in case indemnification issuesarise.  The amount is classified as duefrom escrow on the accompanying balance sheet at August 31, 2002 and November30, 2001, respectively.  These escrowfunds were released on October 15, 2002.

 

 

6

----

 

The Company accounts forsecurities in accordance with Statement of Financial Accounting Standards(SFAS) No. 115, *Accounting for Certain Investments in Debt and Equity Securities*.  Under this standard, the Company is requiredto classify all investments in debt and equity securities into one or more ofthe following three categories: held-to-maturity, available-for-sale ortrading.  Available-for-sale securitiesare recorded at fair market value with unrealized gains and losses excludedfrom earnings and included as a component of stockholders’ equity.  All of the Company’s securities areclassified as available for sale.

 

Securities held as of August 31, 2002 and November 30, 2001 consists ofthe following (in thousands):

 
| **Investments available for sale:**   |   | **Maturity** |   | **August 31,** |   | **November  30,** |   |
|---------------------------------------|--------|--------------|--------|----------------|--------|-------------------|--------|
|                                  |   | **2002**     |   | **2001**       |   |
|                                  |   |         |   |           |   |              |   |
| Corporate  Obligations                |   | 1 - 5 years  |   | $              | 161    |              | $      | 241 |   |
|                                  |   |         |   |           |   |              |   |
| Total  investments available for sale |   |         |   | $              | 161    |              | $      | 241 |   |

 

Securities had acost and market value of $161 and $241 at August 31, 2002 and November 30,2001, respectively.

5.         Inventories

 

Inventories arestated at the lower of first-in, first-out (FIFO) cost or market and consist ofthe following (in thousands): 
|            |   | **August 31,** |   | **November  30,** |   |
|-----------------|--------|----------------|--------|-------------------|--------|
|            |   | **2002**       |   | **2001**          |   |
| Raw materials   |   | $              | 1,126  |              | $      | 811 |   |
| Work-in-process |   | 360            |   | 161               |   |
| Finished goods  |   | 600            |   | 248               |   |
|            |   | $              | 2,086  |              | $      | 1,220 |   |

 

Work-in-processand finished goods inventories include material, labor and manufacturingoverhead. Management performs periodic reviews of inventory and disposes ofitems not required by their manufacturing plan.

6.         Propertyand Equipment, net

 

Property and equipment,net, at August 31, 2002 and November 30, 2001 is stated at cost, lessaccumulated depreciation and amortization, and consists of the following (inthousands):
|                                            |   | **August 31,** |   | **November  30,** |   |
|-------------------------------------------------|--------|----------------|--------|-------------------|--------|
|                                            |   | **2002**       |   | **2001**          |   |
| Machinery and  equipment                        |   | $              | 4,482  |              | $      | 4,169 |   |
| Purchased  software                             |   | 1,677          |   | 1,666             |   |
| Furniture and  fixtures                         |   | 58             |   | 908               |   |
| Leasehold  improvements                         |   | 633            |   | 1,728             |   |
|                                            |   | $              | 6,850  |              | $      | 8,471 |   |
| Less accumulated  depreciation and amortization |   | (4,703         | )      | (4,628            | )      |
|                                            |   | $              | 2,147  |              | $      | 3,843 |   |

 

 

7

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In connection with thesigning of an amendment to the lease of the Company’s principal facility inMarlborough, MA in January 2002, the Company revised the estimated useful lifeof leasehold improvements and certain furniture and fixtures that were notmoved to the new facility. This charge of $849,000 has been reflected as accelerateddepreciation and amortization of fixed assets in the accompanying ConsolidatedStatements of Operations for the nine months ended August 31, 2002.  Amounts classified as leasehold improvementsand furniture and fixtures are additions related to the Company’s new principalfacility.

7.         IntangibleAssets

 

Intangible assets,net at August 31, 2002 and November 30, 2001 consist of the following (inthousands):
|                           |   | **August 31,** |   | **November  30,** |   |
|--------------------------------|--------|----------------|--------|-------------------|--------|
|                           |   | **2002**       |   | **2001**          |   |
| Patents and  Trademarks        |   | $              | 531    |              | $      | 454 |   |
| Acquired Technology            |   | 1,900          |   | 1,900             |   |
| Goodwill                       |   | 2,757          |   | 2,757             |   |
|                           |   | $              | 5,188  |              | $      | 5,111 |   |
| Less accumulated  amortization |   | (5,030         | )      | (3,231            | )      |
|                           |   | $              | 158    |              | $      | 1,880 |   |

 

Patentsand trademarks are being amortized over three years. The Company amortizesgoodwill and developed acquired technology related to its acquisitions using astraight-line method over periods ranging from 2 to 3 years, their estimateduseful life.  As of August 31, 2002,acquired technology and goodwill have been fully amortized.

TheCompany****recordedan expense for the amortization and write-off of intangible assets of $1.5million in the first fiscal quarter of 2001. Included in the $1.5 million was a write-off of goodwill of $880,000related to the acquisitions of 21st Century LLC and J2 DigitalMedia, Inc.  These two acquisitions werecombined to form Streamriver, which was launched in June 2000.  During the first quarter of fiscal 2001, thegoodwill from these two acquisitions was determined to be impaired due tocontinued operating losses in Streamriver and the uncertainty surrounding theCompany’s ability to recover the goodwill through future cash flows.

Duringthe nine months ended August 31, 2002, the Company settled litigation broughtagainst it by the former shareholders of Wired, Inc. (“Wired”), a Companyacquired by the Company in December 1999 (See Note 9 Contingencies).  As part of the settlement, the Companyassigned all rights to the Wired product line, intellectual property relatingto Wired products and on-hand inventory related to the Wired product line tothe former shareholders.  Wired agreedthat no further action will be taken related to the lawsuit previously filedagainst the Company as noted in Note 9 Contingencies.  Wired granted the Company an irrevocable license to use thesource code, technology, know how and intellectual property; provided, however,the license does not include the right to sell Wired products or any equivalentproducts incorporating the source code, technology, know how and intellectualproperty.  In addition, Wired agreed topay the Company a royalty of 5% of adjusted gross sales of the assignedproducts, not to exceed $1.2 million, plus the cost of the inventoryassigned.  Litigation settlementincluded in the Consolidated Statements of Operations for the nine months endedAugust 31, 2002 represents the cost of inventory transferred, the net bookvalue of remaining intangible assets associated with the acquisition, and legalfees associated with the settlement.

8.         NetLoss Per Common Share

 

The Companycomputes net loss per share pursuant to SFAS No. 128, *Earnings Per Share*.  In accordance with SFAS No. 128, basic netloss per share is computed by dividing net income (loss) available for commonshareholders by the weighted-average number of common shares outstanding duringthe period.  Diluted net income (loss)per share is computed dividing the net income (loss) available for commonstockholders by the weighted-average number of common shares outstanding,including potential common shares from the assumed exercise of stock optionsand warrants outstanding during the period, so long as they are notantidilutive, using the treasury stock method.

 

 

8

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Options to purchase approximately 3,072,000and 3,485,000 weighted average shares of common stock have been excluded fromthe computation of diluted average shares outstanding at August 31, 2002 and2001, respectively, as the effect of their inclusion would have beenantidilutive.

9.         Contingencies

 

(i) The Companyprovides accruals for all direct costs associated with the estimated resolutionof known contingencies.  The accrual isestablished at the earliest date at which it is deemed probable that aliability has been incurred and the amount of such liability can be reasonablyestimated.

(ii) On June 7, 1995, alawsuit was filed against the Company by Avid Technology, Inc. (“Avid”) in theUnited States District Court for the District of Massachusetts.  The complaint generally alleges patentinfringement by the Company arising from the manufacture, sale, and use of theCompany’s Media 100 products.  Thecomplaint includes requests for injunctive relief, treble damages, interest,costs and fees.  In July 1995, theCompany filed an answer and counterclaim denying any infringement and assertingthat the Avid patent in question is invalid. The Company is vigorouslydefending this lawsuit. In addition, Avid is seeking reissue of the patent,including claims that it asserts are broader than in the existing patent, andthese reissue proceedings remain pending before the U.S. Patent and TrademarkOffice.  On January 16, 1998, the courtdismissed the lawsuit without prejudice to either party moving to restore it tothe docket upon completion of all matters pending before the U.S. Patent andTrademark Office.

On August 16, 2000, theU.S. Patent and Trademark Office issued an Office Action rejecting all of theclaims made by Avid in their latest request for reexamination of the patentrelated to the aforementioned lawsuit. In addition, the Examiner at the U.S. Patent and Trademark Officedesignated the action as “final”.  OnNovember 29, 2000, Avid filed a Notice of Appeal of the Examiner’s rejectionsto the U.S. Patent and Trademark Office Board of Patent Appeals andInterferences.  That appeal has now beenfully briefed and is awaiting argument and decision.  The litigation remains dismissed pending the outcome of theconsolidated reissue/reexamination proceedings, and there can be no assurancethat the Company will prevail in the appeal by Avid or that the expense orother effects of the appeal, whether or not the Company prevails, will not havea material adverse effect on the Company’s business, operating results andfinancial condition.

**(iii) On January 13, 1999 and January 28, 1999, DigitalOrigin, a subsidiary of the Company, and one of its former directors, CharlesBerger, were named as defendants in two shareholder class action lawsuitsagainst Splash Technology Holdings, Inc. (Splash), various directors andexecutives of Splash and certain selling shareholders of Splash.  The lawsuit alleges, among other things,that the defendants made or were responsible for material misstatements, andfailed to disclose information concerning Splash’s business, finances andfuture business prospects in order to artificially inflate the price of Splashcommon stock.  The complaint does notidentify any statements alleged to have been made by Charles Berger or DigitalOrigin.  The complaint further allegesthat Digital Origin engaged in a scheme to artificially inflate the price ofSplash common stock to reap an artificially large return on the sale of thecommon stock in order to pay off its debt. Digital Origin and the former director vigorously deny all allegationsof wrongdoing and intend to aggressively defend themselves in these matters.Defendant’s two initial motions to dismiss the action were granted with leaveto amend, and plaintiffs have again amended the complaint.  Defendants filed their third motion todismiss, which has been dismissed without leave to amend.  Plaintiffs have appealed this ruling to the9th Circuit Court of Appeals.**

** **

(iv) On October 12, 1999, a lawsuit was filed againstthe Company by McRoberts Software, Inc. (“MSI”) in the United States DistrictCourt for the Southern District of Indiana. The complaint alleges copyright infringement, breach of contract, andtrade secret misappropriation.  Thecomplaint includes requests for unspecified monetary damages and enhanceddamages, interest, costs and fees.  Anunfavorable verdict was filed on February 25, 2002 against the Company in theamount of $2.5 million.  The Company andMSI filed post-trial motions.  Thosemotions have been ruled upon with the trial court reducing the total amountawarded by the jury but assessing prejudgment interest and attorney’sfees.  The Company is appealing theentire judgment, which approximates $2.8 million.  The entire amount of the award has been placed in an escrowaccount while the case is on appeal and approximately $2.8 million is included asrestricted cash in the accompanying balance sheet at August 31, 2002.

 

 

 

9

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The Company hadrecorded a liability in the amount of $2.6 million that included estimatedlegal fees associated with the litigation at November 30, 2001 and the entireamount was expensed in the three months ended November 30, 2001.  During the nine months ended August 31,2002, the Company recorded an additional liability and expense of $397,000 forthe adjusted judgment which included prejudgment interest and attorney’s fees,as well as, estimated legal fees associated with the appeal.

 

 (v) On May 9,2001, a lawsuit was filed against the Company by the former shareholders ofWired, a company acquired by the Company in December 1999.  The complaint alleges fraud, negligentmisrepresentation, breach of express and implied-in-fact contract, breach ofthe implied covenant of good faith and fair dealing, breach of fiduciary dutyand violation of California business and professional code section 17200.  The complaint includes requests forcompensatory and punitive damages, injunctive relief, and fees.  No specific amount or punitive damages arealleged, other than compensatory damages in an amount to be proven at trial,but not less than $25,000, the jurisdictional minimum for the court.  The Company filed a demurrer challenging thelegal sufficiency of the causes of action alleged.  A hearing on that demurrer occurred on November 6, 2001 and theCourt sustained the demurrer to one cause of action, for negligent falsepromise.

 

During the nine months ended August 31, 2002, theCompany settled the Wired litigation. As part of the settlement, the Company assigned all rights to the Wiredproduct line, intellectual property relating to Wired products and on-handinventory related to the Wired product line to the former shareholders.  Wired agreed that no further action will betaken related to the lawsuit previously filed against the Company.  Wired granted the Company an irrevocablelicense to use the source code, technology, know how and intellectual property;provided, however, the license does not include the right to sell Wiredproducts or any equivalent products incorporating the source code, technology,know how and intellectual property.  Inaddition, Wired promised to pay the Company a royalty of 5% of adjusted grosssales of the assigned products, not to exceed $1.2 million, plus the cost ofthe inventory assigned.  Litigationsettlement included in the Consolidated Statements of Operations for the ninemonths ended August 31, 2002 represents the cost of inventory transferred, thenet book value of remaining intangible assets associated with the acquisition,and legal fees associated with the settlement.

 

(vi) From time to time the Company is involved inother disputes and/or litigation encountered in its normal course ofbusiness.  The Company does not believethat the ultimate impact of the resolution of such other outstanding matterswill have a material effect on the Company’s business, operating results orfinancial condition.

 

10.       IncomeTaxes

 

The Companyrecorded an income tax benefit of $102,000 during the nine months ended August31, 2002 as the Company received a refund from the U.S. Government related to aprior period payment.

11.       AccruedExpenses

 

Accrued expensesat August 31, 2002 and November 30, 2001 consist of the following (inthousands):

 
|                                     |   | **August 31,** |   | **November  30,** |   |
|------------------------------------------|--------|----------------|--------|-------------------|--------|
|                                     |   | **2002**       |   | **2001**          |   |
| Payroll, payroll  taxes and other taxes  |   | $              | 652    |              | $      | 942 |   |
| Accrued warranty                         |   | 525            |   | 561               |   |
| Accrued  restructuring                   |   | 335            |   | 527               |   |
| Accrued  inventory                       |   | 359            |   | 323               |   |
| Accrued legal  and professional services |   | 3,225          |   | 3,067             |   |
| Accrued selling  and marketing           |   | 271            |   | 361               |   |
| Accrued other                            |   | 1,356          |   | 2,219             |   |
|                                     |   | $              | 6,723  |              | $      | 8,000 |   |

 

 

10

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12.       Comprehensiveloss

 

The Companyrecords items of comprehensive loss in accordance with SFAS No.130*, ReportingComprehensive Income*, and presents such information in the statementof stockholders’ equity.  The componentsof accumulated other comprehensive loss are as follows (in thousands):

 
|                                                      |   | **Three  months ended August 31,** |   | **Nine  months ended August 31,** |   |
|-----------------------------------------------------------|--------|------------------------------------|--------|-----------------------------------|--------|
|                                                      |   | **2002**                           |   | **2001**                          |   | **2002** |   | **2001** |   |
|                                                      |   |                               |   |                              |   |   |   |   |   |
| Net loss                                                  |   | $                                  | (2,256 | )                                 | $      | (5,018 | ) | $ | (11,809 | ) | $ | (15,823 | ) |
|                                                      |   |                               |   |                              |   |   |   |   |   |
| Cumulative translation  adjustment                        |   | (40                                | )      | (22                               | )      | (98 | ) | (33 | ) |
| Unrealized  holding gain on available for sale securities |   | —                             |   | 44                                |   | — |   | 44 |   |
|                                                      |   |                               |   |                              |   |   |   |   |   |
| Total  comprehensive loss                                 |   | $                                  | (2,296 | )                                 | $      | (4,996 | ) | $ | (11,907 | ) | $ | (15,812 | ) |

 

13.       SegmentInformation

 

The Company applies theprovisions of SFAS No. 131, *Disclosures about Segments of an Enterprise andRelated Information,* which establishes standards for publiccompanies to report operating segment information in annual and interimfinancial statements.  Operatingsegments are defined as components of an enterprise about which separatefinancial information is available that is evaluated regularly by the chiefdecision maker, or decision making group, in deciding how to allocate resourcesand in assessing performance.  The Company’schief operating decision-making group is composed of the Chief ExecutiveOfficer and members of senior management. The Company’s reportable operating segments are digital video systemsand services.

 

 

11

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**Theaccounting policies of the segments are the same as those described in thesummary of significant accounting policies. Net sales are attributed to geographic areas based on where the customeris located.  Segment information for thethree and nine months ended August 31, 2002 and August 31, 2001 is as follows:**
|                                     |   | **Digital** |   |         |   |          |   |      |   |
|------------------------------------------|--------|-------------|--------|--------------|--------|---------------|--------|-----------|--------|
|                                     |   | **Video**   |   |         |   |          |   |      |   |
|                                     |   | **Systems** |   | **Services** |   | **Corporate** |   | **Total** |   |
| ***Three months ended August 31, 2002*** |   |        |   |         |   |          |   |      |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Net sales from  external customers       |   | $           | 3,931  |         | $      | 1,437         |   | $         | — |   | $ | 5,368 |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Gross profit                             |   | 1,453       |   | 1,181        |   | —        |   | 2,634     |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Depreciation and  amortization           |   | 491         |   | 9            |   | —        |   | 500       |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Interest income,  net                    |   | —      |   | —       |   | 31            |   | 31        |   |
|                                     |   |        |   |         |   |          |   |      |   |
| ***Nine months ended August 31, 2002***  |   |        |   |         |   |          |   |      |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Net sales from  external customers       |   | $           | 11,862 |         | $      | 4,583         |   | $         | — |   | $ | 16,445 |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Gross profit                             |   | 4,087       |   | 3,752        |   | —        |   | 7,839     |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Depreciation and  amortization           |   | 2,737       |   | 34           |   | —        |   | 2,771     |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Interest income,  net                    |   | —      |   | —       |   | 146           |   | 146       |   |
|                                     |   |        |   |         |   |          |   |      |   |
| ***Three months ended August 31, 2001*** |   |        |   |         |   |          |   |      |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Net sales from  external customers       |   | $           | 5,485  |         | $      | 2,066         |   | $         | — |   | $ | 7,551 |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Gross profit                             |   | 1,368       |   | 1,718        |   | —        |   | 3,086     |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Depreciation and  amortization           |   | 607         |   | 21           |   | —        |   | 628       |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Interest income,  net                    |   | —      |   | —       |   | 50            |   | 50        |   |
|                                     |   |        |   |         |   |          |   |      |   |
| ***Nine months ended August 31, 2001***  |   |        |   |         |   |          |   |      |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Net sales from  external customers       |   | $           | 18,264 |         | $      | 6,906         |   | $         | — |   | $ | 25,170 |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Gross profit                             |   | 6,493       |   | 5,313        |   | —        |   | 11,806    |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Depreciation and  amortization           |   | 1,907       |   | 160          |   | —        |   | 2,067     |   |
|                                     |   |        |   |         |   |          |   |      |   |
| Interest income,  net                    |   | —      |   | —       |   | 221           |   | 221       |   |

 

 

 

12

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Interestincome is considered a corporate level activity and is, therefore, notallocated to segments.  Managementbelieves transfers between geographic areas are accounted for on an arms-lengthbasis.

Netsales by geographic area for the quarters ended August 31, 2002 and 2001 wereas follows (in thousands):
|                                        |   | **Three  months ended** |   |
|---------------------------------------------|--------|-------------------------|--------|
|                                        |   | **August 31,  2002**    |   | **August 31,  2001** |   |
|                                        |   |                    |   |   |   |
| North America                               |   | $                       | 2,889  |   | $ | 4,898 |   |
| United Kingdom,  Sweden, Denmark and Norway |   | 665                     |   | 767 |   |
| France, Spain,  and Benelux                 |   | 408                     |   | 543 |   |
| Germany, Austria  and Switzerland           |   | 333                     |   | 372 |   |
| Asia, Japan and  other foreign countries    |   | 1,073                   |   | 971 |   |
|                                        |   |                    |   |   |   |
|                                        |   | $                       | 5,368  |   | $ | 7,551 |   |

 
|                                        |   | **Nine  months ended** |   |
|---------------------------------------------|--------|------------------------|--------|
|                                        |   | **August  31,2002**    |   | **August 31,  2001** |   |
|                                        |   |                   |   |   |   |
| North America                               |   | $                      | 9,363  |   | $ | 16,829 |   |
| United Kingdom,  Sweden, Denmark and Norway |   | 2,032                  |   | 2,749 |   |
| France, Spain  and Benelux                  |   | 1,041                  |   | 1,828 |   |
| Germany, Austria  and Switzerland           |   | 921                    |   | 921 |   |
| Asia, Japan and  other foreign countries    |   | 3,088                  |   | 2,843 |   |
|                                        |   |                   |   |   |   |
|                                        |   | $                      | 16,445 |   | $ | 25,170 |   |

 

Long-livedtangible assets by geographic area for the quarters ended August 31, 2002 andNovember 30, 2001 consist of the following (in thousands):
|           |   | **August 31,  2002** |   | **November  30, 2001** |   |
|----------------|--------|----------------------|--------|------------------------|--------|
|           |   |                 |   |                   |   |
| United States  |   | $                    | 1,963  |                   | $      | 3,651 |   |
| United Kingdom |   | 118                  |   | 123                    |   |
| Germany        |   | 14                   |   | 1                      |   |
| France         |   | 52                   |   | 68                     |   |
|           |   |                 |   |                   |   |
|           |   | $                    | 2,147  |                   | $      | 3,843 |   |

 

14.       DiscontinuedOperations

 

On October 5, 2001, theCompany sold its streaming media software product line to Autodesk, Inc. for$16.0 million in cash, of which $2.0 million was deposited into an escrowaccount for a period of one year in case indemnification issues arise.  The amount is classified as due from escrowon the accompanying balance sheet at August 31, 2002 and November 30, 2001,respectively.  The Company’s streamingmedia software product line consisted of products acquired in the Terranacquisition and the merger with Digital Origin.  These escrow funds were released on October 15, 2002.

 

 

13

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The net loss from these operations is included in the accompanyingstatements of operations under “Loss from discontinued operations”.  Operating results of the software productline for the three and nine months ended August 31, 2002 and 2001 are asfollows (in thousands):

 
|                                  |   | **Three  months ended August 31,** |   | **Nine months  ended August 31,** |   |
|---------------------------------------|--------|------------------------------------|--------|-----------------------------------|--------|
|                                  |   | **2002**                           |   | **2001**                          |   | **2002** |   | **2001** |   |
|                                  |   |                               |   |                              |   |   |   |   |   |
| Net sales of  discontinued operations |   | $                                  | — |                              | $      | 1,884 |   | $ | — |   | $ | 10,211 |   |
|                                  |   |                               |   |                              |   |   |   |   |   |
| Loss from  discontinued operations    |   | $                                  | — |                              | $      | (903 | ) | $ | — |   | $ | (2,700 | ) |

 

15.       RestructuringExpense

 

In the third quarter offiscal 2002, the Company implemented a restructuring plan to better align itsoperating costs with its anticipated future revenue stream.  The restructuring charge of $299,000 relatedto the elimination of approximately 43 employees across the followingfunctions: operations (7), technical support (6), research and development(19), selling and marketing (6), and general and administrative (5).  At August 31, 2002, approximately $93,000 ofthe accrued restructuring charge, consisting of severance-related costs,remained. The total cash impact of the restructuring was approximately$299,000, all of which will be paid by the end of the fourth quarter in fiscal2002.

 

In the third quarter offiscal 2001, the Company recorded a restructuring charge of $310,000 related tothe elimination of approximately 42 employees across all functions: operations(14), product development (4), selling and marketing (16), and general andadministrative (8).  At August 31, 2001,all of the accrued restructuring charge, consisting of severance-related costs,remained. The total cash impact of the restructuring is $310,000, all of whichwas paid by the end of the fourth quarter in fiscal 2001.

 

In the fourth quarter offiscal 2001, the Company recorded a restructuring charge of $662,000 related tothe elimination of approximately 11 employees across the following functions:operations (2), selling and marketing (7), general and administrative (2) andfuture lease obligations, net of sublease income, associated with theStreamriver division of approximately $230,000.  At August 31, 2002, $242,000 of the accrued restructuring chargeremained.  Estimated future leaseobligations, net of sublease income accounted for $138,000.  At November 30, 2001, $527,000 of the accruedrestructuring charge remained, of which approximately $218,000 isseverance-related costs and the remainder is related to future leaseobligations.  The total cash impact ofthe restructuring was approximately $662,000.

 

16.       NewAccounting Standards

 

Emerging Issues TaskForce (EITF) Issue No. 01-09 (“Issue”), “*Accounting for Consideration Given by a Vendor to aCustomer or a Reseller of the Vendor’s Products,”*issued duringNovember 2001, codifies previously issued EITF Issue No. 00-25, “*VendorIncome Statement Characterization of Consideration Paid to a Reseller of theVendor’s Products.”* EITF Issue No. 00-25 addresses various aspectsof the accounting for consideration given by a vendor to a customer or areseller of the vendor’s products. Consideration includes sales incentives such as discounts, coupons,rebates, free products or services, slotting fees, coop advertising andbuydowns.  Pursuant to EITF 00-25, suchconsideration is presumed to be a reduction of revenue unless certain criteriaare met.  The Issue should be applied nolater than in annual or interim financial statements for periods beginningafter December 15, 2001 and requires retroactive restatement. The Companypreviously recorded coop advertising expenses and other sales incentives toresellers within selling and marketing expense in the statement ofoperations.  The Company adopted EITFIssue No. 01-09 in the first quarter ended February 28, 2002**. **As a result, the Company hasrecorded $29,000 and $26,000 as a reduction to product sales for the three andnine months ended August 31, 2002, respectively.  Additionally, the Company reclassified $273,000 and $416,000 asreductions of product sales that were previously classified as selling and marketingexpenses for the three and nine months ended August 31, 2001, respectively.

 

 

14

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In September 2000, theEITF issued 00-10 *“Accounting for Shipping and Handling Fees and costs,”*relatingto the accounting for reimbursement for shipping and handling fees and relatedcosts by customers.  In accordance withEITF 00-10, reimbursements received for shipping and handling fees and costsincurred should be characterized as revenue in the statement of operations.  The Company has historically accounted forreimbursement received for shipping and handling fees as a reduction of cost ofsales in the statement of operations to offset the costs incurred.  The Company adopted EITF 00-10 in the firstquarter ended February 28, 2002. As a result, the Company has recorded $10,000and $31,000 as product sales for the three and nine months ended August 31,2002, respectively.  Additionally, theCompany reclassified $28,000 and $104,000 as product sales that were previouslyclassified as reductions to cost of sales for the three and nine months endedAugust 31, 2001, respectively.

 

In July 2002, the FASBissued SFAS No. 146, Accounting for Exit or Disposal Activities.  SFAS No. 146 addresses the accounting forcosts associated with restructuring activities and other disposalactivities.  This statement supersedesEITF Issue No. 94-3, Liability Recognition for Certain Employee TerminationBenefits and Other Costs to Exit and Activity. This statement will be effective for disposal activities initiated afterDecember 31, 2002, and the Company will adopt this statement for any costsrelating to restructuring or disposal activities initiated after the effectivedate.

 

 

15

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ITEM 2. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION ANDRESULTS OF OPERATIONS

 

###### **Overview**

**Thefollowing discussion and analysis of our financial condition and results ofoperations should be read in conjunction with our consolidated financialstatements and the related notes appearing elsewhere in this report. Thediscussion and analysis contains forward-looking statements that involve risks,uncertainties and assumptions.  Thepreparation of these financial statements and related discussions requires managementto make estimates and judgments that affect the reported amounts of assets,liabilities, revenue and expenses, and the related disclosure of contingentassets and liabilities.  On an on-goingbasis, we evaluate our estimates including those related to product returns,bad debts, inventories, contingencies and litigation.  We base our estimates on historical experience and on variousother assumptions that are believed to be reasonable under the circumstances.Our actual results may differ materially from those anticipated in these forward-lookingstatements as a result of a number of factors, including those set forth under“Cautionary Statements” and elsewhere in this report.**

**Wedesign and sell advanced media systems for content design.  Our products are personal computer-basedworkstations configured with proprietary software and hardware that we engineerand manufacture.  In some cases,particularly with our recently-introduced product—844/XTM—we sell our productsas “turnkey” systems, meaning we configure and ship the system to an end user,or reseller, with a host personal computer, our software and hardware, and diskstorage; in other cases, we deliver only our software and hardware(“unbundled”), typically to an independent value-added reseller that configuresthe turnkey system themselves on behalf of an end user.**

Digital Origin Merger andOther Acquisitions

On May 9, 2000, wecompleted our merger with Digital Origin. Under the terms of the agreement, Digital Origin’s shareholders andoption holders received 0.5347 equivalent shares, or approximately 3.7 millionMedia 100 common shares, to effect the business combination.  The transaction has been accounted for as apooling of interests.  With the sale of thestreaming media software product line on October 5, 2001, the results from DigitalOrigin have now been classified as discontinued operations in the accompanyingstatements of operations.

We also acquiredTerran in fiscal 1999 and Wired, J2 Digital Media, 21st CenturyMedia and certain assets of Integrated Computing Engines, Inc. in fiscal year2000.  Each of these acquisitions wasaccounted for as a purchase pursuant to APB No. 16.  As a result, the operations of each acquired entity are reflectedin the Company’s consolidated statement of operations from the date ofacquisition.  With the sale of thestreaming media software product line on October 5, 2001, the results fromTerran have now been classified as discontinued operations in the accompanyingstatements of operations.

On October 5, 2001, theCompany sold its streaming media software product line to Autodesk, Inc. for$16.0 million in cash, of which $2.0 million was deposited into an escrowaccount for a period of one year in case indemnification issues arise.  The amount is classified as due from escrowon the accompanying balance sheet at August 31, 2002 and November 30, 2001,respectively.  The Company’s streamingmedia software product line consisted of products acquired in the Terranacquisition and the merger with Digital Origin.  These escrow funds were released on October 15, 2002.  The net loss from these operations isincluded in the accompanying statements of operations under “discontinuedoperations” (see Note 14 to the Consolidated Financial Statements includedherein).

 

 

 

16

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**Results of Operations**

 

The following table shows certain consolidatedstatements of operations data as a percentage of net sales.
|                                                                |   | **Three  months ended August 31,** |   | **Nine  months ended August  31,** |   |
|---------------------------------------------------------------------|--------|------------------------------------|--------|-----------------------------------------|--------|
|                                                                |   | **2002**                           |   | **2001**                                |   | **2002** |   | **2001** |   |
| Net sales:                                                          |   |                               |   |                                    |   |   |   |   |   |
| Products                                                            |   | 73.2                               | %      | 72.6                                    | %      | 72.1 | % | 72.6 | % |
| Services                                                            |   | 26.8                               |   | 27.4                                    |   | 27.9 |   | 27.4 |   |
| Total net sales                                                     |   | 100.0                              |   | 100.0                                   |   | 100.0 |   | 100.0 |   |
| Cost of sales                                                       |   | 50.9                               |   | 59.1                                    |   | 50.3 |   | 53.1 |   |
| Accelerated  depreciation and amortization of fixed assets (Note 6) |   | —                             |   | —                                  |   | 2.0 |   | — |   |
| Gross profit                                                        |   | 49.1                               |   | 40.9                                    |   | 47.7 |   | 46.9 |   |
| Operating  expenses:                                                |   |                               |   |                                    |   |   |   |   |   |
| Research and  development                                           |   | 39.2                               |   | 35.6                                    |   | 44.0 |   | 32.0 |   |
| Selling and  marketing                                              |   | 30.7                               |   | 30.6                                    |   | 40.2 |   | 37.3 |   |
| General and  administrative                                         |   | 14.8                               |   | 25.5                                    |   | 20.2 |   | 18.3 |   |
| Amortization and  write-off of intangible assets                    |   | 5.2                                |   | 6.4                                     |   | 6.4 |   | 9.6 |   |
| Accelerated  depreciation and amortization of fixed assets (Note 6) |   | —                             |   | 5.2                                     |   | — |   |   |   |
| Settlement of  litigation (Note 7 and 9)                            |   | —                             |   | —                                  |   | 5.6 |   | — |   |
| Restructuring  charge                                               |   | 5.6                                |   | 4.1                                     |   | 1.8 |   | 3.5 |   |
| Total operating  expenses                                           |   | 95.5                               |   | 102.2                                   |   | 123.4 |   | 100.7 |   |
| Operating loss                                                      |   | (46.4                              | )      | (61.3                                   | )      | (75.7 | ) | (53.8 | ) |
| Interest income,  net                                               |   | 0.6                                |   | 0.7                                     |   | 0.9 |   | 0.8 |   |
| Other income  (expense), net                                        |   | 3.8                                |   | 6.1                                     |   | 2.4 |   | 0.8 |   |
| Loss from  continuing operations                                    |   | (42.0                              | )      | (54.5                                   | )      | (72.4 | ) | (52.2 | ) |
| Benefit from  income taxes                                          |   | —                             |   | —                                  |   | (0.6 | ) | — |   |
| Loss from  continuing operations                                    |   | (42.0                              | )      | (54.5                                   | )      | (71.8 | ) | (52.2 | ) |
| Loss from  discontinued operations                                  |   | —                             |   | (12.0                                   | )      | — |   | (10.7 | ) |
| Net loss                                                            |   | (42.0                              | )%     | (66.5                                   | )%     | (71.8 | )% | (62.9 | )% |

 

 

Comparisonof Third Fiscal Quarter of 2002 to Third Fiscal Quarter of 2001

Net sales.  Total net sales for the third fiscal quarterended August 31, 2002 decreased 28.9% to $5.4 million from $7.6 million for thethird quarter of fiscal 2001.  Net salesfrom products for the third fiscal quarter of 2002 decreased 28.3% to $3.9million from $5.5 million for the third quarter of fiscal 2001.  The decrease in net sales from products isdue to a number of factors, including increased competition for our digitalvideo systems resulting in lower unit sales and average selling prices ($3.1million), and lower sales of the MPEG-based products acquired in theacquisition of Wired, Inc. (“Wired”) ($210,000).  These decreases were partially offset by sales of our new contentdesign system, 844/X ($1.7 million), which began shipping in April 2002.  We anticipate this trend of loweryear-over-year sales of our digital video systems to continue for the remainderof this year, partially offset by sales from 844/X.  In addition, as part of the settlement of litigation with theformer shareholders of Wired, dated April 15, 2002, we no longer sell the WiredMPEG-based products.  Net sales fromservices for the third fiscal quarter ended August 31, 2002 decreased 30.4% to$1.4 million from $2.1 million for the third quarter of fiscal 2001.  The decrease in net sales from services isdue to lower sales of service contracts to support our digital video systems($629,000).

Gross profit.  Gross profit decreased 14.6% to $2.6 millionin the third fiscal quarter of 2002 from $3.1 million in the third quarter offiscal 2001.  Overall gross profit as apercentage of net sales increased to 49.1% in the third fiscal quarter of 2002from 40.9% in the third quarter of fiscal 2001.  Specifically, gross profit as a percentage of net product salesincreased to 37.0% in the third fiscal quarter of 2002 from 24.9% in the thirdquarter of fiscal 2001, while gross profit as a percentage of net sales ofservices decreased to 82.2% in the third fiscal quarter of 2002 from 83.2% inthe third quarter of fiscal 2001.  Thedecrease in gross profit as a percentage of net sales of services resulted fromlower sales of service contracts, partially offset by our lower expenses insupport of customers.  Gross profit as apercentage of net product sales increased due to lower manufacturing expensesand an increase of $1.7 million in sales from 844/X, which generates a highergross profit percentage than most other products.  We currently forecast overall gross profit as a percentage of netsales will remain relatively constant over the next several quarters,

 

 

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however, due topotential fluctuations in the mix of products sold, gross profit as apercentage of net sales may vary from one quarter to another.

Research anddevelopment.  Research and developmentexpenses decreased 21.9% to $2.1 million in the third fiscal quarter of 2002from $2.7 million in the third quarter of fiscal 2001.  Research and development expenses consistprimarily of salaries and related benefits for our personnel, consultants,outside services, occupancy and depreciation. The decrease in research anddevelopment expenses resulted primarily from lower payroll-related andoccupancy expense.  At this time, weanticipate research and development expenses will decrease in the fourthquarter of this fiscal year due to the completion of the initial developmenteffort related to our recently introduced content design system, 844/X.  We plan to continue to invest a significantamount of our resources into further development of 844/X; however, for thefourth quarter of fiscal 2002, we do not anticipate this future development tobe as expensive as the previous development costs associated with 844/X.

Selling andmarketing.  Selling and marketingexpenses decreased 28.6% to $1.7 million in the third quarter of fiscal 2002from $2.3 million in the third quarter of fiscal 2001.  Selling expenses consist primarily ofsalaries and related benefits for our sales force, sales commissions, travel,occupancy and depreciation.  Marketingexpenses consist primarily of salaries and related benefits, trade shows,advertising, direct mail, sales literature and lead-generation activities.  The decrease in selling and marketingexpenses resulted primarily from reduced marketing expenses due to lowerproduct sales of our digital video systems. We currently anticipate that our selling and marketing expenses willremain relatively flat in the fourth quarter of fiscal 2002 versus the thirdquarter of fiscal 2002 as we continue to manage our expense levels toanticipated revenue levels.

General and administrative. General and administrative expenses decreased 58.6% to $0.8 million inthe third fiscal quarter of 2002 from $1.9 million in the third quarter offiscal 2001.  General and administrativeexpenses include the cost of human resources, finance, information technology,legal and other administrative functions. The decrease in general and administrative expenses resulted primarilyfrom lower payroll related expenses, lower legal expenses and lower bad debtexpenses.  We currently anticipate thatour general and administrative expenses will decrease in the fourth quarter offiscal 2002 versus the third quarter of fiscal 2002 as we continue to mange ourexpense levels to anticipated revenue levels.

Amortizationand write-off of intangible assets.  Werecorded an expense for the amortization and write-off of intangible assets of$279,000 in the third fiscal quarter of 2002 compared to $480,000 in the thirdquarter of fiscal 2001.  The $279,000recorded in the third quarter of fiscal 2002 related to the amortization ofgoodwill associated with our acquisition of certain assets of IntegratedComputing Engines, Inc.  The $480,000recorded in the third quarter of fiscal 2001 related to Wired, Inc. and certainassets acquired from Integrated Computing Engines, Inc.  In the third quarter of fiscal 2002, wecompleted the amortization of the goodwill and intangible assets related toprevious acquisitions.

Restructuring. In thethird quarter of fiscal 2002, we implemented a restructuring plan to betteralign our operating costs with our anticipated future revenue stream.  The restructuring charge of $299,000 relatedto the elimination of approximately 43 employees across the followingfunctions: operations (7), technical support (6), research and development(19), selling and marketing (6), and general and administrative (5).  At August 31, 2002, approximately $93,000 ofthe accrued restructuring charge, consisting of severance-related costs,remained.  The total cash impact of therestructuring was approximately $299,000 all of which will be paid by the endof the fourth quarter in fiscal 2002.

 

In the third quarter offiscal 2001, we recorded a restructuring charge of $310,000 related to theelimination of approximately 42 employees across all functions: operations(14), product development (4), selling and marketing (16), and general andadministrative (8).  At August 31, 2001,all of the accrued restructuring charge, consisting of severance-related costs,remained. The total cash impact of the restructuring is $310,000, all of whichwas paid by the end of the fourth quarter in fiscal 2001.

Interest income,net.  Interest income decreased 38.0% to$31,000 in the third fiscal quarter of 2002 from $50,000 in the third quarterof fiscal 2001.  The decrease ininterest income is due to lower cash and cash equivalent balances in fiscal2002 versus 2001.  We currentlyanticipate interest income will decline in fiscal 2002 versus 2001 due to lowercash balances.

Other income(expense), net.  Other income, net was$204,000 in the third fiscal quarter of 2002 versus other income, net of$464,000 in the third quarter of fiscal 2001. The decrease in other income, net is due to smaller foreign exchangegains on intercompany transactions with our foreign subsidiaries.

Loss fromcontinuing operations.  As a result ofthe above factors, we had a loss from continuing operations for the thirdfiscal quarter of 2002 in the amount of ($2.3) million, or ($0.17) per share,compared to a net loss from continuing operations of ($4.1) million, or ($0.33)per share, in the third quarter of fiscal 2001.

 

 

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Comparisonof First Nine Months Fiscal 2002 to First Nine Months of Fiscal 2001

Net sales.  Total net sales for the first nine months offiscal 2002 ended August 31, 2002 decreased 34.7% to $16.4 million from $25.2million for the first nine months of fiscal 2001.  Net sales from products for the first nine months of fiscal 2002decreased 35.1% to $11.9 million from $18.3 million for the first nine monthsof fiscal 2001.  The decrease in netsales from products is due to a number of factors, including increasedcompetition for our digital video systems resulting in lower unit sales andaverage selling prices ($9.9 million), and lower sales of the MPEG-basedproducts acquired in the acquisition of Wired, Inc. (“Wired”) ($864,000).  These decreases were partially offset by netsales of our new content-design system, 844/X ($4.3 million), which beganshipping in April 2002.  We anticipatethis trend of lower year-over-year net sales of our digital video systems tocontinue for the remainder of this year, partially offset by net sales from844/X.  In addition, as part of thesettlement of litigation with the former shareholders of Wired, dated April 15,2002, we no longer sell the Wired MPEG-based products.  Sales of the Wired product line for thefirst nine months of fiscal 2002 were approximately $0.9 million.  Net sales from services for the first ninemonths of fiscal 2002 decreased 33.6% to $4.6 million from $6.9 million for thefirst nine months of fiscal 2001.  Thedecrease in net sales from services is due to lower sales of service contractsto support our digital video systems ($2.3 million).

Gross profit.  Gross profit decreased 33.6% to $7.8 millionin the first nine months of fiscal 2002 from $11.8 million in the first ninemonths of fiscal 2001.  Overall gross profitas a percentage of net sales increased to 47.7% in the first nine months offiscal 2002 from 46.9% in the first six months of fiscal 2001.  Specifically, gross profit as a percentageof net product sales decreased to 34.4% in the first nine months of fiscal 2002from 35.6% in the first nine months of fiscal 2001, while gross profit as apercentage of net sales of services increased to 81.9% in the first nine monthsof fiscal 2002 from 76.9% in the first nine months of fiscal 2001.  The increase in gross profit as a percentageof net sales of services resulted primarily from lower expenses in support ofcustomers, partially offset by lower sales of services.  Gross profit as a percentage of net productsales decreased due to lower unit sales of our digital video systems and a chargefor accelerated depreciation, partially offset by sales of 844/X.  The accelerated depreciation charge, relatedprimarily to leasehold improvements, was due to our decision to relocate ourfacility to a new location better suited to meet our needs.  We currently forecast overall gross profit asa percentage of net sales will remain relatively constant in the fourthquarter, however, due to potential fluctuations in the mix of products sold,gross profit as a percentage of net sales may vary from one quarter to another.

Research anddevelopment.  Research and developmentexpenses decreased 10.3% to $7.2 million in the first nine months of fiscal2002 from $8.1 million in the first nine months of fiscal 2001.  Research and development expenses consist primarilyof salaries and related benefits for our personnel, consultants, outsideservices, occupancy and depreciation. The decrease in research and developmentexpenses resulted primarily from lower payroll-related and occupancy expense.  At this time, we anticipate research anddevelopment expenses will decrease in the fourth quarter of fiscal 2002 due tothe completion of the initial development effort related to our recentlyintroduced content design system, 844/X. We plan to continue to invest a significant amount of our resources intofurther development of 844/X; however, for the fourth quarter of fiscal 2002,we do not anticipate this future development to be as expensive as the previousdevelopment costs associated with 844/X.

Selling andmarketing.  Selling and marketingexpenses decreased 29.7% to $6.6 million in the first nine months of fiscal2002 from $9.4 million in the first nine months of fiscal 2001.  Selling expenses consist primarily ofsalaries and related benefits for our sales force, sales commissions, travel,occupancy and depreciation.  Marketingexpenses consist primarily of salaries and related benefits, trade shows,advertising, direct mail, sales literature and lead-generation activities.  The decrease in selling and marketing expensesresulted primarily from reduced marketing expenses due to lower product salesof our digital video systems, partially offset by initial marketing expensesfor the rollout of 844/X.  We currentlyanticipate that our selling and marketing expenses will remain relativelyconstant in the fourth quarter of fiscal 2002 versus the third quarter offiscal 2002 as we continue to manage our expense levels to anticipated revenuelevels.

General and administrative. General and administrative expenses decreased 27.5% to $3.3 million inthe first nine months of fiscal 2002 from $4.6 million in the first nine monthsof fiscal 2001.  General andadministrative expenses include the cost of human resources, finance,information technology, legal and other administrative functions.  We currently anticipate that our general andadministrative expenses will decrease in the fourth quarter of fiscal 2002versus the third quarter of fiscal 2002 as we continue to manage our expenselevels to anticipated revenue levels.

Amortization andwrite-off of intangible assets.  Werecorded an expense for the amortization and write-off of intangible assets of$1.0 million in the first nine months of fiscal 2002 compared to $2.4 millionin the first nine months of fiscal 2001. The $1.0 million recorded in the first nine months of fiscal 2002related to the amortization of goodwill associated with our acquisitions ofWired, Inc. and certain assets of Integrated Computing Engines, Inc.  The $2.4 million recorded in the first ninemonths of fiscal 2001 related to Wired, Inc., Integrated Computing Engines,Inc. and a write-off of goodwill of $880,000 related to the acquisitions of 21stCentury LLC and J2 Digital Media, Inc. These two acquisitions were combined to form Streamriver, which was launchedin June 2000.  During the first quarterof fiscal 2001, the goodwill from these two acquisitions was determined to beimpaired due to continued operating losses in Streamriver and the uncertaintysurrounding our ability to recover the goodwill through future

 

 

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cash flows.  We shut down Streamriver in the secondquarter of fiscal 2001.  In the thirdquarter of fiscal 2002, we completed the amortization of the goodwill andintangible assets from previous acquisitions.

 

Accelerated depreciation and amortization of fixed assets.  We recorded a charge of $849,000 in thefirst nine months of fiscal 2002 related primarily to leasehold improvements atour previous facility in Marlboro, Massachusetts.  During the second quarter of fiscal 2002 we completed ourrelocation from this facility to a new facility, also located in Marlboro,Massachusetts, better suited to meet our needs.  As a result of this decision and the signing of a lease for thenew facility we amortized the remaining book value as of the beginning offiscal 2002 of all leasehold improvements, furniture and fixtures over theremaining months in fiscal 2002 (four) that we occupied our previous facility.

Settlement of litigation. We agreed to settlelitigation brought against us by the former shareholders of Wired, a company weacquired in December 1999.  As part ofthe settlement, we assigned all rights to the Wired product line, intellectualproperty relating to Wired products and on-hand inventory related to the Wiredproduct line to Wired’s former shareholders. Wired agreed that no further action will be taken related to the lawsuitpreviously filed against us as noted in Note 9 to the Consolidated FinancialStatements.  Wired granted us an irrevocablelicense to use the source code, technology, know how and intellectual property;provided, however, the license does not include the right to sell Wiredproducts or any equivalent products incorporating the source code, technology,know how and intellectual property.  Inaddition, we will provide limited manufacturing and marketing support toWired’s former shareholders in exchange for a royalty of 5% of adjusted grosssales of the assigned products, not to exceed $1.2 million, plus the cost ofthe inventory assigned. This agreement resulted in a write-off of the remaininggoodwill created through the acquisition of Wired.  There was no similar expense recorded in the first nine months offiscal 2001.

 

Restructuring. In the first nine months of fiscal2002, we implemented a restructuring plan to better align our operating costswith our anticipated future revenue stream. The restructuring charge of $299,000 related to the elimination ofapproximately 43 employees across the following functions: operations (7),technical support (6), research and development (19), selling and marketing(6), and general and administrative (5). At August 31, 2002, approximately $93,000 of the accrued restructuringcharge, consisting of severance-related costs, remained.  The total cash impact of the restructuringwas approximately $299,000 all of which will be paid by the end of the fourthquarter in fiscal 2002.  In the firstnine months of fiscal 2001, we recorded a restructuring charge of $878,000 dueto headcount reductions.

 

Interest income,net.  Interest income decreased 33.9% to$146,000 in the first nine months of fiscal 2002 from $221,000 in the firstnine months of fiscal 2001.  Thedecrease in interest income is due to lower cash and cash equivalent balances infiscal 2002 versus 2001.  We currentlyanticipate interest income will decline in fiscal 2002 versus 2001 due to lowercash balances.

Other income(expense), net.  Other income, netincreased 95.0% to $390,000 in the first nine months of fiscal 2002 from$200,000 in the first nine months of fiscal 2001.  The increase in other income, net is due to higher foreignexchange gains on intercompany transactions with our foreign subsidiaries.

Benefit fromincome taxes.  We recorded a benefitfrom income taxes of $102,000 in the first nine months of fiscal 2002 due to anincome tax refund we received.  We didnot record a tax provision or benefit in the first nine months of fiscal 2001.

Loss fromcontinuing operations.  As a result ofthe above factors, we had a loss from continuing operations for the first ninemonths of fiscal 2002 in the amount of ($11.8) million, or ($0.92) per share,compared to a net loss from continuing operations of ($13.1) million, or($1.06) per share, in the first nine months of fiscal 2001.

**Liquidityand Capital Resources**

We have funded ouroperations to date primarily from public offerings of equity securities andcash flows from operations, as well as the sale of our streaming media softwareproduct line to Autodesk.  As of August 31,2002, our principal sources of liquidity included cash, cash equivalents andmarketable securities totaling approximately $4.0 million.  This was a decrease of approximately $13.6million of cash, cash equivalents and marketable securities since the end ofour previous fiscal year, which ended November 30, 2001.  Approximately $2.8 million of the $13.6 wasplaced in an escrow account while the McRoberts litigation is under appeal.This amount is classified as restricted cash at August 31, 2002.  In addition, the Company has restricted cashof approximately $388,000 relating to several letters of credit.  In addition to the $4.0 million as of August31, 2002, an additional $2.0 million has been held in escrow as a result of thesale of our streaming media software product line to Autodesk, Inc. in October2001.  These escrow funds were releasedon October 15, 2002.

 

 

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During the nine months of fiscal 2002 ended August 31, 2002, cash usedin operating activities from continuing operations was approximately $13.1million compared to cash used in operating activities from continuingoperations of approximately $8.2 million for the first nine months of fiscal2001.  There was no cash provided by orused in discontinued operations for the first nine months of fiscal 2002.  Cash used in discontinued operations for thefirst nine months of fiscal 2001 totaled $1.0 million.  Cash used in continuing operations duringfiscal 2002 included a net loss of $11.8 million including depreciation andamortization of $2.8 million, amortization of intangible assets of $1.0 millionand a settlement of litigation of $924,000. Cash used in continuing operations was affected by changes in assets andliabilities including an increase in restricted cash of $3.2 million relatingto the McRoberts litigation and several letters of credit, a decrease inaccrued expenses of $1.5 million, an increase in inventories of $957,000relating primarily to the initial buildup of inventory for 844/X and anincrease in inventory for our digital video systems, a decrease in accountspayable of $478,000, a decrease in deferred revenue of $371,000 and an increasein prepaid expenses of $19,000.  Cashprovided by continuing operations included a decrease in accounts receivable of$455,000.  Net cash used in investingactivities for continuing operations was approximately $969,000 for the firstnine months of fiscal 2002 compared to cash provided by investing activities ofapproximately $4.7 million for the first nine months of fiscal 2001.  Cash used in investing activities forcontinuing operations during the first nine months of fiscal 2002 was primarilyfor purchases of capital equipment of $972,000.  Cash provided by financing activities from continuing operationsduring the first nine months of fiscal 2002 was approximately $621,000 comparedto cash used in financing activities from continuing operations of $1.1 millionfor the first nine months of fiscal 2001. In the first nine months of fiscal 2002, cash provided by financingactivities from continuing operations came from proceeds from the issuance ofcommon stock pursuant to stock plans of $621,000.

At August 31, 2002, our contractual cash obligationswere as follows:
|                   |   | **Total** |      | **Less than  1 year** |   | **1 - 3 years** |   |
|------------------------|--------|-----------|-----------|-----------------------|--------|-----------------|--------|
| Lease  commitments     |   | $         | 2,610,000 |                  | $      | 1,041,000       |   | $ | 1,569,000 |   |
| Inventory  commitments |   | $         | 379,000   |                  | $      | 379,000         |   | $ | — |   |

We have already taken a series of actions to reduce the negative cashburn we experienced in the past fiscal year including the termination ofemployees, reductions in the salaries paid to executives and certain otheremployees, relocation of our facility to lower cost office space and areduction in the marketing expenses for existing products.  However, these expense reductions may not beenough to return us to profitability or to allow us to sustain profitability ifit is achieved.  In addition, ourcurrent cash flow projections assume we maintain current sales levels in theshort term and begin to increase sales each quarter from the prior quarter infiscal 2003.  Our current cash flowprojections also assume we will not require substantial cash for capitalpurchases or to fund substantial increases in inventory or other assets and theprojections assume we will be able to continue to collect our accountsreceivables and will not incur substantial bad debts as a result of the failureof our customers to pay us.  We currently anticipate that we may need toraise additional capital through the sale of debt or equity securities to fundfuture operations, develop new and enhance existing products and services, oracquire complementary products, businesses or technologies within the next twelve months.  If additional funds are raised through theissuance of equity or convertible debt securities to fund operations, thepercentage ownership of our existing stockholders may be reduced, ourstockholders may experience additional dilution, and such securities may haverights, preferences or privileges senior to those of our existing stockholders.  Additional financing may not be available onterms favorable to us, or at all.  Asnoted in the Cautionary Statements below, we received a letter from the ListingQualifications Department of the NASDAQ Stock Market, Inc. indicating that ourcommon stock has not maintained the required minimum bid price for continuedquotation on the NASDAQ National Market and are therefore subject todelisting.  If adequate funds are notavailable or are not available on acceptable terms, due to delisting or otherfactors, our ability to fund existing operations and expansion, take advantageof unanticipated opportunities or develop or enhance our products or serviceswould be significantly limited and we may not be able to continue as a goingconcern.  Should we require additionalcapital to fund our operations and are unable to obtain capital, then we willexamine our alternatives, including the sale or liquidation of part or all ofour business.

**Cautionary Statements**

This Quarterly Report on Form 10-Q contains forward-lookingstatements within the safe harbor provisions of the Private SecuritiesLitigation Reform Act of 1995 that involve risks and uncertainties.  Our actual results could differ materiallyfrom those anticipated or projected in these forward-looking statements as aresult of certain factors, including those set forth in the followingcautionary statements and elsewhere in this Quarterly Report on Form 10-Q.  If any of the following risks were to occur,our business, financial condition, or results of operations would likelysuffer.  In that event, the tradingprice of our common stock would decline. Any forward-looking statements should be considered in light of thefactors discussed below.

*History of Losses and Negative CashFlows, Expect to Incur Losses in the Future and May Not Achieve or MaintainProfitability.*  We have incurred substantial operatinglosses during the current year and in the past five fiscal years, haveexperienced negative cash flow from ongoing operations during the currentfiscal year, and we expect to incur operating losses and negative cash flows

 

 

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in future periods.  We incurred an operating loss fromcontinuing operations of approximately $11.8 million for the nine months ended August31, 2002 and as of August 31, 2002, we had an accumulated deficit ofapproximately $212.6 million.

Over the past four years we have significantlyincreased our research and development expenses as a percentage of total salesand we plan to continue to invest in new technology, and as a result, we willincur operating losses in future periods. We will need to generate significant increases in our current saleslevels to achieve and maintain profitability and we may not be able to doso.  If our sales grow more slowly thanwe anticipate or if our operating expenses increase more than we expect orcannot be reduced in the event of lower revenue, our business will besignificantly and adversely affected. Although we implemented a restructuring program in July 2002 to betteralign our operations and cost structure with current and anticipated marketconditions, this program may not be sufficient for us to achieve profitabilityin any future period.  Even if we achieveprofitability in the future on a quarterly or annual basis, we may not be ableto sustain or increase profitability. Our failure to achieve profitability, achieve the level ofprofitability, or sustain the level of profitability expected by investors andsecurities analysts may adversely affect the market price of our common stock.

In addition, we will continue to experience negativeoperating cash flows for the remainder of this fiscal year and into next fiscalyear.  Depending on future cash flow, wemay need to raise additional capital in the future to meet our cashrequirements and we may not be able to find additional financing, if required,on favorable terms or at all. If adequate funds are not available or are notavailable on acceptable terms, our ability to fund existing operations andexpansion, take advantage of unanticipated opportunities or develop or enhanceour products or services would be significantly limited and we may not be ableto continue as a going concern.

*If We Are Unable to ObtainAdditional Capital as Needed in the Future, Our Business May be AdverselyAffected and the Market Price for Our Common Stock Could Decline Significantly.* We have been unable to fund our operations using cash generated from ourbusiness operations and have financed our operations principally through thesale of securities and from existing cash on our balance sheet.  We may need to raise additional debt orequity capital to fund our existing operations, expand operations, maintain andenhance existing products and services or acquire in invest in complementaryproducts, services, businesses or technologies.  If we raise additional funds through further issuance of equityor convertible debt securities, our existing stockholders could suffersignificant dilution, and any new equity securities we issue may have rights,preferences, or privileges superior to those of holders of our commonstock.  In addition, we may not be ableto obtain additional financing on terms favorable to us, if at all.  If adequate funds are not available to us onterms favorable to us, our business may be adversely affected and the marketprice for our common stock could decline significantly. If adequate funds arenot available or are not available on acceptable terms, our ability to fundexisting operations and expansion, take advantage of unanticipatedopportunities or develop or enhance our products or services would besignificantly limited and we may not be able to continue as a going concern.

*SignificantFluctuations and Unpredictability of Operating Results.* Our quarterly operating results are difficult to predict, have variedsignificantly in the past and are likely to vary significantly in the futurefor a number of reasons, including new product announcements and introductionsby ourselves or our competitors, changes in pricing, and the volume and timingof orders received during the quarter. Also, in the past, we have experienceddelays in the development of new products and enhancements, and such delays mayoccur in the future.  These factors makethe forecasting of revenue inherently uncertain.  Additionally, a significant portion of our operating expenses isrelatively fixed, and operating expense levels are based primarily on internalexpectations of future revenue.  As aconsequence, quarterly operating expense levels cannot be reduced rapidly inthe event that quarterly revenue levels fail to meet internalexpectations.  For these reasons, youshould not rely on period-to-period comparisons of our financial results toforecast our future performance.  It is likelythat in some future quarter or quarters our operating results will be below theexpectations of securities analysts or investors.  In addition, we typically realize a significant percentage of oursales for a fiscal quarter in the second half of the third month of thequarter.  As a result, our quarterlyresults may be difficult or impossible to predict.  If quarterly revenue or earnings levels fail to meet internal orexternal expectations, the market price of our common stock may declinesignificantly.

*Dependenceon Key Personnel.*  We believe that our future success willdepend on our continued ability to attract and retain qualified employees,especially in research and development. Our inability to attract and retain qualified personnel on a timelybasis, or the departure of key employees could have a material adverse affecton our business and operating results and negatively affect the price of ourcommon stock.  In addition, if we areunable to maintain existing sales levels or achieve internal sales projectionswe may implement an employee reduction program, which may result in thetermination of key personnel necessary to maintain certain functions oroperations for the company.  The loss ofkey personnel will have a negative effect on our future results and reduce ourability to achieve projected sales levels and profitability.

*Possibilityof NASDAQ Delisting.*  By letter dated October 2, 2002, wereceived notification from the Listing Qualifications Department of The NASDAQStock Market, Inc., indicating that our common stock has not maintained therequired minimum bid price for continued quotation on the NASDAQ NationalMarket and are therefore subject to **delisting**.  NASD Rule 4450(a)(5) requires that, forcontinued quotation on the **NASDAQ**National Market, a company must maintain a minimum bid price of ****$****1 for at least one day duringany period of thirty consecutive business days.  NASDAQ rules provide that a listed company is given a period ofninety calendar days to achieve compliance with the minimum bid requirement inorder to maintain its listing on the NASDAQ National Market.  During the ninety day period, a companywould be considered to be in compliance with NASDAQ’s minimum bid pricerequirements if its minimum bid is ****$****1or greater for any ten consecutive business days.  There can be no assurance that

 

 

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we will be able to takeactions sufficient to bring us back into compliance with the NASDAQ NationalMarket continued listing criteria within the allotted period of time.  If our stock listing is transitioned to theNASDAQ Small Cap Market we would have until March 31, 2003 to trade above ****$****1.00 per share for 30consecutive trading days to remain on the Small Cap Market.  We may also be eligible for an additional180-day calendar grace period beyond March 31, 2003 provided we meet theinitial listing criteria for the Small Cap Market.  If we fail to do that, we would be **delisted from NASDAQ** and wouldmost likely be quoted on the OTC Bulletin Board.  We are reviewing all options available to us to return tocompliance with NASDAQ’s continued listing requirements.  If we are unable to maintain our listing onthe NASDAQ National Market, the price and liquidity of our common stock couldbe adversely affected, our ability to access the capital markets would likelybe more limited, and it may adversely affect our ability to generate new salesof our software product and may cause existing customers and vendors toquestion our viability.  Additionally,our stock may be subject to “penny stock” regulations.

*Weak Worldwide Economic Conditionsand Advertising Market May Result in Decreased Sales and Continued OperatingLosses.*  Growth in sales and a return toprofitability for our company depends on the overall demand for televisionadvertising, which is driven by economic conditions in the markets in which wecompete.  A substantial portion of oursales is to companies providing their services for the creation of televisionadvertisement and demand for our customers’ services is affected by generaleconomic and business conditions. During the past two years, due the weak economic conditions, televisionadvertisers have spent less money advertising their products and services and,as a result, demand for the services our customers provide has decreased.  In this weak economic environment, we maynot be able to effectively promote future growth or maintain existing saleslevels or achieve the sales levels expected by investors and securitiesanalysts in any given period, or achieve profitability and, as a result, ourbusiness and operating results could be materially and adversely affected andour stock price could decline.

*Our Lengthy and Variable Sales CycleMakes it Difficult for Us to Predict When or if Sales Will Occur and ThereforeWe May Experience an Unplanned Shortfall in our Anticipated Sales Levels.* Our 844/X product has a lengthy and unpredictable sales cycle thatcontributes to the uncertainty of our operating results.  Our prospects view the purchase of an 844/Xas a significant and strategic decision for their company.  As a result, prospects generally evaluate844/X and determine its impact on existing infrastructure and workflow.  The purchase of an 844/X may be delayed ifthe prospect has lengthy internal budgeting, approval or evaluationprocesses.  We may incur significantselling and marketing expenses during a prospect’s evaluation period before thecustomer places an order with us.  Someprospects may purchase 844/X as part of multiple simultaneous purchasingdecisions, which may result in unanticipated delayed in receiving an order fromthe customer.  If sales forecasted fromspecific customers are delayed to future quarters, we may experience anunplanned shortfall in sales, which could significantly and adversely affectour operating results and stock price.

*EmergingMarkets.*  The markets in which we offer our systemsproducts and services are intensely competitive and rapidly changing.  We are targeting the emerging market ofbroadcast designers, effects artists, and creative professionals.  This market and the products utilized bythese users are relatively new.  Oursuccess in this emerging market will depend on the rate at which the marketdevelops and our ability to penetrate that market.  We will not succeed if we cannot compete effectively in thismarket and, as a result, our business and operating results could be materiallyand adversely affected.

*RisksAssociated With Development and Introduction of New Products.* If we are not successful in developing and introducing new products tothe markets we serve our business and operating results will suffer.  In late April 2002, we shipped our latestnew product, 844/X, and currently anticipate this new product will generategreater than 50% of the revenue from product sales by the end of the currentfiscal year.  If the adoption of 844/Xis slower than we anticipate or if there are delays in releasing subsequentversions of 844/X, our current revenue expectations may be too high and ouroperating results may be negatively affected. In addition, new product announcements by our competitors and other newproduct announcements by us could have the effect of reducing customer demandfor our existing products.  Also, whenwe introduce new or enhanced products we must effectively manage thetransitions from existing products to minimize disruption of orders from ourcustomers.  New product introductionsrequire us to devote time and resources to the training of our sales channel inthe features and target customers for such new products, which efforts couldresult in less selling efforts being made by the sales channel during suchtraining period.  Our failure toeffectively manage new product announcements or introductions could contributeto significant quarterly fluctuations in operating results as orders for newproducts commence and orders for existing products decline and, as a result,our operating results will suffer.

*Dependence on and competition withApple Computer, Inc.*  As a competitor, Apple Computer, Inc.(“Apple”) could, in the future, inhibit our ability to develop our productsthat operate on the Macintosh platform. Additionally, new products and enhancements to existing products from Applesuch as Final Cut Pro could cause customers to delay purchases of our productsor alter their purchase decision altogether. Furthermore, as the sole supplier of Macintosh computers, any disruptionin the availability of these computers could cause customers to defer or altertheir purchase of our products.  We relyon access to key information from Apple to continue development of our productsand any failure to continue supplying our engineers with this information couldhave a material adverse affect on our business and financial results andnegatively affect the price of our common stock.

 

 

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*Dependence on Microsoft Corporation.* Many of our products operate in the Windows environment and ourengineers depend upon access to information in advance from MicrosoftCorporation (“Microsoft”).  Any failureto continue supplying our engineers with this information could have a materialadverse affect on our business and financial results and negatively affect theprice of our common stock.

*RapidTechnological Change.*  Rapidly changing technology,evolving industry standards and frequent new product introductions characterizethe market for our products.  Our futuresuccess will depend in part upon our ability to enhance existing products andto introduce new products and features in a timely manner to address customerrequirements, respond to competitive offerings, adapt to new emerging industrystandards and take advantage of new enabling technologies that could render ourexisting products obsolete. We plan to continue to invest in research anddevelopment, in connection with our development strategy.  Any delay or failure on our part indeveloping additional new products or features for existing products or anyfailure of such new products or features to achieve market acceptance, couldhave a material adverse effect on our business and operating results and ourstock price will suffer.

*Risksof Third-Party Claims of Infringement.*  There hasbeen substantial industry litigation regarding patent, trademark and otherintellectual property rights involving technology companies.  In the future, litigation may be necessaryto enforce any patents issued to us or to enforce trade secrets, trademarks andother intellectual property rights owned by us, to defend ourselves againstclaimed infringement of the rights of others and to determine the scope andvalidity of the proprietary rights of others. For a description of certain pending litigation instituted against us,see Item 1, Legal Proceedings of Part II, Other Information and Note 9 to theConsolidated Financial Statements included herein.  Any such litigation could be costly and a diversion ofmanagement’s attention, which could adversely affect our business and operatingresults and our financial condition. Adverse determinations in any such litigation could result in the lossof our proprietary rights, subject us to significant liabilities, and requireus to seek licenses from third parties or prevent us from manufacturing orselling our products, any of which could adversely affect our business andoperating results and our financial condition.

*Weak Economic Conditions May Causeour Customers to Experience Financial Difficulties and May Represent a CreditRisk.*  Due to the weak global economy and uncertaintiesrelating to the prospects for near-term global economic growth, some of ourcustomers may experience financial difficulties and may represent a credit riskto us.  If these customers experiencefinancial difficulties or fail to experience commercial success, we may havedifficulty collecting our accounts receivable.

*Competition.* The market for our products is highly competitive and characterized bypressure to reduce prices, incorporate new features and accelerate the releaseof new products.  A number of companiescurrently offer products that compete directly or indirectly with our products,including Accom, Inc., Adobe Systems Inc., Apple Computer, Inc., AvidTechnology, Inc., Discreet (a division of Autodesk, Inc.), Leitch, Inc., MatroxElectronic Systems Ltd., Pinnacle Systems, Inc. and Quantel Ltd. In addition,we expect much larger vendors, such as Matsushita Electric Industrial CompanyLtd., Microsoft Corporation, and Sony Corporation, to develop and introducedigital editing systems that may compete with our products.  Many of these current and potentialcompetitors have greater financial, technical and marketing resources than wehave, including, without limitation, larger and more established selling andmarketing capabilities, greater brand recognition and a larger installed baseof customers, and well-established relationships with our existing andpotential customers, complementary technology vendors and other businesspartners.  As a result, our competitorsmay be able to develop products comparable to or superior to our own products,adapt more quickly than us to new technologies, evolving industry standards orcustomer requirements, or lower their product costs and thus be able to lowerprices to levels at which we could not operate profitably, the occurrence ofany of which could have a material adverse effect on our business and operatingresults.  In this regard, we believethat we will continue to experience competitive pressure to reduce prices,particularly for our high data rate systems. We have historically realized higher gross profit on the sale of thesehigh data rate systems, and such continued competitive pricing pressure couldresult in lower sales and gross margin, which in turn could adversely affectour business and operating results and negatively affect the price of ourcommon stock.

*Dependence on Propriety Technology.* Our ability to compete successfully and achieve future revenue growthwill depend, in part, on our ability to protect our proprietary technology andoperate without infringing the rights of others.  Previously, we have received, and may in the future continue toreceive, communications suggesting that our products may infringe on thepatents or other intellectual property rights of third parties.  Our policy is to investigate the factualbasis of such communications and negotiate licenses where appropriate.  While it may be necessary or desirable inthe future to obtain licenses relating to one or more products, or relating tocurrent or future technologies, there can be no assurance that we will be ableto do so on commercially reasonable terms or at all.  There can be no assurance that these or other futurecommunications can be settled on commercially reasonable terms or that theywill not result in protracted and costly litigation.  Any failure to secure the necessary intellectual property rightof third parties on commercially reasonable terms may adversely affect ourbusiness and operating results and negatively affect the price of our commonstock.

 

 

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*Dependence on Single or LimitedSource Suppliers.*  We are dependent on single or limited sourcesuppliers for several key components used in its products that have no readysubstitutes, including various audio and video signal processing integratedcircuits manufactured in each case only by Crystal Semiconductor Corp.,Fairchild Semiconductor Corp., Gennum Corporation, Toshiba, Kawasaki LSI USAInc., LSI Logic Corp., Philips Semiconductors or Zoran Corp.  The availability of many of these componentsis dependent on our ability to provide suppliers with accurate forecasts of ourfuture requirements, and certain components we use to build our products havebeen subject to industry-wide shortages. We do not carry significant inventories of these components and have noguaranteed supply arrangements with such suppliers.  There can be no assurance that our inventory levels will beadequate to meet production needs during any interruption of supply.  Our inability to develop alternative supplysources, if required, or a reduction or stoppage in supply, could delay productshipments until new sources of supply become available, and any such delaycould adversely affect our business and operating results in any given periodand negatively affect the price of our common stock.

*Dependenceon Distributors and Resellers.*  We relyprimarily on our worldwide network of independent distributors and value-addedresellers (“VARs”) to distribute and sell our products to end-users.  Our distributors and resellers generallyoffer products from several different companies, including in some casesproducts that are competitive with our own products.  In addition, many of the VARs are small organizations withlimited capital resources.  There can beno assurance that our distributors and resellers will continue to purchaseproducts from us, or that our efforts to expand our network of distributors andresellers will be successful.  Anysignificant failure on our part to maintain or expand our network ofdistributors and resellers could have a material adverse effect on our businessand operating results and negatively affect the price of our common stock.

*Relianceon International Sales.*  International sales andoperations may be subject to risks such as the imposition of governmentcontrols, export license requirements, restrictions on the export of criticaltechnology, less effective enforcement of proprietary rights; currency exchangefluctuations, generally longer collection periods, political instability, traderestrictions, changes in tariffs, difficulties in staffing and managinginternational operations, potential insolvency of international resellers anddifficulty in collecting accounts receivable. Our international sales are also subject to more seasonal fluctuationthan domestic sales.  In this regard,the traditional summer vacation period, which occurs during our third fiscalquarter, may result in a decrease in sales, particularly in Europe.  There can be no assurance that these factorswill not have an adverse effect on our future international operations andconsequently, on our business and operating results.  This fluctuation may be material and negatively affect the priceof our common stock.

*Mergerand Acquisition Related Risks.* During thefiscal year ended November 30, 2000, we completed the merger with DigitalOrigin and the acquisitions of Wired, 21st Century Media LLC, and J2Digital Media, Inc. In addition, we completed the acquisition of certain assetsof Integrated Computing Engines, Inc. Our business and results of operations could be materially adverselyaffected in the event we fail to complete publicly announced acquisitions or tosuccessfully integrate the business and operations of the merger or the acquisitions.  In the future, we may continue to acquire ormerge with existing businesses, products, and technologies to enhance andexpand our line of products.  Suchmergers and acquisitions may be material in size and in scope.  There can be no assurance that we will beable to identify, acquire, or profitably manage additional businesses orsuccessfully integrate any acquired businesses into our business withoutsubstantial expenses, delays, or other operational or financial problems.  Acquisitions involve a number of specialrisks and factors, including increasing competition for attractive acquisitioncandidates in our markets, the technological enhancement and incorporation ofacquired products into existing product lines and services, the assimilation ofthe operations and personnel of the acquired companies, failure to retain keyacquired personnel, adverse short-term effects on reported operating results,the amortization of acquired intangible assets, the assumption of undisclosedliabilities of any acquired companies, the failure to achieve anticipatedbenefits such as cost savings and synergies, as well as the diversion ofmanagement’s attention during the acquisition and integration process.  We may not be able to operate the acquiredbusinesses properly and may not be able to successfully recover amounts paidfor such businesses.  Some or all ofthese special risks and factors may have a material adverse impact on ourbusiness, operating results, and financial condition and, as a result, may negativelyaffect the market price of our common stock.

Similarly, we may dispose of assets, either assets we have historicallyused in the business or that we have acquired. During the year ended November30, 2001, operations of Streamriver, which combined the acquisitions of 21stCentury LLC and J2 Digital Media Inc., and the sale of our streaming mediasoftware product line, comprising products acquired from Terran and DigitalOrigin, were disposed.  During the firstquarter of 2002, we settled litigation resulting in the disposition of certainassets relating to our Wired products. Our business and results of operations could materially change dependingon whether or not we are able to dispose of assets in an advantageousmanner.  In addition to obtaining anadvantageous price for the assets to be disposed of, dispositions involve anumber of special risks and factors, including searching for appropriateacquirers; managing the effect of the disposition on existing and proposedproduct lines and services, the divestiture of operations and personnel,adverse short-term effects on reported operating results, potentialpost-divestiture indemnification or liability for liabilities of divestedoperations, as well as the diversion of management’s attention during thedisposition process.  Some or all ofthese special risks and factors may

 

 

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have a materialadverse impact on our business, operating results, and financial condition and,as a result, may negatively affect the market price of our common stock.

*StockPrice Volatility*.  The trading price of our common stock hasbeen highly volatile and has fluctuated significantly in the past.  During the nine months ended August 31, 2002our stock price fluctuated between a low of $0.74 per share and a high of $3.75per share.  During fiscal 2001, ourstock price fluctuated between a low of $0.81 per share and a high of $3.81 pershare.  We believe that the price of ourcommon stock may continue to fluctuate significantly in the future in responseto a number of events and factors relating to our company, our competitors, andthe market for our products and services, many of which are beyond our control,such as, variations in our quarterly operating results; changes in financialestimates and recommendations by securities analysts; changes in marketvaluations of companies in our markets; announcements by us or our competitorsof significant products, acquisitions, or strategic partnerships; failure tocomplete significant business transactions; departures of key personnel;purchases or sales of common stock or other securities by us; or news relatingto trends in our markets.  In addition,the stock market in general, and the market for technology companies inparticular, have experienced extreme volatility over the past twelvemonths.  This volatility has often beenunrelated to the operating performance of particular companies.  These broad and industry fluctuations mayadversely affect the market price of our common stock, regardless of ouroperating performance

Item 3.    Quantitativeand Qualitative Disclosures About Market Risk

Derivative Financial Instruments, Other FinancialInstruments and Derivative Commodity Instruments.  We are not a party to any derivative financial instruments orother financial instruments for which the fair value disclosure would berequired under Statement of Financial Accounting Standards No. 107*DerivativeFinancial Instruments, Other Financial Instruments and Derivative CommodityInstruments**(*SFAS No. 107).  All of our investments are in short-term, investment gradecommercial paper, certificates of deposit and U.S. Government and agencysecurities that are carried at fair value on our books.  Accordingly, we believe that the market riskof such investments is minimal.

Primary Market Risk Exposures.  Our primary market risk exposures are in thearea of interest rate risk and foreign currency exchange rate risk.  Our investment portfolio of cash equivalentsis subject to interest rate fluctuations, but we believe this risk isimmaterial due to the short-term nature of these investments.  Our business in Europe is conducted in localcurrency.  In Asia, business is conductedin U.S. currency.  We have no foreignexchange contracts, option contracts or other foreign hedgingarrangements.  However, we estimate thatany market risk associated with its foreign operations is not significant andis unlikely to have a material adverse effect on our business, results ofoperations, or financial condition.

Item 4.    Control and Procedures

 

Under thesupervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we have evaluatedthe effectiveness of the design and operation of our disclosure controls andprocedures within 90 days of the filing date of this quarterly report, and,based on their evaluation, our principal executive officer and principalfinancial officer have concluded that these controls and procedures areeffective. There were no significant changes in our internal controls or inother factors that could significantly affect these controls subsequent to thedate of their evaluation.

 

Disclosure controls andprocedures are our controls and other procedures that are designed to ensurethat information required to be disclosed by us in the reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reported,within the time periods specified in the Securities and Exchange Commission’srules and forms. Disclosure controls and procedures include, withoutlimitation, controls and procedures designed to ensure that informationrequired to be disclosed by us in the reports that we file under the ExchangeAct is accumulated and communicated to our management, including our principalexecutive officer and principal financial officer, as appropriate to allowtimely decisions regarding required disclosure.

 

 

 

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PART II.  OTHERINFORMATION

 

**Item 1. Legal Proceedings**

(i) On October 12, 1999, a lawsuit was filed againstthe Company by McRoberts Software, Inc. (“MSI”) in the United States DistrictCourt for the Southern District of Indiana. The complaint alleges copyright infringement, breach of contract, andtrade secret misappropriation.  Thecomplaint includes requests for unspecified monetary damages and enhanceddamages, interest, costs and fees.  Anunfavorable verdict was filed on February 25, 2002 against the Company in theamount of $2.5 million.  The Company andMSI filed post-trial motions.  Thosemotions have been ruled upon with the trial court reducing the total amountawarded by the jury but assessing prejudgment interest and attorney’s fees.  The Company is appealing the entirejudgment, which approximates $2.8 million. The entire amount of the award has been placed in an escrow accountwhile the case is on appeal and approximately $2.8 million is included asrestricted cash in the accompanying balance sheet at May 31, 2002.

 

The Company had recorded a liability in the amount of$2.6 million that included estimated legal fees associated with the litigationat November 30, 2001.  During thequarter ended May 31, 2002, the Company recorded an additional liability of$397,000 for the adjusted judgment which included prejudgment interest andattorney’s fees, as well as, estimated legal fees associated with the appeal.

 

(ii) On May 9, 2001, a lawsuit was filed against theCompany by the former shareholders of Wired, a company acquired by the Companyin December 1999 (see Note 9 to the Consolidated Financial Statements).  The complaint alleges fraud, negligentmisrepresentation, breach of express and implied-in-fact contract, breach ofthe implied covenant of good faith and fair dealing, breach of fiduciary dutyand violation of California business and professional code section 17200.  The complaint includes requests forcompensatory and punitive damages, injunctive relief, and fees.  No specific amount or punitive damages arealleged, other than compensatory damages in an amount to be proven at trial,but not less than $25,000, the jurisdictional minimum for the court.  The Company filed a demurrer challenging thelegal sufficiency of the causes of action alleged.  A hearing on that demurrer occurred on November 6, 2001 and theCourt sustained the demurrer to one cause of action, for negligent falsepromise.

 

During the nine months ended August 31, 2002, theCompany settled the Wired litigation. As part of the settlement, the Company assigns all rights to the Wiredproduct line, intellectual property relating to Wired products and remaininginventory to the former shareholders of Wired. Wired agreed that no further action will be taken related to the lawsuitpreviously filed against the Company as noted in Note 9 to the ConsolidatedFinancial Statements.  Wired granted theCompany an irrevocable license to use the source code, technology, know how andintellectual property; provided however the license does not include the rightto sell Wired products or any equivalent products incorporating the sourcecode, technology, know how and intellectual property.  In addition, Wired agreed to pay to the Company a royalty of 5%of adjusted gross sales of the assigned products, not to exceed $1.2 million,plus the cost of the inventory assigned. Litigation settlement included in the Consolidated Statements ofOperations for the nine months ended August 31, 2002 represents the cost ofinventory transferred, the net book value of remaining intangible assetsassociated with the acquisition, and legal fees associated with the settlement.

 

(iii) From time to time the Company is involved inother disputes and/or litigation encountered in its normal course ofbusiness.  The Company does not believethat the ultimate impact of the resolution of such other outstanding matterswill have a material effect on the Company’s business, operating results orfinancial condition.

 

**Item 6. Exhibits and Reports on Form8-K**

**a)  Exhibits**

Exhibits requiredas part of this Quarterly Report on Form 10-Q are listed on the exhibit indexon page 31.

 

**b) Reports on Form 8-K**

 

On June 24, 2002,we filed a current report on Item 4, a change in our independent accountantsfrom Arthur Andersen LLP to Ernst & Young LLP.  A letter from Arthur Andersen LLP to the Securities and ExchangeCommission dated June 24, 2002 was filed under Item 7.

 

 

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SIGNATURES

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|   |             |   | Media 100 Inc. |                                   |
|--------|------------------|--------|----------------|----------------------------------------|
|   |             |   |           |                                   |
|   |             |   |           |                                   |
|   |             |   |           |                                   |
| Date:  | October 15, 2002 |   | By:       | /s/ Steven D. Shea                     |   |
|   |             |   |           |  Steven D.  Shea                  |   |
|   |             |   |           | Chief Financial Officer  and Treasurer |   |
|   |             |   |           | (Principal Financial  Officer)         |   |

 

 

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CERTIFICATIONS

 

I, John A.Molinari, certify that:

 

1.               I have reviewed this quarterly report on Form 10-Q ofMedia 100, Inc.;

 

2.               Based on my knowledge, this quarterly report does notcontain any untrue statement of material fact or omit to state a material factnecessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report;

 

3.               Based on my knowledge, the financial statements, andother financial information included in this quarterly report, fairly representin all material respects the financial condition, results of operations andcash flows of the registrant as of, and for, the periods presented in thisquarterly report;

 

4.               The registrant’s other certifying officers and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act rules 13a-14 and 15d-14) for the registrant andhave:

 

a)              designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is beingprepared;

 

b)             evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

 

c)              presented in this quarterly report our conclusionsabout the effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.               The registrant’s other certifying officers and I havedisclosed, based on our most recent evaluation, to the registrant’s auditorsand the audit committee of the registrant’s board of directors (or personsperforming the equivalent functions):

a)              all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b)             any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls;

 

6.               The registrant’s other certifying officers and I haveindicated in this quarterly report whether there were significant changes ininternal controls or in other factors that could significantly affect internalcontrols subsequent to the date of our most recent evaluation, including anycorrective actions with regard to significant deficiencies and materialweaknesses.

 

 

 

Date:                    October 15, 2002

 
|   |   | /s/ John A. Molinari    |   |   |
|--------|--------|-------------------------|--------|--------|
|   |   | Chief Executive Officer |   |   |
|   |   |                    |   |   |

 

 

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CERTIFICATIONS

 

I, Steven D. Shea,certify that:

 

1.                I have reviewed this quarterly report on Form 10-Q ofMedia 100, Inc.;

 

2.               Based on my knowledge, this quarterly report does notcontain any untrue statement of material fact or omit to state a material factnecessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report;

 

3.               Based on my knowledge, the financial statements, andother financial information included in this quarterly report, fairly representin all material respects the financial condition, results of operations andcash flows of the registrant as of, and for, the periods presented in thisquarterly report;

 

4.               The registrant’s other certifying officers and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act rules 13a-14 and 15d-14) for the registrant andhave:

 

a.               designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is beingprepared;

 

b.              evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

 

c.               presented in this quarterly report our conclusionsabout the effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.               The registrant’s other certifying officers and I havedisclosed, based on our most recent evaluation, to the registrant’s auditorsand the audit committee of the registrant’s board of directors (or personsperforming the equivalent functions):

a.               all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b.              any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls;

 

6.               The registrant’s other certifying officers and I haveindicated in this quarterly report whether there were significant changes ininternal controls or in other factors that could significantly affect internalcontrols subsequent to the date of our most recent evaluation, including anycorrective actions with regard to significant deficiencies and materialweaknesses.

 

 

 

Date:                    October 15, 2002

 
|   |   | /s/ Steven D. Shea                    |   |   |
|--------|--------|---------------------------------------|--------|--------|
|   |   | Chief Financial Officer and Treasurer |   |   |
|   |   | (Principal Financial Officer)         |   |   |

 

 

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EXHIBIT INDEX

 

 

                          Number                                                    Description

 

 

 

 

 

 

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