**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

**           ****ý        QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF**

**                                    THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For The QuarterlyPeriod Ended:     May 31, 2002**

** **

**           ****o        TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF**

**                                    THE SECURITIES EXCHANGE ACT OF 1934**

 

**For TheTransition Period From**     **To**

** **

**CommissionFile Number: 0-14779**

 

| **MEDIA 100 INC.**                                             |
|----------------------------------------------------------------|
| (Exact name of  registrant as specified in its charter)        |
|                                                           |   |   |
| **DELAWARE**                                                   |   | **04-2532613** |
| (State or other jurisdiction  of organization                  |   | (I.R.S. Employer  Identification Number) |
| or incorporation)                                              |   |   |
|                                                           |   |   |
|                                                           |
| **450 DONALD LYNCH BOULEVARD**

**MARLBOROUGH, MASSACHUSETTS** |   | **01752-4748** |
| (Address of principal  executive offices)                      |   | (Zip code) |
|                                                           |
|                                                           |
|                                                           |   |   |
| **(508)  460-1600**                                            |
| (Registrant’s telephone  number, including area code)     |

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.               Yes ý     No o

 

                Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the                                              latest practicable date.

 

| Class                                   |   | Outstanding at July 1,  2002 |
|-----------------------------------------|--------|------------------------------|
| Common Stock, par value  $.01 per share |   | 12,834,411 shares            |

 

----

MEDIA 100 INC.

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

 

2

----

 

PART I — FINANCIALINFORMATION

 

MEDIA 100 INC.

CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)

 

 
|                                                |   | **May 31,** |   | **November  30,** |   |
|-----------------------------------------------------|--------|-------------|--------|-------------------|--------|
|                                                |   | **2002**    |   | **2001**          |   |
| ASSETS                                              |   |        |   |              |   |
| Current assets:                                     |   |        |   |              |   |
| Cash and cash  equivalents                          |   | $           | 5,911  |              | $      | 17,369 |   |
| Available for  sale securities, at fair value       |   | 250         |   | 241               |   |
| Restricted cash  (Notes 4 and 9)                    |   | 3,170       |   | —            |   |
| Due from escrow  (Notes 4 and 14)                   |   | 2,000       |   | 2,000             |   |
| Accounts  receivable, net of allowance for doubtful |   |        |   |              |   |
| accounts of $466  in 2002 and $512 in 2001          |   | 3,073       |   | 2,907             |   |
| Inventories, net                                    |   | 2,647       |   | 1,220             |   |
| Prepaid expenses  and other current assets          |   | 852         |   | 706               |   |
| Total current  assets                               |   | 17,903      |   | 24,443            |   |
|                                                |   |        |   |              |   |
| Property and  equipment, net                        |   | 2,465       |   | 3,843             |   |
| Intangible  assets, net                             |   | 418         |   | 1,880             |   |
|                                                |   |        |   |              |   |
| Total assets                                        |   | $           | 20,786 |              | $      | 30,166 |   |
|                                                |   |        |   |              |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY          |   |        |   |              |   |
| Current  liabilities:                               |   |        |   |              |   |
| Accounts payable                                    |   | $           | 2,374  |              | $      | 1,490 |   |
| Accrued expenses                                    |   | 7,074       |   | 8,000             |   |
| Deferred revenue                                    |   | 3,670       |   | 3,812             |   |
| Total current  liabilities                          |   | 13,118      |   | 13,302            |   |
|                                                |   |        |   |              |   |
| Contingencies  (Note 9)                             |   | —      |   | —            |   |
|                                                |   |        |   |              |   |
| Stockholders’  equity:                         |   |        |   |              |   |
| Common stock                                        |   | 131         |   | 126               |   |
| Capital in  excess of par value                     |   | 218,093     |   | 217,683           |   |
| Accumulated  deficit                                |   | (210,389    | )      | (200,836          | )      |
| Treasury stock,  at cost                            |   | (78         | )      | (78               | )      |
| Accumulated  other comprehensive loss               |   | (89         | )      | (31               | )      |
| Total  stockholders’ equity                    |   | 7,668       |   | 16,864            |   |
|                                                |   |        |   |              |   |
| Total  liabilities and stockholders’ equity    |   | $           | 20,786 |              | $      | 30,166 |   |

 

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

 

3

----

 

MEDIA 100 INC.

CONSOLIDATED STATEMENTSOF OPERATIONS

(in thousands, except pershare data)

(unaudited)

 
|                                                                |   | **Three  Months Ended May 31,** |   | **Six Months  Ended May 31,** |   |
|---------------------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                                |   | **2002**                        |   | **2001**                      |   | **2002** |   | **2001** |   |
| Net sales:                                                          |   |                            |   |                          |   |   |   |   |   |
| Products                                                            |   | $                               | 5,079  |                          | $      | 5,716 |   | $ | 7,931 |   | $ | 12,779 |   |
| Services                                                            |   | 1,500                           |   | 2,308                         |   | 3,146 |   | 4,840 |   |
| Total net sales                                                     |   | 6,579                           |   | 8,024                         |   | 11,077 |   | 17,619 |   |
|                                                                |   |                            |   |                          |   |   |   |   |   |
| Cost of sales                                                       |   | 3,303                           |   | 4,591                         |   | 5,541 |   | 8,899 |   |
| Accelerated  depreciation and amortization of fixed assets (Note 6) |   | 84                              |   | —                        |   | 331 |   | — |   |
| Gross profit                                                        |   | 3,192                           |   | 3,433                         |   | 5,205 |   | 8,720 |   |
|                                                                |   |                            |   |                          |   |   |   |   |   |
| Operating  expenses:                                                |   |                            |   |                          |   |   |   |   |   |
| Research and  development                                           |   | 2,559                           |   | 2,788                         |   | 5,126 |   | 5,366 |   |
| Selling and  marketing                                              |   | 2,716                           |   | 3,591                         |   | 4,964 |   | 7,090 |   |
| General and  administrative                                         |   | 1,427                           |   | 1,179                         |   | 2,534 |   | 2,671 |   |
| Amortization and  write-off of intangible assets                    |   | 273                             |   | 480                           |   | 765 |   | 1,940 |   |
| Accelerated  depreciation and amortization of fixed assets (Note 6) |   | 215                             |   | —                        |   | 849 |   | — |   |
| Settlement of  litigation (Notes 7 and 9)                           |   | —                          |   | —                        |   | 924 |   | — |   |
| Restructuring  charge                                               |   | —                          |   | 568                           |   | — |   | 568 |   |
| Total operating  expenses                                           |   | 7,190                           |   | 8,606                         |   | 15,162 |   | 17,635 |   |
| Operating loss                                                      |   | (3,998                          | )      | (5,173                        | )      | (9,957 | ) | (8,915 | ) |
|                                                                |   |                            |   |                          |   |   |   |   |   |
| Interest income,  net                                               |   | 37                              |   | 64                            |   | 115 |   | 171 |   |
| Other income  (expense), net                                        |   | 270                             |   | (578                          | )      | 187 |   | (264 | ) |
| Loss from  continuing operations before benefit from income taxes   |   | (3,691                          | )      | (5,687                        | )      | (9,655 | ) | (9,008 | ) |
| Benefit from  income taxes                                          |   | —                          |   | —                        |   | (102 | ) | — |   |
| Loss from  continuing operations                                    |   | (3,691                          | )      | (5,687                        | )      | (9,553 | ) | (9,008 | ) |
| Loss from  discontinued operations                                  |   | —                          |   | (1,122                        | )      | — |   | (1,797 | ) |
| Net loss                                                            |   | $                               | (3,691 | )                             | $      | (6,809 | ) | $ | (9,553 | ) | $ | (10,805 | ) |
|                                                                |   |                            |   |                          |   |   |   |   |   |
| Loss per share:                                                     |   |                            |   |                          |   |   |   |   |   |
| Basic                                                               |   |                            |   |                          |   |   |   |   |   |
| Continuing  operations                                              |   | $                               | (0.29  | )                             | $      | (0.46 | ) | $ | (0.75 | ) | $ | (0.73 | ) |
| Discontinued  operations                                            |   | $                               | — |                          | $      | (0.09 | ) | $ | — |   | $ | (0.15 | ) |
| Total                                                               |   | $                               | (0.29  | )                             | $      | (0.55 | ) | $ | (0.75 | ) | $ | (0.88 | ) |
| Diluted                                                             |   |                            |   |                          |   |   |   |   |   |
| Continuing  operations                                              |   | $                               | (0.29  | )                             | $      | (0.46 | ) | $ | (0.75 | ) | $ | (0.73 | ) |
| Discontinued  operations                                            |   | $                               | — |                          | $      | (0.09 | ) | $ | — |   | $ | (0.15 | ) |
| Total                                                               |   | $                               | (0.29  | )                             | $      | (0.55 | ) | $ | (0.75 | ) | $ | (0.88 | ) |
| Weighted average  common shares outstanding:                        |   |                            |   |                          |   |   |   |   |   |
| Basic                                                               |   | 12,784                          |   | 12,359                        |   | 12,710 |   | 12,346 |   |
| Diluted                                                             |   | 12,784                          |   | 12,359                        |   | 12,710 |   | 12,346 |   |

 

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

 

4

----

 

 

MEDIA 100 INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 
|                                                                                                     |   | **Six Months  Ended** |   |
|----------------------------------------------------------------------------------------------------------|--------|-----------------------|--------|
|                                                                                                     |   | **May 31,  2002**     |   | **May 31,  2001** |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                                   |   |                  |   |   |   |
| Net loss                                                                                                 |   | $                     | (9,553 | ) | $ | (10,805 | ) |
| Net loss from  discontinued operations                                                                   |   | —                |   | 1,797 |   |
| (Loss) from  continuing operations                                                                       |   | (9,553                | )      | (9,008 | ) |
| Adjustments to  reconcile net loss from continuing operations to net cash used in operating  activities: |   |                  |   |   |   |
| Depreciation and  amortization                                                                           |   | 2,271                 |   | 1,521 |   |
| Non-cash settlement  of litigation                                                                       |   | 924                   |   | — |   |
| Amortization and  write-off of intangible assets                                                         |   | 765                   |   | 1,940 |   |
| Loss on sale of  marketable securities                                                                   |   | —                |   | 15 |   |
| Changes in  assets and liabilities:                                                                      |   |                  |   |   |   |
| Restricted cash                                                                                          |   | (3,170                | )      | — |   |
| Accounts  receivable                                                                                     |   | (166                  | )      | 1,702 |   |
| Inventories                                                                                              |   | (1,518                | )      | 848 |   |
| Prepaid expenses  and other current assets                                                               |   | (146                  | )      | 61 |   |
| Accounts payable                                                                                         |   | 884                   |   | (1,638 | ) |
| Accrued expenses                                                                                         |   | (1,100                | )      | 312 |   |
| Deferred revenue                                                                                         |   | (142                  | )      | (656 | ) |
| Net cash used in  operating activities                                                                   |   | (10,951               | )      | (4,903 | ) |
|                                                                                                     |   |                  |   |   |   |
| Net cash used in  discontinued operations                                                                |   | —                |   | (1,099 | ) |
|                                                                                                     |   |                  |   |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                                   |   |                  |   |   |   |
| Net purchases of  equipment                                                                              |   | (822                  | )      | (627 | ) |
| Purchase of  intangible assets                                                                           |   | (33                   | )      | (75 | ) |
| Net proceeds  from sales of marketable securities                                                        |   | (9                    | )      | 4,572 |   |
| Net cash  provided by (used in) investing activities                                                     |   | (864                  | )      | 3,870 |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                                   |   |                  |   |   |   |
| Payment on note  payable                                                                                 |   | —                |   | (1,492 | ) |
| Purchase of  treasury stock                                                                              |   | —                |   | (78 | ) |
| Proceeds from  issuance of common stock                                                                  |   | 415                   |   | 225 |   |
| Net cash  provided by (used in) financing activities                                                     |   | 415                   |   | (1,345 | ) |
| EFFECT OF  EXCHANGE RATE CHANGES ON CASH                                                                 |   | (58                   | )      | 77 |   |
| NET DECREASE IN  CASH AND CASH EQUIVALENTS                                                               |   | (11,458               | )      | (3,400 | ) |
| CASH AND CASH  EQUIVALENTS, beginning of period                                                          |   | 17,369                |   | 11,987 |   |
| CASH AND CASH  EQUIVALENTS, end of period                                                                |   | $                     | 5,911  |   | $ | 8,587 |   |
|                                                                                                     |   |                  |   |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                                                       |   |                  |   |   |   |
| Cash received  for income taxes                                                                          |   | $                     | (102   | ) | $ | (42 | ) |
| OTHER  TRANSACTIONS NOT USING CASH:                                                                      |   |                  |   |   |   |
| Change in value  of marketable securities                                                                |   | $                     | — |   | $ | (88 | ) |

 

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

 

5

----

 

MEDIA 100 INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.

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

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 arecarried at cost, which approximates fair market value, and have originalmaturities of less than ninety days. Cash equivalents include money market accounts and repurchase agreementswith overnight maturities. Approximately $388,000 of the cash and cash equivalents is restrictedunder various letters of credit and is classified as restricted cash in theaccompanying balance sheet at May 31, 2002.

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

 

On October 5, 2001, theCompany sold its streaming media software product line to Autodesk, Inc. for$16.0 million in cash, of which $2.0 million was deposited into an escrowaccount for a period of one year in case indemnification issues arise.  The amount is classified as due from escrowon the accompanying balance sheet at May 31, 2002 and November 30, 2001,respectively.

 

6

----

 

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

 

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

 
| **Investments available for sale:**   |   | **Maturity** |   |   |   | **May 31,** |   | **November  30,** |   |
|---------------------------------------|--------|--------------|--------|--------|--------|-------------|--------|-------------------|--------|
|                                  |   |         |   |   |   | **2002**    |   | **2001**          |   |
|                                  |   |         |   |   |   |        |   |              |   |
| Corporate  Obligations                |   | 1-5 years    |   |   |   | $           | 250    |              | $      | 241 |   |
|                                  |   |         |   |   |   |        |   |              |   |
| Total  investments available for sale |   |         |   |   |   | $           | 250    |              | $      | 241 |   |

 

Securities had acost and market value of $250 and $241 at May 31, 2002 and November 30, 2001,respectively.

5.  Inventories

Inventories arestated at the lower of first-in, first-out (FIFO) cost or market and consist ofthe following (in thousands): 
|            |   | **May 31,** |   | **November  30,** |   |
|-----------------|--------|-------------|--------|-------------------|--------|
|            |   | **2002**    |   | **2001**          |   |
| Raw materials   |   | $           | 1,543  |              | $      | 811 |   |
| Work-in-process |   | 368         |   | 161               |   |
| Finished goods  |   | 736         |   | 248               |   |
|            |   | $           | 2,647  |              | $      | 1,220 |   |

 

Work-in-processand finished goods inventories include material, labor and manufacturingoverhead. Management performs periodic reviews of inventory and disposes of itemsnot required by their manufacturing plan.

6. Property andEquipment, net

Property and equipment,net, at May 31, 2002 and November 30, 2001 is stated at cost, less accumulateddepreciation and amortization, and consists of the following (in thousands):
|                                            |   | **May 31,** |   | **November  30,** |   |
|-------------------------------------------------|--------|-------------|--------|-------------------|--------|
|                                            |   | **2002**    |   | **2001**          |   |
| Machinery and  equipment                        |   | $           | 4,392  |              | $      | 4,169 |   |
| Purchased  software                             |   | 1,677       |   | 1,666             |   |
| Furniture and  fixtures                         |   | 55          |   | 908               |   |
| Leasehold  improvements                         |   | 604         |   | 1,728             |   |
|                                            |   | $           | 6,728  |              | $      | 8,471 |   |
| Less accumulated  depreciation and amortization |   | (4,263      | )      | (4,628            | )      |
|                                            |   | $           | 2,465  |              | $      | 3,843 |   |

 

7

----

 

In connection with thesigning of an amendment to the lease of the Company’s principal facility inMarlborough, MA in January 2002, the Company revised the estimated useful lifeof leasehold improvements and certain furniture and fixtures that weren’t movedto the new facility. This charge has been reflected as accelerated depreciationand amortization of fixed assets in the accompanying Consolidated Statements ofOperations.    Amounts classified asleasehold improvements and furniture and fixtures are additions during thequarter ended May 31, 2002 for the Company’s new principal facility.

7. IntangibleAssets

Intangible assets,net at May 31, 2002 and November 30, 2001 consist of the following (inthousands):
|                           |   | **May 31,** |   | **November  30,** |   |
|--------------------------------|--------|-------------|--------|-------------------|--------|
|                           |   | **2002**    |   | **2001**          |   |
| Patents and  Trademarks        |   | $           | 487    |              | $      | 454 |   |
| Acquired  Technology           |   | 1,000       |   | 1,900             |   |
| Goodwill                       |   | 1,225       |   | 2,757             |   |
|                           |   | $           | 2,712  |              | $      | 5,111 |   |
| Less accumulated  amortization |   | (2,294      | )      | (3,231            | )      |
|                           |   | $           | 418    |              | $      | 1,880 |   |

 

Patentsand trademarks are being amortized over three years. The Company amortizesgoodwill and developed acquired technology related to its acquisitions using astraight-line method over periods ranging from 2 to 3 years, their estimateduseful life.

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

Duringthe six months ended May 31, 2002, the Company settled litigation broughtagainst it by the former shareholders of Wired, Inc. (“Wired”), a Companyacquired by the Company in December 1999 (See Note 9 Contingencies).  As part of the settlement, the Companyassigned all rights to the Wired product line, intellectual property relatingto Wired products and on-hand inventory related to the Wired product line tothe former shareholders.  Wired agreedthat no further action will be taken related to the lawsuit previously filedagainst the Company as noted in Note 9 Contingencies.   Wired granted the Company an irrevocable license to use thesource code, technology, know how and intellectual property; provided, however,the license does not include the right to sell Wired products or any equivalentproducts incorporating the source code, technology, know how and intellectualproperty.  In addition, Wired agreed topay the Company a royalty of 5% of adjusted gross sales of the assignedproducts, not to exceed $1.2 million, plus the cost of the inventoryassigned.  Litigation settlementincluded in the Consolidated Statements of Operations 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 Companycomputes net loss per share pursuant to SFAS No. 128, *Earnings Per Share*.  In accordance with SFAS No. 128, basic netloss per share is computed by dividing net income (loss) available for commonshareholders by the weighted-average number of common shares outstanding duringthe period.  Diluted net income (loss)per share is computed dividing the net loss available for common stockholdersby the weighted-average number of common shares outstanding, includingpotential common shares from the assumed exercise of stock options and warrantsoutstanding during the period, if any, using the treasury stock method.

 

8

----

 

Options to purchaseapproximately 1,784,000 and 1,566,000 weighted average shares of common stockhave been excluded from the computation of diluted average shares outstandingat May 31, 2002 and 2001, respectively, as the effect of their inclusion wouldhave been antidilutive.

9.  Contingencies

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

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

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

**(iii) On January 13, 1999 and January 28, 1999, DigitalOrigin and one of its former directors, Charles Berger, were named asdefendants in two shareholder class action lawsuits against Splash TechnologyHoldings, Inc. (Splash), various directors and executives of Splash and certainselling shareholders of Splash.  Thelawsuit alleges, among other things, that the defendants made or wereresponsible 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, andplaintiffs have again amended the complaint. Defendants filed their third motion to dismiss, which has been dismissedwithout leave to amend.  Plaintiffs haveappealed this ruling to the 9th Circuit Court of Appeals.**

** **

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

 

9

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

 

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

 

During the six months ended May 31, 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 productsincorporating the source code, technology, know how and intellectualproperty.  In addition, Wired promisedto pay 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.

 

(vi) From time to time the Company is involved inother disputes and/or litigation 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.

 

10. Income Taxes

The Companyrecorded an income tax benefit of $102,000 during the six months ended May 31,2002 as the Company received a refund from the U.S. Government related to aprior period payment.

11.  Accrued Expenses

Accrued expensesat May 31, 2002 and November 30, 2001 consist of the following (in thousands):

 
|                                     |   | **May 31,** |   | **November  30,** |   |
|------------------------------------------|--------|-------------|--------|-------------------|--------|
|                                     |   | **2002**    |   | **2001**          |   |
| Payroll, payroll  taxes and other taxes  |   | $           | 694    |              | $      | 942 |   |
| Accrued warranty                         |   | 525         |   | 561               |   |
| Accrued  restructuring                   |   | 264         |   | 527               |   |
| Accrued  inventory                       |   | 558         |   | 323               |   |
| Accrued legal  and professional services |   | 3,403       |   | 3,067             |   |
| Accrued selling  and marketing           |   | 234         |   | 361               |   |
| Accrued other                            |   | 1,396       |   | 2,219             |   |
|                                     |   | $           | 7,074  |              | $      | 8,000 |   |

 

10

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12.  Comprehensive loss

 

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

 
|                                                      |   | **Three  months ended May 31,** |   | **Six months  ended May 31,** |   |
|-----------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                      |   | **2002**                        |   | **2001**                      |   | **2002** |   | **2001** |   |
|                                                      |   |                            |   |                          |   |   |   |   |   |
| Net loss                                                  |   | $                               | (3,691 | )                             | $      | (6,809 | ) | $ | (9,553 | ) | $ | (10,805 | ) |
|                                                      |   |                            |   |                          |   |   |   |   |   |
| Cumulative  translation adjustment                        |   | (88                             | )      | —                        |   | (58 | ) | (11 | ) |
| Unrealized  holding gain on available for sale securities |   | —                          |   | 42                            |   | — |   | 88 |   |
|                                                      |   |                            |   |                          |   |   |   |   |   |
| Total  comprehensive loss                                 |   | $                               | (3,779 | )                             | $      | (6,767 | ) | $ | (9,611 | ) | $ | (10,728 | ) |

 

13.  Segment Information

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

 

11

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**Theaccounting policies of the segments are the same as those described in thesummary of significant accounting policies. Net sales are attributed to geographic areas based on where the customeris located.  Segment information for thethree and six months ended May 31, 2002 and May 31, 2001 is as follows:**
|                                   |   | **Digital**

**Video**

**Systems** |         |   |          |   |      |   |   |
|----------------------------------------|--------|-------------------------------------|--------------|--------|---------------|--------|-----------|--------|--------|
|                                   |   |                                |         |   |          |   |      |   |
| ***Three months  ended May 31, 2002*** |   |                                | **Services** |   | **Corporate** |   | **Total** |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Net sales from  external customers     |   | $                                   | 5,079        |   | $             | 1,500  |      | $      | — |   | $ | 6,579 |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Gross profit                           |   | 1,965                               |         | 1,227  |          | — |      | 3,192  |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Depreciation and  amortization         |   | 806                                 |         | 10     |          | — |      | 816    |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Interest income,  net                  |   | —                              |         | — |          | 37     |      | 37     |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| ***Six months ended May 31, 2002***    |   |                                |         |   |          |   |      |   |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Net sales from  external customers     |   | $                                   | 7,931        |   | $             | 3,146  |      | $      | — |   | $ | 11,077 |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Gross profit                           |   | 2,634                               |         | 2,571  |          | — |      | 5,205  |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Depreciation and  amortization         |   | 2,246                               |         | 25     |          | — |      | 2,271  |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Interest income,  net                  |   | —                              |         | — |          | 115    |      | 115    |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| ***Three months ended May 31, 2001***  |   |                                |         |   |          |   |      |   |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Net sales from  external customers     |   | $                                   | 5,716        |   | $             | 2,308  |      | $      | — |   | $ | 8,024 |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Gross profit                           |   | 1,645                               |         | 1,788  |          | — |      | 3,433  |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Depreciation and  amortization         |   | 644                                 |         | 72     |          | — |      | 716    |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Interest income,  net                  |   | —                              |         | — |          | 64     |      | 64     |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| ***Six months ended May 31, 2001***    |   |                                |         |   |          |   |      |   |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Net sales from  external customers     |   | $                                   | 12,779       |   | $             | 4,840  |      | $      | — |   | $ | 17,619 |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Gross profit                           |   | 5,125                               |         | 3,595  |          | — |      | 8,720  |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Depreciation and  amortization         |   | 1,382                               |         | 139    |          | — |      | 1,521  |   |
|                                   |   |                                |         |   |          |   |      |   |   |
| Interest income,  net                  |   | —                              |         | — |          | 171    |      | 171    |   |

 

 

12

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

Netsales by geographic area for the quarters ended May 31, 2002 and 2001 were asfollows (in thousands):
|                                        |   | **Three  months ended** |   |
|---------------------------------------------|--------|-------------------------|--------|
|                                        |   | **May 31,  2002**       |   | **May 31,  2001** |   |
|                                        |   |                    |   |   |   |
| North America                               |   | $                       | 3,695  |   | $ | 5,425 |   |
| United Kingdom,  Sweden, Denmark and Norway |   | 894                     |   | 1,006 |   |
| France, Spain  and Benelux                  |   | 396                     |   | 440 |   |
| Germany, Austria  and Switzerland           |   | 400                     |   | 256 |   |
| Asia, Japan and  other foreign countries    |   | 1,194                   |   | 897 |   |
|                                        |   |                    |   |   |   |
|                                        |   | $                       | 6,579  |   | $ | 8,024 |   |

 
|                                        |   | **Six months  ended** |   |
|---------------------------------------------|--------|-----------------------|--------|
|                                        |   | **May  31,2002**      |   | **May 31,  2001** |   |
|                                        |   |                  |   |   |   |
| North America                               |   | $                     | 6,474  |   | $ | 11,932 |   |
| United Kingdom,  Sweden, Denmark and Norway |   | 1,367                 |   | 1,982 |   |
| France, Spain  and Benelux                  |   | 633                   |   | 1,286 |   |
| Germany, Austria  and Switzerland           |   | 588                   |   | 548 |   |
| Asia, Japan and  other foreign countries    |   | 2,015                 |   | 1,871 |   |
|                                        |   |                  |   |   |   |
|                                        |   | $                     | 11,077 |   | $ | 17,619 |   |

 

Long-livedtangible assets by geographic area for the quarters ended May 31, 2002 andNovember 30, 2001 consist of the following (in thousands):
|           |   | **May 31,  2002** |   | **November  30, 2001** |   |
|----------------|--------|-------------------|--------|------------------------|--------|
|           |   |              |   |                   |   |
| United States  |   | $                 | 2,258  |                   | $      | 3,651 |   |
| United Kingdom |   | 140               |   | 123                    |   |
| Germany        |   | 18                |   | 1                      |   |
| France         |   | 49                |   | 68                     |   |
|           |   |              |   |                   |   |
|           |   | $                 | 2,465  |                   | $      | 3,843 |   |

 

14.Discontinued Operations

On October 5, 2001, theCompany sold its streaming media software product line to Autodesk, Inc. for$16.0 million in cash, of which $2 million is due from escrow and is payable onOctober 5, 2002. The Company’s streaming media software product line consistedof products acquired in the Terran acquisition and the merger with DigitalOrigin.

 

13

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The net loss from theseoperations is included in the accompanying statements of operations under “Lossfrom discontinued operations”. Operating results of the software product line for the three and sixmonths ended May 31, 2002 and 2001 are as follows (in thousands):

 
|                                  |   | **Three  months ended May 31,** |   | **Six months  ended May 31,** |   |
|---------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                  |   | **2002**                        |   | **2001**                      |   | **2002** |   | **2001** |   |
|                                  |   |                            |   |                          |   |   |   |   |   |
| Net sales of  discontinued operations |   | $                               | — |                          | $      | 4,079 |   | $ | — |   | $ | 8,327 |   |
|                                  |   |                            |   |                          |   |   |   |   |   |
| Loss from  discontinued operations    |   | $                               | — |                          | $      | (1,122 | ) | $ | — |   | $ | (1,797 | ) |

 

15.         New Accounting Standards

 

Emerging Issues TaskForce (EITF) Issue No. 01-09 (“Issue”), “*Accounting for Consideration Given by a Vendor to aCustomer or a Reseller of the Vendor’s Products,”*issued duringNovember 2001, codifies previously issued EITF Issue No. 00-25, “*VendorIncome Statement Characterization of Consideration Paid to a Reseller of theVendor’s Products.”* EITF Issue No. 00-25 addresses various aspectsof the accounting for consideration given by a vendor to a customer or areseller of the vendor’s products. Consideration includes sales incentives such as discounts, coupons,rebates, free products or services, slotting fees, coop advertising and buydowns.  Pursuant to EITF 00-25, such considerationis presumed to be a reduction of revenue unless certain criteria are met.  The Issue should be applied no later than inannual or interim financial statements for periods beginning after December 15,2001 and requires retroactive restatement. The Company previously recorded coopadvertising expenses and other sales incentives to resellers within selling andmarketing expense in the statement of operations.  The Company adopted EITF Issue No. 01-09 in the first quarterended February 28, 2002.  As a result,the Company has recorded $10,000 as an increase to product sales for the threemonths ended May 31, 2002 and $3,000 as a reduction to product sales for thesix months ended May 31, 2002, respectively. Additionally, the Company reclassified $ 94,000 and $143,000 asreductions of product sales that were previously classified as selling andmarketing expenses for the three and six months ended May 31, 2001,respectively.

 

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 $14,000 and $21,000 as product sales for the three and sixmonths ended May 31, 2002, respectively. Additionally, the Company reclassified $33,000 and $76,000 as productsales that were previously classified as reductions to cost of sales for thethree and six months ended May 31, 2001, respectively.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL

CONDITION ANDRESULTS OF OPERATIONS

 

###### **Overview**

**Thefollowing discussion and analysis of our financial condition and results ofoperations should be read in conjunction with our consolidated financialstatements and the related notes appearing elsewhere in this report. Thediscussion and analysis contains forward-looking statements that involve risks,uncertainties and assumptions.  Thepreparation of these financial statements and related discussions requiresmanagement to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenue and expenses, and the related disclosure ofcontingent assets and liabilities.  Onan on-going basis, we evaluate our estimates including those related to productreturns, bad debts, inventories, contingencies and litigation.  We base our estimates on historicalexperience and on various other assumptions that are believed to be reasonableunder the circumstances. Our actual results may differ materially from thoseanticipated in these forward-looking statements as a result of a number offactors, including those set forth under “Cautionary Statements” and elsewherein this report.**

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

Digital Origin Merger andOther Acquisitions

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

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

On October 5, 2001, we sold our streaming media software product lineto Autodesk, Inc. for $16.0 million in cash, of which $2.0 million wasdeposited into an escrow account for a period of one year in caseindemnification issues arise.  The netloss from these operations is included in the accompanying statements ofoperations under “discontinued operations” (see Note 14 to the ConsolidatedFinancial Statements included herein).

 

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**Results of Operations**

The following table shows certain consolidatedstatements of operations data as a percentage of net sales.
|                                                                |   | **Three  months ended May 31,** |   | **Six months  ended May 31,** |   |
|---------------------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                                |   | **2002**                        |   | **2001**                      |   | **2002** |   | **2001** |   |
| Net sales:                                                          |   |                            |   |                          |   |   |   |   |   |
| Products                                                            |   | 77.2                            | %      | 71.2                          | %      | 71.6 | % | 72.5 | % |
| Services                                                            |   | 22.8                            |   | 28.8                          |   | 28.4 |   | 27.5 |   |
| Total net sales                                                     |   | 100.0                           |   | 100.0                         |   | 100.0 |   | 100.0 |   |
| Cost of sales                                                       |   | 50.2                            |   | 57.2                          |   | 50.0 |   | 50.5 |   |
| Accelerated  depreciation and amortization of fixed assets (Note 6) |   | 1.3                             |   | —                        |   | 3.0 |   | — |   |
| Gross profit                                                        |   | 48.5                            |   | 42.8                          |   | 47.0 |   | 49.5 |   |
| Operating  expenses:                                                |   |                            |   |                          |   |   |   |   |   |
| Research and  development                                           |   | 38.9                            |   | 34.7                          |   | 46.3 |   | 30.5 |   |
| Selling and  marketing                                              |   | 41.3                            |   | 44.8                          |   | 44.8 |   | 40.2 |   |
| General and  administrative                                         |   | 21.7                            |   | 14.7                          |   | 22.9 |   | 15.2 |   |
| Amortization and  write-off of intangible assets                    |   | 4.1                             |   | 6.0                           |   | 6.9 |   | 11.0 |   |
| Accelerated  depreciation and amortization of fixed assets (Note 6) |   | 3.3                             |   | —                        |   | 7.7 |   | — |   |
| Settlement of  litigation (Note 7 and 9)                            |   | —                          |   | —                        |   | 8.3 |   | — |   |
| Restructuring  charge                                               |   | —                          |   | 7.1                           |   | 3.2 |   |   |   |
| Total operating  expenses                                           |   | 109.3                           |   | 107.3                         |   | 136.9 |   | 100.1 |   |
| Operating loss                                                      |   | (60.8                           | )      | (64.5                         | )      | (89.9 | ) | (50.6 | ) |
| Interest income,  net                                               |   | 0.6                             |   | 0.8                           |   | 1.0 |   | 1.0 |   |
| Other income  (expense), net                                        |   | 4.1                             |   | (7.2                          | )      | 1.7 |   | (1.5 | ) |
| Loss from  continuing operations                                    |   | (56.1                           | )      | (70.9                         | )      | (87.2 | ) | (51.1 | ) |
| Benefit from  income taxes                                          |   | —                          |   | —                        |   | (1.0 | ) | — |   |
| Loss from  continuing operations                                    |   | (56.1                           | )      | (70.9                         | )      | (86.2 | ) | (51.1 | ) |
| Loss from  discontinued operations                                  |   | —                          |   | (14.0                         | )      | — |   | (10.2 | ) |
| Net loss                                                            |   | (56.1                           | )%     | (84.9                         | )%     | (86.2 | )% | (61.3 | )% |

 

Comparisonof Second Fiscal Quarter of 2002 to Second Fiscal Quarter of 2001

Net sales.  Total net sales for the second fiscalquarter ended May 31, 2002 decreased 18.0% to $6.6 million from $8.0 millionfor the second quarter of fiscal 2001. Net sales from products for the second fiscal quarter of 2002 decreased11.1% to $5.1 million from $5.7 million for the second quarter of fiscal 2001.  The decrease in net sales from products isdue to a number of factors including increased competition for our digitalvideo systems resulting in lower unit sales and average selling prices ($2.8million), and lower sales of the MPEG-based products acquired in theacquisition of Wired, Inc. (“Wired”)($400,000).  These decreases were partially offset by sales of our new contentdesign system, 844/X ($2.6 million), which began shipping in April 2002.  We anticipate this trend of loweryear-over-year sales of our digital video systems to continue for the remainderof this year, partially offset by sales from 844/X.  In addition, as part of the settlement of litigation with theformer shareholders of Wired, dated April 15, 2002, we will no longer sell theWired MPEG-based products.  Sales of theWired product line for the second quarter ended May 31, 2002 were approximately$100,000.  Net sales from services forthe second fiscal quarter ended May 31, 2002 decreased 35.0% to $1.5 millionfrom $2.3 million for the second quarter of fiscal 2001.  The decrease in net sales from services isdue to lower sales of service contracts to support our digital video systems($800,000).

Gross profit.  Gross profit decreased 7.0% to $3.2 millionin the second fiscal quarter of 2002 from $3.4 million in the second quarter offiscal 2001.  Overall gross profit as apercentage of net sales increased to 48.5% in the second fiscal quarter of 2002from 42.8% in the second quarter of fiscal 2001.  Specifically, gross profit as a percentage of net product salesincreased to 38.7% in the second fiscal quarter of 2002 from 28.8% in thesecond quarter of fiscal 2001, while gross profit as a percentage of net salesof services increased to 81.8% in the second fiscal quarter of 2002 from 77.5%in the second quarter of fiscal 2001. The increase in gross profit as a percentage of net sales of servicesresulted from lower expenses in support of customers, partially offset by ourlower sales of services.  Gross profitas a percentage of net product sales increased due to lower manufacturingexpenses, partially offset by a charge for accelerated depreciation.  The accelerated depreciation charge, relatedprimarily to leasehold improvements, was due to our decision to relocate ourfacility to a new location better suited to meet our needs.  We currently forecast overall 

 

16

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gross profit as apercentage of net sales will remain relatively constant over the next severalquarters however, due to potential fluctuations in the mix of products sold,gross profit as a percentage of net sales may vary from one quarter to another.

Research anddevelopment.  Research and developmentexpenses decreased 8.2% to $2.6 million in the second fiscal quarter of 2002from $2.8 million in the second quarter of fiscal 2001.  Research and development expenses consistprimarily of salaries and related benefits for our personnel, consultants,outside services, occupancy and depreciation. At this time, we anticipateresearch and development expenses will decrease over the next several quartersdue to the completion of the development effort related to the first version ofour recently introduced content design system, 844/X.  We plan to continue to invest a significant amount of ourresources into further development of 844/X; however, for the second half offiscal 2002, we do not anticipate this future development to be as costly asthe development costs associated with the first version of 844/X.

Selling andmarketing.  Selling and marketingexpenses decreased 24.4% to $2.7 million in the second fiscal quarter of 2002from $3.6 million in the second quarter of fiscal 2001.  Selling expenses consist primarily ofsalaries and related benefits for our sales force, sales commissions, travel,occupancy and depreciation.  Marketingexpenses consist primarily of salaries and related benefits, trade shows,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 willdecrease over the next several quarters due to the completion of the initialmarketing rollout of 844/X in the second quarter of fiscal 2002.

General and administrative. General and administrative expenses increased 21.0% to $1.4 million inthe second fiscal quarter of 2002 from $1.2 million in the second quarter offiscal 2001.  General and administrativeexpenses include the cost of human resources, finance, information technology,legal and other administrative functions. The increase in general and administrative expenses resulted primarilyfrom a charge of $397,000 related to the McRoberts litigation.  We currently anticipate that our general andadministrative expenses will decrease over the next several quarters due tolower legal and headcount related expenses.

Amortizationand write-off of intangible assets.  Werecorded an expense for the amortization and write-off of intangible assets of$273,000 in the second fiscal quarter of 2002 compared to $480,000 in thesecond quarter of fiscal 2001.  The$273,000 recorded in the second quarter of fiscal 2002 related to theamortization of goodwill associated with our acquisition of certain assets ofIntegrated Computing Engines, Inc.  The$480,000 recorded in the second quarter of fiscal 2001 related to Wired, Inc.and certain assets acquired from Integrated Computing Engines, Inc.  We will record an expense for theamortization of intangible assets of $273,000 in the third quarter of fiscal2002 thereby completing the write-off of all of our goodwill currently on ourbalance sheet.

Accelerated depreciation and amortization of fixed assets.  We recorded a charge of $215,000 in thesecond quarter of fiscal 2002 related primarily to leasehold improvements atour previous facility in Marlboro, Massachusetts.  During the second quarter of fiscal 2002 we completed ourrelocation from this facility to a new facility, also located in Marlboro,Massachusetts, better suited to meet our needs.  As result of this decision and the signing of a lease for the newfacility we amortized the remaining book value as of the beginning of fiscal2002 of all leasehold improvements, furniture and fixtures over the remainingmonths in fiscal 2002 (four) that we occupied our previous facility.  There was no similar expense recorded in thesecond quarter of fiscal 2001.

Restructuring. In the second quarter of fiscal 2001 werecorded a restructuring charge of $568,000 related to reorganization thatresulted in consolidation of selling and marketing activities and headcountreductions.  There was no such expenserecorded in the second quarter of fiscal 2002.

Interest income,net.  Interest income decreased 42.2% to$37,000 in the second fiscal quarter of 2002 from $64,000 in the second quarterof fiscal 2001.  The decrease ininterest income is due to lower cash and cash equivalent balances in fiscal2002 versus 2001.  We currentlyanticipate interest income will decline in fiscal 2002 versus 2001 due to lowercash balances.

Other income(expense), net.  Other income, net was$270,000 in the second fiscal quarter of 2002 compared to other expense, net of$578,000 in the second quarter of fiscal 2001. The change from other expense to other income is due to foreign exchangegains on intercompany transactions with our foreign subsidiaries due to theweakened U.S. dollar relative to the Euro.

Loss from continuingoperations.  As a result of the abovefactors, we had a loss from continuing operations for the second fiscal quarterof 2002 in the amount of ($3.7) million, or ($0.29) per share, compared to anet loss from continuing operations of ($5.7) million, or ($0.46) per share, inthe second quarter of fiscal 2001.

 

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

Net sales.  Total net sales for the first six months offiscal 2002 ended May 31, 2002 decreased 37.1% to $11.1 million from $17.6million for the first six months of fiscal 2001.  Net sales from products for the first six months of fiscal 2002decreased 37.9% to $7.9 million from $12.8 million for first six months offiscal 2001.  The decrease in net salesfrom products is due to a number of factors including increased competition forour digital video systems resulting in lower unit sales and average sellingprices ($6.8 million), and lower sales of the MPEG-based products acquired inthe acquisition of Wired, Inc. (“Wired”) ($654,000).  These decreases were partially offset by net sales of our newcontent-design system, 844/X ($2.6 million), which began shipping in April2002.  We anticipate this trend of loweryear-over-year net sales of our digital video systems to continue for theremainder of this year, partially offset by net sales from 844/X.  In addition, as part of the settlement oflitigation with the former shareholders of Wired, dated April 15, 2002, we willno longer sell the Wired MPEG-based products. Sales of the Wired product line for the first six months of fiscal 2002were approximately $0.5 million.  Netsales from services for the first six months of fiscal 2002 decreased 35.0% to$3.1 million from $4.8 million for the first six months of fiscal 2001.  The decrease in net sales from services isdue to lower sales of service contracts to support our digital video systems($1.7 million).

Gross profit.  Gross profit decreased 40.3% to $5.2 millionin the first six months of fiscal 2002 from $8.7 million in the first sixmonths of fiscal 2001.  Overall grossprofit as a percentage of net sales decreased to 47.0% in the first six monthsof fiscal 2002 from 49.5% in the first six months of fiscal 2001.  Specifically, gross profit as a percentageof net product sales decreased to 33.2% in the first six months of fiscal 2002from 40.1% in the first six months of fiscal 2001, while gross profit as apercentage of net sales of services increased to 81.7% in the first six monthsof fiscal 2002 from 74.3% in the first six months of fiscal 2001.  The increase in gross profit as a percentageof net sales of services resulted primarily from lower expenses in support ofcustomers, partially offset by our lower sales of services.  Gross profit as a percentage of net productsales decreased due to lower unit sales of our digital video systems and acharge for accelerated depreciation. The accelerated depreciation charge, related primarily to leaseholdimprovements, was due to our decision to relocate our facility to a newlocation better suited to meet our needs. We currently forecast overall gross profit as a percentage of net saleswill remain relatively constant over the next several quarters, however, due topotential fluctuations in the mix of products sold, gross profit as apercentage of net sales may vary from one quarter to another.

Research anddevelopment.  Research and developmentexpenses decreased 4.5% to $5.1 million in the first six months of fiscal 2002from $5.4 million in the first six months of fiscal 2001.  Research and development expenses consistprimarily of salaries and related benefits for our personnel, consultants,outside services, occupancy and depreciation. At this time, we anticipateresearch and development expenses will decrease over the next several quartersdue to the completion of the development effort related to the first version ofour recently introduced content design system, 844/X.  We plan to continue to invest a significant amount of ourresources into further development of 844/X; however, for the second half of fiscal2002, we do not anticipate this future development to be as costly as thedevelopment costs associated with the first version of 844/X.

Selling andmarketing.  Selling and marketingexpenses decreased 30.0% to $5.0 million in the first six months of fiscal 2002from $7.1 million in the first six months of fiscal 2001.  Selling expenses consist primarily ofsalaries and related benefits for our sales force, sales commissions, travel,occupancy and depreciation.  Marketingexpenses consist primarily of salaries and related benefits, trade shows,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, partially offset by initialmarketing expenses for the rollout of 844/X. We currently anticipate that our selling and marketing expenses willdecrease over the next several quarters due to the completion of the initialmarketing rollout of 844/X in the second quarter of fiscal 2002.

General and administrative. General and administrative expenses decreased 5.1% to $2.5 million inthe first six months of fiscal 2002 from $2.7 million in the first six monthsof fiscal 2001.  General and administrativeexpenses include the cost of human resources, finance, information technology,legal and other administrative functions. We currently anticipate that our general and administrative expenseswill decrease over the next several quarters due to lower legal and headcountrelated expenses.

Amortizationand write-off of intangible assets.  Werecorded an expense for the amortization and write-off of intangible assets of$765,000 in the first six months of fiscal 2002 compared to $1.9 million in thefirst six months of fiscal 2001.  The$765,000 recorded in the first six months of fiscal 2002 related to theamortization of goodwill associated with our acquisitions of Wired, Inc. andcertain assets of Integrated Computing Engines, Inc.  The $1.9 million recorded in the first six months of fiscal 2001related to Wired, Inc., Integrated Computing Engines, Inc. and a write-off ofgoodwill of $880,000 related to the acquisitions of 21st Century LLCand J2 Digital Media, Inc.  These twoacquisitions were combined to form Streamriver, which was launched in June2000.  During the first quarter offiscal 2001, the goodwill from these two acquisitions was determined to beimpaired due to continued operating losses in Streamriver and the uncertaintysurrounding our ability to recover the goodwill through future cash flows.  We shut down Streamriver in the secondquarter of fiscal 2001.  We will recordan expense for the amortization of 

 

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intangibleassets of $273,000 in the third quarter of fiscal 2002 thereby completing thewrite-off of all of our goodwill currently on our balance sheet.

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

Settlement of litigation. We agreed to settlelitigation brought against us by the former shareholders of Wired, a company weacquired by the Company in December 1999. As part of the settlement, we assigned all rights to the Wired productline, intellectual property relating to Wired products and on-hand inventoryrelated to the Wired product line to the former shareholders.  Wired agreed that no further action will betaken related to the lawsuit previously filed against us as noted in Note 9 tothe Consolidated Financial Statements.  Wired granted us 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.  There was no similarexpense recorded in the first six months of fiscal 2001.

 

Restructuring. In the first six months of fiscal 2001we recorded a restructuring charge of $568,000 related to reorganization thatresulted in consolidation of selling and marketing activities and headcountreductions.  There was no such expensein the first six months of fiscal 2002.

Interest income,net.  Interest income decreased 32.7% to$115,000 in the first six months of fiscal 2002 from $171,000 in the first sixmonths of fiscal 2001.  The decrease ininterest income is due to lower cash and cash equivalent balances in fiscal2002 versus 2001.  We currentlyanticipate interest income will decline in fiscal 2002 versus 2001 due to lowercash balances.

Other income(expense), net.  Other income, net was$187,000 in the first six months of fiscal 2002 compared to other expense, netof $264,000 in the first six months of fiscal 2001.  The change from other expense to other income is due to foreignexchange gains on intercompany transactions with our foreign subsidiaries dueto the weakened U.S. dollar relative to the Euro.

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

Loss fromcontinuing operations.  As a result ofthe above factors, we had a loss from continuing operations for the first sixmonths of fiscal 2002 in the amount of ($9.6) million, or ($0.75) per share,compared to a net loss from continuing operations of ($9.0) million, or ($0.73)per share, in the first six months of fiscal 2001.

**Liquidityand Capital Resources**

Wehave funded our operations to date primarily from public offerings of equitysecurities and cash flows from operations, as well as the sale of our streamingmedia software product line to Autodesk. As of May 31, 2002, our principal sources of liquidity included cash,cash equivalents and marketable securities totaling approximately $6.2million.  This was a decrease ofapproximately $11.5 million of cash, cash equivalents and marketable securitiessince the end of our previous fiscal year, which ended November 30, 2001.  Approximately $2.8 million of the $11.5 wasplaced in an escrow account while the McRoberts litigation is under appeal.This amount is classified as restricted cash at May 31, 2002.  In addition, the Company has restricted cashof approximately $388,000 relating to several letters of credit.  In addition to the $6.2 million as of May31, 2002, an additional $2.0 million is held in escrow until October 2002 as aresult of the sale of our streaming media software product line to Autodesk,Inc. in October 2001.

During the first six months of fiscal 2002 ended May 31, 2002, cashused in operating activities from continuing operations was approximately $11.0million compared to cash used in operating activities from continuingoperations of approximately $4.9 million for the first six months of fiscal2001.  There was no cash provided by orused in discontinued operations for the first six months of fiscal 2002.  Cash used in discontinued operations for thefirst six months of fiscal 2001 totaled $1.1 million.  Cash used in continuing 

 

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operations during fiscal 2002 included a net loss of $9.6 millionincluding depreciation and amortization of $2.3 million, amortization ofintangible assets of $765,000 and a settlement of litigation of $924,000.  Cash used in continuing operations wasaffected by changes in assets and liabilities including an increase inrestricted cash of $3.2 million relating to the McRoberts litigation andseveral letters of credit, an increase in inventories of $1,518,000 relatingprimarily to the initial buildup of inventory for 844/X and an increase ininventory for our digital video systems, a decrease in accrued expenses of$1,100,000, an increase in accounts receivable of $166,000, an increase inprepaid expenses and other current assets of $146,000, and a decrease indeferred revenue of $142,000.  Cash wasprovided by an increase in accounts payable of $884,000.  Net cash used in investing activities forcontinuing operations was approximately $864,000 for the first six months offiscal 2002 compared to cash provided by investing activities of approximately$3.9 million for the first six months of fiscal 2001.  Cash used in investing activities for continuing operationsduring the first six months of fiscal 2002 was primarily for purchases of capitalequipment of $822,000.  Cash provided byfinancing activities from continuing operations during the first six months offiscal 2002 was approximately $415,000 compared to cash used in financingactivities from continuing operations of $1.3 million for the first six monthsof fiscal 2001.  In the first six monthsof fiscal 2002, cash provided by financing activities from continuingoperations was proceeds from the issuance of common stock pursuant to stock plansof $415,000.

At May 31, 2002, our contractual cash obligations wereas follows:
|                   |   | **Total** |      | **Less than  1 year** |   | **1-3 years** |   |
|------------------------|--------|-----------|-----------|-----------------------|--------|---------------|--------|
| Lease  commitments     |   | $         | 2,892,000 |                  | $      | 1,075,000     |   | $ | 1,817,000 |   |
| Inventory  commitments |   | $         | 622,000   |                  | $      | 622,000       |   | $ | — |   |

We currently anticipate that our current cashand equivalents plus cash due from escrow will be sufficient to fund ouranticipated cash requirements for working capital and capital expenditures forat least the next twelve months.  We may needto raise additional funds, however, in order to fund our business, develop newand enhance existing products and services, or acquire complementary products,businesses or technologies.  Ifadditional funds are raised through the issuance of equity or convertible debtsecurities, the percentage ownership or our stockholders may be reduced, ourstockholders may experience additional dilution, and such securities may haverights, preferences or privileges senior to those of our existingstockholders.  Additional financing maynot be available on terms favorable to us, or at all.  If adequate funds are not available or are not available onacceptable terms, our ability to fund expansion, take advantage ofunanticipated opportunities or develop or enhance our products or serviceswould be significantly limited.

**Cautionary Statements**

This Quarterly Report on Form 10-Q containsforward-looking statements within the meaning of the Securities LitigationReform Act of 1995 that involve risks and uncertainties.  Our actual results could differ materiallyfrom those anticipated in these forward-looking statements as a result ofcertain factors, including those set forth in the following cautionarystatements 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.

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

*SignificantFluctuations and Unpredictability of Operating Results.* Our quarterly operating results are difficult to predict, have varied significantlyin the past and are likely to vary significantly in the future for a number ofreasons, including new product announcements and introductions by ourselves orour competitors, changes in pricing, and the volume and timing of ordersreceived during the quarter. Also, in the past, we have experienced delays inthe development of new products and enhancements, and such delays may occur inthe future.  These factors make theforecasting of revenue inherently uncertain. Additionally, a significant portion of our operating expenses isrelatively fixed, and operating expense levels are based primarily on internalexpectations of future revenue.  As aconsequence, quarterly operating expense levels cannot be reduced rapidly inthe event that quarterly revenue levels fail to meet internalexpectations.  For these reasons, youshould not rely on period-to-period comparisons of our financial results toforecast our future performance.  It islikely that in some future quarter or quarters our operating results 

 

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will be below the expectations of securities analystsor investors.   If quarterly revenue orearnings levels fail to meet internal or external expectations, the marketprice of our common stock may decline significantly.

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

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

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

*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 received, and may in the future continue to receive, communicationssuggesting that our products may infringe on the patents or other intellectualproperty rights of third parties.  Ourpolicy is to investigate the factual basis of such communications and negotiatelicenses where appropriate.  While itmay be necessary or desirable in the future to obtain licenses relating to oneor more products, or relating to current or future technologies, there can beno assurance that we will be able to do so on commercially reasonable terms orat all.  There can be no assurance thatthese or other future communications can be settled on commercially reasonableterms or that they will not result in protracted and costly litigation.  Any failure to secure the necessaryintellectual property right of third parties on commercially reasonable termsmay adversely affect our business and operating results and negatively affectthe price of our common stock.

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

*Dependenceon Single or Limited Source Suppliers.*  We aredependent on single or limited source suppliers for several key components usedin its products that have no ready substitutes, including various audio andvideo signal processing integrated 

 

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

*Dependenceon Key Personnel.*  We believe that our future success willdepend on our continued ability to attract and retain qualified employees,especially in research and development. Our inability to attract and retain qualified personnel on a timelybasis, or the departure of key employees could have a material adverse affecton our business and operating results and negatively affect the price of ourcommon stock.

*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 ourproducts.  We rely on access to keyinformation from Apple to continue development of our products and any failureto continue supplying our engineers with this information could have a materialadverse affect on our business and financial results and negatively affect theprice of our common stock.

*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 this informationcould have a material adverse affect on our business and financial results andnegatively affect the price of our common stock.

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

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

*Mergerand Acquisition Related Risks.* During thefiscal year ended November 30, 2000, we completed the merger with DigitalOrigin and the acquisitions of Wired, 21st Century Media LLC, and J2Digital Media, Inc. In addition, we completed the acquisition of certain assetsof Integrated Computing Engines, Inc. Our business and results of operations could be materially adverselyaffected in the event we fail to complete publicly announced acquisitions or tosuccessfully integrate the business and operations of the merger or 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,

 

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as well as the diversion of management’s attentionduring the acquisition and integration process.  We may not be able to operate the acquired businesses properlyand may not be able to successfully recover amounts paid for such businesses.  Some or all of these special risks and factorsmay have a material adverse impact on our business, operating results, andfinancial condition and, as a result, may negatively affect the market price ofour common stock.

Similarly, we may disposeof assets, either assets we have historically used in the business or that wehave acquired. During the year ended November 30, 2001, operations ofStreamriver, which combined the acquisitions of 21st Century LLC andJ2 Digital Media Inc., and the sale of our streaming media software productline, comprising products acquired from Terran and Digital Origin, weredisposed.  During the first quarter of2002, we settled litigation resulting in the disposition of certain assetsrelating to our Wired products.  Ourbusiness and results of operations could materially change depending on whetheror not we are able to dispose of assets in an advantageous manner.  In addition to obtaining an advantageousprice for the assets to be disposed of, dispositions involve a number of specialrisks and factors, including searching for appropriate acquirers; managing theeffect of the disposition on existing and proposed product lines and services,the divestiture of operations and personnel, adverse short-term effects onreported operating results, potential post-divestiture indemnification orliability for liabilities of divested operations, as well as the diversion ofmanagement’s attention during the disposition process.  Some or all of these special risks andfactors may have a material adverse impact on our business, operating results,and financial condition and, as a result, may negatively affect the marketprice of our common stock.

*Historyof Losses and Negative Cash Flows.*  We haveincurred substantial operating losses during the current year and in the pastfive fiscal years, and have experienced negative cash flow from ongoingoperations during the current fiscal year. We incurred an operating loss from continuing operations ofapproximately $9.6 million for the six months ended May 31, 2002 and as of May31, 2002, we had an accumulated deficit of approximately $210.4 million.

Over the past four years we have significantlyincreased our research and development expenses as a percentage of total salesand we plan to continue to invest in new technology, and as a result, we mayincur operating losses in future periods. We will need to generate increases in our current sales levels toachieve profitability and we may not be able to do so.  If our sales grow more slowly than weanticipate or if our operating expenses increase more than we expect or cannotbe reduced in the event of lower revenue, our business will be significantlyand adversely affected.  Our failure toachieve profitability or achieve the level of profitability expected byinvestors and securities analysts may adversely affect the market price of ourcommon stock.

In addition, we believe we may continue to experiencenegative operating cash flows for the remainder of this fiscal year and intonext fiscal year, although we currently anticipate that our current cash plusdue from escrow will be sufficient to fund our anticipated cash requirementsfor working capital and capital expenditures for at least the next twelvemonths.  Depending on future cash flow,we may need to raise additional capital in the future to meet our cashrequirements.  We may not be able tofind additional financing, if required, on favorable terms or at all.

*StockPrice Volatility*.  The trading price of our common stock hasbeen highly volatile and has fluctuated significantly in the past.  During the six months ended May 31, 2002 ourstock price fluctuated between a low of $1.10 per share and a high of $3.75 pershare.  During fiscal 2001, our stockprice fluctuated between a low of $0.81 per share and a high of $3.81 pershare.  We believe that the price of ourcommon stock may continue to fluctuate significantly in the future in responseto a number of events and factors relating to our company, our competitors, andthe market for our products and services, many of which are beyond our control,such as, variations in our quarterly operating results; changes in financialestimates and recommendations by securities analysts; changes in marketvaluations of companies in our markets; announcements by us or our competitorsof significant products, acquisitions, or strategic partnerships; failure tocomplete significant business transactions; departures of key personnel;purchases or sales of common stock or other securities by us; or news relatingto trends in our markets.  In addition,the stock market in general, and the market for technology companies inparticular, have experienced extreme volatility over the past twelvemonths.  This volatility has often beenunrelated to the operating performance of particular companies.  These broad and industry fluctuations mayadversely affect the market price of our common stock, regardless of ouroperating performance.

Item 3.    Quantitative and QualitativeDisclosures About Market Risk

Derivative Financial Instruments, Other FinancialInstruments and Derivative Commodity Instruments.  We are not a party to any derivative financial instruments orother financial instruments for which the fair value disclosure would berequired under Statement of Financial Accounting Standards No. 107*DerivativeFinancial Instruments, Other Financial Instruments and Derivative CommodityInstruments* (SFASNo. 107).  All of our 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 ourbooks.  Accordingly, we believe that themarket risk of such investments is minimal.

 

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Primary Market Risk Exposures.  Our primary market risk exposures are in thearea of interest rate risk and foreign currency exchange rate risk.  Our investment portfolio of cash equivalentsis subject to interest rate fluctuations, but we believe this risk isimmaterial due to the short-term nature of these investments.  Our business in Europe is conducted in localcurrency.  In Asia, business isconducted in U.S. currency.  We have noforeign exchange contracts, option contracts or other foreign hedgingarrangements.  However, we estimate thatany market risk associated with its foreign operations is not significant andis unlikely to have a material adverse effect on our business, results ofoperations, or financial condition.

 

PART II. OTHER INFORMATION

 

**Item 1****. Legal Proceedings**

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

 

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

 

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

 

During the six months ended May 31, 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 to the Consolidated Financial Statements.   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.

 

(iii) From time to time the Company is involved in otherdisputes and/or litigation 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.

 

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**Item 4****. Submission ofMatters to a Vote of Security Holders**

The Company heldan annual meeting of stockholders on May 10, 2002, at which the stockholdersapproved the following proposals by the number of shares of Common Stock votedbelow:
| **Proposal**                    |   |                  |   |         |
|---------------------------------|--------|-----------------------|--------|--------------|
| (1)  Election of Directors |   | **Number of  Shares** |   |
|                            |   | **Voted For**         |   | **Withheld** |   |
| John A. Molinari                |   | 11,085,154            |   | 731,469      |   |
| Maurice L.  Castonguay          |   | 11,346,717            |   | 469,906      |   |
| Roger W. Redmond                |   | 11,345,831            |   | 470,792      |   |
| Paul J. Severino                |   | 11,340,355            |   | 476,268      |   |

 
|                                                                                                                                                                                                 |   |          |   | **Number of  Shares** |   |          |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|--------|-----------------------|--------|---------------|--------|
|                                                                                                                                                                                                 |   |          |   | **Voted**             |   |          |   | **Broker** |   |
| (2)                                                                                                                                                                                                  |   | **Voted For** |   | **Against**           |   | **Abstained** |   | **Non-Votes** |   |
| To approve the  2002 Stock Option and Incentive Plan providing for 950,000 shares of the  Company’s Common stock  reserved for  the grant of incentive Options to employees of the Company |   | 2,632,671     |   | 1,446,946             |   | 593,790       |   | 7,143,216 |   |

 

**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 27.

 

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

 

There were noreports on Form 8-K during the quarter ended May 31, 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:  | July 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** |   |
|--------|------------|--------|-----------------|--------|
|   |       |   |            |   |

 

 

 

 

 

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