**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 
| **(Mark  One)** |   |
|-----------------|--------|

 

| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |
|------------|----------------------------------------------------------------------------------------------|

 

**For The Quarterly Period Ended:    February 28, 2002**

 

| **o** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF HE SECURITIES  EXCHANGE ACT OF 1934** |
|-------|----------------------------------------------------------------------------------------------|

 

**For TheTransition PeriodFrom            To            **

 

**Commission File Number: 0-14779**

 

**MEDIA 100 INC.**

(Exact name of registrantas specified in its charter)

 

| **DELAWARE**                                                    |   | **04-2532613**                           |
|-----------------------------------------------------------------|--------|------------------------------------------|
| (State or other  jurisdiction of organization or incorporation) |   | (I.R.S. Employer  Identification Number) |
|                                                            |   |                                     |
| **290 DONALD LYNCH BOULEVARD**                                  |
| **MARLBOROUGH,  MASSACHUSETTS**                                 |
| (Address of principal  executive offices)                       |
|                                                            |   |                                     |
| **01752-4748**                                                  |
| (Zip code)                                                      |
|                                                            |   |                                     |
| **(508)  460-1600**                                             |
| (Registrant’s telephone  number, including area code)      |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes         ý            No           o

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

 

| **Class**                               |   | **Outstanding at March 31, 2002** |
|-----------------------------------------|--------|-----------------------------------|
| Common Stock, par value  $.01 per share |   | 12,760,509 shares                 |

 

 

1

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MEDIA 100 INC.

 

INDEX TO FORM 10-Q

 
| PART I – FINANCIAL  INFORMATION |
|--------------------------------------|
| ITEM 1                               | Consolidated Financial Statements: |
|                                 | Consolidated Balance Sheets  as of February 28, 2002 and November 30, 2001 |
|                                 |   |
|                                 | Consolidated  Statements of Operations for the three months ended February 28, 2002 and  February 28, 2001 |
|                                 |   |
|                                 | Consolidated  Statements of Cash Flows for the three months ended February 28, 2002 and  February 28, 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 |
|                                 |   |
| PART II – OTHER  INFORMATION    |
| ITEM 1                               | Legal Proceedings |
|                                 |   |
| ITEM 6                               | Exhibits and  Reports on Form 8-K |
|                                 |   |
| SIGNATURES                           |
|                                 |   |
| EXHIBIT  INDEX                       |

 

2

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PART I - FINANCIAL INFORMATION

 

MEDIA 100 INC.

CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)

 
|                                                                                          |   | **February 28,2002** |   | **November 30,2001** |   |
|-----------------------------------------------------------------------------------------------|--------|----------------------|--------|----------------------|--------|
| ASSETS                                                                                        |   |                 |   |                 |   |
| Current assets:                                                                               |   |                 |   |                 |   |
| Cash and cash equivalents                                                                     |   | $                    | 13,175 |                 | $      | 17,369 |   |
| Available for sale securities, at fair value                                                  |   | 233                  |   | 241                  |   |
| Due from escrow (Note 14)                                                                     |   | 2,000                |   | 2,000                |   |
| Accounts receivable, net of allowance for doubtful accounts of  $502 in 2002 and $512 in 2001 |   | 2,140                |   | 2,907                |   |
| Inventories, net                                                                              |   | 1,837                |   | 1,220                |   |
| Prepaid expenses and other current assets                                                     |   | 948                  |   | 706                  |   |
| Total current assets                                                                          |   | 20,333               |   | 24,443               |   |
|                                                                                          |   |                 |   |                 |   |
| Property and equipment, net                                                                   |   | 2,736                |   | 3,843                |   |
| Intangible assets, net                                                                        |   | 703                  |   | 1,880                |   |
|                                                                                          |   |                 |   |                 |   |
| Total assets                                                                                  |   | $                    | 23,772 |                 | $      | 30,166 |   |
|                                                                                          |   |                 |   |                 |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                     |   |                 |   |                 |   |
| Current liabilities:                                                                          |   |                 |   |                 |   |
| Accounts payable                                                                              |   | $                    | 1,454  |                 | $      | 1,490 |   |
| Accrued expenses                                                                              |   | 7,394                |   | 8,000                |   |
| Deferred revenue                                                                              |   | 3,621                |   | 3,812                |   |
| Total current liabilities                                                                     |   | 12,469               |   | 13,302               |   |
|                                                                                          |   |                 |   |                 |   |
| Contingencies (Note 9)                                                                        |   |                 |   |                 |   |
|                                                                                          |   |                 |   |                 |   |
| Stockholders’ equity:                                                                    |   |                 |   |                 |   |
| Common stock                                                                                  |   | 130                  |   | 126                  |   |
| Capital in excess of par value                                                                |   | 217,951              |   | 217,683              |   |
| Accumulated deficit                                                                           |   | (206,699             | )      | (200,836             | )      |
| Treasury stock, at cost                                                                       |   | (78                  | )      | (78                  | )      |
| Accumulated other comprehensive loss                                                          |   | (1                   | )      | (31                  | )      |
| Total stockholders’ equity                                                               |   | 11,303               |   | 16,864               |   |
|                                                                                          |   |                 |   |                 |   |
| Total liabilities and stockholders’ equity                                               |   | $                    | 23,772 |                 | $      | 30,166 |   |

 

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

 

3

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MEDIA100 INC. 

CONSOLIDATEDSTATEMENTS OF OPERATIONS

(inthousands, except per share data)

(unaudited)

 
|                                                                |   | **Three Months Ended** |   |
|---------------------------------------------------------------------|--------|------------------------|--------|
|                                                                |   | **February 28,  2002** |   | **February 28,  2001** |   |
| Net sales:                                                          |   |                   |   |   |   |
| Products                                                            |   | $                      | 2,852  |   | $ | 7,063 |   |
| Services                                                            |   | 1,646                  |   | 2,532 |   |
| Total net sales                                                     |   | 4,498                  |   | 9,595 |   |
|                                                                |   |                   |   |   |   |
| Cost of sales                                                       |   | 2,238                  |   | 4,308 |   |
| Accelerated depreciation and amortization of fixed assets (Note  6) |   | 248                    |   | — |   |
| Gross profit                                                        |   | 2,012                  |   | 5,287 |   |
|                                                                |   |                   |   |   |   |
| Operating expenses:                                                 |   |                   |   |   |   |
| Research and development                                            |   | 2,567                  |   | 2,578 |   |
| Selling and marketing                                               |   | 2,248                  |   | 3,499 |   |
| General and administrative                                          |   | 1,106                  |   | 1,492 |   |
| Amortization and write-off of intangible assets                     |   | 492                    |   | 1,460 |   |
| Accelerated depreciation and amortization of fixed assets (Note  6) |   | 634                    |   | — |   |
| Settlement of litigation (Note 7 and 9)                             |   | 924                    |   | — |   |
| Total operating expenses                                            |   | 7,971                  |   | 9,029 |   |
| Operating loss                                                      |   | (5,959                 | )      | (3,742 | ) |
|                                                                |   |                   |   |   |   |
| Interest income, net                                                |   | 78                     |   | 107 |   |
| Other income (expense), net                                         |   | (84                    | )      | 314 |   |
| Loss from continuing operations before benefit from income taxes    |   | (5,965                 | )      | (3,321 | ) |
| Benefit from income taxes                                           |   | (102                   | )      | — |   |
| Loss from continuing operations                                     |   | (5,863                 | )      | (3,321 | ) |
| Loss from discontinued operations                                   |   | —                 |   | (675 | ) |
| Net loss                                                            |   | $                      | (5,863 | ) | $ | (3,996 | ) |
|                                                                |   |                   |   |   |   |
| Loss per share:                                                     |   |                   |   |   |   |
| Basic                                                               |   |                   |   |   |   |
| Continuing operations                                               |   | $                      | (0.46  | ) | $ | (0.27 | ) |
| Discontinued operations                                             |   | $                      | — |   | $ | (0.05 | ) |
| Total                                                               |   | $                      | (0.46  | ) | $ | (0.32 | ) |
|                                                                |   |                   |   |   |   |
| Diluted                                                             |   |                   |   |   |   |
| Continuing operations                                               |   | $                      | (0.46  | ) | $ | (0.27 | ) |
| Discontinued operations                                             |   | $                      | — |   | $ | (0.05 | ) |
| Total                                                               |   | $                      | (0.46  | ) | $ | (0.32 | ) |
| Weighted average common shares outstanding:                         |   |                   |   |   |   |
| Basic                                                               |   | 12,636                 |   | 12,333 |   |
| Diluted                                                             |   | 12,636                 |   | 12,333 |   |

 

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

 

4

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MEDIA 100 INC. 

CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 
|                                                                                                    |   | **Three Months Ended** |   |
|---------------------------------------------------------------------------------------------------------|--------|------------------------|--------|
|                                                                                                    |   | **February 28,2002**   |   | **February 28,2001** |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                   |   |                   |   |   |   |
| Net loss                                                                                                |   | $                      | (5,863 | ) | $ | (3,996 | ) |
| Net loss from discontinued operations                                                                   |   | —                 |   | 675 |   |
| (Loss) from continuing operations                                                                       |   | (5,863                 | )      | (3,321 | ) |
| Adjustments to reconcile net loss from continuing operations to  net cash used in operating activities: |   |                   |   |   |   |
| Depreciation and amortization                                                                           |   | 1,455                  |   | 805 |   |
| Non-cash settlement of litigation                                                                       |   | 924                    |   | — |   |
| Amortization and write-off of intangible assets                                                         |   | 492                    |   | 1,460 |   |
| Loss on sale of marketable securities                                                                   |   | —                 |   | 15 |   |
| Changes in assets and liabilities:                                                                      |   |                   |   |   |   |
| Accounts receivable                                                                                     |   | 767                    |   | 1,191 |   |
| Inventories                                                                                             |   | (708                   | )      | 88 |   |
| Prepaid expenses and other current assets                                                               |   | (242                   | )      | 49 |   |
| Accounts payable                                                                                        |   | (36                    | )      | (2,546 | ) |
| Accrued expenses                                                                                        |   | (780                   | )      | (834 | ) |
| Deferred revenue                                                                                        |   | (191                   | )      | (312 | ) |
| Net cash used in operating activities                                                                   |   | (4,182                 | )      | (3,405 | ) |
|                                                                                                    |   |                   |   |   |   |
| Net cash used in discontinued operations                                                                |   | —                 |   | (230 | ) |
|                                                                                                    |   |                   |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                   |   |                   |   |   |   |
| Net purchases of equipment                                                                              |   | (312                   | )      | (542 | ) |
| Purchase of intangible assets                                                                           |   | (10                    | )      | (32 | ) |
| Net proceeds from sales of marketable securities                                                        |   | 8                      |   | 5,067 |   |
| Net cash provided by (used in) investing activities                                                     |   | (314                   | )      | 4,493 |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                   |   |                   |   |   |   |
| Payment on note payable                                                                                 |   | —                 |   | (1,492 | ) |
| Proceeds from issuance of common stock                                                                  |   | 272                    |   | 223 |   |
| Net cash provided by (used in) financing activities                                                     |   | 272                    |   | (1,269 | ) |
| EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                                 |   | 30                     |   | 33 |   |
| NET DECREASE IN CASH AND CASH EQUIVALENTS                                                               |   | (4,194                 | )      | (378 | ) |
| CASH AND CASH EQUIVALENTS, beginning of period                                                          |   | 17,369                 |   | 11,987 |   |
| CASH AND CASH EQUIVALENTS, end of period                                                                |   | $                      | 13,175 |   | $ | 11,609 |   |
|                                                                                                    |   |                   |   |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                                       |   |                   |   |   |   |
| Cash (received) paid for income taxes                                                                   |   | $                      | (102   | ) | $ | 7 |   |
| OTHER TRANSACTIONS NOT USING CASH:                                                                      |   |                   |   |   |   |
| Change in value of marketable securities                                                                |   | $                      | — |   | $ | 46 |   |

 

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

 

5

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MEDIA 100 INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED, EXCEPTFOR NOVEMBER 30, 2001 AMOUNTS)

 

1.  Basis of Presentation

 

The accompanyinginterim consolidated financial statements include the accounts of Media 100Inc. (“the Company”), a Delaware corporation, and its wholly ownedsubsidiaries.  The interim financial statementsare unaudited.  However, in the opinionof management, the interim consolidated financial statements and disclosuresreflect all adjustments necessary for fair presentation. Interim results arenot necessarily indicative of results expected for a full year or for any otherinterim period.  Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Stateshave been condensed or omitted pursuant to the rules and regulations of theSecurities and Exchange Commission. These consolidated condensed financialstatements should be read in conjunction with the consolidated financialstatements and the notes thereto included in the Company’s latest auditedfinancial statements, which are included in the Company’s Annual Report on Form10-K for the fiscal year ended November 30, 2001, filed with the Securities andExchange 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 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 newly-introduced product—844/XTM—we sell our products as“turnkey” systems, meaning we configure and ship the system to an end user, orreseller, 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.

 

2.  Principles of 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 significantaccounting policies, as described below and elsewhere in the notes to theconsolidated financial statements. These consolidated financial statements are prepared in accordance withaccounting principles 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 forSale Securities

 

Cash equivalents are carried at cost, whichapproximates fair market value, and have original maturities of less thanninety days.  Cash equivalents includemoney market accounts and repurchase agreements with overnight maturities.  Approximately $140,000 of the cash and cashequivalents was restricted under various letters of credit at February 28,2002.  On March 29, 2002, the Companyopened an irrevocable standby letter of credit in the amount of $250,000 onbehalf of a vendor to expire on September 29, 2002.  At March 29, 2002, $400,000 of the cash and cash equivalents wasrestricted under various letters of credit.

 

On October 5, 2001, the Company sold its streamingmedia software product line to Autodesk, Inc. for $16.0 million in cash ofwhich $2.0 million was deposited into an escrow account for a period of oneyear in case indemnification issues arise. The amount was classified due from escrow on the accompanying balancesheet at February 28, 2002 and November 30, 2001, respectively.

 

6

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The Company accounts for securities in accordance withStatement of Financial Accounting Standards (SFAS) No. 115, *Accountingfor 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 February 28, 2002 and November 30, 2001 consistof the following (in thousands):

 
| **Investments available for sale:**  |   | **Maturity**    |   | **February 28,2002** |   | **November 30,2001** |   |
|--------------------------------------|--------|-----------------|--------|----------------------|--------|----------------------|--------|
| Corporate Obligations                |   | 1–5  years |   | $                    | 233    |                 | $      | 241 |   |
|                                 |   |            |   |                 |   |                 |   |
| Total investments available for sale |   |            |   | $                    | 233    |                 | $      | 241 |   |

 

Securities had acost of  $233 and $241, and a marketvalue of $233 and $241 at February 28, 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): 

 
|            |   | **February  28,2002** |   | **November  30,2001** |   |
|-----------------|--------|-----------------------|--------|-----------------------|--------|
| Raw materials   |   | $                     | 978    |                  | $      | 811 |   |
| Work-in-process |   | 486                   |   | 161                   |   |
| Finished goods  |   | 373                   |   | 248                   |   |
|            |   | $                     | 1,837  |                  | $      | 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.  Property and Equipment, net

 

Property andequipment, net, at February 28, 2002 and November 30, 2001 is stated at cost,less accumulated depreciation and amortization, and consists of the following(in thousands):

 
|                                            |   | **February 28,2002** |   | **November  30,2001** |   |
|-------------------------------------------------|--------|----------------------|--------|-----------------------|--------|
| Machinery and equipment                         |   | $                    | 4,420  |                  | $      | 4,169 |   |
| Purchased  software                             |   | 1,677                |   | 1,666                 |   |
| Furniture and  fixtures                         |   | 908                  |   | 908                   |   |
| Leasehold  improvements                         |   | 1,728                |   | 1,728                 |   |
|                                            |   | $                    | 8,733  |                  | $      | 8,471 |   |
| Less accumulated  depreciation and amortization |   | (5,997               | )      | (4,628                | )      |
|                                            |   | $                    | 2,736  |                  | $      | 3,843 |   |

 

7

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In connection withthe signing 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 weren’t movedto the new facility. This charge has been reflected as accelerated depreciationand amortization of fixed assets in the Consolidated Statements ofOperations.  The Company expects anadditional charge of approximately $294,000 for accelerated depreciation andamortization of fixed assets for the quarter ended May 31, 2002.

 

7.  Intangible Assets

 

Intangible assets,net at February 28, 2002 and November 30, 2001 consist of the following (inthousands):

 
|                           |   | **February  28,2002** |   | **November  30,2001** |   |
|--------------------------------|--------|-----------------------|--------|-----------------------|--------|
| Patents and  Trademarks        |   | $                     | 464    |                  | $      | 454 |   |
| Acquired  Technology           |   | 1,000                 |   | 1,900                 |   |
| Goodwill                       |   | 1,225                 |   | 2,757                 |   |
|                           |   | $                     | 2,689  |                  | $      | 5,111 |   |
| Less accumulated  amortization |   | (1,986                | )      | (3,231                | )      |
|                           |   | $                     | 703    |                  | $      | 1,880 |   |

 

Patents and trademarksare being amortized over three years. The Company amortizes goodwill anddeveloped acquired technology related to its acquisitions using a straight-linemethod over periods ranging from 2 to 3 years, their estimated useful life.

 

The Company****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.

 

Subsequent to the fiscalquarter ended February 28, 2002, the Company settled litigation brought againstit by the former shareholders of Wired, Inc. (Wired), a Company acquired by theCompany in December 1999 (See Note 9 Contingencies).  As part of the settlement, the Company assigned all rights to theWired product line, intellectual property relating to Wired products andon-hand inventory related to the Wired product line to the formershareholders.  Wired agreed that nofurther action will be taken related to the lawsuit previously filed against theCompany as noted in Note 9 Contingencies.  Wired granted the Company an irrevocable license to use the source code,technology, know how and intellectual property; provided, however, the licensedoes not include the right to sell Wired products or any equivalent productsincorporating the source code, technology, know how and intellectualproperty.  In addition, Wired agreed topay to 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 represents the cost ofinventory transferred, the net book value of remaining intangible assetsassociated with the acquisition, and legal fees associated with the settlement.

 

8.  Net Loss Per Common Share

 

The Company computesearnings per share pursuant to SFAS No. 128, *Earnings Per Share*.  In accordance with SFAS No. 128, basic netincome (loss) per share is computed using the weighted-average number of commonshares outstanding.  Diluted income pershare is computed using the weighted-average number of common sharesoutstanding and potential common shares from the assumed exercise of stockoptions and warrants outstanding during the period, if any, using the treasurystock method.

 

8

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The Company excludespotentially dilutive securities from its diluted net income (loss) per sharecomputation when either the exercise price of the securities exceeds the fairvalue of the Company’s common stock or when the Company reports a net loss andthe effect of including such securities would be antidilutive.   During the three months ended February 28,2002 and 2001, options to purchase approximately 1,733,000 and 2,813,000weighted average shares of common stock, respectively, were not included in thecomputation of diluted net loss per share as a result of their antidilutiveeffect.

 

9.  Contingencies

 

(i)  The Company provides accruals for all directcosts associated with the estimated resolution of known contingencies.  The accrual is established at the earliestdate at which it is deemed probable that a liability has been incurred and theamount of such liability can be reasonably estimated.

 

(ii)  On June 7, 1995, a lawsuit was filed againstthe Company by Avid Technology, Inc. (Avid) in the United States District Courtfor the District of Massachusetts.  Thecomplaint generally alleges patent infringement by the Company arising from themanufacture, sale, and use of the Company’s Media 100 products.  The complaint includes requests forinjunctive relief, treble damages, interest, costs and fees.  In July 1995, the Company filed an answerand counterclaim denying any infringement and asserting that the Avid patent inquestion is invalid. The Company intends to vigorously defend the lawsuit. Inaddition, Avid is seeking reissue of the patent, including claims that itasserts are broader than in the existing patent, and these reissue proceedingsremain pending before the U.S. Patent and Trademark Office.  On January 16, 1998, the court dismissed thelawsuit without prejudice to either party moving to restore it to the docketupon completion of all matters pending before the U.S. Patent and TrademarkOffice.

 

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 or othereffects of the appeal, whether or not the Company prevails, will not have amaterial adverse effect on the Company’s business, operating results andfinancial condition.

 

(iii)  On January 13, 1999 andJanuary 28, 1999, Digital Origin 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 againamended the complaint.  Defendants filedtheir third motion to dismiss, which has been dismissed without leave toamend.  Plaintiffs have appealed thisruling to the 9th Circuit Court of Appeals.

 

(iv)  On October 12, 1999, alawsuit was filed against the Company by McRoberts Software, Inc. in the UnitedStates District Court for the Southern District of Indiana.  The complaint alleges copyrightinfringement, breach of contract, and trade secret misappropriation.  The complaint includes requests forunspecified monetary damages and enhanced damages, interest, costs andfees.  An unfavorable verdict was filedon February 25, 2002 against the Company in the amount of $2.5 million.  The Company plans to file post-trial motionswith the trial court seeking to reverse the judgement.  If those post-trial motions are notsuccessful, the Company will appeal the judgement.  However, at November 30, 2001, the Company has recorded aliability in the amount of $2.6 million that includes estimated legal feesassociated with the litigation.

 

9

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(v)  On May 9, 2001, a lawsuitwas filed against the Company by the former shareholders of Wired, a companyacquired by the Company in December 1999. The complaint alleges fraud, negligent misrepresentation, breach ofexpress and implied-in-fact contract, breach of the implied covenant of goodfaith and fair dealing, breach of fiduciary duty and violation of Californiabusiness and professional code section 17200. The complaint includes requests for compensatory and punitive damages,injunctive relief, and fees.  Nospecific amount or punitive damages are alleged, other than compensatorydamages in an amount to be proven at trial, but not less than $25,000, thejurisdictional minimum for the court. The Company filed a demurrer challenging the legal sufficiency of thecauses of action alleged.  A hearing onthat demurrer occurred on November 6, 2001 and the Court sustained the demurrerto one cause of action, for negligent false promise.

 

Subsequent to the fiscal quarter ended February 28, 2002, the Companysettled the Wired litigation.  As partof the settlement, the Company assigned all rights to the Wired product line,intellectual property relating to Wired products and on-hand inventory relatedto the Wired product line to the former shareholders.  Wired agreed that no further action will be taken related to thelawsuit previously filed against the Company.  Wired granted the Company an irrevocable license to use the source code,technology, know how and intellectual property; provided, however, the licensedoes not include the right to sell Wired products or any equivalent products incorporatingthe source code, technology, know how and intellectual property.  In addition, Wired promised to pay theCompany a royalty of 5% of adjusted gross sales of the assigned products, notto exceed $1.2 million, plus the cost of the inventory assigned.  Litigation settlement included in theConsolidated Statements of Operations represents the cost of inventorytransferred, the net book value of remaining intangible assets associated withthe acquisition, and legal fees associated with the settlement.

 

(vi)  From time to time theCompany is involved in other disputes and/or litigation encountered in itsnormal course of business.  The Companydoes not believe that the ultimate impact of the resolution of such otheroutstanding matters will have a material effect on the Company’s business,operating results or financial condition.

 

10.  Income Taxes

 

The Company recorded an income tax benefit of $102,000 during the threemonths ended February 29, 2002 as the Company received a refund from the U.S.Government related to a prior period payment.

 

11.  Accrued Expenses

 

Accrued expenses at February 28, 2002 and November 30, 2001 consist ofthe following (in thousands):

 
|                                     |   | **February  28,2002** |   | **November  30,2001** |   |
|------------------------------------------|--------|-----------------------|--------|-----------------------|--------|
| Payroll, payroll  taxes and other taxes  |   | $                     | 857    |                  | $      | 942 |   |
| Accrued warranty                         |   | 561                   |   | 561                   |   |
| Accrued  restructuring                   |   | 321                   |   | 527                   |   |
| Accrued  inventory                       |   | 360                   |   | 323                   |   |
| Accrued legal  and professional services |   | 3,121                 |   | 3,067                 |   |
| Accrued selling  and marketing           |   | 280                   |   | 361                   |   |
| Accrued other                            |   | 1,894                 |   | 2,219                 |   |
|                                     |   | $                     | 7,394  |                  | $      | 8,000 |   |

 

10

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12.  Comprehensive loss

 

The Companyrecords items of comprehensive income or 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** |   |
|------------------------------------------------------------------|--------|-------------------------|--------|
|                                                             |   | **February 28,  2002**  |   | **February 28,  2001** |   |
| Net loss                                                         |   | $                       | (5,863 | ) | $ | (3,996 | ) |
| Cumulative  translation adjustment                               |   | 30                      |   | (12 | ) |
| Unrealized  holding gain (loss) on Available-for-sale securities |   | —                  |   | 46 |   |
| Total  comprehensive loss                                        |   | $                       | (5,833 | ) | $ | (3,962 | ) |

 

13.  SegmentInformation

 

The Company applies the provisions of SFAS No. 131, *Disclosuresabout Segments of an Enterprise and Related Information,* whichestablishes standards for public companies to report operating segmentinformation in annual and interim financial statements.  Operating segments are defined as componentsof an enterprise about which separate financial information is available thatis evaluated regularly by the chief decision maker, or decision making group,in deciding how to allocate resources and in assessing performance.  The Company’s chief operatingdecision-making group is composed of the Chief Executive Officer and members ofsenior management.  The Company’sreportable operating segments are digital video systems and services.

 

The accounting policies of the segments arethe same as those described in the summary of significant accountingpolicies.  Revenues are attributed togeographic areas based on where the customer is located.  Segment information for the quarters endedFebruary 28, 2002 and February 28, 2001 is as follows:

 
|                               |   |                      |   |         |   |          |   |      |   |
|------------------------------------|--------|---------------------------|--------|--------------|--------|---------------|--------|-----------|--------|
|                               |   |                      |   |         |   |          |   |      |   |
|                               |   | **DigitalVideo  Systems** |   | **Services** |   | **Corporate** |   | **Total** |   |
| ***February 28, 2002***            |   |                      |   |         |   |          |   |      |   |   |   |   |   |
| Net sales from  external customers |   | $                         | 2,852  |         | $      | 1,646         |   | $         | — |   | $ | 4,498 |   |
|                               |   |                      |   |         |   |          |   |      |   |
| Gross profit                       |   | 669                       |   | 1,344        |   | —        |   | 2,012     |   |
|                               |   |                      |   |         |   |          |   |      |   |
| Depreciation and  amortization     |   | 1,440                     |   | 15           |   | —        |   | 1,455     |   |
|                               |   |                      |   |         |   |          |   |      |   |
| Interest income,  net              |   | —                    |   | —       |   | 78            |   | 78        |   |
|                               |   |                      |   |         |   |          |   |      |   |
| ***February 28, 2001***            |   |                      |   |         |   |          |   |      |   |
| Net sales from  external customers |   | $                         | 7,063  |         | $      | 2,532         |   | $         | — |   | $ | 9,595 |   |
|                               |   |                      |   |         |   |          |   |      |   |
| Gross profit                       |   | 3,480                     |   | 1,807        |   | —        |   | 5,287     |   |
|                               |   |                      |   |         |   |          |   |      |   |
| Depreciation and  amortization     |   | 738                       |   | 67           |   | —        |   | 805       |   |
|                               |   |                      |   |         |   |          |   |      |   |
| Interest income,  net              |   | $                         | — |         | $      | —        |   | $         | 107    |   | $ | 107 |   |

 

11

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Interest income is considered a corporate level activity and is,therefore, not allocated to segments. Management believes transfers between geographic areas are accounted foron an arms length basis.

 

Net sales by geographic area for the quarters ended February 28, 2002and 2001 were as follows (in thousands):

 
|                                        |   | **February  28,2002** |   | **February  28,2001** |   |
|---------------------------------------------|--------|-----------------------|--------|-----------------------|--------|
| North America                               |   | $                     | 2,779  |                  | $      | 6,507 |   |
| United Kingdom,  Sweden, Denmark and Norway |   | 473                   |   | 976                   |   |
| France, Spain  and Benelux                  |   | 237                   |   | 846                   |   |
| Germany, Austria  and Switzerland           |   | 188                   |   | 292                   |   |
| Asia, Japan and  other foreign countries    |   | 821                   |   | 974                   |   |
|                                        |   | $                     | 4,498  |                  | $      | 9,595 |   |

 

Long-lived tangible assets by geographic area for the quarters endedFebruary 28, 2002 and November 30, 2001 consist of the following (inthousands):

 
|           |   | **February  28,2002** |   | **November  30,2001** |   |
|----------------|--------|-----------------------|--------|-----------------------|--------|
| United States  |   | $                     | 2,513  |                  | $      | 3,651 |   |
| United Kingdom |   | 145                   |   | 123                   |   |
| Germany        |   | 24                    |   | 1                     |   |
| France         |   | 54                    |   | 68                    |   |
|           |   | $                     | 2,736  |                  | $      | 3,843 |   |

 

14.  Discontinued Operations

 

On October 5, 2001, the Company sold its streaming media softwareproduct line to Autodesk, Inc. for $16.0 million in cash, of which $2 millionis due from escrow and is payable on August 29, 2002. The Company’s streamingmedia software product line consisted of products acquired in the Terranacquisition and the merger with Digital Origin.

 

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 fiscal quarters ended February 28, 2002 and 2001 are as follows(in thousands):

 
|                                  |   | **2002** |       | **2001**   |       |
|---------------------------------------|--------|----------|------------|------------|------------|
| Net sales of  discontinued operations |   | $        | —     |       | $          | 4,248 |   |
|                                  |   |     |       |       |       |
| Loss from  discontinued operations    |   | $        | —     | ** ** | **$**      | 675 | ** ** |
|                                  |   |     | ** ** |       | ** ** |

 

12

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15.  New Accounting Standards

 

EmergingIssues Task Force (EITF) Issue No. 01-09, “*Accountingfor Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’sProducts,”*issued during November 2001, codifies previously issuedEITF Issue No. 00-25, “*Vendor Income StatementCharacterization of Consideration Paid to a Reseller of the Vendor’s Products.”* EITF Issue No. 00-25 addresses variousaspects of the accounting for consideration given by a vendor to a customer ora reseller 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 beginning afterDecember 15, 2001and requires retroactive restatement. The Company previouslyrecorded coop advertising expenses and other sales incentives to resellerswithin sales and marketing expense in the statement of operations.  The Company adopted EITF Issue No. 01-09 inits interim period ended February 28, 2002. As a result, the Company has recorded $13,000 as a reduction to productsales in the first quarter ended February 28, 2002.  Additionally, the Company reclassified $49,000 as a reduction ofproduct sales that were previously classified as selling and marketing expensesin the first quarter ended February 28, 2001.

 

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 ofoperations.  The Company hashistorically accounted for reimbursement received for shipping and handlingfees as a reduction of cost of sales in the statement of operations to offsetthe costs incurred.  The Company adoptedEITF 00-10 in the first quarter ended February 28, 2002. As a result, theCompany has recorded $7,000 as product sales in the first quarter endedFebruary 28, 2002.  Additionally, theCompany reclassified $43,000 as product sales that were previously classifiedas a reduction to cost of sales in the first quarter ended February 28, 2001.

 

13

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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 requires management to make estimates and judgements thateffect the reported amounts of assets, liabilities, revenue and expenses, andthe related disclosure of contingent assets and liabilities.  Our actual results may differ materiallyfrom those anticipated in these forward-looking statements as a result of anumber of factors, including those set forth under “Cautionary Statements” andelsewhere 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 newly-introduced product—844/XTM—we sell our products as“turnkey” systems, meaning we configure and ship the system to an end user, orreseller, 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.

 

DigitalOrigin Merger and Other Acquisitions

 

On May 9, 2000, we completed our merger with Digital Origin.  Under the terms of the agreement, DigitalOrigin’s shareholders and option holders received 0.5347 equivalent shares, orapproximately 3.7 million Media 100 common shares, to effect the businesscombination.  The transaction has beenaccounted for as a pooling of interests. With the sale of the streaming media software product line in on October5, 2001, the results from Digital Origin have now been classified asdiscontinued operations in the accompanying statements of operations.

 

We also acquired Terranin fiscal 1999 and Wired, J2 Digital Media, 21st Century Media andcertain assets of Integrated Computing Engines, Inc. in fiscal year 2000.  Each of these acquisitions was accounted foras a purchase pursuant to APB No. 16. As a result, the operations of each acquired entity are reflected in theCompany’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, wesold our streaming media software product line to Autodesk, Inc. for $16.0million in cash of which $2.0 million was deposited into an escrow account fora period of one year in case indemnification issues arise.  The net loss from these operations areincluded in the accompanying statements of operations under “discontinuedoperations” (see Note 14 to the Consolidated Financial Statements includedherein).

 

 **CriticalAccounting Policies and Estimates**

** **

Thismanagement’s discussions and analysis of financial condition and results ofoperations discusses our consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States.  The preparation of thesefinancial statements requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and the disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.  On an ongoing basis, management evaluatesits estimates and judgements, including those related to revenue recognition,inventories, the impairment of long lived assets, legal contingencies anddiscontinued operations.  Managementbases its estimates and judgements on historical experience and on variousother factors that are believed to be reasonable under the circumstances, theresults of which form the basis for making judgements about the carrying valuesof assets and liabilities that are not readily apparent from othersources.  Actual results may differ fromthese estimates under different assumptions or conditions.

 

Webelieve the following critical accounting policies most significantly affectthe portrayal of our financial condition and require management’s mostdifficult and subjective judgements.

 

RevenueRecognition

 

Werecognize revenue in accordance with Statement of Position 97-2, *Software Revenue Recognition* as amended bySOP 98-9, *Modification of SOP*97-2, *Software Revenue Recognition, withrespect to Certain Transactions*. Net sales are recognized

 

14

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followingestablishment of persuasive evidence of an arrangement, provided that thelicense fee is fixed or determinable, delivery of product has occurred viaphysical shipment or electronically, a determination has been made bymanagement that collection is probable and the Company has no remainingobligations. Revenues under multiple element arrangements, which typicallyinclude products and maintenance sold together, are allocated to each elementusing the residual method in accordance with SOP 98-9.  The Company provides for estimated returnsat the time of shipment. The Company recognizes maintenance revenue from thesale of post-contract support services ratably over the life of the contract.We maintain allowances for estimated losses resulting from the inability of ourcustomers to make required payments, however, if the financial condition of ourcustomers were to deteriorate, resulting in an impairment of their ability tomake payments, allowances would be required.

 

Inventories

 

Our reserve for excessand obsolete inventory is primarily based upon forecasted demand for ourproducts and any change to the reserve arising from forecast revisions isreflected in cost of sales in the period the revision is made. The Companywrites down its inventory for estimated obsolescence or unmarketable inventoryequal to the difference between the cost of inventory and the estimated marketvalue based upon assumptions about future demand and market conditions. Ifactual future demand or market conditions are less favorable than thoseprojected by management, additional inventory write-downs may be required.

 

Long-livedAssets

** **

Property and equipment, including leasehold improvements, aredepreciated over their useful lives. Useful lives are based on management’s estimates of the period that theCompany will realize the benefit of these assets.

 

Legal Contingencies

 

We are currently involved in legal proceedings.  As discussed in Note 9 of the consolidatedfinancial statements, as of February 28, 2002, we have provided accruals forall direct costs associated with the estimated resolution of known contingencies.  The accrual is established at the earliestdate at which it is deemed probable that a liability has been incurred and theamount of such liability can be reasonably estimated.  This litigation could take several years to complete.  Accordingly, actual legal fees and,possibly, damages awards or settlements, could differ significantly from ourestimates.  It is possible, however,that future results of operations for any particular quarterly or annual periodcould be materially affected by changes in our assumptions, or theeffectiveness of our strategies, related to these proceedings.

 

Discontinued operations

 

Our financial statements are prepared using discontinued operationsaccounting for our streaming media software product line. The Company’s streamingmedia software product line consisted of products acquired in the Terranacquisition and the merger with Digital Origin.  Under discontinued operations accounting, we accrued estimates ofour expected liabilities related to the discontinued operations through theireventual discharge, which in many cases, was expected to be several years inthe future.  Our accrual for this leaseliability could be materially affected by factors such as our ability to securesubleases, the credit worthiness of subleases and our success at negotiatingearly termination agreements with lessors. These factors are significantly dependent on the general health of theeconomy and the resultant demand for commercial property.

 

15

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**Results of Operations**

 

The following table showscertain consolidated statements of operations data as a percentage of netsales.

 
|                                                              |   | **Three  months ended** |   |
|-------------------------------------------------------------------|--------|-------------------------|--------|
|                                                              |   | **February 28,  2002**  |   | **February 28,  2001** |   |
| Net sales:                                                        |   |                    |   |   |   |
| Products                                                          |   | 63.4                    | %      | 73.6 | % |
| Services                                                          |   | 36.6                    |   | 26.4 |   |
| Total net sales                                                   |   | 100.0                   |   | 100.0 |   |
| Cost of sales                                                     |   | 49.8                    |   | 44.9 |   |
| Accelerated  depreciation and amortization of fixed assets        |   | 5.5                     |   | — |   |
| Gross profit                                                      |   | 44.7                    |   | 55.1 |   |
| Operating  expenses:                                              |   |                    |   |   |   |
| Research and  development                                         |   | 57.1                    |   | 26.9 |   |
| Selling and marketing                                             |   | 50.0                    |   | 36.5 |   |
| General and  administrative                                       |   | 24.6                    |   | 15.5 |   |
| Amortization and  write-off of intangible assets                  |   | 10.9                    |   | 15.2 |   |
| Accelerated  depreciation and amortization Of fixed assets        |   | 14.1                    |   | — |   |
| Settlement of  litigation                                         |   | 20.5                    |   | — |   |
| Total operating  expenses                                         |   | 177.2                   |   | 94.1 |   |
| Operating loss                                                    |   | (132.5                  | )      | (39.0 | ) |
| Interest income-  net                                             |   | 1.7                     |   | 1.1 |   |
| Other income  (expense)- net                                      |   | (1.9                    | )      | 3.3 |   |
| Loss from  continuing operations before benefit from income taxes |   | (132.6                  | )      | (34.6 | ) |
| Benefit from  income taxes                                        |   | (2.3                    | )      | — |   |
| Loss from  continuing operations                                  |   | (130.3                  | )      | (34.6 | ) |
| Loss from  discontinued operations                                |   | —                  |   | (7.0 | ) |
| Net loss                                                          |   | (130.3                  | )%     | (41.6 | )% |

 

Comparison of FirstFiscal Quarter of 2002 to First Fiscal Quarter of 2001

 

Net sales.  Total net sales for the first fiscal quarterended February 28, 2002 decreased 53.1% to $4.5 million from $9.6 million forthe first quarter of fiscal 2001.  Netsales from products for the first fiscal quarter ended February 28, 2002decreased 59.6% to $2.9 million from $7.1 million for 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 ($3.9million), and lower sales of the MPEG-based products acquired in theacquisition of Wired, Inc. (“Wired”)($267,000).  We anticipate this trend of lower year-over-year net sales of ourdigital video systems to continue for the remainder of this year, partially offsetby net sales from our recently introduced content design system, 844/X.  In addition, as part of the settlement oflitigation with the former shareholders of Wired, dated April 15, 2002, theCompany will no longer sell the MPEG-based products from Wired. Sales of theWired product line for the first quarter ended February 28, 2002 wasapproximately $400,000.  Net sales fromservices for the first fiscal quarter ended February 28, 2002 decreased 35.0%to $1.6 million from $2.5 million for the first quarter of fiscal 2001.  The decrease in net sales from services isdue to the elimination of encoding and hosting services offered throughStreamriver ($177,000) and lower sales of services to support our digital videosystems ($723,000).  Streamriver was shutdown in the second quarter of fiscal 2001 due to weak demand for theseInternet-related services.

 

Gross profit.  Gross profit decreased 61.9% to $2.0 millionin the first fiscal quarter of 2002 from $5.3 million in the first quarter offiscal 2001.  Overall gross profit as apercentage of net sales decreased to 44.7% in the first fiscal quarter of 2002from 55.1% in the first quarter of fiscal 2001.  Specifically, gross profit as a percentage of net product salesdecreased to 23.5% in the first fiscal quarter of 2002 from 49.3% in the firstquarter of fiscal 2001, while gross profit as a percentage of net sales ofservices increased to 81.7% in the first fiscal quarter of 2002 from 71.4% inthe first quarter of fiscal 2001.  Thepercentage increase in gross profit as a percentage of net sales of servicesresulted from the elimination of sales of encoding and hosting service, whichprovide lower gross profit as a percentage of net sales than customer supportcontracts for digital video systems. Gross profit as a percentage of net product sales decreased due to lowerunit sales and average selling prices for our digital video systems and acharge of $248,000 for accelerated depreciation.  The accelerated depreciation charge, related primarily toleasehold improvements, is due to our decision to relocate our facility to anew location better suited to meet our needs. We expect an additional charge ofapproximately $82,000 for accelerated depreciation and amortization of fixedassets for the quarter ended May 31, 2002. We currently forecast overall gross profit as a percentage of net saleswill increase over the next several quarters

 

16

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due to the introductionof our new content design system, 844/X, however, due to potential fluctuationsin the mix of products sold, gross profit as a percentage of net sales may varyfrom one quarter to another.

 

Research anddevelopment.  Research and developmentexpenses were $2.6 million in the first fiscal quarter of 2002, flat with the$2.6 million reported in the first quarter of fiscal 2001.  Research and development expenses consistprimarily of salaries and related benefits, consultants, outside services,occupancy and depreciation. At this time, we anticipate research anddevelopment expenses will remain relatively stable in our second quarter offiscal 2002 versus our first quarter and then decrease slightly over thefollowing quarters as we complete the development effort related to the firstversion of our recently introduced content design system, 844/X.

 

Selling andmarketing.  Selling and marketingexpenses decreased 35.8% to $2.2 million in the first fiscal quarter of 2002from $3.5 million in the first quarter of fiscal 2001.  Selling expenses consist primarily ofsalaries and related benefits, commissions, travel, occupancy anddepreciation.  Marketing expensesconsist primarily of salaries and related benefits, trade shows, seminars,advertising, 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 willincrease in the second quarter of fiscal 2002 in support of the introduction of844/X and then decrease through the remainder of our current fiscal year, afterthe completion of the initial introduction of 844/X.

 

General andadministrative.  General andadministrative expenses decreased 25.9% to $1.1 million in the first fiscalquarter of 2002 from $1.5 million in the first quarter of fiscal 2001.  General and administrative expenses includethe cost of human resources, finance, information technology, legal and otheradministrative functions of the Company. The decrease in general and administrative expenses resulted primarilyfrom lower salaries and related benefits and professional fees.** **We currently anticipate that ourgeneral and administrative expenses will decrease over the next severalquarters due to lower legal expenses.

 

Amortization andwrite-off of intangible assets.  Werecorded an expense for the amortization and write-off of intangible assetsof  $492,000 in the first fiscal quarterof 2002 compared to $1.5 million in the first fiscal quarter of fiscal2001.  The $492,000 recorded in thefirst quarter of fiscal 2002 related to the amortization of goodwill associatedwith our acquisition of Wired, Inc. and certain assets of Integrated ComputingEngines, Inc.  The $1.5 million recordedin the first quarter of fiscal 2001 related to Wired, Inc., IntegratedComputing Engines, Inc. and a write-down of goodwill of $880,000 related to theacquisitions of 21st Century LLC and J2 Digital Media, Inc.  These two acquisitions were combined to formStreamriver, which was launched in June 2000. During the first quarter of fiscal 2001, the goodwill from these twoacquisitions was determined to be impaired due to continued operating losses inStreamriver and the uncertainty surrounding our ability to recover the goodwillthrough future cash flows.  The Companyshut down Streamriver in the second quarter of fiscal 2001.

 

Accelerated depreciationand amortization of fixed assets.  Werecorded a charge of $634,000 related primarily to leasehold improvements atour existing facility in Marlboro, Massachusetts and our decision to relocatefrom this facility to a new facility better suited to meet our needs.  As result of this decision and the signingof a new lease for the new facility we will amortize the remaining book valueas of the beginning of fiscal 2002 of all leasehold improvements, furniture andfixtures over the remaining months in fiscal 2002 (four) that we would occupyour previous facility.  Consequently, wewill record a charge for accelerated depreciation in our second quarter offiscal 2002 for the fourth month of the accelerated period.  We estimate this charge to be approximately$212,000.

 

Settlement of litigation.We agreed to settle litigation brought against it by the former shareholders ofWired, a Company acquired by the Company in December 1999.  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 to theformer shareholders.  Wired agreed thatno further action will be taken related to the lawsuit previously filed againstthe Company as noted in Note 9 Contingencies.  Wired granted the Company an irrevocable license to use the source code,technology, know how and intellectual property; provided, however, the licensedoes not include the right to sell Wired products or any equivalent productsincorporating the source code, technology, know how and intellectualproperty.  In addition, we will providelimited manufacturing and marketing support to the former shareholders inexchange for 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. Thisagreement resulted in a write-off of the remaining goodwill created through theacquisition of Wired.   We currentlyanticipate this transfer will be completed in the second quarter of fiscal2002.  There was no similar expenserecorded in the first fiscal quarter of 2001.

 

Interest income,net.  Interest income decreased 27.1% to$78,000 in the first fiscal quarter of 2002 from $107,000 in the first quarterof fiscal 2001.  The decrease ininterest income is due to lower cash and cash equivalent balances in fiscal2002 versus 2001 and lower interest rates. The Company currently anticipates interest income will decline in fiscal2002 versus 2001 due to lower cash balances.

 

17

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Other income (expense),net.  Other expense, net was $84,000 inthe first fiscal quarter of 2002 compared to other income, net of $314,000 inthe first quarter of fiscal 2001.  Thedecrease is due to foreign exchange losses on intercompany transactions withour foreign subsidiaries.

 

Benefit from incometaxes.  We recorded a benefit fromincome taxes of $102,000 in the first quarter of fiscal 2002 due to an incometax refund we received.  We did notrecord a tax provision or benefit in the first quarter of fiscal 2001.

 

Loss from continuingoperations.  As a result of the abovefactors, we had a loss from continuing operations for the first fiscal quarterof 2002 in the amount of ($5.9) million, or ($0.46) per share, compared to anet loss of ($3.3) million, or ($0.27) per share, in the first quarter offiscal 2001.

 

 **Liquidity and 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 ofFebruary 28, 2002, our principal sources of liquidity included cash, cashequivalents and marketable securities totaling approximately $13.4million.  This was a decrease ofapproximately $4.2 million of cash, cash equivalents and marketable securitieswe had as of November 30, 2001.  Inaddition to the $13.4 million as of February 28, 2002, an additional $2.0million is held in escrow until October 2002 as a result of the sale of ourstreaming media software product line to Autodesk, Inc. in October 2001.

 

During the first quarterended February 28, 2002, cash used in operating activities from continuingoperations was approximately $4.2 million compared to cash used in operatingactivities from continuing operations of approximately $3.4 million for thefirst quarter ended February 28, 2001. There was no cash provided by or used in discontinued operations for thefirst quarter ended February 28, 2002. Cash used in discontinued operations for the first quarter endedFebruary 28, 2001 totaled $230,000. Cash used in continuing operations during fiscal 2002 included a netloss of $5.9 million including depreciation and amortization of $1.5 million,amortization of intangible assets of $492,000 and a settlement of litigation of$924,000.  Cash used in continuingoperations was affected by changes in assets and liabilities including anincrease in inventories of $708,000 relating primarily to the initial buildupof inventory for 844/X, prepaid expenses and other current assets of $242,000,and reductions in accounts payable of $36,000, accrued expenses of $780,000 anddeferred revenue of $191,000. Cash was provided by the reduction in accountsreceivable of $767,000.  Net cash usedin investing activities for continuing operations was approximately $314,000for the first quarter ended February 28, 2002 compared to cash provided byinvesting activities of approximately $4.5 million for the first quarter endedFebruary 28, 2001.  Cash used ininvesting activities for continuing operations during 2002 was primarilypurchases of capital equipment of $312,000. Cash provided by financing activities from continuing operations duringthe first quarter ended February 28, 2002 was approximately $272,000 comparedto cash used in financing activities from continuing operations of $1.3 millionfor the first quarter ended February 28, 2001. In 2002, cash provided by financing activities from continuingoperations was from the issuance of common stock pursuant to stock plans of$272,000.

 

At February 28, 2002, ourcontractual cash obligations were as follows:

 
|                   |   | **Total** |      | **Less than  1 year** |   | **1–3 years** |   |
|------------------------|--------|-----------|-----------|-----------------------|--------|--------------------|--------|
| Lease  commitments     |   | $         | 2,899,000 |                  | $      | 1,112,000          |   | $ | 1,787,000 |   |
| Inventory  commitments |   | $         | 1,077,000 |                  | $      | 1,077,000          |   | $ | — |   |

 

We currently anticipatethat our current cash and equivalents will be sufficient to fund ouranticipated cash requirements for working capital and capital expenditures forat least the next twelve months.  We mayneed to raise additional funds, however, in order to fund expansion of ourbusiness, develop new and enhance existing products and services, or acquirecomplementary products, businesses or technologies.  If additional funds are raised through the issuance of equity orconvertible debt securities, the percentage ownership or our stockholders maybe reduced, our stockholders may experience additional dilution, and suchsecurities may have rights, preferences or privileges senior to those of ourexisting stockholders.  Additionalfinancing may not be available on terms favorable to us, or at all.  If adequate funds are not available or arenot available on acceptable terms, our ability to fund expansion, takeadvantage of unanticipated opportunities or develop or enhance our products orservices would be significantly limited.

** **

**Cautionary Statements**

 

This Quarterly Report onForm 10-Q contains forward-looking statements within the meaning of theSecurities Litigation Reform Act of 1995 that involve risks anduncertainties.  Our actual results coulddiffer materially from those anticipated in these forward-looking statements asa result 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.

 

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*Risks Associated With Development and Introduction of NewProducts.*  If we are not successful in developing andintroducing new products to the markets we serve our business and operatingresults will suffer.  In late February2002, we announced our latest new product, 844/X, and currently anticipate thisnew product will generate greater than 50% of the revenue from product sales inthe current fiscal year.  If theadoption of 844/X is slower than we anticipate or if there are delays inreleasing 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.

* *

*Significant Fluctuations and Unpredictability of OperatingResults.*  Our quarterly operating results aredifficult to predict, have varied significantly in the past and are likely tovary significantly in the future for a number of reasons, including new productannouncements and introductions by ourselves or our competitors, changes inpricing, and the volume and timing of orders received during the quarter. Also,in the past, we have experienced delays in the development of new products andenhancements, and such delays may occur in the future.  These factors make the forecasting ofrevenue 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 islikely that in some future quarter or quarters our operating results will bebelow the expectations of securities analysts or investors.   If quarterly revenue or earnings levelsfail to meet internal or external expectations, the market price of our commonstock may decline significantly.

* *

*Emerging Markets.*  The marketsin which we offer our systems products and services are intensely competitiveand rapidly changing.  We are targetingthe emerging market of broadcast designers, effects artists, and creativeprofessionals.  This market and theproducts utilized by these users are relatively new.  Our success in this emerging market will depend on the rate atwhich the market develops and our ability to penetrate that market.  We will not succeed if we cannot competeeffectively in this market and, as a result, our business and operating resultscould be materially and adversely affected.

* *

*Rapid Technological Change.*  Rapidlychanging technology, evolving industry standards and frequent new productintroductions characterize the market for our products.  Our future success will depend in part uponour ability to enhance existing products and to introduce new products andfeatures in a timely manner to address customer requirements, respond tocompetitive offerings, adapt to new emerging industry standards and takeadvantage of new enabling technologies that could render our existing productsobsolete. We plan to continue to invest in research and development, inconnection with our development strategy. Any delay or failure on our part in developing additional new productsor features for existing products or any failure of such new products orfeatures to achieve market acceptance, could have a material adverse effect onour business and operating results and our stock price will suffer.

* *

*Competition.*  The marketfor our products is highly competitive and characterized by pressure to reduceprices, incorporate new features and accelerate the release of newproducts.  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.

* *

*Dependenceon Propriety Technology.*  Our ability to competesuccessfully and achieve future revenue growth will depend, in part, on ourability to protect our proprietary technology and operate without infringingthe rights of others.  Previously, wehave

 

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received, and may in the future continue to receive,communications suggesting that our products may infringe on the patents orother intellectual property rights of third parties.  Our policy is to investigate the factual basis of suchcommunications 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.

* *

*Risks of Third-Party Claims of Infringement.* There has been substantial industry litigation regarding patent,trademark and other intellectual property rights involving technologycompanies.  In the future, litigationmay be necessary to enforce any patents issued to us or to enforce tradesecrets, trademarks and other intellectual property rights owned by us, todefend ourselves against claimed infringement of the rights of others and todetermine the scope and validity of the proprietary rights of others.  For a description of certain pending litigationinstituted against the Company, see Item 1, Legal Proceedings of Part II, OtherInformation and Note 9 to the Consolidated Financial Statements includedherein.  Any such litigation could becostly and a diversion of management’s attention, which could adversely affectour business and operating results and our financial condition.  Adverse determinations in any suchlitigation could result in the loss of our proprietary rights, subject us tosignificant liabilities, require us to seek licenses from third parties orprevent us from manufacturing or selling our products, any of which couldadversely affect our business and operating results and our financialcondition.

* *

*Dependence on Single or Limited Source Suppliers.* The Company is dependent on single or limited source suppliers forseveral key components used in its products that have no ready substitutes,including various audio and video signal processing integrated circuitsmanufactured in each case only by Crystal Semiconductor Corp., FairchildSemiconductor Corp., Gennum Corporation, Toshiba, Kawasaki LSI USA Inc., LSILogic Corp., Philips Semiconductors or Zoran Corp.  The availability of many of these components is dependent on ourability to provide suppliers with accurate forecasts of our futurerequirements, and certain components we use to build our products have beensubject to industry-wide shortages.  Wedo not carry significant inventories of these components and have no guaranteedsupply arrangements with such suppliers. There can be no assurance that our inventory levels will be adequate tomeet 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.

* *

*Dependence on Key Personnel.*  Competitionfor employees with the skills required by us is intense in the geographic areasin which we maintain physical operations. We believe that our future success will depend on our continued abilityto attract and retain qualified employees, especially in research anddevelopment.  Any significant delay inhiring key personnel could have a material adverse affect on our business andoperating results and negatively affect the price of our common stock.

* *

*Dependenceon and competition with Apple Computer, Inc.*  As acompetitor, Apple Computer, Inc. (“Apple”) could, in the future, inhibit ourability to develop our products that operate on the Macintosh platform.  Additionally, new products and enhancementsto existing products from Apple such as Final Cut Pro could cause customers todelay purchases of our products or alter their purchase decisionaltogether.  Furthermore, as the solesupplier of Macintosh computers, any disruption in the availability of thesecomputers could cause customers to defer or alter their purchase of our products.  We rely on access to key information fromApple to continue development of our products and any failure to continuesupplying our engineers with this information could have a material adverseaffect on our business and financial results and negatively affect the price ofour common stock.

* *

*Dependenceon Microsoft Corporation.*  Many of our products operatein the Windows environment and our engineers depend upon access to informationin advance from Microsoft Corporation (“Microsoft”).  Any failure to continue supplying our engineers with thisinformation could have a material adverse affect on our business and financialresults and negatively affect the price of our common stock.

* *

*Dependence on Distributors and Resellers.* We rely primarily on our worldwide network of independent distributors andvalue-added resellers (“VARs”) to distribute and sell our products toend-users.  Our distributors andresellers generally offer products from several different companies, includingin some cases products that are competitive with our own products.  In addition, many of the VARs are smallorganizations with limited capital resources. There can be no assurance that our distributors and resellers willcontinue to purchase products from us, or that our efforts to expand ournetwork of distributors and resellers will be successful.  Any significant failure on our part tomaintain or expand our network of distributors and resellers could have amaterial adverse effect on our business and operating results and negativelyaffect the price of our common stock.

 

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*Reliance on International Sales.* International sales and operations may be subject to risks such as theimposition of government controls, export license requirements, restrictions onthe export of critical technology, less effective enforcement of proprietaryrights; currency exchange fluctuations, generally longer collection periods,political instability, trade restrictions, changes in tariffs, difficulties instaffing and managing international operations, potential insolvency ofinternational resellers and difficulty in collecting accounts receivable.  Our international sales are also subject tomore seasonal fluctuation than domestic sales. In this regard, the traditional summer vacation period, which occursduring our third fiscal quarter, may result in a decrease in sales,particularly in Europe.  There can be noassurance that these factors will not have an adverse effect on our futureinternational operations and consequently, on our business and operatingresults.  This fluctuation may bematerial and negatively affect the price of 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, and J2Digital Media. In addition, we completed the acquisition of certain assets ofIntegrated Computing Engines, Inc.  Ourbusiness and results of operations could be materially adversely affected inthe event we fail to complete publicly announced acquisitions or tosuccessfully integrate the business and operations of the merger or theacquisitions.  In the future, we maycontinue to acquire or merge with existing businesses, products, andtechnologies to enhance and expand our line of products.  Such mergers and acquisitions may bematerial in size and in scope.  Therecan be no assurance that we will be able to identify, acquire, or profitablymanage additional businesses or successfully integrate any acquired businessesinto our business without substantial expenses, delays, or other operational orfinancial problems.  Acquisitionsinvolve a number of special risks and factors, including increasing competitionfor attractive acquisition candidates in our markets, the technologicalenhancement and incorporation of acquired products into existing product linesand services, the assimilation of the operations and personnel of the acquiredcompanies, failure to retain key acquired personnel, adverse short-term effectson reported operating results, the amortization of acquired intangible assets,the assumption of undisclosed liabilities of any acquired companies, thefailure to achieve anticipated benefits such as cost savings and synergies, aswell as the diversion of management’s attention during the acquisition andintegration process.  We may not be ableto operate the acquired businesses properly and may not be able to successfullyrecover amounts paid for such businesses. Some or all of these special risks and factors may 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.

 

Similarly, we may dispose of assets, either assets wehave historically used in the business or that we have acquired. During theyear ended November 30, 2001, operations of Streamriver, which combined theacquisitions of 21st Century and J2 Digital Media, and the sale ofour streaming media software product line, comprising products acquired fromTerran and Digital Origin, were disposed. During the first quarter of 2002, the Company settled litigationresulting in the disposition of certain assets relating to our Wired products.  Our business and results of operations couldmaterially change depending on whether or not we are able to dispose of assetsin an advantageous manner.  In additionto obtaining an advantageous price for the assets to be disposed of,dispositions involve a number of special risks and factors, including searchingfor appropriate acquirers; managing the effect of the disposition on existingand proposed product lines and services, the divestiture of operations andpersonnel, 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 have a material adverse impact on ourbusiness, operating results, and financial condition and, as a result, maynegatively affect the market price of our common stock.

* *

*Historyof Losses.*  We have incurred substantial operatinglosses during the current year and in the past five fiscal years.  We incurred an operating loss fromcontinuing operations of approximately $5.9 million for the quarter endedFebruary 28, 2002 and as of February 28, 2002, we had an accumulated deficit ofapproximately $206.7 million.  Over thepast four years we have significantly increased our research and developmentexpenses as a percentage of total sales and we plan to continue to invest innew technology, and as a result, we may incur operating losses in futureperiods.  We will need to generateincreases in our current sales levels to achieve profitability and we may notbe able to do so.  If our sales growmore slowly than we anticipate or if our operating expenses increase more thanwe expect or cannot be reduced in the event of lower revenue, our business willbe significantly and adversely affected. Our failure to achieve profitability or achieve the level ofprofitability expected by investors and securities analysts may adverselyaffect the market price of our common stock.

* *

*Stock Price Volatility*.  The tradingprice of our common stock has been highly volatile and has fluctuatedsignificantly in the past.  Duringfiscal 2001, our stock price fluctuated between a low of $0.81 per share and ahigh of $3.81 per share.  We believethat the price of our common stock may continue to fluctuate significantly inthe future in response to a number of events and factors relating to ourcompany, our competitors, and the market for our products and services, many ofwhich are beyond our control, such as, variations in our quarterly operatingresults; changes in financial estimates and recommendations by securitiesanalysts; changes in market valuations of companies in our markets;announcements by us or our competitors of significant products, acquisitions,or strategic partnerships; failure to complete significant businesstransactions; departures of key personnel; purchases or sales of common stockor other securities by us; or news relating to trends in our markets.  In addition, the stock market in

 

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general, and the marketfor technology companies in particular, have experienced extreme volatilityover the past twelve months.  Thisvolatility has often been unrelated to the operating performance of particularcompanies.  These broad and industryfluctuations may adversely affect the market price of our common stock,regardless of our operating performance.

 

Item 3.    Quantitativeand Qualitative Disclosures About Market Risk

 

Derivative FinancialInstruments, Other Financial Instruments and Derivative CommodityInstruments.  The Company is not a partyto any derivative financial instruments or other financial instruments forwhich the fair value disclosure would be required under Statement of FinancialAccounting Standards No. 107*Derivative Financial Instruments, Other FinancialInstruments and Derivative Commodity Instruments* ( SFAS No. 107).  All of the Company’s investments are inshort-term, investment grade commercial paper, certificates of deposit and U.S.Government and agency securities that are carried at fair value on theCompany’s books.  Accordingly, theCompany believes that the market risk of such investments is minimal.

 

Primary Market RiskExposures.  The Company’s primary marketrisk exposures are in the area of interest rate risk and foreign currencyexchange rate risk.  The Company’sinvestment portfolio of cash equivalents is subject to interest ratefluctuations, but the Company believes this risk is immaterial due to theshort-term nature of these investments. The Company’s business in Europe is conducted in local currency.  In Asia, business is conducted in U.S.currency.  The Company has no foreignexchange contracts, option contracts or other foreign hedgingarrangements.  However, the Companyestimates that any market risk associated with its foreign operations is notsignificant and is unlikely to have a material adverse effect on the Company’sbusiness, results of operations, or financial condition.

 

PART II.  OTHERINFORMATION

 

Item 1. Legal Proceedings

 

(i) On June 7, 1995, a lawsuit was filed against theCompany by Avid Technology, Inc. (Avid) in the United States District Court forthe District of Massachusetts.  Thecomplaint generally alleges patent infringement by the Company arising from themanufacture, sale, and use of the Company’s Media 100 products.  The complaint includes requests forinjunctive relief, treble damages, interest, costs and fees.  In July 1995, the Company filed an answerand counterclaim denying any infringement and asserting that the Avid patent inquestion is invalid. The Company intends to vigorously defend the lawsuit. Inaddition, Avid is

 

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seeking reissue of the patent, including claims thatit asserts are broader than in the existing patent, and these reissueproceedings remain pending before the U.S. Patent and Trademark Office.  On January 16, 1998, the court dismissed thelawsuit without prejudice to either party moving to restore it to the docketupon completion of all matters pending before the U.S. Patent and TrademarkOffice.

 

On August 16, 2000, the U.S. Patent and TrademarkOffice issued an Office Action rejecting all of the claims made by Avid intheir latest request for reexamination of the patent related to the aforementionedlawsuit.  In addition, the Examiner atthe U.S. Patent and Trademark Office designated the action as “final”.  On November 29, 2000, Avid filed a Notice ofAppeal of the Examiner’s rejections to the U.S. Patent and Trademark OfficeBoard of Patent Appeals and Interferences. That appeal has now been fully briefed and is awaiting argument anddecision.  The litigation remainsdismissed pending the outcome of the consolidated reissue/reexaminationproceedings, and there can be no assurance that the Company will prevail in theappeal by Avid or that the expense or other effects of the appeal, whether ornot the Company prevails, will not have a material adverse effect on theCompany’s business, operating results and financial condition.

** **

(ii) On January 13, 1999 and January 28,1999, Digital Origin and one of its former directors, Charles Berger, werenamed as defendants in two shareholder class action lawsuits against SplashTechnology Holdings, Inc. (Splash), various directors and executives of Splashand certain selling shareholders of Splash. The lawsuit alleges, among other things, that the defendants made orwere responsible for material misstatements, and failed to disclose informationconcerning Splash’s business, finances and future business prospects in orderto artificially inflate the price of Splash common stock.  The complaint does not identify anystatements alleged to have been made by Charles Berger or Digital Origin.  The complaint further alleges that DigitalOrigin engaged in a scheme to artificially inflate the price of Splash commonstock to reap an artificially large return on the sale of the common stock inorder to pay off its debt.  DigitalOrigin and the former director vigorously deny all allegations of wrongdoingand intend to aggressively defend themselves in these matters. Defendant’s twoinitial motions to dismiss the action were granted with leave to amend, and plaintiffs have again amendedthe complaint.  Defendants filed theirthird motion to dismiss, which has been dismissed without leave to amend.  Plaintiffs have appealed this ruling to the9th Circuit Court of Appeals.

 

(iii) On October 12, 1999, a lawsuit was filed against the Company byMcRoberts Software, Inc. in the United States; District Court for the SouthernDistrict of Indiana.  The complaintalleges copyright infringement, breach of contract, and trade secretmisappropriation.  The complaintincludes requests for unspecified monetary damages and enhanced damages,interest, costs and fees.  Anunfavorable verdict was filed on February 25, 2002 against the Company in theamount of $2.5 million.  The Companyplans to file post-trial motions with the trial court seeking to reverse thejudgement.  If those post-trial motionsare not successful, the Company will appeal the judgement.  However, at November 30, 2001, the Companyhas recorded a liability in the amount of $2.6 million that includes estimatedlegal fees associated with the litigation.

 

(iv) On May 9, 2001, a lawsuit was filed against the Company by theformer shareholders of Wired, a company acquired by the Company in December1999 (see Note 9 of 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.

 

Subsequent to the fiscal quarter ended February 28, 2002, the Companysettled the Wired litigation.  As partof the settlement, the Company assigns all rights to the Wired product line,intellectual property relating to Wired products and remaining inventory to theformer shareholders of Wired.  Wiredagreed that no further action will be taken related to the lawsuit previouslyfiled against the Company as noted in Note 9 Contingencies.   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 Wired productsor any equivalent products incorporating the source code, technology, know howand intellectual property.  In addition,Wired agreed to pay to the Company a royalty of 5% of adjusted gross sales ofthe assigned products, not to exceed $1.2 million, plus the cost of theinventory assigned.  Litigationsettlement included in the Consolidated Statements of Operations represents thecost of inventory transferred, the net book value of remaining intangibleassets associated with the acquisition, and legal fees associated with thesettlement.

 

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(v) From time to time the Company is involved in other disputes and/orlitigation encountered in its normal course of business.  The Company does not believe that theultimate impact of the resolution of such other outstanding matters will have amaterial effect on the Company’s business, operating results or financialcondition.

 

Item 6. Exhibits and Reports on Form 8-K

 

a)  Exhibits

 

Exhibits requiredas part of this Quarterly Report on Form 10-Q are listed on the exhibit indexon page 26.

 

b)  Reports on Form 8-K

 

There were no reports on Form 8-K during the quarter ended February 28,2002.

 

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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:  | April 15, 2002 | By:            | /s/ Steven D. Shea |   |
|   |           |           | Steven D. Shea |
|   |           |           | Chief Financial Officer  and |
|   |           |           | Treasurer |
|   |           |           | (Principal Financial  Officer) |
|        |                |                |  |  |  |  |

 

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EXHIBIT INDEX

 
| **Number** |   | **Description**      |
|------------|--------|----------------------|
| 10.26      |   | Settlement agreement |

 

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