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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2004

OR

For the transition period from                      to                     

Commission File No. 0-24784

PINNACLE SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

(650) 526-1600

(Registrant’s telephone number, including area code)

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 in Rule 12b-2 of the Securities Exchange Act of 1934).     Yes  x    No  ¨

The number of shares of the registrant’s common stock outstanding as of May 4, 2004 was 68,804,059.

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INDEX

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PART 1—FINANCIAL INFORMATION

PINNACLE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands; unaudited)

See accompanying notes to unaudited condensed consolidated financial statements.

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PINNACLE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data; unaudited)

See accompanying notes to unaudited condensed consolidated financial statements.

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PINNACLE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands; unaudited)

See accompanying notes to unaudited condensed consolidated financial statements.

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PINNACLE SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of Pinnacle Systems, Inc. and its wholly owned subsidiaries (“Pinnacle” or the “Company”). Intercompany transactions and related balances have been eliminated in consolidation. These financial statements have been prepared in conformity with generally accepted accounting principles for interim financial information and in accordance with the instructions of Form 10-Q and Rule 10 of Regulation S-X. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reported periods. The most significant estimates included in these financial statements include revenue recognition, allowances for doubtful accounts and sales returns, inventory valuation, the valuation of goodwill and intangibles, and the deferred tax asset valuation allowance. Actual results could differ from those estimates. These condensed consolidated financial statements reflect all adjustments that, in the opinion of management, are necessary for a fair statement of the consolidated financial position, results of operations and cash flows as of and for the interim periods. Such adjustments consist of items of a normal recurring nature. Certain information or footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).

The condensed consolidated financial statements included herein should be read in conjunction with the financial statements and notes thereto, which include information as to significant accounting policies, for the fiscal year ended June 30, 2003 included in the Company’s Annual Report on Form 10-K as filed with the SEC on September 18, 2003. Results of operations for interim periods are not necessarily indicative of results for a full fiscal year.

Reclassifications

Certain prior period balances have been reclassified to conform to the current period’s presentation.

Revenue Recognition

The Company recognizes revenue from sales of software in accordance with AICPA Statement of Position (SOP) 97-2, “Software Revenue Recognition,” as modified by SOP 98-9. Revenue from non-software sales is recognized in accordance with the SEC Staff Accounting Bulletin (SAB) 101, “Revenue Recognition In Financial Statements,” SAB 104, “Revenue Recognition,” and EITF 00-21, “Revenue Arrangements with Multiple Deliverables.”

The Company derives its revenue primarily from the sale of products, including both hardware and perpetual software licenses and, to a lesser extent, from product support and services including product support contracts, installation and training services.

The Company recognizes revenues from sales of products upon shipment, net of estimated returns, provided title and risk of loss has passed to the customer, there is evidence of an arrangement, fees are fixed or determinable and collectibility is reasonably assured. If applicable to the sales transaction, revenue is only recorded if the revenue recognition criteria of Statement of Position 97-2, “Software Revenue Recognition,” as amended, are met.

Revenue from post-contract customer support (“PCS”) is recognized ratably over the contractual term (typically one year). Installation and training revenue is deferred and recognized as these services are performed. For systems with complex installation processes where installation is considered essential to the functionality of the product (for example, when the services can only be performed by us), product and installation revenue is deferred until completion of the installation. In addition, if such orders include a customer acceptance provision, no revenue is recognized until the customer’s acceptance of the products and services has been received, the acceptance period has lapsed, or a certain event, such as achievement of system “on-air” status, which contractually constitutes acceptance. For shrink-wrapped products with telephone support and bug fixes bundled in as part of the original sale, revenue is recognized at the time of product shipment and the costs to provide this telephone support and bug fixes are accrued, as these costs are deemed insignificant. Shipping and handling amounts billed to customers are included in revenue.

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Revenue from certain channel partners is subject to arrangements allowing limited rights of return, stock rotation, rebates and price protection. Accordingly, the Company reduces revenue recognized for estimated future returns, estimated funds for marketing development activities, price protection and rebates, at the time the related revenue is recorded. In order to estimate future product returns and reserves for rebates and price protection, the Company analyzes historical returns and credits, current economic trends, changes in customer demand, inventory levels in the distribution channel and general marketplace acceptance of its products.

Revenue from certain channel partners, who have unlimited return rights and payment that is contingent upon the product being sold through to their customers, is recognized when the products are sold through to the customer, instead of being recognized at the time products are shipped to these channel partners.

The Company records OEM licensing revenue, primarily royalties, when OEM partners ship products incorporating Pinnacle software, provided collection of such revenue is deemed probable.

The Company’s systems sales frequently involve multiple element arrangements in which a customer purchases a combination of hardware product, PCS, and/or professional services. For multiple element arrangements revenue is allocated to each element of the arrangement based on the relative fair value of each of the elements. When evidence of fair value exists for each of the undelivered elements but not for the delivered elements, the Company uses the residual method to recognize revenue for the delivered elements. Under this method, the fair value of the undelivered elements is deferred until delivered and the remaining portion of the revenue is recognized. If evidence of the fair value of one or more of the undelivered elements does not exist, then revenue is only recognized when delivery of those elements has occurred or fair value has been established. Fair value is based on the prices charged when the same element is sold separately to customers.

For arrangements where undelivered services are essential to the functionality of delivered software, the Company recognizes both the product revenues and service revenues using the percentage-of-completion method in accordance with the provisions of Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” The Company follows the percentage-of-completion method when reasonably dependable estimates of progress toward completion of a contract can be made. The Company estimates the percentage of completion on contracts using costs incurred to date as a percentage of total costs estimated to complete the contract. Costs incurred include labor costs and equipment placed in service. If the Company does not have a sufficient basis on which to measure the progress toward completion, the Company recognizes revenue using the completed-contract method, and thus recognizes revenue when the Company receives final acceptance from the customer. To the extent that there is no evidence of fair value for the support element, or a gross margin cannot otherwise be estimated since estimating the final outcome of the contract may be impractical except to assure that no loss will be incurred, the Company uses a zero estimate of profit (recognizing revenue to the extent of direct and incremental costs incurred) until such time as a gross margin can be estimated or the contract is completed. Upon contract completion, if a zero estimate of profit was used due to a lack of fair value for support, the profit for the contract will be recognized on a straight-line basis over the support contract period, commonly 12 to 24 months for contracts of this type.

Deferred revenue includes PCS (support) revenue and invoiced fees from arrangements where revenue recognition criteria are not yet met.

Goodwill

The Company reviews its goodwill and intangible assets with indefinite useful lives for impairment, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, on an annual basis or whenever significant events or changes occur in its business. If the Company determines that its goodwill has been impaired, it will recognize an impairment charge. The Company has chosen the first quarter of each fiscal year, which ends on September 30, as the date of the annual impairment test.

During the three months ended December 31, 2003, the Company re-assessed its business plan and revised the operating cash flows for each of its reporting units, which triggered an interim impairment analysis of goodwill.

The Company performed an interim goodwill impairment analysis as required by SFAS No. 142 during the three months ended December 31, 2003 and concluded that its goodwill was impaired, as the carrying value of one of its reporting units in the Broadcast and Professional segment exceeded its fair value. As a result, the Company recorded a goodwill impairment charge of $6.0 million during the three months ended December 31, 2003 to reduce the carrying amount of its goodwill. As of June 30, 2003 and March 31, 2004, the Company had approximately $60.6 million and approximately $83.6 million of goodwill, respectively. (See Note 6).

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Impairment of Long-Lived Assets

The Company reviews long-lived assets and amortizable intangible assets for impairment, in accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets,” whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. The Company assesses these assets for impairment based on estimated undiscounted future cash flows from these assets. If the carrying value of the assets exceeds the estimated future undiscounted cash flows, a loss is recorded for the excess of the asset’s carrying value over the fair value.

Acquisition-related intangible assets result from our acquisition of businesses accounted for under the purchase method of accounting and consist of the values of amortizable intangible assets, including core/developed technology, customer-related intangibles, trademarks and trade names, and other amortizable intangibles. Acquisition-related intangibles are being amortized using the straight-line method over periods ranging from three to six years.

The Company restructured its consumer and audio business, which is part of the Business and Consumer segment, during the three months ended December 31, 2003, which triggered an impairment analysis of amortizable intangible assets as required by SFAS No. 144. As a result, the Company concluded that its amortizable intangible assets were impaired and recorded an impairment charge of $10.3 million for amortizable intangible assets during the three months ended December 31, 2003 to reduce the carrying amount of its intangible assets. The $10.3 million impairment loss related entirely to our Business and Consumer segment and was comprised of $7.0 million for the impairment of customer-related intangibles and $3.3 million for the impairment of core/developed technology. The Company recorded an income tax benefit of $3.5 million in the three months ended December 31, 2003 to reduce the deferred tax liability associated with the impairment of its amortizable intangible assets. As of June 30, 2003 and March 31, 2004, the Company had approximately $29.3 million and approximately $19.3 million of other intangible assets, respectively. (See Note 6).

Stock-Based Compensation

The Company accounts for its employee stock-based compensation plans using the intrinsic value method in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees.” 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, “Accounting for Stock-Based Compensation,” and SFAS No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure,” to stock-based employee compensation.

The pro forma effects of stock-based compensation on net loss and net loss per common share have been estimated at the date of grant using the Black-Scholes option-pricing model. For purposes of pro forma disclosures, the estimated fair value of the options is assumed to be amortized to compensation expense over the options’ vesting periods. The pro forma effects of recognizing compensation expense under the fair value method on net loss and net loss per common share were as follows:

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The fair value of stock options granted using the Black-Scholes option-pricing model was estimated using the following assumptions for the three months ended March 31, 2004: volatility of 138%, no expected dividends, an average risk-free interest rate of 2.8% and an average expected option term of 3.2 years. The fair value of stock options granted using the Black-Scholes option-pricing model were estimated using the following assumptions for the three months ended March 31, 2003: volatility of 85%, no expected dividends, an average risk-free interest rate of 2.7% and an average expected option term of 3.2 years. The weighted average fair value of options granted for the three months ended March 31, 2004 and 2003 was $6.21 and $6.10, respectively.

The fair value of stock options granted using the Black-Scholes option-pricing model was estimated using the following assumptions for the three months ended December 31, 2003: volatility of 139%, no expected dividends, an average risk-free interest rate of 3.0% and an average expected option term of 2.8 years. The fair value of stock options granted using the Black-Scholes option-pricing model were estimated using the following assumptions for the three months ended December 31, 2002: volatility of 85%, no expected dividends, an average risk-free interest rate of 2.9% and an average expected option term of 2.8 years. The weighted average fair value of options granted for the three months ended December 31, 2003 and 2002 was $5.72 and $6.74, respectively.

The fair value of stock options granted using the Black-Scholes option-pricing model was estimated using the following assumptions for the three months ended September 30, 2003: volatility of 141%, no expected dividends, an average risk-free interest rate of 2.90% and an average expected option term of 3.2 years. The fair value of stock options granted using the Black-Scholes option-pricing model were estimated using the following assumptions for the three months ended September 30, 2002: volatility of 86%, no expected dividends, an average risk-free interest rate of 3.19% and an average expected option term of 3.4 years. The weighted average fair value of options granted for the three months ended September 30, 2003 and 2002 was $5.43 and $5.83, respectively.

The fair value of employees’ stock purchase rights under the 1994 employee stock purchase plan using the Black-Scholes option-pricing model was estimated using the following assumptions for the three months ended March 31, 2004: volatility of 138%, no expected dividends, an average risk-free interest rate of 1.46% and an average expected option term of 0.5 years. The fair value of employees’ stock purchase rights under the employee purchase plan using the Black-Scholes option-pricing model was estimated using the following assumptions for the three months ended March 31, 2003: volatility of 85%, no expected dividends, an average risk-free interest rate of 1.47% and an average expected option term of 0.5 years.

The fair value of employees’ stock purchase rights under the 1994 employee stock purchase plan using the Black-Scholes option-pricing model was estimated using the following assumptions for the three months ended December 31, 2003: volatility of 139%, no expected dividends, an average risk-free interest rate of 1.58% and an average expected option term of 0.5 years. The fair value of employees’ stock purchase rights under the employee purchase plan using the Black-Scholes option-pricing model was estimated using the following assumptions for the three months ended December 31, 2002: volatility of 85%, no expected dividends, an average risk-free interest rate of 1.7% and an average expected option term of 0.5 years.

The fair value of employees’ stock purchase rights under the 1994 employee stock purchase plan using the Black-Scholes option-pricing model was estimated using the following assumptions for the three months ended September 30, 2003: volatility of 141%, no expected dividends, an average risk-free interest rate of 1.45% and an average expected option term of 0.5 years. The fair value of employees’ stock purchase rights under the employee purchase plan using the Black-Scholes option-pricing model was estimated using the following assumptions for the three months ended September 30, 2002: volatility of 86%, no expected dividends, an average risk-free interest rate of 2.0% and an average expected option term of 0.5 years.

Recent Accounting Pronouncements

In December 2003, the SEC issued Staff Accounting Bulletin (“SAB”) No, 104 “ Revenue Recognition” which codifies, revises and rescinds certain sections of SAB No. 101, “ Revenue Recognition”, in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The adoption of SAB No. 104 did not have a material impact on our consolidated financial position, results of operations or cash flows.

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In April 2003, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The adoption of SFAS No. 149 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In November 2002, the EITF reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 had no impact on the Company’s consolidated financial position, results of operations or cash flows.

2. Net Loss Per Share

Basic net loss per share is computed using the weighted-average number of common shares outstanding. Diluted net loss per share is computed using the weighted-average number of common shares outstanding and potential dilutive common shares from the assumed exercise of options outstanding during the period, if any, using the treasury stock method.

The following table sets forth the common shares that were excluded from the diluted loss per share computations because either the exercise price of the securities exceeded the average fair value of the Company’s common stock or the Company had net losses before cumulative effect of change in accounting principle, and therefore, these securities were anti-dilutive:

The Company was previously contingently liable to issue up to 399,363 shares of its common stock in connection with the acquisition of the Montage Group, Ltd. in April 2000, and the subsequent related buyout decision in April 2001 of the earnout payments under that acquisition agreement. However, as a result of a settlement agreement between the Company and a former shareholder of DES and Montage, the Company issued 24,960 shares in December 2003 and retained unconditionally 74,881 shares in December 2003 as satisfaction for one of the Montage shareholder’s indemnification obligation for the Athle-Tech claim. The Company is contingently liable to issue up to an additional 299,522 shares of its common stock. The Company’s obligation to issue these 299,522 contingent shares is contingent upon the final legal damages and costs assessed against the Company in the Athle-Tech litigation and the outcome of the Company’s claim for indemnification against certain of the former shareholders of Montage for the Athle-Tech damages and costs (see Note 8). If and when the 299,522 contingent shares are issued, the Company would increase the number of basic and diluted weighted-average shares outstanding and record an increase to common stock of approximately $2.8 million.

3. Comprehensive Income (Loss)

The Company’s comprehensive income (loss) includes net loss, unrealized gain (loss) on available-for-sale securities, and foreign currency translation adjustments, which are reflected as a component of shareholders’ equity. The components of comprehensive income (loss), net of tax, were as follows:

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4. Inventories

As of March 31, 2004 and June 30, 2003, inventories were comprised of the following:

The finished goods inventory included approximately $6.0 million as of March 31, 2004 and approximately $2.0 million as of June 30, 2003 located at customer sites related to deferred revenue.

5. Acquisitions

(a) SCM Microsystems, Inc. and Dazzle Multimedia, Inc.

In July 2003, the Company acquired certain assets of SCM Microsystems, Inc. and Dazzle Multimedia, Inc., a company that specializes in digital media and video solutions. The Company integrated Dazzle’s digital video business into its existing home video editing business in the Business and Consumer division during the three months ended September 30, 2003.

The purchase price was approximately $24.0 million, of which approximately $2.0 million was subsequently paid in cash on November 7, 2003, $7.7 million was subsequently paid in cash on December 11, 2003, and approximately $13.9 million represents the value of the 1,866,851 shares of the Company’s common stock that were issued. The value of the common stock issued was determined based on the average market price of the Company’s common stock over a period of two days prior to and two days after the date the terms were agreed to and announced. The amount of shares issued was calculated based on the average closing price of the shares on NASDAQ for thirty consecutive days ending on the date three business days prior to the July 25, 2003 closing date. The $2.0 million cash payment related to purchase price adjustments for inventory and backlog. The Company also incurred approximately $0.4 million in transaction costs. The synergies that the Company plans to generate by using this technology in other products was the justification for a purchase price of approximately $12.4 million higher than the fair value of the net identifiable acquired assets. The Company recorded this $12.4 million amount as goodwill at the acquisition date. The results of the operations for the business acquired from SCM Microsystems, Inc. and Dazzle Multimedia, Inc. have been included in the Company’s consolidated financial statements since the acquisition date.

According to the terms of the Asset Purchase Agreement, the Company made an additional cash payment of $7.7 million on December 11, 2003 to SCM Microsystems, Inc. and Dazzle Multimedia, Inc. as an adjustment to the market price at which the Company’s common stock was issued relative to the market price at which the stock was sold.

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The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition (in thousands):

The identifiable intangible assets include developed core technology of $5.6 million, trademarks and trade names of $1.7 million, and customer-related intangibles of $0.2 million, all of which are being amortized over a five-year period. The Company also acquired in-process research and development of $2.2 million, which was subsequently expensed during the three months ended September 30, 2003. The $12.4 million of goodwill was assigned to the Business and Consumer division and has not been amortized, in accordance with the requirements of SFAS No. 142.

(b) Jungle KK

In July 2003, the Company acquired a 95% interest in Jungle KK, a privately held distribution company based in Tokyo, Japan that specializes in marketing and distributing retail software products in Japan. The Company plans to continue to sell Jungle’s products and to utilize Jungle’s marketing and distribution channels to sell and distribute the Company’s consumer products into the Japanese market.

The purchase price was approximately $5.0 million, of which approximately $3.6 million was paid in cash and approximately $0.8 million represents the value of the 72,122 shares of the Company’s common stock that were issued. The value of the common stock issued was determined based on the average market price of the Company’s common stock over a period of two days prior to and two days after the date the terms were agreed to and announced. The Company also incurred approximately $0.6 million in transaction costs. The synergies that the Company plans to generate by using Jungle’s marketing and distribution channels was the justification for a purchase price of approximately $3.4 million higher than the fair value of the net identifiable acquired assets. The Company recorded this $3.4 million amount as goodwill at the acquisition date. The results of the operations for Jungle KK have been included in the Company’s consolidated financial statements since the acquisition date.

The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition (in thousands):

The identifiable intangible assets include trademarks and trade names of $0.8 million and customer-related intangibles of $0.8 million, and are being amortized over a five-year period. The $3.4 million of goodwill was assigned to the Business and Consumer division and has not been amortized, in accordance with the requirements of SFAS No. 142.

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(c) Pro Forma Financial Information for Acquisitions (unaudited)

The following unaudited pro forma financial information presents the results of operations for the three months and nine months ended March 31, 2004 and 2003, as if the acquisition of certain assets of SCM Microsystems, Inc. and Dazzle Multimedia, Inc. in July 2003 occurred at the beginning of fiscal 2004 and 2003. The pro forma financial information excludes charges for acquired in-process research and development. The pro forma financial information has been prepared for comparative purposes only and is not indicative of what operating results would have been if the acquisitions had taken place at the beginning of fiscal 2004 and 2003 or of future operating results.

Pro forma results of operations related to the acquisition of a 95% interest in Jungle KK in July 2003 have not been presented, as they would not be materially different from the consolidated financial statements.

(d) In-Process Research and Development

During the three months ended September 30, 2003, the Company recorded in-process research and development costs of approximately $2.2 million, all of which related to the acquisition of certain assets of SCM Microsystems, Inc. and Dazzle Multimedia, Inc. in July 2003. The value assigned to purchased in-process research and development was determined by estimating the cost to develop the purchased in-process research and development into commercially viable products, estimating the resulting net cash flows from such projects, and discounting the net cash flows back to the time of acquisition using a risk-adjusted discount rate.

During the three months ended March 31, 2003, the Company recorded in-process research and development costs of approximately $0.5 million, related to the acquisition of Steinberg. The value assigned to purchased in-process research and development was determined by estimating the cost to develop the purchased in-process research and development into commercially viable products, estimating the resulting net cash flows from such projects, and discounting the net cash flows back to the time of acquisition using a risk-adjusted discount rate.

6. Goodwill and Other Intangible Assets

In July 2001, the FASB issued SFAS No. 142, which the Company adopted on July 1, 2002. As a result of the adoption of SFAS No. 142, the Company no longer amortizes goodwill and amortizable intangible assets with indefinite lives. Intangible assets with definite lives continue to be amortized.

Upon adoption, the Company evaluated the remaining useful lives of its other intangible assets to determine if any adjustments to the useful lives were necessary or if any of these assets had indefinite lives and were, therefore, not subject to amortization. The Company determined that no adjustments to the useful lives of its other intangible assets were necessary.

In accordance with SFAS No. 142, the Company evaluates, on an annual basis or whenever significant events or changes occur in its business, whether its goodwill has been impaired. If the Company determines that its goodwill has been impaired, it will recognize an impairment charge. The Company has chosen the first quarter of each fiscal year, which ends on September 30, as the period of the annual impairment test.

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The Company performed the transitional goodwill impairment analysis required by SFAS No. 142 as of July 1, 2002 and concluded that goodwill was impaired, as the carrying value of two of its reporting units in the Broadcast and Professional division exceeded their fair value. As a result, the Company recorded a charge of $19.3 million during the three months ended September 30, 2002 to reduce the carrying amount of goodwill. This charge was reflected as a cumulative effect of change in accounting principle during the nine months ended March 31, 2003 in the accompanying consolidated statements of operations.

The Company performed the annual goodwill impairment analysis required by SFAS No. 142 as of July 1, 2003 and concluded that goodwill was not impaired.

During the three months ended December 31, 2003, the Company re-assessed its business plan and revised the operating cash flows for each of its reporting units, which triggered an interim impairment analysis of goodwill.

The Company performed an interim goodwill impairment analysis as required by SFAS No. 142 during the three months ended December 31, 2003 and concluded that its goodwill was impaired, as the carrying value of its reporting units in the Broadcast and Professional segment exceeded its fair value. As a result, the Company recorded a goodwill impairment charge of $6.0 million during the three months ended December 31, 2003 to reduce the carrying amount of its goodwill. As of June 30, 2003 and March 31, 2004, the Company had approximately $60.6 million and approximately $83.6 million of goodwill, respectively.

The Company restructured its consumer and audio business, which is part of the Business and Consumer segment, during the three months ended December 31, 2003, which triggered an impairment analysis of amortizable intangible assets as required by SFAS No. 144. As a result, the Company concluded that its amortizable intangible assets were impaired and recorded an impairment charge of $10.3 million for amortizable intangible assets during the three months ended December 31, 2003. The $10.3 million impairment loss related entirely to the Company’s Business and Consumer segment and was comprised of $7.0 million for the impairment of customer-related intangibles and $3.3 million for the impairment of core/developed technology. The Company recorded an income tax benefit of $3.5 million in the three months ended December 31, 2003 to reduce the deferred tax liability associated with the impairment of its amortizable intangible assets. As of June 30, 2003 and March 31, 2004, the Company had approximately $29.3 million and approximately $19.3 million of other intangible assets, respectively.

In summary, the Company recorded a total impairment charge of $16.3 million during the three months ended December 31, 2003, which was comprised of a goodwill impairment charge of approximately $6.0 million and an amortizable intangible assets impairment charge of approximately $10.3 million.

The transitional, annual and interim goodwill impairment analysis, each consisted of the following two-step process:

In both Step 1 and Step 2, below, the fair value of each reporting unit was determined by estimating the present value of future cash flows for each reporting unit.

Step 1. The Company compared the fair value of its reporting units to its carrying amount, including the existing goodwill and other intangible assets. If the carrying amount of any of the Company’s reporting units exceeded their fair value, the comparison indicated that the reporting units’ goodwill was impaired (see Step 2 below).

Step 2. For purposes of performing the second step, the Company used a purchase price allocation methodology to assign the fair value of the reporting unit to all of the assets, including unrecognized intangibles, and liabilities of each of these reporting units, respectively. The residual fair value after the purchase price allocation is the implied fair value of the reporting unit goodwill. If the implied fair value of the reporting unit goodwill was less than the carrying amount of goodwill, an impairment loss was recorded for the excess of the reporting unit’s carrying value over the implied fair value.

The impairment analysis for long-lived assets and amortizable intangible assets consisted of the Company assessing these assets for impairment based on estimated undiscounted future cash flows from these assets. If the carrying value of the assets exceeds the estimated future undiscounted cash flows, a loss was recorded for the excess of the asset’s carrying value over the fair value.

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A summary of changes in the Company’s goodwill during the nine months ended March 31, 2004 by business segment is as follows (in thousands):

In December 2003, the Company reduced its estimated accrual for lease obligations related to its acquisition of Steinberg Media Technologies in January 2003 by $0.8 million, which was accounted for as a decrease to both goodwill and accrued liabilities. In December 2003, the Company issued 1,452,929 shares in connection with the settlement of the DES earnout, which was accounted for as a $11.6 million increase to both goodwill and common stock. In December 2003, the Company issued 24,960 shares in connection with the settlement of the Company’s claim for indemnification from one Montage shareholder, which was accounted for as a $0.2 million increase to both goodwill and common stock.

The following tables set forth the carrying amount of other intangible assets that will continue to be amortized (in thousands):

The Company recorded a total impairment charge of $10.3 million for amortizable intangible assets during the three months ended December 31, 2003, which was reflected as an operating expense in our consolidated results of operations. The $10.3 million impairment charge related entirely to our Business and Consumer segment and was comprised of $7.0 million for the impairment of customer-related intangibles and $3.3 million for the impairment of core/developed technology.

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The total amortization expense related to goodwill and other intangible assets is set forth in the table below (in thousands):

The total estimated future annual amortization related to other intangible assets is set forth in the table below (in thousands):

7. Segment and Geographic Information

The Company is organized into two customer-focused lines of business: (1) Broadcast and Professional, and (2) Business and Consumer. On July 1, 2002, the Company renamed the Business and Consumer division from its prior name, the Personal Web Video division, but did not change the structure or operations of this division.

The Company organizes its divisions, which equate to reportable segments, by evaluating criteria such as economic characteristics, the nature of products and services, the nature of the production process, and the type of customers. The Company currently operates its business as two reportable segments: (1) Broadcast and Professional, and (2) Business and Consumer, formerly Personal Web Video.

The Company’s chief operating decision maker evaluates the performance of these divisions based on net sales, cost of sales, and operating income (loss) before income taxes, interest and other income, net, excluding the effects of certain nonrecurring or non-cash charges including the amortization of other intangibles, the impairment of goodwill and other intangible assets, certain restructuring costs, in-process research and development costs, and the legal judgment. Operating results also include allocations of certain corporate expenses.

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Table of Contents

The following is a summary of the Company’s operations by operating segment for the three months and nine months ended March 31, 2004 and 2003 (in thousands):