MEDIA 100 INC - 10-Q Quarterly Report

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act). Yes ¨ No x

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

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

The accompanying interim unaudited consolidated financial statements include the accounts of Media 100 Inc. (“the Company”), a Delaware corporation, and its wholly owned subsidiaries. In the opinion of management, the interim consolidated financial statements and disclosures reflect all adjustments necessary for fair presentation. Interim results are not necessarily indicative of results expected for a full year or for any other interim period. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s latest audited financial statements, which are included in the Company’s Annual Report on Form 10-K for the fiscal year ended November 30, 2002, filed with the Securities and Exchange Commission.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Media 100 Inc., and subsidiaries (the Company) design and sell advanced media systems for content design. In the case of the Company’s newest and most advanced development, 844/X^™, we have integrated the previously separate workflows of real-time video editing and the compositing of layers of video, computer graphics, audio, and metadata. We believe this workflow integration is a technical breakthrough that over time will attract existing and new video editing users who wish to be able to design more complex content that comprises dozens, even hundreds of distinct content layers. The Company has developed new technology—integrated software and hardware, including Application-Specific Integrated Circuits (“ASICs”)—to perform compositing in real time or at high speed to allow compositing operations to be performed within an editing environment and executed at high speed without host-based rendering, which is slow and impedes productivity.

The Company’s products are personal computer-based workstations configured with proprietary software and hardware that we engineer and manufacture. In some cases, particularly with 844/X, we sell our products as fully integrated systems, meaning we configure and ship the system to an end user, or reseller, with a host personal computer, our software and hardware, and optional disk storage; in other cases, we deliver only our software and hardware (“unbundled”), typically to an independent value-added reseller that configures the turnkey system themselves on behalf of an end user.

The Company has incurred an operating loss during the six months ended May 31, 2003 and operating losses in the past five fiscal years. In addition, it has experienced negative cash flow from ongoing operations during fiscal 2003. The Company incurred a net loss of approximately $2.7 million for the six months ended May 31, 2003 and as of May 31, 2003; the Company had an accumulated deficit of approximately $217 million.

The Company has already taken a series of actions to reduce the negative cash flow it experienced in the past fiscal year including the termination of employees, reductions in the salaries paid to executives and certain other employees, relocation of its facility to lower cost space and a reduction in the marketing expenses for existing products. However, these expense reductions will not be enough to return the Company to profitability without revenue growth. The Company’s current operating plan and cash flow projections assume a certain level of revenue and operating expenses. If the Company fails to achieve its revenue plan then management will reduce operating expenses as a result of the revised revenue expectations at that time in order to conserve cash. The current cash flow projections also assume the Company will not require substantial cash for capital purchases or to fund substantial increases in inventory, accounts receivable or other assets and the projections assume the Company will be able to continue to collect accounts receivables in a timely basis and will not incur substantial bad debts as a result of the failure of customers to pay.

On May 14, 2003, the Company announced that Coghill Capital Management, LLC (“CCM”) executed an agreement to invest $2.5 million in a new series of class A preferred shares that are convertible into common stock. In May 2003, the Company received $1,045,000 of the total $2.5 million. The remaining funds are subject to stockholder approval. The proceeds of the transaction will provide additional capital for the continued development and marketing of the Company’s 844/X products and for general corporate purposes. Please see Note 15 for further discussion of the Preferred shares.

The Company’s ability to continue to operate as a going concern through at least the next twelve months is contingent upon the achievement of forecasted revenue growth from its 844/X product and management’s ability to manage expenses consistent with actual revenues achieved. Although the Company has raised approximately $1 million from a current investor and has an agreement to raise an additional $1.5 million from this investor, which is subject to shareholder approval, management does not believe these funds will be sufficient to sustain operations for at least the next twelve months without the attainment of planned revenue growth, a further reduction in operating expenses, or both. If management is unable to reduce expenses to manageable levels to support its current and anticipated revenue levels, the Company will begin to explore alternatives relating to a sale of all or part of the Company’s business.

The accompanying interim unaudited consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries after elimination of significant intercompany transactions and balances. These consolidated financial statements reflect the use of the following significant accounting policies, as described below and elsewhere in the notes to the interim unaudited consolidated financial statements. These interim unaudited consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States.

Cash equivalents are carried at cost, which approximates fair market value, and have original maturities of less than 90 days. Cash equivalents include money market accounts and repurchase agreements with overnight maturities.

As part of the McRoberts litigation discussed in Note 9, the Company had placed approximately $2.8 million in an escrow account as of November 30, 2002 while the case was on appeal. The appellate court rendered its decision in favor of McRoberts on May 14, 2003. Approximately $2.8 million was released from escrow as a partial payment of the judgment during the quarter ended May 31, 2003. Approximately $37,000 remained in escrow and was included as restricted cash in the accompanying balance sheet at May 31, 2003. Subsequent to May 31, 2003, the Company released the remaining escrow, as well as, approximately $261,000 as payment for the trade secret judgment awarded during the appeal. Approximately $213,000 and $388,000 of the cash and cash equivalents was restricted under various letters of credit at May 31, 2003 and November 30, 2002, respectively.

The Company accounts for securities 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 required to classify all investments in debt and equity securities into one or more of the following three categories: held-to-maturity, available-for-sale or trading. Available-for-sale securities are recorded at fair market value with unrealized gains and losses excluded from earnings and included as a component of stockholders’ equity. All of the Company’s securities are classified as available for sale.

Securities held as of May 31, 2003 and November 30, 2002 consists of the following (in thousands):

Marketable securities had a cost of $116 and a market value of $126 at November 30, 2002.

Inventories are stated at the lower of first-in, first-out (FIFO) cost or market and consist of the following (in thousands):

Work-in-process and finished goods inventories include material, labor and manufacturing overhead. Management performs periodic reviews of inventory and disposes of items not required by their manufacturing plan. Our reserve for excess and obsolete inventory is primarily based upon forecasted demand for our products. The Company writes down its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual future demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

Property and equipment, net, at May 31, 2003 and November 30, 2002 is stated at cost, less accumulated depreciation and amortization, and consists of the following (in thousands):

In connection with the signing of the lease amendment for the Company’s principal facility in January 2002, the Company revised the estimated useful life of leasehold improvements and certain furniture and fixtures that would not be moved to the new facility. The charge has been reflected as accelerated depreciation and amortization of property and equipment in the accompanying Consolidated Statements of Operations. Amounts classified as leasehold improvements are additions related to the Company’s new principal facility.

Intangible assets, net at May 31, 2003 and November 30, 2002 consist of the following (in thousands):

During the year ended November 30, 2002, the Company settled litigation with the former shareholders of Wired, which was acquired by the Company in fiscal 2000. As part of the settlement, the Company assigned all rights to the Wired product line, intellectual property relating to Wired products and on-hand inventory related to the Wired product line to the former shareholders. In return, Wired granted the Company an irrevocable license to use the source code, technology, know how and intellectual property; provided however, the license does not include the right to sell Wired products or any equivalent products incorporating the source code, technology, know how and intellectual property. In addition, Wired promised to pay the Company a royalty of 5% of adjusted gross sales of the assigned products not to exceed $1.2 million, plus the cost of the inventory assigned. The Company has recorded approximately $25,000 in royalty income during the three months ended May 31, 2003. Litigation settlement included in the Consolidated Statements of Operations for the six months ended May 31, 2002 represents the cost of inventory transferred, the net book value of remaining intangible assets associated with the acquisition, and legal fees associated with the settlement.

The Company computes earnings per share pursuant to SFAS No. 128, Earnings Per Share. In accordance with SFAS No. 128, basic net income (loss) per share is computed using the weighted-average number of common shares outstanding. Diluted income per share is computed using the weighted-average number of common shares outstanding and potential common shares from the assumed exercise of stock options and warrants outstanding during the period, if any, using the treasury stock method.

The Company excludes potentially dilutive securities from its diluted net income (loss) per share computation when either the exercise price of the securities exceeds the fair value of the Company’s common stock or when the Company reports a net loss and the effect of including such securities would be antidilutive. Options to purchase approximately 2,998,000 and 2,992,000 weighted average shares of common stock have been excluded from the computation of diluted average shares outstanding at May 31, 2003 and May 31, 2002, respectively, as the effect of their inclusion would have been antidilutive.

The Company accounts for stock-based awards to employees using the intrinsic value method prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations. Accordingly, no compensation expense is recorded for options issued to employees in fixed amounts and with fixed exercise prices at least equal to the fair market value of the Company’s common stock at the date of the grant. The Company follows the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” and SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure,” for all employee awards.

The following table illustrates the effect on net loss and net loss per share as if the Company had applied the fair value recognition provisions of SFAS No. 123, to stock-based employee awards (in thousands, except per share data).

Under SFAS 123, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model and is amortized over the stock option’s vesting period.

The Company provides accruals for all direct costs associated with the estimated resolution of known contingencies. The accrual is established at the earliest date at which it is deemed probable that a liability has been incurred and the amount of such liability can be reasonably estimated.

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

On August 16, 2000, the U.S. Patent and Trademark Office issued an Office Action rejecting all of the claims made by Avid in their latest request for reexamination of the patent related to the aforementioned lawsuit. In addition, the Examiner at the U.S. Patent and Trademark Office designated the action as “final”. Avid filed a Notice of Appeal of the Examiner’s rejections to the U.S. Patent and Trademark Office Board of Patent Appeals and Interferences. On February 20, 2003, oral argument regarding the reexamination of Avid’s U.S. Patent No. 5,045,940 occurred and on March 21, 2003 a decision was rendered rejecting all of Avid’s claims and sustaining the Examiner’s rejection of all claims made on appeal. On May 19, 2003, Avid filed a Notice of Appeal of the Board’s decision to the United States Court of Appeals for the Federal Circuit. The appeal is pending. There can be no assurance that the Company will prevail in the appeal by Avid or that the expense or other effects of the appeal, whether or not the Company prevails, will not have a material adverse effect on the Company’s business, operating results and financial condition. The Company has not made any provision in the accompanying financial statements regarding this matter.

On October 12, 1999, a lawsuit was filed against the Company by McRoberts Software, Inc. (“MSI”) in the United States DistrictCourt for the Southern District of Indiana. The complaint alleged copyright infringement, breach of contract, and trade secret misappropriation. The complaint included requests for unspecified monetary damages and enhanced damages, interest, costs and fees. An unfavorable verdict was filed on February 25, 2002 against the Company in the amount of $2.5 million. The Company and MSI filed post-trial motions. Those motions were ruled upon with the trial court reducing the total amount awarded by the jury but assessing prejudgment interest and attorney’s fees. The Company appealed the entire judgment to the United States Court of Appeals for the Seventh Circuit and on May 14, 2003 the appeal court rendered a decision in favor of McRoberts. As part of its decision, the appellate court reinstated a $300,000 trade secret component of damages. On May 29, 2003, the Company released approximately $2.8 million from escrow and later paid the remaining $39,000 escrow and an additional $261,000 from unrestricted cash to pay the judgment. McRoberts is seeking attorneys’ fees of approximately $90,000 for the appeal. That amount remains in dispute and for resolution before the Seventh Circuit and has not been provided for by the Company at May 31, 2003. McRoberts is seeking pre-judgment and post-judgment interest on its trade secret award in an amount yet to be quantified. Claims for interest remain in dispute and have not been provided for the accompanying financial statements at May 31, 2003.

From time to time the Company is involved in other disputes and/or litigation encountered in its normal course of business. The Company does not believe that the ultimate impact of the resolution of such other outstanding matters will have a material effect on the Company’s business, operating results or financial condition.

Under the terms of the Company’s standard product license and sale contracts, the Company indemnifies its customers for the potential liability associated with the infringement of other parties’ technology based upon the Company’s products. There is a possibility that the Company may be liable to any of its customers in the event that there is infringement occurring. The Company is not aware of any infringement related to the Company’s technology, and therefore has not accrued any amounts for the replacement or refund of any software products sold through May 31, 2003.

The Company recorded 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 a prior period payment.

Accrued expenses at May 31, 2003 and November 30, 2002 consist of the following (in thousands):

The Company records items of comprehensive income or loss in accordance with SFAS No.130, Reporting Comprehensive Income, and presents such information in the statement of stockholders’ equity. The components of accumulated other comprehensive loss are as follows (in thousands):

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

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Revenues are attributed to geographic areas based on where the customer is located. Segment information for the three and six months ended May 31, 2003 and May 31, 2002 is as follows:

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

Net sales by geographic area for the quarters ended May 31, 2003 and 2002 were as follows (in thousands):

Long-lived tangible assets by geographic area as of May 31, 2003 and November 30, 2002 consist of the following (in thousands):

On December 31, 2002, SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” was issued. SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation”, to provide alternative methods of transition to the fair value method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure provisions of SFAS No. 123 to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. SFAS No. 148 does not amend SFAS No. 123 to require companies to account for their employee stock-based awards using the fair value method. However, the disclosure provisions are required for all companies with stock-based employee compensation, regardless of whether they utilize the fair value method of accounting described in SFAS No. 123 or the intrinsic value method described in APB Opinion No. 25, “Accounting for Stock Issued to Employees”. SFAS No. 148’s amendment of the transition and annual disclosure provisions of SFAS No. 123 are effective for fiscal years ending after December 15, 2002. The Company has adopted the annual disclosure provisions of SFAS No. 123 and has begun with quarterly disclosures for the quarter ended May 31, 2003. The adoption of this standard did not have a material impact on the Company’s financial statements.

In November 2002, the Financial Accounting Standards Board (FASB) issued Interpretation No. (FIN) 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (the Interpretation). The Interpretation requires certain guarantees to be recorded at fair value, which is different from current practice, which is generally to record a liability only when a loss is probable and reasonably estimable, as those terms are defined in SFAS No. 5, “Accounting for Contingencies”. The Interpretation also requires a guarantor to make new disclosures, even when the likelihood of making any payments under the guarantee is remote. The Interpretation applies to public and non-public entities, and its disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of the interpretation has not had a material impact on the Company’s position or results of operations.

During May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 clarifies the accounting for certain financial instruments with characteristics of both liabilities and equity and requires that those instruments be classified as liabilities in statements of financial position. Previously, many of those financial instruments were classified as equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company does not expect the adoption of SFAS No. 150 to have a significant impact on its results of operations or financial position.

On May 14, 2003, Media 100 Inc. (“Media 100”) entered into a Series A Convertible Preferred Stock Purchase Agreement pursuant to which Media 100 will sell and issue 2,500 shares of its Series A Convertible Preferred Stock, par value $.01 per share, in a private placement to CCM Master Fund Ltd. (“CCM”) for an aggregate purchase price of up to $2,500,000. According to the agreement, the Company must meet certain covenants regarding stockholders’ equity or be required to pay cash dividends. On May 14, 2003, the Company issued 1,045 shares for approximately $1.0 million. These covenants include achieving a minimum level of stockholders’ equity by September 2003 and May 2004 of $3.4 million and $4.9 million, respectively. If these levels are not met, the dividend is 10% and 20% of the funds invested, respectively. In addition, the preferred stock has certain liquidation preferences including potentially receiving 200% of the funds invested in the event of a liquidating event such as a change in control of the Company. For a further explanation of the terms of the stock purchase agreement, see our Form 8-K filed on May 21, 2003.

The Preferred Shares are convertible into Common Stock at an initial conversion price of $0.967, initially representing 2,585,315 shares of common stock. Subject to certain conditions, each Preferred Share carries a mandatory conversion provision whereby if the closing price of Media 100’s Common Stock exceeds 300% of the conversion price for 45 consecutive trading days, the Preferred Shares shall automatically convert into Common Stock at the conversion price then in effect. The Preferred Shares are subject to the terms and conditions of the Certificate of Designation of Series A Convertible Preferred Stock which under certain circumstances are mandatorily redeemable based on events beyond the Company’s control. Accordingly, the carrying value of the preferred shares has been shown as an obligation of the Company and excluded from Stockholders’ equity.

Under the terms of the agreement, the Company must seek stockholder approval for $1,455,000 of the purchase amount because this transaction combined with CCM’s existing ownership, will exceed the 20% threshold requirement of the The NASDAQ Stock Market, Inc. Under terms of the purchase agreement, under certain circumstances, CCM may exercise a right of first refusal to subscribe for certain equity issued by the Company in its future financings.

Neither the Series A Preferred Securities nor the conversion shares are currently registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. Subject to certain conditions as part of the financing, at any time after the first anniversary of the closing date, the holders of the Registrable Securities constituting at least 50% interest of the total share of Registrable Securities then outstanding may request in writing that Media 100 file a registration agreement with the Securities and Exchange Commission covering the resale of the conversion shares.

In the second quarter of fiscal 2003, the Media 100 implemented a restructuring plan to better align its operating costs with its anticipated future revenue stream. The restructuring charge of $214,000 related to the elimination of approximately 25 employees across the following functions: operations (8), product development (11), and selling and marketing (6). The restructuring expense included professional fees relating to the restructuring. At May 31, 2003, $117,000 of the accrued restructuring charge was unexpended. The total cash used related to the restructuring during the quarter was approximately $214,000.

As part of the Digital Origin, Inc. (“DO”) acquisition in May 2000, Media 100 acquired an investment in a private company consisting of series A & B preferred and common stock. At the time, no value had been placed on either the preferred or common stock due to the uncertainty of realization of value from the investment. In addition to the series A & B preferred stock, the company also has series C, D, and E preferred stock outstanding which would have been given preference in a liquidation event. On May 12, 2003, the private company converted all outstanding preferred stock into secured promissory notes. In the recapitalization, Media 100 received a promissory note in the amount of $934,615 in exchange for its series B preferred stock and a promissory note in the amount of $674,326 in exchange for its series A preferred stock. The private company has approximately $10.5 million of these notes outstanding to all debt holders. Payments under the Series B commence May 1, 2009 and payments under series A commence May 1, 2012. Given the extended time period before the notes are payable to Media 100, combined with the fact the notes are non-interest bearing, Media 100 continues to ascribe no value to this investment in its accompanying financial statements. The Company will periodically reevaluate its accounting for these notes based on changes in fact and circumstances as they may occur.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our interim unaudited consolidated financial statements and the related notes appearing elsewhere in this report. The discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. The preparation of these requires management to make estimates and judgements that affect the reported amounts of assets, liabilities, revenue and expenses, and the related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates including those related to product returns, bad debts, inventories, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under “Cautionary Statements” and elsewhere in this report.

We design and sell advanced media systems for content design. In the case of our newest and most advanced development, 844/X^™, we have integrated the previously separate workflows of real-time video editing and the compositing of layers of video, computer graphics, audio, and metadata. We believe this workflow integration is a technical breakthrough that over time will attract existing and new video editing users who wish to be able to design more complex content that comprises dozens, even hundreds of distinct content layers. Our Company has developed new technology—integrated software and hardware, including Application-Specific Integrated Circuits (“ASICs”)—to perform compositing in real time or at high speed to allow compositing operations to be performed within an editing environment and execute at high speed without host-based rendering, which is slow and impedes productivity.

Our products are personal computer-based workstations configured with proprietary software and hardware that we engineer and manufacture. In some cases, particularly with 844/X, we sell our products as fully integrated systems, meaning we configure and ship the system to an end user, or reseller, with a host personal computer, our software and hardware, and optional disk storage; in other cases, we deliver only our software and hardware (“unbundled”), typically to an independent value-added reseller that configures the turnkey system themselves on behalf of an end user.

This management’s discussions and analysis of financial condition and results of operations discuss our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates and judgements, including those related to revenue recognition, inventories, the impairment of long lived assets, legal contingencies and discontinued operations. Management bases its estimates and judgements on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgements about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies most significantly affect the portrayal of our financial condition and require management’s most difficult and subjective judgements.

We recognize revenue in accordance with Statement of Position 97-2, Software Revenue Recognition as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with respect to Certain Transactions. Net sales are recognized following establishment of persuasive evidence of an arrangement, provided that the license fee is fixed or determinable, delivery of product has occurred via physical shipment or electronically, a determination has been made by management that collection is probable and the Company has no remaining obligations. Revenues under multiple element arrangements, which typically include products and maintenance sold together, are allocated to each element using the residual method in accordance with SOP 98-9. The Company provides for estimated returns at the time of shipment. The Company recognizes maintenance revenue from the sale of post-contract support services ratably over the life of the contract. We maintain allowances for estimated losses resulting from the inability of our customers to make required payments, however, if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, allowances would be required.

Our reserve for excess and obsolete inventory is primarily based upon forecasted demand for our products and any change to the reserve arising from forecast revisions is reflected in cost of sales in the period the revision is made. The Company writes down its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual future demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

Property and equipment, including leasehold improvements, are depreciated over their estimated useful lives.

We are currently involved in legal proceedings. As discussed in Note 9 of the consolidated financial statements, as of May 31, 2003, we have provided accruals for all direct costs associated with the estimated resolution of known contingencies. The accrual is established at the earliest date at which it is deemed probable that a liability has been incurred and the amount of such liability can be reasonably estimated. Litigation could take several years to complete. Accordingly, actual legal fees and, possibly, damages awards or settlements, could differ significantly from our estimates. It is possible, however, that future results of operations for any particular quarterly or annual period could be materially affected by changes in our assumptions, or the effectiveness of our strategies, related to these proceedings.

The following table shows certain consolidated statements of operations data as a percentage of net sales.

Comparison of Second Fiscal Quarter of 2003 to Second Fiscal Quarter of 2002

Net sales. We derive our sales from the licensing and sale of our software and systems for advanced media systems for content design, and from services in the form of annual contracts supporting our software and systems. In the case of software and systems, we recognize revenue upon shipment or distribution over the Internet to a customer provided there exists persuasive evidence of an arrangement, the license fee is fixed or determinable, a determination has been made by management that the collection is probable and the Company has no remaining obligations. In the case of services that support our software and systems products, called Platinum Services, we recognize revenue ratably over the life of the service contract.

Our total net sales for the second quarter of fiscal 2003 decreased 22.0% to $5.1 million from $6.6 million for the second quarter of fiscal 2002. Net sales from products for the second quarter of fiscal 2003 decreased 23.8% to $3.9 million from $5.1 million for the second quarter of fiscal 2002. The decrease in net sales from products is due to lower sales of our digital video editing systems (decrease of $1.2 million) due to increased competition resulting in lower unit sales and average selling prices. We recognized approximately $900,000 of previously deferred 844/X revenue during the second quarter of fiscal 2003 due to the delivery of an upgrade, which we announced in the first quarter of fiscal 2003 and shipped in the second quarter of fiscal 2003. We anticipate the trend of lower year-over-year sales of our digital video systems to continue in fiscal 2003, offset by sales from 844/X. Services for the second quarter of fiscal 2003 decreased 15.8% to $1.3 million from $1.5 million for the second quarter of fiscal 2002. The decrease in services is the result of lower sales of service contracts due to lower unit sales of our digital video editing systems and lower renewal rates of these service contracts from our installed base.

Net sales from customers outside of North America accounted for approximately 33.2% and 43.8% of net sales in the second quarter of fiscal 2003 and the second quarter of fiscal 2002, respectively. With the introduction of 844/X in April 2002, we are continuing to develop our indirect distribution channels in North America, Europe, Asia and Latin America and currently anticipate that customers outside North America will continue to account for a substantial portion of our net sales, and as a percentage of net sales, to range between 35% and 45% during the remainder of fiscal 2003.

Cost of sales. Cost of sales for products consists of the cost of manufacturing PCI hardware boards for our advanced media systems for content design and our digital video editing systems and royalties paid to third parties for their software that has been integrated into our systems. Cost of sales also includes the cost of manuals and other product documentation, related labor and, in the case of 844/X, may include third-party components such as disk drives, personal computers and other third-party hardware components. Cost of sales for our service offerings consists of salaries and related expenses for service personnel delivering the service to the customer.

Total cost of sales decreased 26.5% to $2.5 million in the second quarter of fiscal 2003 from $3.4 million in the second quarter of fiscal 2002. The decrease in cost of sales is related to lower unit sales of our digital video editing systems and the elimination of an expense for accelerated depreciation.

Gross profit. Our gross profit decreased 17.2% to $2.6 million in the second quarter of fiscal 2003 from $3.2 million in the second quarter of fiscal 2002. Overall gross profit as a percentage of net sales increased to 51.5% in the second quarter of fiscal 2003 from 48.5% in the second quarter of fiscal 2002. Gross profit as a percentage of net sales of products increased to 41.2% in the second quarter of fiscal 2003 from 38.7% in the second quarter of fiscal 2002, while gross profit as a percentage of net sales of services increased to 82.2% in the second quarter of fiscal 2003 from 81.8% in the second quarter of fiscal 2002. The increase in gross profit for products in the second quarter of fiscal 2003 over the second quarter of fiscal 2002 was the result of higher average selling prices for 844/X and the elimination of an expense for accelerated depreciation of leasehold improvements and other property and equipment located in our former facility and not moved to our new facility. The slightly higher gross profit for services in the second quarter of fiscal 2003 over the second quarter of fiscal 2002 was the result of lower personnel costs related to technical support. During the remainder of fiscal 2003, we currently anticipate that gross margins will remain stable.

Research and development. Research and development expenses include costs incurred to develop and improve our existing intellectual property and develop new intellectual property and are charged to expense as incurred. To date, development costs for our systems have been charged to expense as incurred because the costs incurred from the attainment of technological feasibility to general product release have not been significant. Our research and development costs may fluctuate from quarter to quarter due to the nature of the products under development. Some of our systems have PCI hardware included in the product and the costs associated with designing and developing this type of hardware can be expensive. In addition, our software developers require this hardware in order to integrate the software code they develop with the hardware to create a fully integrated advanced media system for content design.

Research and development expenses decreased 30.1% to $1.8 million in the second quarter of fiscal 2003 from $2.6 million in the second quarter of fiscal 2002. The majority of the decrease in research and development expenses represented lower development

costs associated with 844/X, which shipped in April 2002. We currently anticipate our research and development expenses will decrease in absolute dollars in fiscal 2003 versus fiscal 2002 because we believe that ongoing development costs and the cost of improvements to 844/X will not be as high in fiscal 2003 as the development costs incurred in fiscal 2002 when we shipped the first version of the product.

Selling and marketing. Selling and marketing expenses consist primarily of salaries and related benefits, travel, commissions and marketing costs such as advertising, trade shows, marketing materials, lead generation activities and public relations. Our selling and marketing expenses may fluctuate from quarter to quarter based on the timing of trade shows and sales commissions, which vary based on sales.

Selling and marketing expenses decreased 41.4% to $1.6 million in the second quarter of fiscal 2003 from $2.7 million in the second quarter of fiscal 2002. In the second quarter of fiscal 2002, we were preparing for the introduction of 844/X and incurred significant marketing expenses in connection with these activities. These product launch activities and the expenses associated with them, occurred in the first and second quarters of fiscal 2002. In the second quarter of fiscal 2003 there were no product launch activities still ongoing and the marketing expenses incurred in the period were in support of ongoing promotion and sales of 844/X, which are considerably less than the initial product launch expenses. We currently anticipate that our selling and marketing expenses will decrease in absolute dollars in fiscal 2003 versus fiscal 2002 as we execute our strategy of leveraging the indirect channel of resellers we developed in fiscal 2002 to sell 844/X. Also, in the first half of fiscal 2002, we incurred significant marketing expenses related to the introduction of 844/X and, while we plan to continue aggressively marketing 844/X, we believe our marketing costs in fiscal 2003 will be less than fiscal 2002.

General and administrative. General and administrative expenses consist primarily of salaries and related benefits, travel and outside services for human resources, finance, information technology, legal, and other administrative functions. General and administrative expenses decreased 62.1% to $541,000 in the second quarter of fiscal 2003 from $1.4 million in the second quarter of fiscal 2002. The decrease in general and administrative expenses resulted primarily from lower expenses in the following categories: legal fees; employee-related; occupancy; and outside services. We currently anticipate that our general and administrative expenses will decrease in fiscal 2003 compared to fiscal 2002 as we align our expense structure with anticipated revenue levels.

Amortization of intangible assets. We recorded amortization expense of $273,000 in the second quarter of fiscal 2002 related to the acquisitions of Wired, Inc. and certain assets of Integrated Computing Engines, Inc. During fiscal 2002, we expensed all remaining goodwill related to these acquisitions and, therefore, there was no amortization expense in the second quarter of fiscal 2003.

Accelerated depreciation and amortization of property and equipment. We recorded a charge of $215,000 in the second quarter of fiscal 2002 related primarily to leasehold improvements at our previous facility in Marlborough, Massachusetts. During the second quarter of fiscal 2002 we completed our relocation from this facility to a new facility, also located in Marlborough, Massachusetts, better suited to meet our needs. As a result of this decision and the signing of a lease for the new facility we amortized the remaining book value as of the beginning of fiscal 2002 of all leasehold improvements, furniture and fixtures over the remaining months in fiscal 2002 (four) that we occupied our previous facility and, therefore, there was no such charge in the second quarter of fiscal 2003.

Restructuring expense. We recorded a restructuring expense of $214,000 in the second quarter of fiscal 2003 related to a reduction in force plan implemented during the quarter in an effort to reduce our operating costs going forward. We estimate annual savings as a direct result of this plan of approximately $1.6 million. There was no such expense recorded in the second quarter of fiscal 2002.

Interest income, net. Interest income, net, decreased 67.6% to $12,000 in the second quarter of fiscal 2003 from $37,000 in the second quarter of fiscal 2002. The decrease in interest income, net, resulted from lower cash and cash equivalents due primarily to the net loss incurred in fiscal 2002 and the first half of fiscal 2003. We currently anticipate that interest income will decline in fiscal 2003 versus 2002 due to lower cash levels.

Other income, net. Other income, net declined 33.3% to $180,000 for the second quarter of fiscal 2003 from $270,000 for the second quarter of fiscal 2002. In the second quarters of fiscal 2003 and 2002, other income, net primarily consisted of foreign exchange gains on intercompany transactions with our foreign subsidiaries. Gains and losses on our intercompany transactions with our foreign subsidiaries are impacted by changes in the value of the U.S. dollar relative to certain European currencies.

Tax provision or benefit. We did not record a tax provision or benefit in the second quarters of either fiscal 2003 or 2002 due to the net loss incurred during both periods.

Net loss. As a result of the above factors, we recorded a net loss in the second quarter of fiscal 2003 in the amount of ($1.3) million, or ($0.10) per share, compared to a net loss of ($3.7) million, or ($0.29) per share, in the second quarter of fiscal 2002.

Comparison of First Six Months of Fiscal 2003 to First Six Months of Fiscal 2002

Our total net sales for the first six months of fiscal 2003 decreased 10.4% to $9.9 million from $11.1 million for the first six months of fiscal 2002. Net sales from products for the first six months of fiscal 2003 decreased 6.4% to $7.4 million from $7.9 million for the first six months of fiscal 2002. The decrease in net sales from products is due to a decrease in sales of our digital video editing systems (decrease of $2.4 million) due to increased competition resulting in lower unit sales and average selling prices. This decrease was partially offset by increased sales of 844/X (increase of $1.9 million), which began shipping in the second quarter of fiscal 2002. We recognized approximately $1.3 million of previously deferred 844/X revenue during the first six months of fiscal 2003 due to the delivery of an upgrade, which we announced in the fourth quarter of fiscal 2002 and shipped in the first quarter of fiscal 2003. Upon shipment of the upgrade we recognized all revenue previously deferred that was associated with the upgrade. We anticipate the trend of lower year-over-year sales of our digital video systems to continue in fiscal 2003, offset by sales from 844/X. Net sales from services for the first six months of fiscal 2003 decreased 20.4% to $2.5 million from $3.1 million for the first six months of fiscal 2002. The decrease in net sales from services is the result of lower sales of service contracts due to lower unit sales of our digital video editing systems and lower renewal rates of these service contracts from our installed base.

Net sales from customers outside of North America accounted for approximately 39.1% and 41.6% of net sales in the first six months of fiscal 2003 and the first six months of fiscal 2002, respectively. With the introduction of 844/X in April 2002, we are continuing to develop our indirect distribution channels in North America, Europe, Asia and Latin America and currently anticipate that customers outside North America will continue to account for a substantial portion of our net sales, and as a percentage of net sales, to range between 35% and 45% during the remainder of fiscal 2003.

Total cost of sales decreased 15.7% to $5.0 million in the first six months of fiscal 2003 from $5.9 million in the first six months of fiscal 2002. The decrease in cost of sales is related to lower unit sales of our digital video editing systems and the elimination of an expense for accelerated depreciation, partially offset by increased cost of sales due to higher sales of 844/X.

Gross profit. Our gross profit decreased 4.4% to $5.0 million in the first six months of fiscal 2003 from $5.2 million in the first six months of fiscal 2002. Overall gross profit as a percentage of net sales increased to 50.1% in the first six months of fiscal 2003 from 47.0% in the first six months of fiscal 2002. Gross profit as a percentage of net sales of products increased to 39.4% in the first six months of fiscal 2003 from 33.2% in the first six months of fiscal 2002, while gross profit as a percentage of net sales of services increased to 82.1% in the first six months of fiscal 2003 from 81.7% in the first six months of fiscal 2002. The increase in gross profit for products in the first six months of fiscal 2003 over the first six months of fiscal 2002 was the result of the elimination of an expense for accelerated depreciation of leasehold improvements and other property and equipment located in our former facility and not moved to our new facility. During the remainder of fiscal 2003, we currently anticipate that gross margins will improve slightly from current levels.

this hardware in order to integrate the software code they develop with the hardware to create a fully integrated advanced media system for content design.

Research and development expenses decreased 30.5% to $3.6 million in the first six months of fiscal 2003 from $5.1 million in the first six months of fiscal 2002. The majority of the decrease in research and development expenses represented lower development costs associated with 844/X, which shipped in April 2002. We currently anticipate our research and development expenses will decrease in absolute dollars in fiscal 2003 versus fiscal 2002 because we believe that ongoing maintenance costs and the cost of improvements to 844/X will not be as high in fiscal 2003 as the development costs to create the first version of the product.

Selling and marketing expenses decreased 38.4% to $3.1 million in the first six months of fiscal 2003 from $5.0 million in the first six months of fiscal 2002. In the first half of fiscal 2002, we were preparing for the introduction of 844/X and incurred significant marketing expenses in connection with these activities. These product launch activities and the expenses associated with them, occurred in the first and second quarters of fiscal 2002. In the first six months of fiscal 2003 there were no product launch activities still ongoing and the marketing expenses incurred in the period were in support of ongoing promotion and sales of 844/X, which are considerably less than the initial product launch expenses. We currently anticipate that our selling and marketing expenses will decrease in absolute dollars in fiscal 2003 versus fiscal 2002 as we execute our strategy of leveraging the indirect channel of resellers we developed in fiscal 2002 to sell 844/X. Also, in the first half of fiscal 2002, we incurred significant marketing expenses related to the introduction of 844/X and, while we plan to continue aggressively marketing 844/X, we believe our marketing costs in fiscal 2003 will be less than fiscal 2002.

General and administrative. General and administrative expenses consist primarily of salaries and related benefits, travel and outside services for human resources, finance, information technology, legal, and other administrative functions. General and administrative expenses decreased 53.2% to $1.2 million in the first six months of fiscal 2003 from $2.5 million in the first six months of fiscal 2002. The decrease in general and administrative expenses resulted primarily from lower expenses in the following categories: legal fees; employee-related; occupancy; and outside services. We currently anticipate that our general and administrative expenses will decrease in fiscal 2003 compared to fiscal 2002 as we align our expense structure with anticipated revenue levels.

Amortization of intangible assets. We recorded amortization expense of $765,000 in the first six months of fiscal 2002 related to the acquisitions of Wired, Inc. and certain assets of Integrated Computing Engines, Inc. During fiscal 2002, we expensed all remaining goodwill related to these acquisitions and, therefore, there was no amortization expense in the first six months of fiscal 2003.

Accelerated depreciation and amortization of property and equipment. We recorded a charge of $849,000 in the first six months of fiscal 2002 related primarily to leasehold improvements at our previous facility in Marlborough, Massachusetts. During the second quarter of fiscal 2002 we completed our relocation from this facility to a new facility, also located in Marlborough, Massachusetts, better suited to meet our needs. As a result of this decision and the signing of a lease for the new facility we amortized the remaining book value as of the beginning of fiscal 2002 of all leasehold improvements, furniture and fixtures over the remaining months in fiscal 2002 (four) that we occupied our previous facility and, therefore, there was no such charge in the first six months of fiscal 2003.

Restructuring expense. We recorded a restructuring expense of $214,000 in the first six months of fiscal 2003 related to a reduction in force plan implemented during the second quarter of fiscal 2003 in an effort to reduce our operating costs going forward. We estimate annual savings as a direct result of this plan of approximately $1.6 million. There was no such expense recorded in the first six months of fiscal 2002.

Settlement of litigation. We agreed to settle litigation brought against us by the former shareholders of Wired, Inc., a company we acquired in December 1999. As part of the settlement, we assigned all rights to the Wired product line, intellectual property relating to Wired products and on-hand inventory related to the Wired product line to the former shareholders. Wired granted us an irrevocable license to use the source code, technology, know how and intellectual property; provided, however, the license does not include the right to sell Wired products or any equivalent products incorporating the source code, technology, know how and intellectual property. In addition, we agreed to provide limited manufacturing and marketing support to the former shareholders. In exchange for all these items, we will receive 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. This agreement resulted in a write-off of the remaining goodwill created through

the acquisition of Wired. There was no similar expense recorded in the first six months of fiscal 2003. Litigation settlement of $924,000, included in the Consolidated Statements of Operations for the first six months of fiscal year 2002, represents the cost of inventory transferred, the net book value of remaining intangible assets associated with the acquisition, legal fees associated with the settlement, less a reimbursement related to the litigation from the Company’s insurance carrier.

Interest income, net. Interest income, net, decreased 68.7% to $36,000 in the first six months of fiscal 2003 from $115,000 in the first six months of fiscal 2002. The decrease in interest income, net, resulted from lower cash and cash equivalents due primarily to the net loss incurred in fiscal 2002 and the first six months of fiscal 2003. We currently anticipate that interest income will decline in fiscal 2003 versus 2002 due to lower cash levels.

Other income, net. Other income, net increased 88.2% to $352,000 for the first six months of fiscal 2003 from $187,000 for the first six months of fiscal 2002. Other income, net primarily consists of foreign exchange gains on intercompany transactions with our foreign subsidiaries. Gains and losses on our intercompany transactions with our foreign subsidiaries are impacted by changes in the value of the U.S. dollar relative to certain European currencies.

Tax provision or benefit. We did not record a tax provision or benefit in the first six months of either fiscal 2003 or 2002 due to the net loss incurred during both periods.

Net loss. As a result of the above factors, we recorded a net loss in the fist six months of fiscal 2003 in the amount of ($2.7) million, or ($0.20) per share, compared to a net loss of ($9.6) million, or ($0.75) per share, in the first six months of fiscal 2002.

As of May 31, 2003, our principal sources of liquidity included cash, cash equivalents and marketable securities totaling approximately $2.8 million. This was a decrease of approximately $600,000 million of cash, cash equivalents and marketable securities since the end of our previous fiscal quarter, which ended February 28, 2003. Additionally, we have restricted cash of approximately $250,000 relating to several letters of credit.

During the first six months of fiscal 2003, cash used in operating activities was approximately $2.6 million compared to cash used in operating activities of approximately $11.0 million for the first six months of fiscal 2002. Cash used in operations during the first six months of fiscal 2003 included a net loss of $2.7 million including depreciation and amortization of $683,000 and was affected by changes in assets and liabilities including decreases in accrued expenses of $2.6 million, deferred revenue of $1.6 million, accounts payable of $322,000 and prepaid expenses and other current assets of $266,000. These uses of cash were offset by decreases in restricted cash of $2.9 million (which is related to the decrease in accrued expenses of $2.6 million due to the payment to McRoberts as discussed in Note 9), inventories of $1.3 million and accounts receivable of $28,000. We ended the first six months of fiscal 2003 with days sales outstanding (DSO) of 43. At the end of fiscal 2002, DSOs were 84 due to the deferral of 844/X revenue from the fourth quarter of fiscal 2002 to the first quarter of fiscal 2003. Net cash used in investing activities was $183,000 for the first six months of fiscal 2003 compared to $864,000 for the first six months of fiscal 2002. Cash used in investing activities for the first six months of fiscal 2003 was primarily for purchases of capital equipment of $277,000 and purchases of intangible assets of $32,000, partially offset by net proceeds from sales of marketable securities of $126,000. Net cash provided by financing activities during the first six months of fiscal 2003 was $1.1 million compared to $415,000 for the first six months of fiscal 2002. In the first six months of fiscal 2003, cash provided by financing activities resulted from the sale of preferred stock of $1.0 million and from proceeds from the issuance of common stock pursuant to stock plans of $78,000.

In addition to the above contractual obligations, the Company has other contractual obligations. The Company has entered into indemnification agreements with the non-employee members of the Board of Directors. Additionally, the Company has from time to time entered into employment and executive retention agreements with certain employees and executive officers, which, among other things, include certain severance and change of control provisions. Under the terms of the Company’s standard product license and sale contracts, the Company indemnifies its customers for the potential liability associated with the infringement of other parties’ technology based upon the Company’s products. There is a possibility that the Company may be liable to any of its customers in the event that there is infringement occurring. The Company is not aware of any infringement related to the

Company’s technology, and therefore has not accrued any amounts for the replacement or refund of any software products sold through May 31, 2003.

We have already taken a series of actions to reduce the negative cash flow we experienced in the past fiscal year including the termination of employees, reductions in the salaries paid to executives and certain other employees, relocation of our facility to lower cost office space and a reduction in the marketing expenses for existing products. However, these expense reductions will not be enough to return us to profitability without revenue growth. Our current operating plan and cash flow projections assume a certain level of revenue and operating expenses. If we fail to achieve our revenue plan then we will reduce our operating expenses as a result of the revised lower revenue expectations in order to conserve cash. Our current cash flow projections also assume we will not require substantial cash for capital purchases or to fund substantial increases in inventory, accounts receivable or other assets and the projections assume we will be able to continue to collect our accounts receivables and will not incur substantial bad debts as a result of the failure of our customers to pay us.

We have recently raised additional capital to fund operations and may need to raise more capital within the next twelve months through the sale of debt or equity securities to fund future operations, develop new and enhance existing products and services, or acquire complementary products, businesses or technologies. At this time, we are in the process of seeking stockholder approval for $1.5 million of the total $2.5 million additional capital committed in the recent round of fundraising. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our existing stockholders may be reduced, our stockholders may experience additional dilution, and such securities may have rights, preferences or privileges senior to those of our existing stockholders (see Cautionary Statements for additional details). Additional financing may not be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms our ability to fund existing operations and expansion, take advantage of unanticipated opportunities or develop or enhance our products or services would be significantly limited and we may need to revise our operating plan to reduce operating expenses further. The Company’s ability to continue to operate as a going concern through at least the next twelve months is contingent upon the achievement of forecasted revenue growth from its 844/X product and management’s ability to manage expenses consistent with actual revenues achieved. Although the Company has raised approximately $1 million from a current investor and has an agreement to raise an additional $1.5 million from this investor, which is subject to shareholder approval, management does not believe these funds will be sufficient to sustain operations for at least the next twelve months without the attainment of planned revenue growth, a further reduction in operating expenses, or both. If management is unable to reduce expenses to manageable levels to support its current and anticipated revenue levels, the Company will begin to explore alternatives relating to a sale of all or part of the Company’s business.

Should we require additional capital to fund our operations and are unsuccessful in our efforts to raise sufficient capital; we will examine our alternatives, including the sale or liquidation of part or all of our business.

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in the following cautionary statements and elsewhere in this Quarterly Report on Form 10-Q. If any of the following risks were to occur, our business, financial condition, or results of operations would likely suffer. In that event, the trading price of our common stock would decline.

History of Losses and Negative Cash Flows, Expect to Incur Losses in the Future and May Not Achieve or Maintain Profitability. We have incurred substantial operating losses during the past fiscal year and in four of the past five fiscal years, have experienced negative cash flow from ongoing operations in the last fiscal year ended November 30, 2002, and we expect to incur operating losses and negative cash flows for at least the first half of fiscal 2003. We incurred a loss from continuing operations of approximately $2.7 million for the first six months of fiscal 2003 ended May 31, 2003 and as of May 31, 2003 we had an accumulated deficit of approximately $217.0 million.

Over the past four years we have significantly increased our research and development expenses as a percentage of total sales and we plan to continue to invest in new technology, and as a result, we may incur operating losses in future periods. We will need to generate increases in our current sales levels to achieve and maintain profitability and we may not be able to do so. Our current operating plan and cash flow projections assume a certain level of revenue and operating expenses. If we fail to achieve our revenue plan then we will reduce our operating expenses as a result of the reduced revenue expectations in order to conserve cash. If our sales grow more slowly than we anticipate or if our operating expenses increase more than we expect or cannot be reduced in the event of lower revenue, our business will be significantly and adversely affected. Although we implemented restructuring programs in July 2002 and again in May 2003 to better align our operations and cost structure with current and anticipated market conditions, these programs will not be sufficient for us to achieve profitability in any future period

without revenue growth. Even if we achieve profitability in the future on a quarterly or annual basis, we may not be able to sustain or increase profitability. Our failure to achieve profitability, achieve the level of profitability, or sustain the level of profitability expected by investors and securities analysts may adversely affect the market price of our common stock.

In addition, we expect that we will continue to experience negative operating cash flows in the third quarter of fiscal 2003. Depending on future cash flow, we may need to raise additional capital in the future to meet our cash requirements and we may not be able to find additional financing, if required, on favorable terms or at all. If adequate funds are not available or are not available on acceptable terms, our ability to fund existing operations and expansion, take advantage of unanticipated opportunities or develop or enhance our products or services would be significantly limited and we may need to revise our operating plan to reduce operating expenses further.

If We Are Unable to Obtain Additional Capital as Needed in the Future, Our Business May be Adversely Affected and the Market Price for Our Common Stock Could Decline Significantly. We have been unable to fund our operations using cash generated from our business operations and have financed our operations principally through the prior sales of securities and from existing cash on our balance sheet. We may need to raise additional debt or equity capital to fund our existing operations, expand operations, maintain and enhance existing products and services or acquire or invest in complementary products, services, businesses or technologies. At this time, we are in the process of seeking stockholder approval for $1.5 million of the total $2.5 million additional capital committed in the recent round of fundraising. In the future, if we raise additional funds through further issuance of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity or debt securities we issue may have rights, preferences, or privileges superior to those of holders of our common stock. If we do raise capital through the issuance of equity or convertible debt the amount of dilution will depend upon several factors including, but not necessarily limited to, the amount of capital raised, the security or securities issued, the terms of the security and the market price of the company’s common stock. Additionally, the terms of the equity or debt securities we may issue to the investor(s) may have rights, preferences or privileges superior to those of holders of our common stock including, but not limited to, liquidation preferences, anti-dilution provisions, dividends, voting rights, protective provisions, right of first refusal on certain future financing transactions and consent provisions for certain transactions. The effect of some of these new terms may be to provide what is perceived as a disproportionate return to the new investor. For example, a new investor might obtain an equity stake based on current market values, but with the right to some multiple of the investment being required to be returned to the new investor before any return is made to existing shareholders. Even after offering these terms we may not be able to obtain additional financing. If adequate funds are not available to us on terms favorable to us, our business may be adversely affected and the market price for our common stock could decline significantly. If adequate funds are not available or are not available on acceptable terms, our ability to fund existing operations and expansion, take advantage of unanticipated opportunities or develop or enhance our products or services would be significantly limited and we may need to revise our operating plan to reduce operating expenses further. At this time we believe that we will be able to continue to operate our business as a going concern for at least the next twelve months based upon the amount of our existing capital, our current operating plan and our commitment to reduce operating expenses further if we do not achieve the revenues anticipated in our current operating plan. However, we offer no assurances in this regard.

Possibility of NASDAQ Delisting. On May 27, 2003, our stock began trading on the NASDAQ Small Cap Market. At that time, we satisfied all of the listing requirements; however, in order for our stock to remain listed on this stock exchange we must maintain minimum listing requirements including a minimum stock price of $1.00 for 30 consecutive days and minimum stockholders’ equity of $2.5 million. As of May 31, 2003, our stockholders’ equity was $1.2 million and therefore does not meet the minimum listing requirements to remain listed on the NASDAQ Small Cap Market. We are in the process of raising a total of $2.5 million in additional capital, with $1.0 million already received by the Company in May 2003 but not yet classified as stockholders’ equity. The remaining $1.5 million of the $2.5 million of additional capital requires stockholders’ approval. We are in the process of seeking such approval from our stockholders; however, our stockholders may not approve the additional capital. Therefore, we may not be able to raise the additional capital or maintain the minimum-listing requirement for stockholders’ equity. Additionally, we must classify this additional capital as part of permanent equity on our balance sheet in order to satisfy the minimum listing requirement and, currently, the security we issued in raising the $1.0 million and the securities we plan to issue for the remaining $1.5 million of new capital do not satisfy the Securities and Exchange definition for inclusion in permanent equity due to a redemption provision. We are currently in the process of seeking to amend the securities to remove the redemption provision; however, we may be unsuccessful in doing so in which case we will be unable to classify this additional capital in permanent equity and will not satisfy the minimum listing requirement for stockholders’ equity. There can be no assurance that we will be able to take actions sufficient to achieve or maintain compliance with the continued listing criteria of The NASDAQ Small Cap Market. As a result, the price and liquidity of our common stock could be adversely affected, our ability to access the capital markets would likely be more limited, and our ability to generate new sales of our products may be adversely affected and may cause existing customers and vendors to question our viability. Additionally, our stock may be subject to “penny stock” regulations.

Significant Fluctuations and Unpredictability of Operating Results. Our quarterly operating results are difficult to predict, have varied significantly in the past and are likely to vary significantly in the future for a number of reasons, including new product announcements and introductions by ourselves or our competitors, changes in pricing, and the volume and timing of orders received during the quarter. Also, in the past, we have experienced delays in the development of new products and enhancements, and such delays may occur in the future. These factors make the forecasting of revenue inherently uncertain. Additionally, a significant portion of our operating expenses is relatively fixed, and operating expense levels are based primarily on internal expectations of future revenue. As a consequence, quarterly operating expense levels cannot be reduced rapidly in the event that quarterly revenue levels fail to meet internal expectations. For these reasons, you should not rely on period-to-period comparisons of our financial results to forecast our future performance. It is likely that in some future quarter or quarters our operating results will be below the expectations of securities analysts or investors. In addition, we typically realize a significant percentage of our sales for a fiscal quarter in the second half of the third month of the quarter. As a result, our quarterly results may be difficult or impossible to predict. If quarterly revenue or earnings levels fail to meet internal or external expectations, the market price of our common stock may decline significantly.

Dependence on Key Personnel. We believe that our future success will depend 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 timely basis, or the departure of key employees could have a material adverse affect on our business and operating results and negatively affect the price of our common stock. In addition, if we are unable to maintain existing sales levels or achieve internal sales projections we may implement an employee reduction program, which may result in the termination of key personnel necessary to maintain certain functions or operations for the Company. The loss of key personnel will have a negative effect on our future results and reduce our ability to achieve projected sales levels and profitability.

Weak Worldwide Economic Conditions and Advertising Market May Result in Decreased Sales and Continued Operating Losses. Growth in sales and a return to profitability for our company depends on the overall demand for television advertising, which is driven by economic conditions in the markets in which we compete. A substantial portion of our sales is to companies providing their services for the creation of television advertisement and demand for our customers’ services is affected by general economic and business conditions. During the past two years, due to weak economic conditions, television advertisers have spent less money advertising their products and services and, as a result, demand for the services our customers provide has decreased. In this weak economic environment, we may not be able to effectively promote future growth or maintain existing sales levels or achieve the sales levels expected by investors and securities analysts in any given period, or achieve profitability and, as a result, our business and operating results could be materially and adversely affected and our stock price could decline.

Our Lengthy and Variable Sales Cycle Makes it Difficult for Us to Predict When or if Sales Will Occur and Therefore We May Experience an Unplanned Shortfall in our Anticipated Sales Levels. 844/X has a lengthy and unpredictable sales cycle that contributes to the uncertainty of our operating results. Our prospects view the purchase of 844/X as a significant and strategic decision for their company. As a result, prospects generally evaluate 844/X and determine its impact on existing infrastructure and workflow. The purchase of 844/X may be delayed if the prospect has lengthy internal budgeting, approval or evaluation processes. We may incur significant selling and marketing expenses during a prospect’s evaluation period before the customer places an order with us. Some prospects may purchase 844/X as part of multiple simultaneous purchasing decisions, which may result in unanticipated delay in receiving an order from the customer. If sales forecasted from specific customers are delayed to future quarters, we may experience an unplanned shortfall in sales, which could significantly and adversely affect our operating results and stock price.

Emerging Markets. The markets in which we offer our systems products and services are intensely competitive and rapidly changing. We are targeting the emerging market of broadcast designers, effects artists, and creative professionals. This market and the products utilized by these users are relatively new. Our success in this emerging market will depend on the rate at which the market develops and our ability to penetrate that market. We will not succeed if we cannot compete effectively in this market and, as a result, our business and operating results could be materially and adversely affected.

Risks Associated With Development and Introduction of New Products. If we are not successful in developing and introducing new products to the markets we serve our business and operating results will suffer. In April 2002, we began shipping 844/X, and currently anticipate this new product will generate greater than 50% of the revenue from product sales beginning in fiscal 2003. If the adoption of 844/X is slower than we anticipate or if there are delays in releasing subsequent versions of 844/X, our current revenue expectations may be too high and our operating results may be negatively affected. In addition, new product announcements by our competitors and other new product announcements by us could have the effect of reducing customer demand for our existing products. Also, when we introduce new or enhanced products we must effectively manage the transitions from existing products to minimize disruption of orders from our customers. New product introductions require us to devote time and resources to the training of our sales channel in the features and target customers for such new products, which efforts could result in less selling efforts being made by the sales channel during such training period. Our failure to effectively manage new

product announcements or introductions could contribute to significant quarterly fluctuations in operating results as orders for new products commence and orders for existing products decline and, as a result, our operating results will suffer.

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

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

Rapid Technological Change. Rapidly changing technology, evolving industry standards and frequent new product introductions characterize the market for our products. Our future success will depend in part upon our ability to enhance existing products and to introduce new products and features in a timely manner to address customer requirements, respond to competitive offerings, adapt to new emerging industry standards and take advantage of new enabling technologies that could render our existing products obsolete. We plan to continue to invest in research and development, in connection with our development strategy. Any delay or failure on our part in developing additional new products or features for existing products or any failure of such new products or features to achieve market acceptance, could have a material adverse effect on our business and operating results and our stock price will suffer.

Risks of Third-Party Claims of Infringement. There has been substantial industry litigation regarding patent, trademark and other intellectual property rights involving technology companies. In the future, litigation may be necessary to enforce any patents issued to us or to enforce trade secrets, trademarks and other intellectual property rights owned by us, to defend ourselves against claimed infringement of the rights of others and to determine the scope and validity of the proprietary rights of others. For a description of certain pending litigation instituted against us, see Note 8 to the Interim Unaudited Consolidated Financial Statements included herein. Any such litigation could be costly and a diversion of management’s attention, which could adversely affect our business and operating results and our financial condition. Adverse determinations in any such litigation could result in the loss of our proprietary rights, subject us to significant liabilities, and require us to seek licenses from third parties or prevent us from manufacturing or selling our products, any of which could adversely affect our business and operating results and our financial condition.

Weak Economic Conditions May Cause our Customers to Experience Financial Difficulties and May Represent a Credit Risk. Due to the weak global economy and uncertainties relating to the prospects for near-term global economic growth, some of our customers may experience financial difficulties and may represent a credit risk to us. If these customers experience financial difficulties or fail to experience commercial success, we may have difficulty collecting our accounts receivable.

Competition. The market for our products is highly competitive and characterized by pressure to reduce prices, incorporate new features and accelerate the release of new products. A number of companies currently offer products that compete directly or indirectly with our products, including Accom, Inc., Adobe Systems Inc., Apple Computer, Inc., Avid Technology, Inc., Discreet (a division of Autodesk, Inc.), Leitch, Inc., Matrox Electronic Systems Ltd., Pinnacle Systems, Inc. and Quantel Ltd. In addition, we expect much larger vendors, such as Matsushita Electric Industrial Company Ltd., Microsoft Corporation, and Sony Corporation, to develop and introduce digital editing systems that may compete with our products. Many of these current and potential competitors have greater financial, technical and marketing resources than we have, including, without limitation, larger and more established selling and marketing capabilities, greater brand recognition and a larger installed base of customers, and well-established relationships with our existing and potential customers, complementary technology vendors and other business partners. As a result, our competitors may be able to develop products comparable to or superior to our own products, adapt more quickly than us to new technologies, evolving industry standards or customer requirements, or lower their product costs and thus be able to lower prices to levels at which we could not operate profitably, the occurrence of any of which could have a material adverse effect on our business and operating results. In this regard, we believe that we will continue to experience competitive pressure to reduce prices, particularly for our high performance systems. We have historically realized higher gross profit on the sale of these high performance systems, and such continued competitive pricing pressure could result in lower sales and gross margin, which in turn could adversely affect our business and operating results and negatively affect the price of our common stock.

Dependence on Propriety Technology. Our ability to compete successfully and achieve future revenue growth will depend, in part, on our ability to protect our proprietary technology and operate without infringing the rights of others. Previously, we have received, and may in the future continue to receive, communications suggesting that our products may infringe on the patents or other intellectual property rights of third parties. Our policy is to investigate the factual basis of such communications and negotiate licenses where appropriate. While it may be necessary or desirable in the future to obtain licenses relating to one or more products, or relating to current or future technologies, there can be no assurance that we will be able to do so on commercially reasonable terms or at all. There can be no assurance that these or other future communications can be settled on commercially reasonable terms or that they will not result in protracted and costly litigation. Any failure to secure the necessary intellectual property right of third parties on commercially reasonable terms may adversely affect our business and operating results and negatively affect the price of our common stock.

Dependence on Single or Limited Source Suppliers. We are dependent on single or limited source suppliers for several key components used in its products that have no ready substitutes, including various audio and video signal processing integrated circuits manufactured in each case only by Crystal Semiconductor^® Corp., Fairchild Semiconductor^® Corp., Gennum^® Corporation, Toshiba, Kawasaki LSI USA^® Inc., Philips^® Semiconductors, Silicon Optix^™, Faraday Technology, Scientific Conversion, Xilinx^®, Altera^®, Lattice^®, Agere^®, Marvel^®, and IDT^®. The availability of many of these components is dependent on our ability to provide suppliers with accurate forecasts of our future requirements, and certain components we use to build our products have been subject to industry-wide shortages and the continued viability of these suppliers and product line. We do not carry significant inventories of these components and have no guaranteed supply arrangements with such suppliers. There can be no assurance that our inventory levels will be adequate to meet production needs during any interruption of supply. Our inability to develop alternative supply sources, if required, or a reduction or stoppage in supply, could delay product shipments until new sources of supply become available, and any such delay could adversely affect our business and operating results in any given period and negatively affect the price of our common stock.

Dependence on Distributors and Resellers. We rely primarily on our worldwide network of independent distributors and value-added resellers (“VARs”) to distribute and sell our products to end-users. Our distributors and resellers generally offer products from several different companies, including in some cases products that are competitive with our own products. In addition, many of the VARs are small organizations with limited capital resources. There can be no assurance that our distributors and resellers will continue to purchase products from us, or that our efforts to expand our network of distributors and resellers will be successful. Any significant failure on our part to maintain or expand our network of distributors and resellers could have a material adverse effect on our business and operating results and negatively affect the price of our common stock.

Reliance on International Sales. International sales and operations may be subject to risks such as the imposition of government controls, export license requirements, restrictions on the export of critical technology, less effective enforcement of proprietary rights; currency exchange fluctuations, generally longer collection periods, political instability, trade restrictions, changes in tariffs, difficulties in staffing and managing international operations, potential insolvency of international resellers and difficulty in collecting accounts receivable. Our international sales are also subject to more seasonal fluctuation than domestic sales. In this regard, the traditional summer vacation period, which occurs during our third fiscal quarter, may result in a decrease in sales, particularly in Europe. There can be no assurance that these factors will not have an adverse effect on our future international operations and consequently, on our business and operating results. This fluctuation may be material and negatively affect the price of our common stock.

Merger and Acquisition Related Risks. We may dispose of assets, either assets we have historically used in the business or that we have acquired. Our business and results of operations could materially change depending on whether or not we are able to dispose of assets in an advantageous manner. In addition to obtaining an advantageous price for the assets to be disposed of, dispositions involve a number of special risks and factors, including searching for appropriate acquirers; managing the effect of the disposition on existing and proposed product lines and services, the divestiture of operations and personnel, adverse short-term effects on reported operating results, potential post-divestiture indemnification or liability for liabilities of divested operations, as well as the diversion of management’s attention during the disposition process. Some or all of these special risks and factors may have a material adverse impact on our business, operating results, and financial condition and, as a result, may negatively affect the market price of our common stock.

Similarly, our business and results of operations could be materially adversely affected in the event we fail to complete publicly announced acquisitions or to successfully integrate the business and operations of the previously completed mergers or the acquisitions. In the future, we may continue to acquire or merge with existing businesses, products, and technologies to enhance and expand our line of products. Such mergers and acquisitions may be material in size and in scope. There can be no assurance that we will be able to identify, acquire, or profitably manage additional businesses or successfully integrate any acquired businesses into our business without substantial expenses, delays, or other operational or financial problems. Acquisitions involve a number of special risks and factors, including increasing competition for attractive acquisition candidates in our markets, the

technological enhancement and incorporation of acquired products into existing product lines and services, the assimilation of the operations and personnel of the acquired companies, failure to retain key acquired personnel, adverse short-term effects on reported operating results, the amortization of acquired intangible assets, the assumption of undisclosed liabilities of any acquired companies, the failure to achieve anticipated benefits such as cost savings and synergies, as well as the diversion of management’s attention during the acquisition and integration process. We may not be able to operate the acquired businesses properly and may not be able to successfully recover amounts paid for such businesses. Some or all of these special risks and factors may have a material adverse impact on our business, operating results, and financial condition and, as a result, may negatively affect the market price of our common stock.

Stock Price Volatility. The trading price of our common stock has been highly volatile and has fluctuated significantly in the past. During the fiscal year ended November 30, 2002 our stock price fluctuated between a low of $0.35 per share and a high of $3.75 per share. We believe that the price of our common stock may continue to fluctuate significantly in the future in response to a number of events and factors relating to our company, our competitors, and the market for our products and services, many of which are beyond our control, such as, variations in our quarterly operating results; changes in financial estimates and recommendations by securities analysts; changes in market valuations of companies in our markets; announcements by us or our competitors of significant products, acquisitions, or strategic partnerships; failure to complete significant business transactions; departures of key personnel; purchases or sales of common stock or other securities by us; or news relating to trends in our markets. In addition, the stock market in general, and the market for technology companies in particular, has experienced extreme volatility over the past twelve months. This volatility has often been unrelated to the operating performance of particular companies. These broad and industry fluctuations may adversely affect the market price of our common stock, regardless of our operating performance.

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

Primary Market Risk Exposures. The Company’s primary market risk exposures are in the area of interest rate risk and foreign currency exchange rate risk. The Company’s investment portfolio of cash equivalents is subject to interest rate fluctuations, but the Company believes this risk is immaterial due to the short-term nature of these investments. The Company’s business in Europe is conducted in local currency. In Asia, business is conducted in U.S. currency. The Company has no foreign exchange contracts, option contracts or other foreign hedging arrangements. However, the Company estimates that any market risk associated with its foreign operations is not significant and is unlikely to have a material adverse effect on the Company’s business, results of operations, or financial condition.

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

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

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

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

(iii) On October 12, 1999, a lawsuit was filed against the 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, and trade secret misappropriation. The complaint includes requests for unspecified monetary damages and enhanced damages, interest, costs and fees. An unfavorable verdict was filed on February 25, 2002 against the Company in the amount of $2.5 million. The Company and MSI filed post-trial motions. Those motions were ruled upon with the trial court reducing the total amount awarded by the jury but assessing prejudgment interest and attorney’s fees. The Company appealed the entire judgment to the United States Court of Appeals for the Seventh Circuit and on May 14, 2003 the appeal court rendered a decision in favor of McRoberts. As part of its decision, the appellate court reinstated a $300,000 trade secret component of damages. On May 29, 2003, the Company released approximately $2.8 million from escrow and later paid the remaining $39,000 escrow and an additional $261,000 from unrestricted cash to pay the judgment. McRoberts is seeking attorneys’ fees of approximately $90,000 for the appeal. That amount remains in dispute and for resolution before the Seventh Circuit and has not been provided for by the Company at May 31, 2003. McRoberts is seeking pre-judgment and post-judgment interest on its trade secret award in an amount yet to be quantified. Claims for interest remain in dispute and have not been provided for the accompanying financial statements at May 31, 2003.

(iv) During the year ended November 30, 2002, the Company settled litigation with the former shareholders of Wired, which was acquired by the Company in fiscal 2000. As part of the settlement, the Company assigned all rights to the Wired product line, intellectual property relating to Wired products and on-hand inventory related to the Wired product line to the former shareholders. In return, Wired granted the Company an irrevocable license to use the source code, technology, know how and intellectual property. In addition, Wired promised to pay the Company a royalty of 5% of adjusted gross sales of the assigned products, not to exceed $1.2 million, plus the cost of the inventory assigned. Litigation settlement included in the Consolidated Statements of Operations for the six months ended May 31, 2002 represents the cost of inventory transferred, the net book value of remaining intangible assets associated with the acquisition, and legal fees associated with the settlement.

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

The Company held an annual meeting of stockholders on April 15, 2003, at which the stockholders approved the following proposals by the number of shares of Common Stock voted below:

Exhibits required as part of this Quarterly Report on Form 10-Q are listed on the exhibit index on page 33.

On April 3, 2003, the Company filed a report on Form 8-K under Item 9 incorporating its press release announcing first quarter 2003 results. In accordance with interim guidance issued by the Securities and Exchange Commission on March 27, 2003, the information in the Form 8-K, which the Company intended to furnish under Item 12 was furnished under Item 9.

On May 21, 2003, the Company filed a report on Form 8-K under Item 5 with respect to the execution of an agreement with Coghill Capital Management, LLC to invest $2.5 million in a new series of class A preferred shares.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

/s/ John A. Molinari

John A. Molinari

Chief Executive Officer and President

/s/ Steven D. Shea

Steven D. Shea

Chief Financial Officer and Treasurer

(Principal Financial Officer)

Common Stock, par value $.01 per share		13,195,638 shares
Class		Outstanding at July 10, 2003

		PAGE NUMBER
PART I—FINANCIAL INFORMATION

ITEM 1	Consolidated Financial Statements:

	Consolidated Balance Sheets as of May 31, 2003 and November 30, 2002	3

	Consolidated Statements of Operations for the three and six months ended May 31, 2003 and May 31, 2002	4

	Consolidated Statements of Cash Flows for the six months ended May 31, 2003 and May 31, 2002	5

	Notes to Consolidated Financial Statements	6 - 15

ITEM 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16 - 28

ITEM 3	Quantitative and Qualitative Disclosures About Market Risk	28

ITEM 4	Controls and Procedures	28

PART II—OTHER INFORMATION

ITEM 1	Legal Proceedings	29 - 30

ITEM 4	Submission of Matters to a Vote of Security Holders	30

ITEM 6	Exhibits and Reports on Form 8-K	30

SIGNATURES		31

CERTIFICATIONS		32

EXHIBIT INDEX

	May 31, 2003			November 30, 2002
ASSETS
Current assets:
Cash and cash equivalents	$	2,802		$	4,573
Available for sale securities, at fair value		—			126
Restricted cash		250			3,184
Accounts receivable, net of allowance for doubtful accounts of $413 in 2003 and $409 in 2002		2,407			2,435
Inventories		1,195			2,447
Prepaid expenses and other current assets		782			516

Total current assets		7,436			13,281

Property and equipment, net		1,517			1,870
Intangible assets, net		124			145

Total assets	$	9,077		$	15,296

Current liabilities:
Accounts payable	$	973		$	1,295
Accrued expenses		2,950			5,588
Deferred revenue		2,887			4,504

Total current liabilities		6,810			11,387

Contingencies (Note 9)

Series A convertible preferred stock, $ .01 par value Authorized—2,500 shares, 1,045 issued and outstanding at May 31, 2003 and none issued and outstanding at November 30, 2002		1,045			—

Stockholders’ equity:
Common stock, $.01 par value, Authorized—25,000,000 shares—13,116,000 and 12,977,000 issued and 13,086,000 and 12,947,000 outstanding at May 31, 2003 and November 30, 2002		131			130
Capital in excess of par value		218,396			218,319
Accumulated deficit		(216,971	)		(214,319	)
Treasury stock, 30,000 shares at cost		(78	)		(78	)
Accumulated other comprehensive loss		(256	)		(143	)

Total stockholders’ equity		1,222			3,909

Total liabilities and stockholders’ equity	$	9,077		$	15,296

	Three Months Ended May 31,						Six Months Ended May 31,
	2003			2002			2003			2002
Net sales:
Products	$	3,869		$	5,079		$	7,426		$	7,931
Services		1,263			1,500			2,503			3,146

Total net sales		5,132			6,579			9,929			11,077

Cost of sales		2,489			3,303			4,951			5,541
Accelerated depreciation and amortization of property and equipment (Note 5)		—			84			—			331

Gross profit		2,643			3,192			4,978			5,205

Operating expenses:
Research and development		1,789			2,559			3,562			5,126
Selling and marketing		1,591			2,716			3,056			4,964
General and administrative		541			1,427			1,186			2,534
Amortization and write-off of intangible assets		—			273			—			765
Accelerated depreciation and amortization of property and equipment (Note 5)		—			215			—			849
Restructuring expense		214			—			214			—
Settlement of litigation (Notes 6 and 9)		—			—			—			924

Total operating expenses		4,135			7,190			8,018			15,162

Operating loss		(1,492	)		(3,998	)		(3,040	)		(9,957	)

Interest income, net		12			37			36			115
Other income, net		180			270			352			187

Loss from operations before benefit from income taxes		(1,300	)		(3,691	)		(2,652	)		(9,655	)
Benefit from income taxes					—						(102	)

Net loss	$	(1,300	)	$	(3,691	)	$	(2,652	)	$	(9,553	)

Loss per share:
Basic	$	(0.10	)	$	(0.29	)	$	(0.20	)	$	(0.75	)

Diluted	$	(0.10	)	$	(0.29	)	$	(0.20	)	$	(0.75	)

Weighted average common shares outstanding:
Basic		13,084			12,784			13,061			12,710

Diluted		13,084			12,784			13,061			12,710

	Six Months Ended
	May 31, 2003			May 31, 2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(2,652	)	$	(9,553	)
Adjustments to reconcile net loss from operations to net cash used in operating activities:
Depreciation and amortization		683			2,271
Non-cash settlement of litigation		—			924
Amortization and write-off of intangible assets		—			765
Changes in assets and liabilities:
Restricted cash		2,934			(3,170	)
Accounts receivable		28			(166	)
Inventories		1,252			(1,518	)
Prepaid expenses and other current assets		(266	)		(146	)
Accounts payable		(322	)		884
Accrued expenses		(2,638	)		(1,100	)
Deferred revenue		(1,617	)		(142	)

Net cash used in operating activities		(2,598	)		(10,951	)

CASH FLOWS FROM INVESTING ACTIVITIES:
Net purchases of equipment		(277	)		(822	)
Purchase of intangible assets		(32	)		(33	)
Net proceeds from sales of marketable securities		126			(9	)

Net cash used in investing activities		(183	)		(864	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of preferred stock		1,045			—
Proceeds from issuance of common stock		78			415

Net cash provided by financing activities		1,123			415

EFFECT OF EXCHANGE RATE CHANGES ON CASH		(113	)		(58	)

NET DECREASE IN CASH AND CASH EQUIVALENTS		(1,771	)		(11,458	)
CASH AND CASH EQUIVALENTS, beginning of period		4,573			17,369

CASH AND CASH EQUIVALENTS, end of period	$	2,802		$	5,911

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash (received) paid for income taxes	$	—		$	(102	)

NON CASH INVESTING ACTIVITY:
Change in value of marketable securities	$	10		$	—

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Investments available for sale:	Maturity	May 31, 2003		November 30, 2002
Equity securities		$	—	$	44
Corporate Obligations	Less than 1 year		—		82

Total investments available for sale		$	—	$	126

	May 31, 2003		November 30, 2002
Raw materials	$	520	$	846
Work-in-process		233		403
Finished goods		442		1,198

	$	1,195	$	2,447

	May 31, 2003			November 30, 2002
Machinery and equipment	$	4,687		$	4,445
Purchased software		1,677			1,677
Furniture and fixtures		63			59
Leasehold improvements		684			653

	$	7,111		$	6,834
Less accumulated depreciation and amortization		(5,594	)		(4,964	)

	$	1,517		$	1,870

	May 31, 2003			November 30, 2002
Patents and Trademarks	$	580		$	548
Less accumulated amortization		(456	)		(403	)

	$	124		$	145

	Three months ended May 31,						Six months ended May 31,
	2003			2002			2003			2002
Net loss as reported	$	(1,300	)	$	(3,691	)	$	(2,652	)	$	(9,553	)
Add: Stock-based employee compensation expense determined under fair value method for all awards		(115	)		(416	)		(439	)		(675	)

Pro forma net loss	$	(1,415	)	$	(4,107	)	$	(3,091	)	$	(10,228	)

Loss per share:
Basic–as reported	$	(0.10	)	$	(0.29	)	$	(0.20	)	$	(0.75	)

Basic–pro forma	$	(0.11	)	$	(0.32	)	$	(0.24	)	$	(0.80	)


Diluted–as reported	$	(0.10	)	$	(0.29	)	$	(0.20	)	$	(0.75	)

Diluted–pro forma	$	(0.11	)	$	(0.32	)	$	(0.24	)	$	(0.80	)

	May 31, 2003		November 30, 2002
Payroll, payroll taxes and other taxes	$	771	$	838
Accrued warranty		525		525
Accrued restructuring		117		14
Accrued inventory		302		241
Accrued legal		331		3,015
Accrued selling and marketing		195		205
Accrued other		709		750

	$	2,950	$	5,588

	Digital Video Systems		Services		Corporate		Total
*Three months ended May 31, 2003*
Net sales from external customers	$	3,869		1,263				5,132

Gross profit		1,605		1,038				2,643

Depreciation and amortization		312		8				320

Interest income, net						12		12

*Six months ended May 31, 2003*
Net sales from external customers	$	7,426		2,503				9,929

Gross profit		2,923		2,055				4,978

Depreciation and amortization		666		17				683

Interest income, net						36		36

*Three months ended May 31, 2002*
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, 2003		May 31, 2002
North America	$	3,426	$	3,695
United Kingdom, Sweden, Denmark and Norway		606		894
France, Spain and Benelux		339		396
Germany, Austria and Switzerland		286		400
Asia, Japan and other foreign countries		475		1,194

	$	5,132	$	6,579

	May 31, 2003		November 30, 2002
United States	$	1,427	$	1,741
United Kingdom		40		63
Germany		18		19
France		32		47

	$	1,517	$	1,870

	Total		Less than 1 year		1 –5 years
Lease commitments	$	1,142,000	$	563,000	$	579,000
Inventory commitments	$	417,000	$	417,000	$	—

	Number of Shares
(1) Election of Directors	Voted For	Withheld
John A. Molinari	11,585,403	651,882
Maurice L. Castonguay	11,811,346	425,939
Roger W. Redmond	11,537,621	699,664
Paul J. Severino	11,543,856	693,429

	Media 100 Inc.

Date: July 15, 2003	By:	/s/ Steven D. Shea
		Steven D. Shea
		Chief Financial Officer and Treasurer (Principal Financial Officer)

Number		Description

99.1		Statement Pursuant to 18 U.S.C. Section 1350, dated as of July 15, 2003