-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, J2MKzLUv3k3aOPl6A8qWveqrlIW5GtBHZn+UAlyd3dl1Aaq60Fo1FqvIHeW4wpe3 0IGCnGGn4sH0x/zEDRcc1A== 0000950005-97-000736.txt : 19970912 0000950005-97-000736.hdr.sgml : 19970912 ACCESSION NUMBER: 0000950005-97-000736 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19970630 FILED AS OF DATE: 19970829 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: PINNACLE SYSTEMS INC CENTRAL INDEX KEY: 0000774695 STANDARD INDUSTRIAL CLASSIFICATION: PHOTOGRAPHIC EQUIPMENT & SUPPLIES [3861] IRS NUMBER: 943003809 STATE OF INCORPORATION: CA FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-24784 FILM NUMBER: 97672381 BUSINESS ADDRESS: STREET 1: 280 N BERNARDO AVE CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043 BUSINESS PHONE: 4155261600 MAIL ADDRESS: STREET 1: 280 N BERNARDO AVE CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043 10-K 1 ANNUAL REPORT SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [x] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended June 30, 1997 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ________________ to _______________. Commission file number: 0-24784 PINNACLE SYSTEMS, INC. (Exact name of registrant as specified in its charter) California 94-3003809 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 280 North Bernardo, Mountain View, CA 94043 (Address of principal executive office) (zip code) Registrant's telephone number, including area code: (415) 526-1600 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- ------------------- None None Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value Preferred Share Purchase Rights, no par value (Title of Class) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock on August 22, 1997 as reported on the Nasdaq National Market System, was approximately $ 154,096,000. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of August 22, 1997, registrant had outstanding 7,344,958 shares of Common Stock. DOCUMENTS INCORPORATED BY REFERENCE The Registrant has incorporated by reference into Part III of this Form 10-K portions of its Proxy Statement for Registrant's Annual Meeting of Shareholders to be held October 28, 1997. Portions of the Registrant's Annual Report to Shareholders for the fiscal year ended June 30, 1997 are incorporated by reference into Parts II and IV of this Form 10-K. PART I Special Note Regarding Forward-Looking Statements Certain statements in this Report constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, the following: the risks associated with the acquisition of products and technology; the risk associated with a concentration of sales to significant customers; significant fluctuations in the Company's quarterly operating results; risks associated with developing and selling products into the Consumer market; risks associated with development and introduction of new products; the Company's highly competitive industry, rapid technological change and competition within the Company's industry; the Company's dependence on retention and attraction of key employees; the risks associated with contract manufacturers and single source suppliers; the uncertainty of patent and proprietary technology protection and reliance on technology licensed from third parties; the risks of third party claims of infringement; the absence of a direct sales force; the risks associated with international sales; the risks associated with future acquisitions; general economic and business conditions; and other factors referenced in this Report. Pinnacle Systems is a registered trademark of Pinnacle Systems, Inc. ("Pinnacle" or the "Company"), and Pinnacle believes that all of its product names, other than Alladin, are trademarks of Pinnacle Systems, Inc. This Report also includes trademarks of companies other than Pinnacle Systems, Inc. ITEM 1. BUSINESS Pinnacle Systems, Inc. designs, manufactures, markets and supports video post-production tools for high quality real time video processing. The Company's products combine computer based and specialized video processing technologies which perform a variety of video post production functions such as the addition of special effects, graphics and titles to multiple streams of live or previously recorded video material. The Company has sold over 10,000 post-production systems since the company's inception in 1986 to customers in more than 60 countries. In 1994 the Company introduced Alladin, its first PC-based product that connected directly to an external computer and offered real-time video manipulation and special effects capabilities with performance comparable to traditional video products but at a substantially lower price. The Company has since introduced additional video products which address needs in the Broadcast, Desktop and Consumer video post production markets. To further Pinnacle's strategy of providing an expanded line of easy to use computer based video production products, in July 1997, the Company signed a letter of intent to acquire the miro Digital Video Products from miro Computer Products AG. In the anticipated acquisition, the Company will acquire the assets of the miro Digital Video Products group, including the miroVIDEO and miroMOTION product lines, certain technology and other assets. The Company expects to pay approximately $15 million in cash, $5 million in common stock, assume liabilities of between $2 million and $3 million, and incur approximately $2 million in costs associated with executing the transaction and integrating the businesses. The Company anticipates that a significant portion of the purchase price will be charged as in-process research and development and other non-recurring costs in the quarter ending September 30, 1997. The agreement also includes an earnout provision in which miro Computer Products AG will receive additional consideration equal to 50% of sales generated in excess of $37 million during the first twelve full months following the acquisition as long as operating profits related to such sales exceed 3% of sales, increasing to 85% of sales -1- for those sales which exceed $59 million during the same twelve month period. Any earnout payments will be paid in common stock of the Company. Industry Background The video production industry has historically created program material for commercial broadcast and television advertising. Producers of commercial program material and advertising have traditionally used video editing suites equipped with expensive, dedicated video production equipment to produce high quality video programming. A large and established market exists for video equipment used in traditional video editing suites. Expanding channels of distribution, including cable television, direct satellite broadcast, the Internet, CD-ROM , DVD (Digital Versatile Disk), and video-on demand, have led to a rapid increase in demand for video content for existing and new applications. New applications for video content include multimedia entertainment, video games, music videos, special event videos, education and training and corporate communications. These new applications cannot, in general, support the high cost and complexity of video production associated with traditional editing suites. Computer based video products, which combine the technology of personal computers with specialized video processing hardware and software, have reached a point where they can provide quality video output comparable to that of traditional video editing suites at significantly lower cost. Video Production Process The development of a video program involves three distinct processes, which together comprise video production. The first phase, pre-production, involves planning and preparation for the recording, or "shooting," of the video program and includes scripting, storyboarding (the artist's rendering of planned video segments) and developing the production budget. The second phase, production, involves the actual shooting of video material either on location or in a studio. This process follows the pre-production script, recording actual video segments outlined by the storyboard sketches. Production also includes the creation of still-images and computer animated images to be included in the program. The final phase, post-production, involves the organization of raw video segments acquired in the production phase into a cohesive and appealing program. During the post-production phase, the producer utilizes sophisticated equipment to incorporate essential elements such as titles, graphics and transitions between video segments and to composite multiple layers of video and graphics. The overall quality and impact of a video production is, in many cases, judged by the quality of the video processing performed in the post-production phase. Viewers expect the same level of video program quality that they see daily with broadcast television programming, where high quality graphics, smooth transitions and compositing of multiple layers of graphics and video are commonplace. Video Editing Suites To implement high quality post-production video effects, producers of commercial broadcast and television advertising have traditionally used multiple pieces of dedicated equipment, linked together with a complex interconnection, routing and control system to form a video "editing suite." Typical editing suites incorporate switchers, digital video effects systems ("DVEs), still image management systems ("Still Stores"), character generators, electronic paint and compositing systems and 3D modeling and animation tools, typically provided by multiple manufacturers and used to implement a single effect or group of related effects. Traditional editing suites allow video professionals to produce a high quality finished product in real time, whereby the operator can touch a button or move a joystick or mouse and see the desired effect -2- instantaneously. Real time interactivity, which allows the video producer spontaneously and interactively to try many different video manipulations and fine tune the resulting video content, is a critical requirement in the video post-production process. Because of the complexity and large number of components required, traditional video editing suites are expensive, ranging in cost from $100,000 to several million dollars for a fully equipped suite. Furthermore, each component within the suite often has its own user interface and therefore its own user training equipment. A video professional has therefore required significant training to become proficient in the operation of equipment in a traditional editing suite. Because traditional editing suites are expensive and complex, they are usually operated as time-shared resources. Producers typically rent a video editing suite together with highly trained operators for between $100 to $1,000 per hour. The high cost of traditional editing suites makes them unsuitable for video applications where high development costs cannot be supported. Computer based video post-production Video post-production tools based on standard computer platforms have become a real alternative to traditional video editing. Such tools are based on a combination of personal computers, graphical user interfaces, video input/output and specialized processing hardware and software. These tools are designed to be much lower cost than traditional tools since they can take advantage of the ongoing cost improvements in computer and video processing technology. In addition, they are often easier to use since they can utilize common computer user interfaces, and can be dedicated to an individual user rather than time-shared between multiple projects. Computer based video post-production tools are well-suited for many new video applications, including multi-media entertainment, video games, music videos, special event videos, education and training and corporate communications as well as the traditional applications such as broadcast and on-air applications. The low-cost of desktop video tools allows video programs to be developed more efficiently and inexpensively. The lower cost and increased ease of use of desktop video tools makes it easy for a large number of creative individuals, previously untrained in video production, to produce professional quality video programming. Historically, the inability of computer based video post-production tools to implement, in real time, the same sophisticated high quality video effects as are available in traditional editing suites limited their use. To produce special effects and compositing, computer based tools have historically relied upon software to render the desired effect. The initial creation and each subsequent alteration of complex video manipulations could require many hours of software rendering time. Video rendering time has continued to improve as computer processing power has improved, but complex video manipulations can still not be performed on standard computer platforms in real time without specialized video processing technology. Company Strategy Pinnacle has developed video processing technologies and products which allow complex video manipulation in real time. Those technologies includes real time digital video processing, real time software algorithms, video input/output and advanced video manipulation user interfaces. Used in conjunction with standard computer platforms these technologies provide high quality, cost effective, computer based solutions for the video post production markets. As a result, Pinnacle has become a leading supplier of real time computer based video manipulation technology for video post production markets. -3- Pinnacle's strategy is to leverage its leading market and technological position to continue to provide innovative, real time, computer based solutions for three video post production markets which the Company characterizes as the Broadcast market, the Desktop video market, and the Consumer video market. The Broadcast market generally requires very high technical performance such as real time 10-bit processing, control of multiple channels of live video, and specialized filtering and interpolation. To address this market the Company is pursuing a strategy of providing high performance, specialized, Windows NT based, computer solutions for high end post production and broadcast on-air applications. The Desktop market is generally more cost conscious, demands products that work in an open architecture computer environment but that still provide high quality real time video processing capabilities. For this market, the company expects to continue to pursue a strategy of providing real time video manipulation technology to support both linear, or tape based, and non-linear, or computer based, editing environments. In addition, the Company plans to expand the scope of its products in this market to encompass certain COmpression/DECompression (CODEC) technology required to control and transfer video into and out of the computer. By combining the Company's real time video processing technology with CODEC technology, the Company intends to provide a complete video processing platform which can work with software from companies specializing in video editing applications. The Company expects to commence shipment of its first video processing platform product during fiscal 1998 The Consumer market requires a much lower price point and puts more emphasis on ease of use and installation. The Company's strategy for this market is to provide low cost, easy to use, complete video editing solutions which allows consumers to edit their home videos using a combination of their home PC, camcorder and VCR. To effectively pursue these market strategies, the Company intends to expand its core technologies, leverage its product design resources, drive down the cost of real time manipulation technology, and expand its product lines, as follows: Expand Core Technologies: The Company has continued to expanded its core software and hardware technologies since the Company's inception, and the Company expects to continue to expand this technological base through both internal development and through acquisitions. During fiscal 1997, the Company completed the internal development of certain technology which allows 10-bit real time video manipulation processing on multiple channels of live video. In addition, the Company acquired certain technologies. In June 1996, the Company acquired the Video Director product line from Gold Disk, Inc. which added consumer oriented software editing capabilities, and camcorder and VCR control to the Company's core technology base. In April 1997 the Company acquired the Deko character generation technology from Digital Graphix, which allows real time generation of video characters and graphics for the broadcast and on-air applications. Leverage Product Designs: The Company considers it important to leverage design resources within the company to maximize the new product designs and time-to-market. The Company uses an "object oriented" design mentality to "mix and match" components of technology when developing new products. This "object oriented" design methodology allows the company to leverage its investment in reasearch and development since components of technology can be used for multiple product designs. It also improves the Company's ability to get products into the market faster since certain pieces of technology can be quickly incorporated. This methodology has been applied to software code and to hardware and ASIC designs. For example, the ASIC chip used in Studio 200, one of the Company's consumer products, was originally designed for Genie, one of the company's real time desktop products. Similarly, certain software and hardware originally designed for Genie was subsequently designed into Lightning, the company's new Image -4- Management product. Reduce Cost of Real Time Video Manipulation Technology: Pinnacle has continued to drive down the cost of its real time video manipulation technology by integrating more of that technology into application specific integrated circuits (ASIC). The company intends to continue to identify opportunities to integrate more functionality into ASIC's so that real time video manipulation technology can be provided at lower market price points. The Company believes that as the cost of providing video processing technology decreases, the number of potential market seats will likely increase. In addition, by using similar components of technology, specifically ASIC and field programmable arrays, material costs are reduced since the Company can take advantage of higher unit volumes, especially when those components are included in the higher volume consumer products. Expand Product Lines: The company expanded its product offerings during fiscal 1997, and expects to add new products during fiscal 1998. For example of the Company's history, in June 1994, the Company commenced shipment of Alladin, its first product designed to provide real time video manipulation for the desktop video market. Since then, the Company has broadened the Alladin product family to include a PAL version, and component and CCIR601 capabilities. In June 1996, the Company introduced the Genie family of products, designed to meet the video manipulation needs of desktop video users at a price point much lower than Alladin. During fiscal 1997, the Company combined the Video Director with internally developed real time video processing technology and created VideoDirector Studio 200. In April 1997, the Company acquired the Deko product line from Digital Graphix and commenced shipment of the first Pinnacle branded character generator that month. In June 1997, the Company commenced shipment of the Windows NT based DVEextreme and Lightning product families. The Company expects to continue to expand its product lines though both internal development and possibly through additional acquisitions. Products Pinnacle has developed the following products to address video post production needs for each the Broadcast, Desktop, and Consumer markets. Broadcast Products: For the Broadcast market the Company currently has products that provide real time digital effects, still image management and storage, and real time video character generation. These products generally include proprietary Pinnacle hardware and software and specialized control panels and/or key boards for ultra-quick operations, especially for on-air applications. The primary broadcast products sold during fiscal 1997 were the Prizm and Flashfile family of products. In April 1997, the Company introduced two new product families, DVExtreme and Lightning, which are designed to address the markets previously addressed by Prizm and Flashfile. Also in April 1997 the Company completed the acquisition of the Deko product line from Digital Graphix, Inc. These three new product families comprise Pinnacle's new suite of high performance real time Windows NT-based products designed for broadcast and high end post production applications. Prizm Family The Prizm family of products was first introduced in 1990. Prizm is designed to provide sophisticated 3D digital video effects which includes real time 3D warps, positioning, sizing, rotation with perspective and clipping of live video images. Prizm operates on a Microsoft DOS based platform. Options -5- to Prizm include compositing, key processing, still image capture and storage, and the DVEator option. The DVEator option permits the creation of unique special effects by combining 3D modeling techniques with digital video technology to map live video in real time onto animated 3D shapes. A base Prizm system has a suggested list price of $23,990. Flashfile Family The FlashFile family of products was first introduced in 1992 and provides broadcast quality still image creation and storage for the broadcast television market. The FlashFile stillstore offers a broad set of features for video still image acquisition, storage and on-air playback, including transitions, file import and export and library management. Operating on a Microsoft DOS platform, Flashfile offers a computer-based graphical user interface and may also be controlled using a dedicated hardware control panel for fast, on-air applications. The Company offers a networked version of FlashFile, FlashNet, that is targeted toward broadcast applications requiring online storage of up to several hundred thousand still images with distributed access using standard Ethernet networking. Using the FlashBrowse PC software package, a standard personal computer may be connected to the FlashNet network enabling viewing and cataloging of video still images stored on a network server. A base Flashfile system has a suggested list price of $16,990 for both NTSC and PAL versions. DVExtreme Family DVExtreme is Pinnacle's newest high performance real time DVE for broadcast and post production customers to incorporate unique special effects into their programming. It is a Windows NT-based, multi-channel system with 10-bit digital processing. It can simultaneously manipulate up to three channels of live video and can generate effects such as four-corner page peels and turns with highlights and shadows, water ripples, ball effects, wave patterns, and other effects, all in real time. It also includes Pinnacle's proprietary ParticalFX and PainterlyFX technology which allows the creation of video textures and paint-look effects. Because it is based on a Windows NT platform it can be connected to a standard computer network to easily transfer files and effects throughout the network. A standard two channel digital DVEextreme has a suggested list price of $44,990 for an NTSC version and $51,990 for a PAL version. Lightning Family Lightning is Pinnacle's new high performance image and graphics management system designed for broadcast and post production applications such as news and sports programs. It is a Windows NT-based system that can have up to three channels of video, plus additional virtual channels for previewing on a monitor. It uses 4:2:2:4 digital video processing to ensure broadcast quality images. Lightning has an internal storage capacity for over ten thousand images, and a fast SCSI interface to external disks for expanded storage needs. Lightning can also perform 3D digital video effects on captured video images. A standard single channel Lightning with digital serial input has a suggested list price of $25,990 for an NTSC version and $28,990 for a PAL version. Deko Family The Deko family of products are designed to provide high performance titling and character generation for broadcast and on-air applications. Based on a Windows NT operating systems, Type Deko includes powerful text and graphics tools such as real time text scrolling, text manipulation, font enhancement, multiple layers for text composition, TrueType fonts and it supports a wide range of international character sets. The product supports a large variety of file import and export graphic file -6- formats to import backgrounds, textures and images. In addition, a Fast Action Keyboard is available as an option for on-air applications. A standard TypeDeko-Pentiium Pro 200 system has a suggested list price of $26,300 for an NTSC version and $30,245 for a PAL version. Desktop Products: The Company's desktop products are designed to provide high quality real time video manipulation capabilities for computer based video post-production systems. They are generally offered at significantly lower price points than traditional systems having comparable capabilities, are sold separate from the computer and are integrated into the computer by a value added reseller, an OEM, or the end user. The Company has two families of Desktop products, the Alladin family and the Genie family products. Alladin Family The Alladin product family is designed to provide high quality real time video manipulation capabilities for desktop video post-production. It allows the user to manipulate and process up to four simultaneous streams of live video supplied from either video tape or computer disk. It provides a variety of high quality real time video effects including dissolves, compositing of live video with text or graphics, transparency, clipping of a live image, sizing, rotation with perspective, 3D positioning and warping. The Alladin connects to and is controlled by a standard Microsoft Windows-based personal computer. The Company commenced shipment of Alladin in June 1994. A standard Alladin with composite analog I/O has a suggested list price of $10,490 for an NTSC version and $12,490 for a PAL version. Genie Family The Genie family of products offers a complete set of professional quality, real-time 3D digital effects, switching, character generation, paint and still storage on a single PCI board. It has much of the functionality of Alladin but at a much lower price point and fits inside the computer rather than connecting through an external port as does Alladin. There are two versions of Genie, GeniePlus for the linear market and an OEM version for the non-linear market. GeniePlus integrates into linear desktop editing environments and includes an input/output piggyback card and software allowing the user to process up to two simultaneous streams of live video. The Company commenced shipments of the GeniePlus in June 1996, and the OEM version in September 1996. The non-linear version is sold to OEM vendors, including Avid Technology, Inc. and Media 100, Inc. who integrate and sell it with their non-linear editing products. GeniePlus has a suggested list price of $5,990 for an NTSC version and $6,990 for a PAL version. Consumer Products The Company's Consumer products provide complete video editing solutions which allows consumers to edit their home videos using a combination of their home PC, camcorder and VCR. They are sold at lower price points than the Company's other products and are sold as software packages and as computer peripheral products. The Company entered the consumer video editing market by acquiring the VideoDirector product line from Gold Disk, Inc. in June 1996. In March 1997, the Company commenced shipment of its first in house developed consumer editing product, the VideoDirector Studio 200. VideoDirector Suite VideoDirector Suite is a low-cost video editing software package which allows home enthusiasts to edit their personal videos by eliminating unwanted sections of video, rearranging the sequence of video clips -7- and add audio to the finished product. It includes the VideoDirector software, a title and audio editor, and a smart cable for connecting a camcorder. It is compatible with most camcorders and VCRs, and uses a Windows based PC to control the editing process. VideoDirector Suite has a suggested list price of $99. Video Director Studio 200 VideoDirector Studio 200 combines the functionality of VideoDirector Suite with certain real time effects technology originally developed for Pinnacle's desktop products. The product includes all of the functionality of VideoDirector, and includes the Studio 200 mixer which contains the real time processing hardware. VideoDirector Studio 200 not only allows basic editing, but it provides an array of special effects for titles and graphics, animation, fade-in and out, full linear keying for translucent titles or backgrounds, and Windows fonts with shadows, outline, and frame options. The product is easy to install since it doesn't require users to open up their PC and it does not require hard disc space for the storage of video since the final video production is output to tape in real time. VideoDirector Studio 200 has a suggested list price of $299. Technology The Company is a technological leader in video manipulation technology. The National Academy of Television Arts and Sciences' Outstanding Technical Achievement EMMY award that has been awarded to the Company on two occasions. In 1990, the Company received an EMMY for pioneering the concept of the video workstation, and in 1994 the Company received an EMMY for developing technology which allows real time mapping of live video onto animated 3D surfaces. Video Manipulation Architecture Many of the Company's products share a common internal architecture. This design approach allows the Company to maximize the return on its research and development expenditures by utilizing similar hardware and software modules in multiple products. The Company's video manipulation architecture is fundamental to the performance and capabilities of its products. All of the Company's products use or work with an industry standard Intel microprocessor running Microsoft DOS/Windows or Windows NT for control of video manipulation functions. In all of the Broadcast products the control microprocessor is embedded within the product. The Desktop and Consumer products are inserted into or connect externally to a Windows based personal computer. The use of industry standard microprocessors for control offers three main advantages over traditional video products: lower software development costs due to the availability of powerful off-the-shelf software development tools; lower product manufacturing costs due to the low costs of standard microprocessors; and the ability to integrate third party software such as networking or 3D rendering software to provide additional functionality. Essentially all real-time video manipulation must be performed on uncompressed video data. Since uncompressed digital video rates are too high to be processed by a microprocessor in real-time, video signals are internally distributed over a separate high-speed digital video bus ("DVB") and processed using the Company's proprietary real time video manipulation hardware. The video data on the DVB is processed in the standard digital component format, which fully complies with the highest digital component video standards of the International Radio Consultation Committee ("CCIR"), an organization which develops and publishes standards for international telecommunication systems. The DVB supports a digital key channel that defines the edges of an irregularly shaped image for proper manipulation. The wide bandwidth and -8- industry standard format of the DVB helps to ensure high quality video output. The software in all of the Company's video manipulation products is divided into two layers: the user interface layer and the video manipulation algorithm layer. The user interface layer is different and has been optimized for each product family. The video manipulation algorithm layer is, for the most part, common to most Pinnacle products and incorporates all the proprietary low level routines which allow Pinnacle products to perform high quality real-time video manipulations. This software architecture has three main advantages: real-time video manipulation algorithms that are complex and difficult to develop can be used in multiple products; the user interface can be tailored to meet specific user requirement; and the user interface can independently be ported to alternative computer platforms. Core Technologies The Company's core technical expertise is in real-time digital video processing, real-time software algorithms, video input/output, advanced user interfaces and, in the case of Video Director, software control of commercially available camcorders and VCRs. o Real-Time Digital Video Processing. The Company has devoted significant resources to the development of proprietary technology for real time video processing, including high speed digital filters, image transformation buffers, plane and perspective addressing, and nonlinear image manipulation. The Company's patented DVEator technology allows real-time mapping of live video onto multiple, complex, animated 3D shapes and surfaces. This technology includes a proprietary data compression algorithm that compresses the address information and allows inexpensive decompression of this data in real time. o Real-Time Software Algorithms. The digital video manipulation functions of the Company's products use common core software that performs complex computations in real-time (at video rates) under user control. The Company has developed certain algorithms that allow the high speed computation of multiple complex equations which are required for real-time video effects. o Video Input/Output. The Company has developed technology for video input and output of both composite analog and component digital video data streams. All of the Company's products work with NTSC and PAL video standards. In addition, the Company has developed interfaces to support input/output of video streams stored on computer disks. o User Interface Design. The Company has extensive experience in design of computer-based user interfaces for video control and manipulation. The Company uses interactive menu driven user interfaces to control video manipulation functions. o Camcorder and VCR Control. With the acquisition of the VideoDirector product line in June 1996, the Company obtained software code which enables a computer to control most commercially available camcorders and VCRs. The Company has historically devoted a significant portion of its resources to engineering and product development programs and expects to continue to allocate significant resources to these efforts. In addition, the Company has acquired certain technologies which has aided the company's ability to more rapidly develop and market new products, such as the VideoDirector Studio 200. The Company's future operating results will depend to a considerable extent on its ability to continually develop, acquire, introduce -9- and deliver new hardware and software products that offer its customers additional features and enhanced performance at competitive prices. Delays in the introduction or shipment of new or enhanced products, the inability of the Company to timely develop and introduce such new products, the failure of such products to gain market acceptance or problems associated with new product transitions could adversely affect the Company's business, operating results and financial condition, particularly on a quarterly basis. As of June 30, 1997, the Company had 47 people engaged in engineering and product development. The Company's engineering and product development expenses (excluding purchased in process research and development) in fiscal 1997, 1996 and 1995 were $ 7.6 million, $5.1 million and $2.4 million, respectively, and represented 20.2%, 11.1% and 10.8%, respectively, of net sales. Customers, Marketing and Sales Customers Since the introduction of its first video workstation in 1987, the Company has shipped over 10,000 systems to customers in more than 60 countries. End users of the Company's products, none of whom accounted for a material amount of the Company's net sales during any period, range from individual users to major corporate/government, video production and broadcast facilities worldwide. There can be no assurance that any of the end users of the Company's products will purchase the Company's products in the future. The Company's customers and their locations include:
Broadcast Corporate/Government - --------- -------------------- The Walt Disney Co./ABC-New York ABC Home Health Services, Inc. - Georgia ESPN-Singapore and USA Essex Corp. - New Mexico Providence Journal Broadcast Corp.-Rhode Island Federal Reserve Bank - San Francisco MCOT-Thailand Hyundai Corporate Culture Office - Korea Australis-Australia National Cattlemens' Assn. - Colorado Swiss Television-Switzerland Nissan Motors - Tennessee RTBF-Belgium Primerica - Georgia Gameshow Network-California PSE&G Training Center - New Jersey Trane Corporation - Tennessee Post-Production Independent Videographers - --------------- ------------------------- Armour Productions - California Christie Entertainment -Illinois Cable Video Entertainment - New Jersey Colin Campbell Communications - North Carolina China Motion Picture Co. - Taiwan Eric Blum Productions - California Helical Post - Colorado Innovision - Pennsylvania Studio Hamburg - Germany Northwest Video - Washington Terra Firma Productions - California Spot Productions - California The Video Company - Louisiana Video Vision - Maryland Video Imagen Communications Ltd. - Brazil Video Productions - Florida
Marketing The Company's marketing efforts are targeted at users of broadcast and desktop post production suites, and at home video editing enthusiasts. In order to increase awareness of its products, the Company -10- attends a number of tradeshows, the major ones being National Association of Broadcasters (NAB) show and the Comdex show, both in the United States, and the International Broadcasters Convention (IBC) in Europe. The Company uses targeted direct mail campaigns and advertisements in trade and computer publications for most of its product lines. Sales The Company sells its broadcast and desktop products to end users through an established domestic and international network of independent dealers and through OEMs. The Company also maintains a sales management organization consisting of six US regional sales managers and five international regional sales managers primarily responsible for supporting independent dealers and making direct sales in geographic regions without dealer coverage or to customers that prefer to transact directly with the Company. The Company sells its consumers products through large consumer electronic chains and through direct customer orders placed by phone or through the Company's web site. The Company's broadcast and desktop products are sold to end users through independent dealers who specialize in selling video production equipment. As of June 30, 1997, the Company had over 170 dealers covering more than 40 countries. These independent dealers are selected for their ability to provide effective field sales and technical support to the Company's customers. Dealers generally carry the Company's products as demonstration units, advise customers on system configuration and installation and perform ongoing post-sales customer support. The Company believes that many end users depend on the technical support offered by independent dealers in making product purchase decisions. In North America, the Company manages its independent dealers with six regional sales managers and independent sales representatives. In Europe, the Company manages its independent dealers with an office of twelve people located in the United Kingdom. Independent dealers in the Far East are managed by regional sales managers located in Japan and Singapore. Central and South America is managed by a regional sales manager located in Miami, Florida. No single dealer individually accounted for more than 10% of the Company's net sales in fiscal 1997, 1996 or 1995. The Company sells and distributes its products through OEMs that incorporate the Company's products into their video editing products and resell these products to other resellers and end users. OEM partners generally purchase the Company's products and are responsible for conducting their own marketing, sales and support activities. The Company attempts to identify and align itself with OEMs that are market share and technology leaders in the Company's target market segments. In particular, the Company is highly dependent on sales of Alladin and Genie to Avid. Avid is a leading supplier of digital, nonlinear video and audio editing systems for the professional video and film editing market. Sales to Avid accounted for approximately 26.4% of net sales in fiscal 1997, and 43.3% of sales in fiscal 1996. No customer accounted for more than 10% of the Company's net sales during fiscal 1995. This concentration of the Company's net sales to a single OEM customer subjects the Company to a number of risks, in particular the risk that its operating results will vary on a quarter to quarter basis as a result of variations in the ordering patterns of the OEM customer. Variations in the timing of revenues can cause significant fluctuations in quarterly results of operations. The Company's results of operations could be materially adversely affected by the failure of anticipated orders to materialize and by deferrals or cancellations of orders as a result of changes in Avid's requirements. As a result, if the Company were to lose Avid as a customer, or if orders from Avid were to otherwise decrease, the Company's business, operating results and financial condition would be materially adversely affected. With the introduction of the Genie product line, the Company adopted a similar OEM distribution -11- strategy. The Company expects that a substantial portion of sales of the Genie product line will continue to be to OEMs who could also develop and offer products which compete with Genie. The Company is dependent upon these resellers to assist it in promoting market acceptance of the professional video products and desktop video systems and creating demand for the Company's products. There can be no assurance that these dealers and OEMs will devote the resources necessary to provide effective sales and marketing support to the Company. In addition, there is a risk that these dealers may give higher priority to products of other suppliers, thus reducing their efforts to sell the Company's products. If a significant number of its dealers were to experience financial difficulties, or otherwise become unable or unwilling to promote, sell or pay for the Company's products, the Company's results of operations would be adversely affected. The Company's consumer products are sold through a different channel than the Company's other products. VideoDirector Suite and VideoDirector Studio 200 products are sold primarily through large computer software distributors such as Ingram Micro Inc. who then distribute the products to large computer software and hardware retailers such as CompUSA, ComputerCity, and Egghead Software who in turn sell the products to end-users. The Company also sells its VideoDirector products directly to some retailers such as The Good Guys. In addition, VideoDirector products are sold via direct telemarketing, mail order and over the Internet. The consumer market is characterized by longer payment terms and higher sales returns than the Company's broadcast and desktop markets. There can be no assurance that computer retailers will continue to stock and sell the Company's VideoDirector products. If a significant number of computer retailers were to discontinue selling VideoDirector products, the Company's results of operations would be adversely affected. Sales outside of North America represented approximately 39.7%, 38.7% and 46.5% of the Company's net sales for fiscal 1997, 1996 and 1995, respectively. All of the Company's international sales through fiscal 1994 were denominated in U.S. dollars. In fiscal 1995, the Company began foreign currency denominated sales in the United Kingdom. From time to time the Company makes foreign currency denominated sales in other countries, but the dollar amount was nominal during fiscal 1997. It is likely that the Company will increase the amount of sales denominated in foreign currency during fiscal 1998, especially for sales of Consumer products into Europe. International sales and operations may be subject to risks such as currency fluctuations, the imposition of governmental controls, export license requirements, restrictions on the export of critical technology, generally longer receivable collection periods, political instability, trade restrictions, changes in tariffs, difficulties in staffing and managing international operations, potential insolvency of international dealers and difficulty in collecting accounts receivable. There can be no assurance that these factors will not have an adverse effect on the Company's future international sales and, consequently, on the Company's business, operating results and financial condition. Service and Support The Company believes that its ability to provide customer service and support is an important element in the marketing of its products. The customer service and support operation also provides the Company with a means of understanding customer requirements for future product enhancements. The Company maintains an in-house repair facility and also provides telephone access to its technical support staff. The Company's technical support engineers not only provide assistance in diagnosing problems, but work closely with customers to address system integration issues and to assist customers in increasing the efficiency and productivity of their systems. The Company supports its customers in Europe and Asia primarily through its international dealers. The Company typically warrants its products against defects in materials and workmanship for one year after shipment to the dealer. The Company believes its warranties are similar to those offered by other video production equipment suppliers. To date, the Company has not -12- encountered any significant product maintenance problems. Competition The video production equipment market is highly competitive and is characterized by rapid technological change, new product development and obsolescence, evolving industry standards and significant price erosion over the life of a product. Competition is fragmented with several hundred manufacturers supplying a variety of products to this market. The Company anticipates increased competition in the video post-production equipment market from both existing manufacturers and new market entrants. Competition for Pinnacle's broadcast products are generally based on product performance, breadth of product line, service and support, market presence and price. The Company believes that it competes favorably for sales of video production equipment used in traditional editing suites in situations where price/performance is a primary factor in equipment selection. The Company's principal competitors in this market include Scitex Video (a division of Scitex Corporation Ltd.)("Scitex"), The Grass Valley Group, Inc. (a subsidiary of Tektronix, Inc.) ("Grass Valley Group"), Matsushita Electric Industrial Co. Ltd. ("Matsushita"), Quantel Ltd. (a division of Carlton Communications Plc) ("Quantel") and Sony Corporation ("Sony"), each of which has substantially greater financial, technical, marketing, sales and customer support resources, greater name recognition and larger installed customer bases than the Company. In addition, these companies have established relationships with current and potential customers of the Company. Some of the Company's competitors also offer a wide variety of video equipment, including professional video tape recorders, video cameras and other related equipment. In some cases, these competitors may have a competitive advantage based upon their ability to bundle their equipment in certain large system sales. The Company expects that potential competition in the desktop market may come from a number of potential groups of video companies such as traditional video equipment suppliers, providers of desktop editing solutions, video software application companies, or others. Suppliers of traditional video equipment such as Grass Valley Group, Matsushita, Quantel, Scitex and Sony have the financial resources and technical know-how to develop high quality real time video manipulation products for the desktop video market. Suppliers of desktop editing video systems such as Avid Technology, Media 100, Fast Electronic, Matrox, Newtek, Inc., Truevision, Inc.and Scitex Video, which have established desktop video distribution channels, experience in marketing low price products and significant financial resources, may acquire or develop high quality real time video manipulation products for the desktop video market. Suppliers of video manipulation software such as Adobe Systems, Inc. or SoftImage, a subsidiary of Microsoft Corporation may develop products which compete directly with the Company's real time manipulation products. The software products supplied by these companies are, and will continue to be, significantly less expensive than the systems marketed by the Company, but they generally require lengthy rendering time and therefore do not provide the real time capabilities currently offered by both Alladin and Genie. Increased competition could result in price reductions, reduced margins and loss of market share, all of which would materially and adversely affect the Company's business, operating results and financial condition. There can be no assurance that the Company will be able to compete successfully against current and future competitors. Manufacturing and Suppliers The Company's manufacturing operations, located at its Mountain View, California facility, consist primarily of testing printed circuit assemblies, final product assembly, configuration and testing, quality -13- assurance and shipping for the Company's broadcast and desktop products. Manufacturing of the Company's consumer products is performed by an independent subcontractor and products are generally shipped directly to the distributor or retailer. Each of the Company's products undergoes quality inspection and testing at the board level and final assembly stage. The Company manages its materials with a software system that integrates purchasing, inventory control and cost accounting. The Company relies on independent subcontractors who manufacture to the Company's specifications major subassemblies used in the Company's products. This approach allows the Company to concentrate its manufacturing resources on areas where it believes it can add the most value, such as product testing and final assembly, and reduces the high cost of owning and operating a full scale manufacturing facility. The Company has manufacturing agreements with Quadrus, a division of Bell Microproducts, Inc., for the manufacture of major subassemblies used in its broadcast and desktop products, and with Solectron for the manufacture of the Company's consumer products. The Company's reliance on subcontractors to manufacture major subassemblies used in its products involves a number of significant risks including the loss of control over the manufacturing process, the potential absence of adequate capacity, the unavailability of or interruptions in access to certain process technologies and reduced control over delivery schedules, manufacturing yields, quality and costs. In the event that any significant subcontractor were to become unable or unwilling to continue to manufacture these subassemblies in required volumes, the Company's business, operating results and financial condition would be materially adversely affected. To the extent possible, the Company and its manufacturing subcontractors use standard parts and components available from multiple vendors. However, the Company and its subcontractors are dependent upon single or limited source suppliers for a number of key components and parts used in all of its products, including a proprietary application specific integrated circuits manufactured only by LSI Logic Corp., several video processing integrated circuits manufactured only by Raytheon Corporation, field programmable gate arrays manufactured only by Altera Corporation and serial RAM memory modules manufactured only by Hitachi, Ltd. The Company's manufacturing subcontractors generally purchase these single or limited source components pursuant to purchase orders placed from time to time in the ordinary course of business, do not carry significant inventories of these components and have no guaranteed supply arrangements with such suppliers. In addition, the availability of many of these components to the Company's manufacturing subcontractors is dependent in part on the Company's ability to provide its manufacturers, and their ability to provide suppliers, with accurate forecast of its future requirements. The Company and its manufacturing subcontractors endeavor to maintain ongoing communication with its suppliers to guard against interruptions in supply. Any extended future interruption or limitation of any of the components currently obtained from single or limited source suppliers could result in delays or reductions in product shipments which would have a material adverse effect on the Company's results of operations. Also, because of the reliance on these single or limited source components, the Company may be subject to increases in component costs which could have an adverse effect on the Company's results of operations. The Company has experienced interruptions in the supply of certain key integrated circuits from suppliers which accordingly delayed product shipments, and any extended interruption or reduction in the future supply of any key components currently obtained from a single or limited source could have a significant adverse effect on the Company's business, operating results and financial condition in any given period. In the traditional video market segment, the Company's customers generally order on an as-needed basis. The Company typically ships its products within 30 to 60 days of receipt of an order, depending on customer requirements, although certain customers, including OEMs, may place substantial orders with the expectation that shipments will be staged over several months. A substantial majority of product shipments in a period relate to orders received in that period, and accordingly, the Company generally operates with a limited backlog of orders. The absence of a significant historical backlog means that quarterly results are -14- difficult to predict and delays in product delivery and in the closing of sales near the end of a quarter can cause quarterly revenues to fall below anticipated levels. In addition, customers may cancel or reschedule orders without significant penalty and the prices of products may be adjusted between the time the purchase order is booked into backlog and the time the product is shipped to the customer. As a result of these factors, the Company believes that the backlog of orders as of any particular date is not necessarily indicative of the Company's actual sales for any future period. Proprietary Rights and Licenses The Company's ability to compete successfully and achieve future revenue growth will depend, in part, on its ability to protect its proprietary technology and operate without infringing the rights of others. The Company relies on a combination of patent, copyright, trademark and trade secret laws and other intellectual property protection methods to protect its proprietary technology. In addition, the Company generally enters into confidentiality and nondisclosure agreements with its employees and OEM customers and limits access to and distribution of its proprietary technology. The Company currently holds two United States patent covering certain aspects of the technologies utilized by Prizm and DVExtreme. Although the Company intends to pursue a policy of obtaining patents for appropriate inventions, the Company believes that the success of its business will depend primarily on the innovative skills, technical expertise and marketing abilities of its personnel, rather than upon the ownership of patents. Certain technology used in the Company's products is licensed from third parties on a royalty-bearing basis. Such royalties to date have not been, and are not expected to be, material. Generally, such agreements grant to the Company nonexclusive, worldwide rights with respect to the subject technology and terminate only upon a material breach by the Company. The Company has in the past received communications suggesting that its products may utilize concepts covered by patent rights of third parties and, in the future, may receive communications asserting that the Company's products infringe patents or other intellectual property rights of third parties. There can be no assurance that there will not be any future such communications. The Company's policy is to investigate the factual basis of such communications and to negotiate licenses where appropriate. While it may be necessary or desirable in the future to obtain licenses relating to one or more of its products, or relating to current or future technologies, there can be no assurance that the Company will be able to do so on commercially reasonable terms or at all. There can be no assurance these or other future communications can be settled on commercially reasonable terms or that they will not result in protracted litigation. 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 the Company to protect trade secrets, trademarks and other intellectual property rights owned by the Company to defend the Company against claimed infringement of the rights of others and to determine the scope and validity of the proprietary rights of others. Any such litigation could be costly and a diversion of management's attention, which could have material adverse effect on the Company's business, operating results and financial condition. Adverse determinations in such litigation could result in the loss of the Company's proprietary rights, subject the Company to significant liabilities, require the Company to seek licenses from third parties or prevent the Company from manufacturing or selling its products, any of which could have a material adverse effect on the Company's business, operating results and financial condition. Employees As of June 30, 1997, the Company had 158 full-time employees, including 47 engaged in engineering and product development activities, 33 in manufacturing, 68 in marketing and sales and 10 in administration -15- and finance. The Company believes that its future success will depend, in part, on its continuing ability to attract, retain and motivate qualified technical, marketing and managerial personnel. None of the Company's employees is represented by a collective bargaining agreement, nor has the Company experienced work stoppages. The Company believes that its relations with its employees are good. Subsidiaries: The Company has two subsidiaries which were organized to take advantage of certain tax benefits related to export sales. The Company established a Domestic International Sales Corp. ("DISC) in fiscal 1988. In fiscal 1996, the Company discontinued use of the DISC and established a Foreign Sales Corporation ("FSC"). The FSC provides certain permanent federal income tax benefits for export sales by the Company. ITEM 2. PROPERTIES The Company's principal administrative, marketing, manufacturing and product development facility is located in Mountain View, California. This facility occupies approximately 106,500 square feet pursuant to a lease which commenced August 15, 1996 and which will terminate December 31, 2003. The Company has also entered into an agreement to sublease approximately 41,500 of the Mountain View Facility to Network Computing Devices. That sublease agreement is currently scheduled to terminate on August 31, 1998. In addition, the Company occupies sales and customer support facilities in Uxbridge, United Kingdom; Singapore; and Tokyo, Japan consisting of 6,000 square feet, 850 square feet and 350 square feet, respectively. The Company has two engineering development facilities outside of California. One is in Gainesville, Florida, consisting of 1,000 square feet and the other is in Paramus, New Jersey, consisting of approximately 4,000 square feet. ITEM 3. LEGAL PROCEEDINGS Not Applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable. -16- EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company and their ages as of August 27, 1997 are as follows:
- ---------------------------------- -------- ------------------------------------------------------------------------ Name Age Position ---- --- -------- - ---------------------------------- -------- ------------------------------------------------------------------------ Mark Sanders.................... 54 President, Chief Executive Officer and Director Ajay Chopra...................... 40 Chairman of the Board, Vice President, General Manager, Desktop Products Arthur D. Chadwick............... 40 Vice President, Finance and Administration and Chief Financial Officer Pat Burns........................ 50 Vice President, Corporate Marketing and Domestic Sales Brian R. Conner.................. 51 Vice President, Sales, Europe, Africa & Middle East Tavy A. Hughes................... 42 Vice President, Manufacturing William Loesch................... 43 Vice President, General Manager, Consumer Products William Ludwig................... 49 Vice President, Sales, Latin America & Asia Keith Trickett................... 57 Vice President, General Manager, Deko Products Robert Wilson.................... 43 Vice President, General Manager, Broadcast Products - ---------------------------------- -------- ------------------------------------------------------------------------
Mr. Sanders has served as President, Chief Executive Officer and a director of the Company since January 1990. From 1988 to 1990, Mr. Sanders was an independent business consultant. Prior to that time, Mr. Sanders served in a variety of management positions, most recently as Vice President and General Manager of the Recording Systems Division, of Ampex Incorporated, a manufacturer of video broadcast equipment. Mr. Chopra, a founder of the Company, has served as Chairman of the Board of Directors since January 1990, and has served as a director of the Company since its inception in May 1986. Mr. Chopra has served as Vice President, General Manager, Desktop products since April 1997. He previously served as Chief Technology Officer from June 1996 to April 1997, Vice President of Engineering from January 1990 to June 1996, and President and Chief Executive Officer of the Company from its inception to January 1990. From 1983 to 1986, Mr. Chopra served as Engineering Supervisor for Mindset Corporation, a computer graphics manufacturer. -17- Mr. Chadwick has served as Vice President, Finance and Administration and Chief Financial Officer of the Company since January 1989. From February 1987 to January 1989 he served as Plant Manager, Gould Semiconductor, Philippines, a semiconductor company. From March 1984 to February 1987 he served as Corporate Controller for Gould Semiconductor Inc., a semiconductor company. From February 1982 to March 1984 as Controller, Austria Microsystems, an Austrian subsidiary of American Microsystems, Inc., a semiconductor company. Mr. Burns has served as Vice President, North American Sales and Corporate Marketing of the Company since December 1996. From March 1996 to November 1996, Mr. Burns served as a marketing and strategy consultant to software developers in the film and video markets. From April 1995 to February 1996, he served as Vice President and General Manager of Video and Graphics products at Radius, Inc., a graphics company. From May 1994 to April 1995, Mr. Burns served as Vice President and General Manager of Chyron's West Coast operations. From April 1993 to May 1994, Mr. Burns served as Director of International Marketing for VeriFone, Inc., a financial transaction company. From November 1991 through January 1993, Mr. Burns was Vice President of Macrovision, Inc., a video encryption company. Mr. Conner has served as Vice President, Sales of the Company and General Manager of Pinnacle Systems Ltd., the Company's sales subsidiary covering Europe, Africa and the Middle East, since February 1995. From January 1993 to February 1995, Mr. Conner was a founder and served as President of BCA Inc., an independent European sales representative company. From January 1991 to January 1993, Mr. Conner served as General Manager of European, African and Middle East Sales of Videomedia, Inc., a manufacturer of video editing systems. Prior to that, Mr. Conner was Managing Director of Videomedia Europe Ltd., a European sales representative. Ms. Hughes has served as Vice President, Manufacturing of the Company since January 1995, Director of Manufacturing from April 1994 to January 1995 and a Manager from September 1993 until April 1994. From July 1991 to September 1993, Ms. Hughes served as an independent business consultant. From 1985 to June 1991, Ms. Hughes served as Manufacturing Manager of Alta Group, Inc., a manufacturer of digital video post-production equipment. Mr. Loesch has served as Vice President, General Manager, Consumer Products since April, 1997, and as Vice President, New Business Development of the Company since May 1994. From July 1993 to May 1994, Mr. Loesch served as an independent business consultant. From June 1990 to November 1992, Mr. Loesch co-founded and served as President of SHOgraphics Inc., a 3D graphics systems company, and from November 1992 until July 1993 served as its Executive Vice President and Chief Technical Officer. From 1989 to June 1990, Mr. Loesch was an independent business consultant. Prior to that time, Mr. Loesch co-founded and served as Chief Executive Officer and President of IKOS Systems, Inc., a computer aided engineering company. Mr. Ludwig has served as Vice President, Latin American and Far East Sales of the Company since July 1996. From January of 1996 to June of 1996, Mr. Ludwig served as Director of Sales for Americas / Pacific Region for FAST Electronics, a video equipment manufacturer. From 1985 until January 1996, Mr. Ludwig served in several executive sales positions with Abekas Video Systems, a video equipment manufacturer, including International Sales Director for Americas / Pacific Region. Mr. Trickett has served as Vice President, Deko Products since April 1997. Prior to that, Mr. Trickett served as the President and CEO of Digital GraphiX Inc, from November 1994 until the recent acquisition of its Deko product by Pinnacle in April 1997. Mr. Trickett was President of Montage Group Ltd., a video company, from August 1993 to September of 1994, and before that spent nine years with Techexport Inc and -18- an Executive Director and Vice President of Strategic Planning, and European Operations. Mr. Wilson has served as Vice President, Broadcast Products since April 1997. From May 1994 to April 1997, Mr. Wilson served as Executive Vice President, Chief Operating Officer and Chief Financial officer of Accom, Inc., a video company. Mr. Wilson has served on the board of directors at Accom since April 1995. From March 1991 to April 1994, Mr. Wilson served as President and Chief Executive Officer of The Grass Valley Group (a subsidiary of Tektronix, Inc.), which provides video systems to the high-end production, post-production and broadcast market. From March 1989 to March 1991, Mr. Wilson was a Vice President of the Merchant Banking Group of Wasserstein Perella & Co., Inc., an investment bank; in that capacity, he was Chief Financial Officer and director of the Wickes Companies, which was an affiliate of Wasserstein Perella. -19- PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information required by this item is incorporated by reference to Note 11 of Notes to Consolidated Financial Statements in the Company's 1997 Annual Report to Shareholders for the fiscal year ended June 30, 1997, filed as Exhibit 13.1 hereto (the "Annual Report to Shareholders"). ITEM 6. SELECTED FINANCIAL DATA The information required by this item is incorporated by reference to the captions entitled "Statement of Operations Data" and "Balance Sheet Data" in of the Company's Annual Report to Shareholders. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this item is incorporated by reference to the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report to Shareholders. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is incorporated by reference to pages F-1 to F-14 of the Company's Annual Report to Shareholders. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item concerning the Company's directors is incorporated by reference from the section captioned "Election of Directors" contained in the Company's Proxy Statement related to the Annual Meeting of Shareholders to be held October 28, 1997, to be filed by the Company with the Securities and Exchange Commission within 120 days of the end of the Company's fiscal year pursuant to General Instruction G(3) of Form 10-K (the "Proxy Statement"). The information required by this item concerning executive officers is set forth in Part I of this Report. The information required by this item concerning compliance with Section 16(a) of the Exchange Act is incorporated by reference from the section captioned " Section 16(a) Beneficial Ownership Reporting Compliance" contained in the Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference from the section captioned "Executive Compensation and Other Matters" contained in the Proxy Statement. -20- ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference from the section captioned "Record Date and Principal Share Ownership" contained in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference from the sections captioned "Compensation Committee Interlocks and Insider Participation" and "Certain Transactions With Management" contained in the Proxy Statement. -21- PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a)(1) Financial Statements The financial statements are incorporated by reference in Item 8 of this Report: Independent Auditors' Report Consolidated Balance Sheets, June 30, 1997 and 1996 Consolidated Statements of Operations for years ended June 30, 1997, 1996 and 1995 Consolidated Statements of Shareholders' Equity for the years ended June 30, 1997, 1996 and 1995 Consolidated Statements of Cash Flows for the years ended June 30, 1997, 1996 and 1995 Notes to Financial Statements (a)(2) Financial Statement Schedules Schedule II - Valuation and Qualifying Accounts Schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. (a)(3) Exhibits 3.1(1) Restated Articles of Incorporation of the Registrant. 3.2(1) Bylaws of the Registrant, as amended to date. 4.1(2) Preferred Share Rights Agreement, dated December 12, 1996, between Registrant and Chase Mellon Shareholder Services, L.L.C. 10.1(1) Registration Rights Agreement, dated December 21, 1990, as amended on September 9, 1993. 10.2(1) Series G Preferred Stock Purchase Agreement, dated September 9, 1993. 10.3(1) 1987 Stock Option Plan, as amended, and form of agreements thereto. 10.4(3) 1994 Employee Stock Purchase Plan, as amended and form of agreement thereto. 10.5(1) 1994 Director Stock Option Plan, and form of agreement thereto. 10.6(1) Form of Indemnification Agreement between the Registrant and its officers and directors. 10.7(1) Business Loan Agreement and ancillary documents thereto between Registrant and Imperial Bank, dated January 3, 1994. 10.8(1) Amendment to Business Loan Agreement between Registrant and Imperial Bank, dated October 12, 1994. 10.9(1) Software Development and License Agreement, effective as of November 23, 1987, between Registrant and CrystalGraphics, Inc. 10.10*(1) Systems Marketing Agreement, dated December 7, 1990, as amended, between Registrant and BTS Broadcast Television Systems. 10.11*(1) Development and Original Equipment Manufacturing and Supply Agreement, dated March 16, 1994, between Registrant and Avid Technology, Inc. 10.12*(1) Value-added Reseller Agreement, dated July 15, 1994, between Registrant and Matrox Corporation. 10.13*(1) Letter Agreement, dated December 17, 1993, between Registrant and Capital -22- Cities/ABC, Inc. 10.14(1) Master Agreement, dated March 4, 1994, between Registrant and Bell Microproducts, Inc. 10.15*(1) Contract Services Agreement, dated May 31, 1994, between Registrant and Liberty Contract Services, a division of Wyle Laboratories. 10.16.1(1) Industrial Lease Agreement, dated July 20, 1992, as amended, between Registrant and Aetna Life Insurance Company. 10.16.2(4) Amendment to Industrial Lease Agreement, dated June 8, 1995 between Registrant and Aetna Life Insurance Company. 10.17(1) Agreement, dated September 8, 1994, between Registrant and Mark L. Sanders. 10.18.1(5) Agreement Concerning Assignment of Leases, dated June 5, 1996, between Registrant and Network Computing Devices, Inc. 10.18.2(5) Assignment and Modification of Leases, dated August 16, 1996, between Registrant, Network Computing Devices, Inc. and D.R. Stephens & Company. 10.19.1(6)* OEM Agreement between Registrant and Data Translation, Incorporated. 10.19.2(6)* Amendment to OEM Agreement between Registrant and Data Translation, Incorporated. 10.20(7) Industrial Lease Agreement, dated November 19, 1996 between Registrant and CNC Grand Union Limited. 10.21(8) 1996 Stock Option Plan, and form of agreements thereto. 10.22(8) 1996 Supplemental Stock Option Plan, and form of agreements thereto. 10.23 Lease Agreement, dated July 28, 1995, between Digital Graphics Incorporated and Allied Securities Co. 11.1 Statement of Computation of Net Income (Loss) Per Share. 13.1 Portions of Annual Report to Shareholders for the fiscal year ended June 30, 1997. 22.1 List of subsidiaries of the Registrant. 23.1 Report on Financial Statement Schedule and Consent of Independent Auditors Schedule. 24.1 Power of Attorney (See Page 25). 27.1 Financial Data Schedule. - ------------------ * Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission. 1 Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form S- 1 (Reg. No. 33-83812) as declared effective by the Commission on November 8, 1994. 2 Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form 8-A (Reg. No. 000-24784) as declared effective by the Commission on February 17, 1997. 3 Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form S-8 (Reg. No. 333-25697) as filed on April 23, 1997. 4 Incorporated by reference to exhibits filed with Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1995. 5 Incorporated by reference to exhibits filed with Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1996. 6 Incorporated by reference to exhibits filed with Registrant's Quarterly Report on Form 10-Q for the three months ended September 27, 1996. 7 Incorporated by reference to exhibits filed with Registrant's Quarterly Report on Form 10-Q for the three months ended December 27, 1996. -23- 8 Incorporated by reference by reference to exhibits filed with Registrant's Registration Statement on Form S-8 (Reg. No. 333-16999) as filed on November 27, 1996. (b) Reports on Form 8-K. The Company did not file any reports on Form 8-K during the last quarter of the fiscal year ended June 30, 1997. (c) Exhibits. See Item 14(a)(3) above. (d) Financial Statement Schedule. See Item 14(a)(2) above. -24- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. PINNACLE SYSTEMS, INC. By: /s/ MARK L. SANDERS -------------------------------------- Mark L. Sanders President, Chief Executive Officer and Director Date: August 28, 1997 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Mark L. Sanders and Arthur D. Chadwick, and each of them, his true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, to sign any and all amendments (including post-effective amendments) to this Annual Report on Form 10-K and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or their substitute or substitutes, or any of them, shall do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
Signature Title Date --------- ----- ---- /s/ MARK L. SANDERS President, Chief Executive Officer and Director August 28, 1997 - ------------------------------- (Principal Executive Officer) Mark L. Sanders /s/ ARTHUR D. CHADWICK Vice President, Financial and Administration and August 28, 1997 - ------------------------------- Chief Financial Officer (Principal Financial and Arthur D. Chadwick Accounting Officer) /s/ AJAY CHOPRA Chairman of the Board, Vice President, Desktop August 28, 1997 - ------------------------------- Products Ajay Chopra /s/ JOHN LEWIS Director August 28, 1997 - ------------------------------- John Lewis -25- /s/ CHARLES J. VAUGHAN Director August 28, 1997 - ------------------------------- Charles J. Vaughan /s/ NYAL D. McMULLIN Director August 28, 1997 - ------------------------------- Nyal D. McMullin /s/ GLENN E. PENISTEN Director August 28, 1997 - ------------------------------- Glenn E. Penisten
-26- PINNACLE SYSTEMS, INC. AND SUBSIDIARIES SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS (In thousands)
Balance at Provision Balance beginning charged to Account at end of period expense charge-off of period --------- ------- ---------- --------- Year ended June 30, 1995, allowance for doubtful accounts and returns............................. $173 $204 $16 $361 ==== ==== === ==== Year ended June 30, 1996, allowance for doubtful accounts and returns............................. $361 $522 $43 $840 ==== ==== === ==== Year ended June 30, 1997, allowance for doubtful accounts and returns............................. $840 $1,151 $237 $1,754 ==== ====== ==== ======
S-1 EXHIBIT INDEX (a)(3) Exhibits 3.1(1) Restated Articles of Incorporation of the Registrant. 3.2(1) Bylaws of the Registrant, as amended to date. 4.1(2) Preferred Share Rights Agreement, dated December 12, 1996, between Registrant and Chase Mellon Shareholder Services, L.L.C. 10.1(1) Registration Rights Agreement, dated December 21, 1990, as amended on September 9, 1993. 10.2(1) Series G Preferred Stock Purchase Agreement, dated September 9, 1993. 10.3(1) 1987 Stock Option Plan, as amended, and form of agreements thereto. 10.4(3) 1994 Employee Stock Purchase Plan, as amended and form of agreement thereto. 10.5(1) 1994 Director Stock Option Plan, and form of agreement thereto. 10.6(1) Form of Indemnification Agreement between the Registrant and its officers and directors. 10.7(1) Business Loan Agreement and ancillary documents thereto between Registrant and Imperial Bank, dated January 3, 1994. 10.8(1) Amendment to Business Loan Agreement between Registrant and Imperial Bank, dated October 12, 1994. 10.9(1) Software Development and License Agreement, effective as of November 23, 1987, between Registrant and CrystalGraphics, Inc. 10.10*(1) Systems Marketing Agreement, dated December 7, 1990, as amended, between Registrant and BTS Broadcast Television Systems. 10.11*(1) Development and Original Equipment Manufacturing and Supply Agreement, dated March 16, 1994, between Registrant and Avid Technology, Inc. 10.12*(1) Value-added Reseller Agreement, dated July 15, 1994, between Registrant and Matrox Corporation. 10.13*(1) Letter Agreement, dated December 17, 1993, between Registrant and Capital Cities/ABC, Inc. 10.14(1) Master Agreement, dated March 4, 1994, between Registrant and Bell Microproducts, Inc. 10.15*(1) Contract Services Agreement, dated May 31, 1994, between Registrant and Liberty Contract Services, a division of Wyle Laboratories. 10.16.1(1) Industrial Lease Agreement, dated July 20, 1992, as amended, between Registrant and Aetna Life Insurance Company. 10.16.2(4) Amendment to Industrial Lease Agreement, dated June 8, 1995 between Registrant and Aetna Life Insurance Company. 10.17(1) Agreement, dated September 8, 1994, between Registrant and Mark L. Sanders. 10.18.1(5) Agreement Concerning Assignment of Leases, dated June 5, 1996, between Registrant and Network Computing Devices, Inc. 10.18.2(5) Assignment and Modification of Leases, dated August 16, 1996, between Registrant, Network Computing Devices, Inc. and D.R. Stephens & Company. 10.19.1(6)* OEM Agreement between Registrant and Data Translation, Incorporated. 10.19.2(6)* Amendment to OEM Agreement between Registrant and Data Translation, Incorporated. 10.20(7) Industrial Lease Agreement, dated November 19, 1996 between Registrant and CNC Grand Union Limited. 10.21(8) 1996 Stock Option Plan, and form of agreements thereto. 10.22(8) 1996 Supplemental Stock Option Plan, and form of agreements thereto. 10.23 Lease Agreement, dated July 28, 1995, between Digital Graphics Incorporated and Allied Securities Co. 11.1 Statement of Computation of Net Income (Loss) Per Share. 13.1 Portions of Annual Report to Shareholders for the fiscal year ended June 30, 1997. 22.1 List of subsidiaries of the Registrant. 23.1 Report on Financial Statement Schedule and Consent of Independent Auditors Schedule. 24.1 Power of Attorney (See Page 25). 27.1 Financial Data Schedule. - ------------------ * Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission. 1 Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form S- 1 (Reg. No. 33-83812) as declared effective by the Commission on November 8, 1994. 2 Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form 8-A (Reg. No. 000-24784) as declared effective by the Commission on February 17, 1997. 3 Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form S-8 (Reg. No. 333-25697) as filed on April 23, 1997. 4 Incorporated by reference to exhibits filed with Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1995. 5 Incorporated by reference to exhibits filed with Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1996. 6 Incorporated by reference to exhibits filed with Registrant's Quarterly Report on Form 10-Q for the three months ended September 27, 1996. 7 Incorporated by reference to exhibits filed with Registrant's Quarterly Report on Form 10-Q for the three months ended December 27, 1996. 8 Incorporated by reference by reference to exhibits filed with Registrant's Registration Statement on Form S-8 (Reg. No. 333-16999) as filed on November 27, 1996. (b) Reports on Form 8-K. The Company did not file any reports on Form 8-K during the last quarter of the fiscal year ended June 30, 1997. (c) Exhibits. See Item 14(a)(3) above. (d) Financial Statement Schedule. See Item 14(a)(2) above. EX-10.23 2 LEASE LEASE ALLIED SECURITIES CO., (Lessor) to DIGITAL GRAPHIX INCORPORATED, (Lessee) Dated: 07/18/95 Standard Office Building Lease adopted by New Jersey Builders, Owners & Managers Association - July 1969 INDEX Signature Page TITLE PAGE Premises ................................................. 1 TITLE PAGE Parking Privileges ....................................... 1 Article 1 Term ..................................................... 1 Article 2 Rent & Security Deposit .................................. 1 Article 3 Use ...................................................... 2 Article 4 Increase or Decrease of Base Rent ........................ 3 Article 5 Repairs, Replacements and Alterations .................... 4 Article 6 Services by Lessor ....................................... 5 Article 7 Assignment, Mortgage, Etc. ............................... 6 Article 8 Indemnity ................................................ 6 Article 9 Subordination to Mortgages ............................... 7 Article 10 Loss or Damage to Property ............................... 7 Article 11 Holding Over ............................................. 7 Article 12 Earlier Possession by Lessee ............................. 7 Article 13 Surrender at End of Term ................................. 8 Article 14 Damage by Fire or Other Cause ............................ 8 Article 15 Additional Rent .......................................... 8 Article 16 Mechanics' Liens ......................................... 8 Article 17 Eminent Domain ........................................... 8 Article 18 Bankruptcy ............................................... 8 Article 19 Default .................................................. 9 Article 20 No Waiver ............................................... 10 Article 21 Rights Reserved by Lessor ............................... 10 Article 22 Waiver of Trial by Jury ................................. 11 Article 23 Entry by Lessor ......................................... 11 Article 24 Lessee's Damage or Injury to the Premises or Building ... 11 Article 25 Bills and Notices ....................................... 11 Article 26 Inability to Perform .................................... 12 Article 27 Rules and Regulations ................................... 12 Article 28 Sprinklers .............................................. 12 Article 29 Offer by Managing Agent ................................. 12 Article 30 No Representations by Lessor ............................ 12 Article 31 Marginal Notes .......................................... 12 Article 32 Broker .................................................. 12 Article 33 Quiet Enjoyment ......................................... 12 Article 34 Assigns ................................................. 12 Article 35 Definitions ............................................. 12 Article 36 Certificate of Lessee ................................... 13 Article 37 Entire Agreement ........................................ 13 Signature Page ......................................................... 13 Rules and Regulations ....................................................... 14 Addenda ......................................................... 15 NOTE: Marginal notes where underlined STANDARD OFFICE BUILDING LEASE adopted have blanks to be completed. by New Jersey Builders, Owners & Managers Association - July 1969. c 1969 LEASE Draft: 4/26/95 Revised: 5/3/95 6/7/95 LEASE made this 28th day of, July 7/18/95 Final Date 1995, between ALLIED SECURITIES CO., a New Jersey partnership having a place of business at One East Ridgewood Avenue, Paramus, NJ (hereinafter called "Lessor") and Parties DIGITAL GRAPHIX INCORPORATED, a Delaware corporation having a place of business at 1280 Blue Hills Avenue, Bloomfield, CT (hereinafter called Lessee). Premises WITNESSETH: Lessor leases to Lessee and Lessee hires from Lessor approximate1y 7,235 square feet on the first floor (hereinafter called "the demised premises" or "the premises") in the building known as 6 Forest Avenue in the Borough of Paramus, State of New Jersey , for the term and upon the payment of the rents and the keeping, performance and observance of all the terms, covenants, provisions, conditions and limitations hereinafter set forth, and each of the parties covenants and agrees to keep, perform and observe all of the same on its part to be kept, performed and observed. Parking Privileges Parking areas shall not be considered part of the demised premises; however, Lessee shall have the following parking privileges during the term of the Lease, which privileges may not be assigned, sublet or transferred in any way by the Lessee: Lessee shall be assigned 36 parking spaces as shown on the site plan attached hereto and made a part hereof. The assigned parking spaces will be appropriately marked. These parking privileges are deemed a part of the leased premises and may be assigned or subleased by the Lessee in accordance with the terms of this lease in connection with the assignment or subleasing of space in the building. Lessor agrees that any of the parking space not assigned to Lessee, shall be maintained for the benefit of the other lessees leasing space in the Building Complex. Lessor will not separately lease parking spaces to anyone not occupying space in the Building Complex. Term 1. The term of this lease shall be for five (5) years, commencing on the 1st day of September, nineteen hundred and ninety five and ending on the last day of August two thousand, both dates inclusive (unless such term shall later commence or shall sooner cease and expire as hereinafter provided). Commencement of Term (if New Construction) Rent and Security Deposit 2. (a) Lessee covenants and agrees to pay to Lessor the Base Rent and additional rents hereinafter provided. As Base Rent for the demised premises the Lessee shall pay lessor the sum of ONE HUNDRED SIX THOUSAND SEVEN HUNDRED SIXTEEN & 25/100 ($106,716.25) Dollars per annum, payable in equal monthly Installments of $8,893.02 in advance, on the first day of each and every calendar month during the term, without any deduction or set-off whatsoever except that Lessee shall pay the first monthly installment on the execution hereof and all security deposits, and Lessor acknowledges receipt of such month's installment and security deposits by its execution of this lease. Lessee covenants and agrees that the Base Rent and all additional rents, charges and adjustments hereunder shall be paid to Lessor in legal tender of the United States of America without any demand therefor, at the address of Lessor as above, or at such other place as Lessor may from time to time designate by notice in writing. The above base rent reflects a rate of $14.75 per square foot. Lessor:____________ Lessee:____________ 1 (c) Lessee has deposited with Lessor the sum of $17,786.04 as security for the faithful performance and observance by Lessee of the terms, provisions and conditions of this lease; it is agreed that in the event Lessee defaults in respect of any of the terms, provisions and conditions of this lease, including, but not limited to, the payment of rent and additional rent, Lessor may use, apply or retain the whole or any part of the security so deposited to the extent required for the payment of any rent and additional rent or any other sum as to which Lessee is in default or for any sum which Lessor may expend or may be required to expend by reason of Lessees default in respect of any of the terms, covenants and conditions of this lease, including but not limited to, any damages or deficiency in the reletting of the premises, whether such damages or deficiency accrued before or after summary proceedings or other re-entry by Lessor. In the event that Lessee shall fully and faithfully comply with all of the terms, provisions, covenants and conditions of the lease, the security shall be returned to the Lessee after the date fixed as the end of the Lease and after delivery of possession of the entire demised premises to Lessor. In the event of a sale of the land and building or leasing of the building, of which the demised premises form a part, Lessor shall have the right to transfer the security to the vendee or lessee and Lessor shall thereupon be released by lessee from all liability for the return of such security; and Lessee agrees to look to the new Lessor solely for the return of said security; and it is agreed that the provisions hereof shall apply to every transfer or assignment made of the security to a new Lessor. Lessee further covenants that it will not assign or encumber or attempt to assign or encumber the monies deposited herein as security and that neither Lessor nor its successors or assigns shall be bound by any such assignment, encumbrance, attempted assignment or attempted encumbrance. Use 3. (a) Lessee shall use and occupy the demised premises for the following purposes: any lawful purpose, except banking activities and for no other purposes. Limitations on Use of Premises (b) Lessee shall not use or permit the demised premises to be used for any unlawful or illegal business or purpose or for lodging and no cooking shall be done therein. *Lessee at its sole expense shall comply promptly with all laws, orders and regulations of Federal, State, County and Municipal Authorities and with any direction of any public officer or officers which shall impose any liability, order or duty upon Lessor or Lessee with respect Lessee's use or occupancy of the demised premises; Lessee shall not illegally sell or store upon the demised premises any spirituous, malt or vinous liquor or any narcotic drugs and shall not exhibit, sell or offer for sale on the demised premises or in the building anything whatsoever except such as are essentially connected with the stated use of the demised premises. Lessee shall not do or permit to be done any act or thing upon the demised premises which will invalidate or be in conflict with any fire insurance policies or increase the rate for fire insurance covering the building of which the demised premises form a part and shall not do or permit to be done any act or thing upon the demised premises which shall or might subject Lessor to any liability or responsibility for injury to any person or persons or to property by reason of any business or operation being carried on in the demised premises or for any other reason. In no event shall any explosives or flammable materials be taken into or retained in the premises. If by reason of failure of Lessee to comply with the provisions hereof including, but not limited to, the use to which Lessee puts the premises, the fire insurance rate shall at the commencement of the term or at any time thereafter be higher than it otherwise would be, then Lessee shall reimburse Lessor, as additional rent hereunder, for that part of all fire insurance premiums thereafter paid by Lessor, which shall have been charged because of such failure or use by Lessee and shall make such reimbursement upon the first day of the month following payment of such additional cost by Lessor. Lessee will not at any time use or occupy the demised premises in violation of any certificate of occupancy issued for the building or the premises Certificates, Laws and Orders In the event any governmental authority having jurisdiction shall hereafter at any time contend and/or declare by notice, violation, order, statute, rule, regulation or in any other manner whatsoever that the demisee premises are used for a purpose which is in violation of any such law, order or certificate of occupancy, Lesser shall upon five (5) days written notice from Lessor, immediately discontinue such use of said premises. Failure 2 *except Lessee may maintain microwave and coffee systems for its own convenience by Lessee to discontinue such use after such notice shall be deemed a default in the fulfillment of a covenant of this lease and Lessor shall have the right to terminate this lease immediately, and in addition shall have any and all the rights, privileges and remedies given to Lessor by and pursuant to the provisions of Article 19 hereof. Increase or Decrease of Base Rent 4. (a) As used in, and for the purposes of, this Article: Real Estate Taxes (i) "taxes" shall mean real estate taxes and assessments, special or otherwise, levied upon or with respect to the building and the land upon which it is located, imposed by Federal, State or local governments (but shall not include income, franchise, capital stock, estate or inheritance taxes or taxes based on receipts of rentals, unless the same shall be in substitution for or in lieu of a real estate tax or assessment) and any personal property taxes imposed upon the fixtures, machinery, equipment, apparatus, systems and appurtenances in, upon or used in connection with said building for. the operation thereof, provided that, if because of any change in the method of taxation of real estate any other or additional tax or assessment is imposed upon Lessor and/or the owner of the land and/or building, or upon or with respect to the land and/or building or the rents or income therefrom, as or in substitution for or in lieu of any tax or assessment which would otherwise be a real estate tax, or personal property tax of the type referred to above, such other tax or assessment shall also be deemed a real estate tax. Tax Base (ii) "Tax base" shall mean the annual real property tax or taxes assessed upon the building and demised premises including all parking areas for the year 1995. Expenses Expenses (iii) See "Continuation of. Paragraph 4(a}(iii)" on Rider attached Base Base Expenses (iv) "base expenses" shall mean expenses for maintaining and operating the building for the first: 12 months of occupancy adjusted to reflect 95% occupancy, where appropriate. Tax Increase or Decrease (b) For the purposes of the provision of this Paragraph 4(b) of the lease; (a) the demised premises shall be deemed to be a total rentable area of 8,643 square feet; (b) said building shall be deemed to contain a total rentable area of 27,482 square feet; and (c) accordingly, the percentage of the real estate taxes imposed or assessed upon the land and building and parking area of which the demised premises form a part applicable to the demised premises is 31.45% as aforesaid. Subject to the 61st item in the Rider below. Expense Increase or Decrease (c) If, in any calendar year during the term of this lease, expenses for maintaining and operating the building shall be increased above or decreased below the base expenses, the Base Rent described in Article 2 shall be increased or decreased, as the case may be, by 31.45% of such increase or decrease. Statements (d) (i) On or before November 1, 1996 and on or before November 1 each subsequent year (and that day immediately following the expiration of the term of this lease if the term of this lease shall expire between January 1 and February 15), Lessor will furnish to Lessee a statement which shall show (a) a comparison of the expenses for maintaining and operating a building for a calendar year next preceeding the year in which the comparative statement is submitted to the base expenses and; (b) the amount, if any, of the increase or decrease in base rent to be enforced as hereinafter provided. in the event that Lessor shall for any reason fail to furnish such a comparative statement on or before December 31 of any year, Lessor shall on or before such date furnish Lessee with a written notice to the effect that Lessor is entitled to an estimated increase or that Lessee is entitled to an estimated decrease in rent as the case may be, and that the provisions of this Article 4 will be invoked with respect thereof. In such event Lessor shall furnish Lessee with a comparative statement on or before the following December 31 with the same force and effect as a comparative statement would have had if delivered as provided herein and appropriate adjustment in the estimate shall be made. The failure of Lessor to furnish a comparative statement for any calendar year shall be without prejudice to the right of Lessor to furnish comparative statements for any subsequent calendar years. All-statements shall be adjusted on a timely basis to allocate Lessee's share of base expenses for the time periods as set forth above. Lessor: ____________ Lessee: ____________ (ii) On or before July 15, 1996 and on or before July 15 in each subsequent year (and that day immediately following the expiration of the term of this lease and, if the term of this lease shall expire between July 15, and August 30), Lessor will furnish to Lessee a statement which shall show (a) a comparison of the taxes imposed for the calendar year in which the comparative statement is submitted to the tax base and (b) the amount, if any, of the increase or decrease in base rent to be enforced as hereinafter provided. In the event that Lessor shall for any reason fail to furnish such a comparative statement on or before July 15 of any year, Lessor shall on or before such date furnish Lessee with a written notice to the effect that Lessor is entitled to an estimated increase or that Lessee is entitled to an estimated decrease in rent as the case may be, and that the provisions of this Article 4 will be invoked with the respect thereof. In such event, Lessor shall furnish Lessee with a comparative statement on or before the following August 30th with the same force and effect as a comparative statement would have had if delivered as provided herein and appropriate adjustment in the estimate shall be made. The failure of Lessor to furnish a comparative statement for any calender year shall be without prejudice to the right of Lessor to furnish comparative statements for any subsequent calender years. Payment Credit (e) The payment of any increase or credit for any decrease in rent pursuant to the provisions of this Article 4 shall be made as follows: On the first day for the payment of rent under this lease following the furnishing of a comparative statement or notice (1) Lessee, in case of an increase, shall pay to Lessor a sum equal to one-twelfth of such increase multiplied by the number of months then elapsed commencing with the first day of the preceding calender year and, in advance, one-twelfth of such increase in respect of the then current month and Lessee, in the case of a decrease, shall be entitled to a credit against rent next becoming due to a sum equal to one-twelfth of such decrease multiplied by the number of months then elapsed commencing with the first day of the preceeding calender year, and (2) thereafter, until a different comparitive statement or notice shall be submitted as above provided, the monthly installments of rent payable under this lease shall be increased or decreased, as the case may be, by an amount equal to one-twelfth of such increase or decrease. Under no circumstances shall any tenant be liable for any increase in rent or shall be credited for any decrease in rent imposed for any period of time prior to commencement of the lease to the tenant. (f) In the event that a subsequent comparative statement shall show an increase or decrease in rent which shall be different from that shown by the last previous comparitive statement, then the rent payable by Lessee shall be adjusted proportionately consistant with the foregoing provisions. Appropriate credit shall be given for any refund less the costs and expenses incurred in obtaining such refund obtained by reason of a reduction in the assessed valuation by the Assessors or the Tax Commission or the Courts. The original computations, as well as payments of additional rent, if any, or credit, if any, under the provisions of the Article 4 shall be based on the original assessed valuations with the adjustments to be made at a later date when the tax refund, if any, shall be paid to Lessor by the taxing authorities. {g) If Lessee shall dispute in writing any specific item or items included by Lessor in any statement of the expenses for maintaining and operating the building and/or the adjustment for ninety five percent (95%) occupancy, and such dispute is not amicably settled between Lessor and Lessee within ninety (90) days after statement therefor has been rendered, either party may during the ninety (90) days next following the expiration of the first mentioned ninety (90) days (upon written notice to the other party accompanied by a copy of its letter of submission setting forth the items of dispute) refer such disputed item or items to an independent nationally recognized certified public accounting firm selected by the parties for decision and the decision of such accounting firm shall be conclusive and binding upon Lessor and Lessee. The expenses involved in such determination shall be borne by the party against whom a decision is rendered by said accounting firm provided that if more than one item is disputed and a decision shall be rendered against each party in respect to any item or number of items so disputed the, the expenses shall be apportioned according to the number of items decided against each party. Lessor shall have the right, for a period of twelve months after the rendering of any statements to send corrected statements to Lessee, and any rent adjustments required thereby shall be made within (90) days thereafter. If Lessee shall not so dispute any item or items of any such statement or corrected statement within ninety (90) days after such statement or corrected statement has been rendered, Lessee shall be deemed to have approved such statement or corrected statement. Records (h) Lessor shall keep and make available to Lessee's accountant for a period of sixty (60) days after statements are rendered as provided in this Article 4, records in reasonable detail of the matters included in the statements for the period covered by such statements and shall permit Lessee's accountant, upon the giving of reasonable prior notice, to examine and audit such of its records as may be reasonably required to verify such statements, at reasonable times during business hours. Repairs, Replacements and Alterations 5. Lessee shall take good care of the demised premises and the fixtures and appurtenances therein. Lessee shall make at its own expense all repairs and replacements required to keep the demised premises and fixtures in good working order and condition except (a) structural repairs, (b) repairs required to be made by Lessor pursuant to Article 14 hereof, and (c) such repairs as may be required of Lessor in furnishing the services specified in Article 6 hereof. Lessee shall maintain, at its own expense, all light bulbs, fluorescent tubes, and lighting fixtures in the demised premises, including all component parts such as starters, ballasts, and lenses or grills. All repairs made by Lessee shall be at least equal in quality to the original work. Lessee shall not make any installations, alterations, additions or improvements in or to the demised premises without first obtaining Lessor's written consent thereto, which consent shall not be unreasonably withheld and shall make the same and all repairs only between such hours and by such contractors or mechanics as may be approved in writing by Lessor. All alterations, decorations, installations, additions or im- 4 provements upon the demised premises made by either party (including but not limited to panelling, partitions, railings, and the like), except Lessee's movable trade fixtures* and furniture, shall, unless Lessor elects otherwise (by notice in writing to Lessee given not less than twenty (20) days prior to the expiration or other termination of this lease or of any renewal or extension thereof) become the property of Lessor and shall remain upon, and be surrendered with, said premises, as a part thereof at, the end of said term or renewal term, as the case may be. Lessee may remove at its expense such alterations, installations, additions or improvements made by Lessee upon the premises as Lessor shall so elect, and Lesser shall repair and restore the premises to original condition at its sole expense prior to the expiration of the term. *not affixed to the realty (Continued on Rider attached hereto and made a part hereof) Services by Lessor: 6. As long as Lessee is not in default under any of the covenants of this lease, Lessor shall furnish the following services. Air Cooling (a) Air cooling during the months of June, July, August and September on business days from 8:00 A.M. to 7:00 P.M. when in the judgment of Lessor it may be required for the comfortable occupancy of the demised premises. * At other times during business days and similar hours, Lessor shall provide ventilation for the demised premises. Lessee at all times agrees to cooperate fully with Lessor and to abide all regulations and requirements which Lessor may prescribe for the proper functioning and protection of its air conditioning system. Lessor shall have free access to any and all mechanical installations of Lessor, including but not limited to air conditioning, fans, ventilating and machine rooms and electrical closets; and Lessee agrees that there shall be no construction of partitions or other obstructions which might interfere with Lessor's free access thereto, or interfere with the moving of Lessor's equipment to and from the enclosures containing said installations. Lessee agrees that neither Lessee, its agents, employees or contractors shall at any time enter the said enclosures, or tamper with, adjust, touch or otherwise in any manner affect Lessor's said mechanical installations. *Air Conditioning shall be provided as same maybe necessary to maintain temperatures as permitted under current Federal Energy Standards and shall cool the premises to at least 74 or cooler. Elevators (b) Automatic operatorless elevator facilities on business days from 8:00 A.M. to 7:00 P.M. and have such an elevator available at all other times. Heat (c) Heat, when and as required by law, on business days from 8:00 A.M. to 7:00 P.M. Wherever heat generating machines or equipment are used by Lessee in the demised premises which affect the temperature otherwise maintained by the air-cooling system, Lessor reserves the right to install supplementary air-conditioning units in the demised premises and the cost, installation, operation and maintenance charges therefor shall be paid by the Lessee to the Lessor. Cleaning (d) Janitorial service shall be supplied at Lessor's own cost and expense and shall consist of standard janitorial service and cleaning in all offices, sales and training areas and appropriate periodic cleaning of technical and storage areas. See description of janitorial services attached hereto. Water (e) Cold and hot water at standard building temperatures to all lavatories, public or private, for ordinary drinking, cleaning, sanitary and lavatory purposes. If Lessee requires, uses or consumes water for any purpose in addition to ordinary drinking, cleaning, sanitary or lavatory purposes, Lessor may install a water meter and thereby measure Lessee's water consumption for all purposes. In such event Lessee shall pay Lessor for the cost of the installation thereof and throughout the duration of Lessee's occupancy Lessee shall keep said meter and installation equipment in good working order and repair at Lessee's own cost and expense in default of which Lessor may cause such meter and equipment to be replaced or repaired and collect the cost thereof from Lessee. Lessee agrees to pay for water consumed, as shown on said meter as and when bills are rendered, and on default in making such payment Lessor may pay such charges and collect the same from Lessee. Lessee covenants and agrees to pay any sewer rent, charge or any other tax, rent, levy or charge which now or hereafter is assessed, imposed or shall become a lien upon the demised premises or the realty of which they are part pursuant to law, order or regulation made or issued in connection with any metered use, consumption, maintenance or supply of water, water system, or sewage or sewage connection or system based upon water for which Lessee is to pay as provided in this subparagraph (e). The bill rendered by Lessor for the above shall be based upon Lessee's consumption and shall be payable by Lessee as additional rent within ten (10) days of rendition. Any such costs of expenses incurred or payments made by Lessor for any of the reasons or purposes hereinabove stated shall be deemed to be additional rent payable by Lessee and collectible by Lessor as such. Independently of and in addition to any of the remedies reserved to Lessor hereinabove or elsewhere in this lease, Lessor may sue for and collect any monies to be paid by Lessee or paid by Lessor for any of the reasons or purposes hereinabove set forth. Electric Current (f) Electric current to be supplied by the Lessor at the expense of the Lessee,* *In accordance with the terms of Paragraph 39 of Rider attached hereto and made a part hereof. Lessor________ 5 Business Days (h) The term "Business Days" as used in this lease shall mean Monday to Friday, inclusive, excluding Saturdays, Sundays and all days observed by the State or Federal Government as legal holidays. Continued on Rider attached hereto and made a part hereof. Suspension of Services (i) Lessor reserves the right, without being liable to Lessee and without abatement or diminution in rent, to suspend, delay or stop any of the services to be furnished and provided by Lessor under this lease whenever necessary by reason of fire, storm, explosion, strike, lockout, labor dispute, casualty or accident, lack or failure of sources of supply of labor or fuel (or inability in the exercise of reasonable diligence to obtain any required fuel), acts of God or the public enemy, riots, interferences by civil or military authorities in compliance with the laws of the United States of America or with the laws, orders or regulations of any governmental authority, or by reason of any other cause substantially beyond Lessor's control, or for emergency, or for inspection, cleaning, repairs, replacements, alterations, improvements or renewals in Lessor's judgment desirable or necesssary to be made; and Lessor may suspend any such services until completion of any such work. Assignment, Mortgage, Etc. 7. Superseded by Paragraph 40th of Rider attached hereto. 6 Subordination to Mortgages 9. Provided Lessee shall be provided with a standard non-disturbance agreement from such Mortgagee, This lease and all rights of Lessee hereunder are subject and subordinate to all ground and/or underlying leases and to all trust indentures and mortgages, blanket or otherwise, which do now or may hereafter affect the same or the real property of which the demised premises form a part (and which may also affect other property) and to any and all renewals, modifications, consolidations, replacements and extensions thereof. It is the intention of the parties that this provision be self-operative and that no further instrument shall be required to effect such subordination of this lease. Lessee shall, however, upon demand at any time or times promptly execute, acknowledge and deliver to Lessor, without expense to Lessor, any and all instruments that may be necessary or proper to subordinate this lease and all rights of Lessee hereunder to any such leases, indentures, and/or mortgages or to confirm or evidence said subordination, and in the event that Lessee shall fail or neglect so to execute, acknowledge and deliver any such subordination instrument or certificate, Lessee covenants and agrees, in the event any proceedings are brought for the foreclosure of any such mortgage, to attorn to the purchaser upon any such foreclosure sale and to recognize such purchaser as the lessor under this lease or, in the event of the termination, for any reason whatsoever, of any such underlying lease above referred to, that Lessee (at the option of the holder of the reversion under such underlying lease to be evidenced by written notice of election to Lessee) will attorn to and recognize such holder as the then Lessor under this lease to the same extent and effect as the original Lessor hereunder. Lessee agrees to execute and deliver at any time and from time to time, upon the request of Lessor or of any such holder, any instrument which, in the sole judgment of Lessor, may be necessary or appropriate in any of such events to evidence such attornment. Lessor further waives the provisions of any statute or rule of law, now or hereafter in effect, which may give or purport to give Lessee any right or election to terminate or otherwise adversely affect this lease and the obligation of Lessee hereunder in the event any such foreclosure proceeding is brought, and agrees that this lease shall not be affected in any way whatsoever by any such foreclosure proceeding. Loss or Damage to Property 10. All personal property belonging to Lessee, its servants, employees, suppliers, consignors, customers, licensees, located in or about the building or demised premises shall be there at sole risk of Lessee and neither Lessor or Lessor's agents shall be liable for the theft, loss or misappropriation thereof nor for any damage or injury thereto, nor shall the Lessor be considered the voluntary or involuntary bailee of such personal property, nor for damage or injury to Lessee or any of its officers , agents or employees or to any other persons or to any property caused by fire, explosion, water, rain, snow, frost, steam, gas, electricity, heat or cold, dampness, falling plaster, sewers or sewage, odors, noise, leaks from any part of said building or the roof, the bursting or leaking of pipes, plumbing, electrical wiring and equipment and fixtures of all kinds*, or by any act or neglect of other tenants or occupants of the building or of any other person, or caused in any manner whatsoever, nor shall Lessor be liable for any latent defect in the demised premises or in the building. Lessee shall give immediate written notice to Lessor in case of fire or accident in the demised premises or of any defects, damage or injury therein or in any fixtures or equipment. Lessee will protect, indemnify and save harmless Lessor from all losses, costs or damages sustained by reason of any act or occurrence causing injury to any person and/or property whomsoever or whatsoever, due directly or indirectly to the use of the premises or any part thereof by Lessee. Lessee agrees to maintain such liability insurance as may be required by the Lessor in amounts, coverage and companies acceptable to the Lessor. In all such liability policies the Lessor shall be named as loss payee. Proof of such insurance shall be submitted to the Lessor from time to time upon request. Such policies shall further provide that the Lessor must be notified in writing at least ten (10) days prior to the cancellation of any such policies. The parties agree, however, that in no event shall any right of subrogation be asserted against the other for any injury or damage suffered by either party aforesaid, whether due to negligence or otherwise, and undertakes to have an appropriate clause to the effect in all appropriate policies of insurance carried by both parties and to exhibit such policies to the other upon request. *except for loss arising from Lessor's negligence or willful misconduct. Earlier Possession By Lessee 12. If permission is given to Lessee to enter into the possession of the demised premises or to occupy premises other than the demised premises prior to the first day of the term of this lease, Lessee covenants and agrees that such occupancy shall be deemed to be under all the terms, covenants, conditions and provisions of this lease, including as to the covenant to pay rent pro rata. In any event, rent shall commence on the first day of the term. Taking possession of the demised premises by Lessee shall be conclusive evidence as against Lessee that the premises were in good order and satisfactory condition when Lessee took possession. This lease does not grant any right to light or air over property, and Lessor shall not be liable to Lessee for any expense, injury, loss or damages, resulting from work done in or upon, or by reason of the use of, any adjacent or nearby building, land, street or alley. Lessor:____________ Lessee:____________ 7 Surrender at End of Term 13. Lessee shall quit and surrender the premises at the expiration or earlier termination of the term broom clean and in as good condition as ordinary wear and reasonable use will permit, damage by fire, other casualty and the elements excepted and, subject to Lessor's exercise of the election provided in Article 5, with all installations, alterations, additions and improvements, including partitions which may have been installed by either of the parties upon the premises (except that Lessee's removable trade fixtures and furniture shall remain Lessee's property, and Lessee shall remove the same). Lessee's obligations to observe and perform this covenant shall survive the said expiration or earlier termination of this lease. If the last day of the term or of any renewal thereof falls on a Saturday, Sunday or legal holiday, the term shall expire on the business day immediately preceding. Damage by Fire or Other Causes 14. If the demised premises shall be partially damaged by fire or other casualty, the damage shall be repaired by and at the expense of Lessor and the rent until such repairs shall be made shall be apportioned according to the part of the demised premises which is usable by Lessee; or (ii) if such damage shall be due to the fault or neglect of Lessee, its servants, employees, agents, visitors or licensees (without prejudice to any other rights and remedies of Lessor), there shall be no abatement or apportionment of rent. Lessor shall incur no liability on account of any delay in the completion of such repairs which may arise by reason of adjustment of insurance, labor difficulties or any other cause beyond Lessor's control. If all or substantially all of the demised premises or the building are wholly destroyed or become unfit for occupancy as a result of fire or other cause or casualty, Lessor may elect, by written notice to Lessee within ninety (90) days after the casualty date (a) to terminate this lease as of the date when the demised premises or building became unfit for occupancy; or (b) to repair, restore or rehabilitate the building or demised premises (at the expense of Lessor) commencing within ninety days after Lessor is able to take possession of the damaged premises and undertake reconstruction or repairs and thereafter to prosecute the work with reasonable diligence, in which latter event the lease shall not terminate but rent shall be abated on a per diem basis while the premises. are unfit for occupancy, If Lessor elects to repair, restore and rehabilitate the building and the demised premises, but if same shall not be able to be repaired and restored to substantially their former condition within one year after the date of the casualty (delays caused by adjustment of insurance, labor difficulties or other causes beyond Lessor's control to be excluded from such computation). Either party shall have the right the right to terminate this lease as of the casualty date by written notice to the other within Thirty (30) days after the occurence. In the event of such termination of this lease, Lessee's liability for rent shall cease as of the date the premises or the building were made unfit for occupany. If the lease shall be terminated pursuant to this Article, Lessee shall promptly vacate the premises and surrender the same to Lessor. If the damage or destruction be due to the fault or neglect of Lessee, the debris shall be removed at the expense of Lessee. Additional Rent 15. All costs, charges, adjustments and expenses which Lessee assumes or agrees to pay pursuant to this lease shall at Lessor's election be treated as additional rent and, in the event of nonpayment, Lessor shall have the rights and remedies herein provided for in the case of nonpayment or rent or a breach of condition. If Lessee shall default in making any payment required to be made by Lessee (other than the payment of rent required by Articles 2 and 4 hereof) or shall default in performing any term, covenant or condition of this lease on the part of Lessee to be performed hereunder, Lessor at Lessor's option may (but shall not be obligated to) immediately or at any time thereafter on ten (10) days notice make such payment or, on behalf of Lessee, cause the same to be performed for the account of Lessee and expend such sum as may be necessary to perform and fulfill such term, covenant or condition, and any and all sums so expended by Lessor, with interest thereon at the rate of eight percent (8%) per annum from the date of such expenditure, shall be and be deemed to be additional rent, in addition to the Base Rent, and shall be repaid by Lessee to Lessor on demand, but no such payment or expenditure by Lessor shall be deemed a waiver of Lessee's default nor shall it affect any other remedy of Lessor by reason of such default. Mechanics' Liens 16. If, because of any act or omission of Lessee or anyone claiming through or under Lessee, any mechanic's or other lien or order for the payment of money shall be filed against the demised premises or the building, or against Lessor (whether or not such lien or order is valid or enforceable as such), Lessee shall, at Lessee's own cost and expense, cause the same to be cancelled and discharged of record within sixty (60) days after the date of filing thereof, and shall also indemnify and save harmless Lessor from and against any and all costs, expenses, claims, losses or damages, including reasonable counsel fees, resulting therefrom or by reason thereof. Eminent Domain 17. If the whole or any part of the demised premises shall be condemned and taken for any public or quasipublic use, this lease shall wholly expire on the date title shall vest in the condemnor. In no event whatsoever shall Lessee have any claim against Lessor by reason of any condemnation or taking of the whole or any part of the demised premises or of the building, nor shall Lessee have any claim to the amount or any portion thereof that may be awarded as damages or paid as the result of any condemnation and taking. Lessee hereby assigns to Lessor all Lessee's right, title and interest in and to any and all amounts awarded or paid by reason of any condemnation and taking. Bankruptcy 18.(a) If at any time prior to the date herein fixed as the commencement of the term of this lease there shall be filed by Lessee in any court pursuant to any statute either of the United States or of any State a petition in bankruptcy or insolvency or for reorganization, arrangement or composition, or for the appointment of a receiver or trustee of all or a portion of Lessee's property, or if such petition shall be filed against Lessee (and within thirty (30) days thereof, Lessee fails to secure a stay or discharge thereof) or if Lessee makes an assignment for the benefit of creditors, this lease shall ipso facto be cancelled and terminated and in such event neither Lessee nor any person claiming through or under Lessee or by virtue of any statute or of an order of any court shall be entitled to possession of the demised premises and Lessor, in addition to the other rights and remedies given by 8 virtue of any other provision herein or elsewhere in this lease contained or by virtue of any statute or rule of law, may exercise any right of off-set, and/or may retain as liquidated damages any rent, security, deposit or monies received by Lessor from Lessee or others in behalf of Lessee upon the execution hereof. (b) If at the date fixed as the commencement of the term of this lease or if at any time during the term hereof there shall be filed by Lessee in any court pursuant to any statute either of the United States or of any State a petition in bankruptcy or insolvency or for reorganization, arrangement or composition, or for the appointment of a receiver or trustee of all or a portion of Lessee's property or if any such petition shall be filed against Lessee (and within thirty (30) days thereof, Lessee fails to secure a stay or discharge thereof) or if Lessee makes an assignment for the benefit of creditors this lease at the option of Lessor, exercised by written notice to Lessee within a reasonable time after notice of the happening of any one or more of such events, may be cancelled and terminated and in such event neither Lessee nor any person claiming through or under Lessee by virtue of any statute or of any order of any court shall be entitled to possession or to remain in possession of the premises demised but shall forthwith quit and surrender the premises, and Lessor, in addition to the other rights and remedies Lessor has by virtue of any other provision herein or elsewhere in this lease contained or by virtue of any statute or rule of law, may exercise any right of off-set, and/or may retain as liquidated damages any rent, security, deposit or monies received by Lessor from Lessee or others on behalf of Lessee. Default 19.(a) If Lessee defaults in fulfilling any of the covenants of this lease other than the covenants for the payment of rent or additional rent, or if the demised premises become vacant or deserted, then in any one or more of such events, Lessor may serve a written notice upon Lessee specifying the nature of said default and that this lease will be terminated on a date which is thirty (30) days after the giving of such notice and upon the expiration of said thirty (30) days (unless before such date all defaults at the time existing under this lease shall have been fully cured and made good, or in case of a default being of such nature that the same cannot be completely cured or remedied within said day period, Lessee shall then be diligently proceeding to remedy or cure such default and shall promptly complete such remedying or curing, in which event such default and such notice from Lessor shall be deemed to be annulled) this lease and the term hereby demised and all rights of Lessee under this lease shall expire and terminate as fully and completely as if the date of expiration of such thirty (30) day period were the date herein definitely fixed for the end and expiration of this lease and the term thereof and Lessee shall then quit and surrender the demised premises to Lessor but Lessee shall remain liable as hereinafter provided. (b) If (1) the notice provided for in subparagraph (a) hereof shall have been given and the term shall expire as aforesaid; or (2a) if Lessee shall default in the payment of the rent reserved herein or any item of additional rent herein mentioned or any part of either or in making any other payment herein provided; or (2b) if any execution or attachment shall be issued against Lessee or any of Lessee's property whereby the demised premises shall be taken or occupied or attempted to be taken or occupied by someone other than Lessee; or (2c) if Lessee shall default with respect to any other lease between Lessor and Lessee, its subsidiaries and/or affiliates, if any; or (2b) if Lessee shall fail to move into or take possession of the premises within thirty (30) days after commencement of the term of this lease; then and in any of such events Lessor may without notice, re-enter the demised premises either by force or otherwise, and dispossess, by summary proceeding or otherwise, Lessee, the legal representatives of Lessee or any other occupant of demised premises and remove their effects and hold the premises as if this lease had not been made, and Lessee hereby waives the service or notice of intention to re-enter or to institute legal proceedings to that end. If Lessee shall default hereunder prior to the date fixed as the commencement of any renewal or extension of this lease, Lessor may cancel and terminate such renewal or extension agreement by written notice. Remedies of Lessor (c) In case of any such default, re-entry, expiration and/or dispossess by summary proceedings or otherwise, (1) all rent and additional rent shall become due thereupon and be paid up to the time of such re-entry, disposses and/or expiration, together with such expenses as Lessor may incur for legal expenses, and, reasonable attorneys' fees, brokerage, and/or putting the demised premises in good order, or for preparing the same for re-rental; (2) Lessor may re-let the premises or any part or parts thereof, either in the name of Lessor or otherwise, for a term or terms which may at Lessor's option be less than or exceed the period which would otherwise have constituted the balance of the term of this lease and may grant concessions or free rent; and/or (3) Lessee or the legal representatives of Lessee shall also pay Lessor as liquidated damages for the failure of Lessee to observe and perform said Leesee's covenants herein contained, any deficiency between the rent hereby reserved and/or convenanted to be paid and the net amount, if any, of the rents collected on account of the lease or leases of the demised premises for each month of the period which would otherwise have constituted the balance of the term of this lease. The failure of Lessor to re-let the premises or any part or parts thereof shall not release or affect Lessee's liability for damages. In computing such liquidated damages there shall be added to the said deficiency such expenses as Lessor may incur in connection with re-letting, such as legal expenses, reasonable attorneys' fees, brokerage and for keeping the demised premises in good order or for preparing the same for re-letting. Any such liquidated damages shall be paid in monthly installments by Lessee on the rent day specified in this lease and any suit brought to collect the amount of the deficiency for any month shall not prejudice in any way the fights of Lessor to collect the deficiency for any subsequent month by a similar proceeding. Lessor at Lessor's option may make such alterations, repairs, replacements and/or decorations in the demised premises as Lessor in Lessor's sole judgment considers advisable and necessary for the purpose of re-letting the demised premises; and the making of such alterations and/or decorations shall not operate or be construed to release Lessee from liability hereunder as aforesaid. Lessor shall in no event be liable in any way whatsoever for failure to re-let the demised premises, or in the event that the demised premises are re-let, for failure to collect the rent thereof under such re-letting, provided Lessor has acted in good faith. In the event of a breach or threatened breach by Lessee of any of the covenants or provisions hereof, Lessor shall have the right of injunction and the right to invoke any remedy allowed at law or in equity as if re-entry, summary pro- Lessor:__________ Lessee:__________ 9 ceeding and other remedies were not herein provided for. Mention in this lease of any particular remedy shall not preclude Lessor from any other available remedy, in law or in equity. Lessee hereby expressly waives any and all fights of redemption granted by or under any present or future laws in the event of Lessee being evicted or dispossessed for any cause, or in the event of Lessor obtaining possession of the demised premises, by reason of the violation by lessee of any of the covenants and conditions of this lease or otherwise. Notwithstanding the foregoing, Lessor shall make a good faith effort to mitigate the Lessee's damages by procuring a substitute lessee for the premises utilizing standards*. No Waiver 20. (a) No receipt of money by Lessor from Lessee with knowledge of the breach of any covenant or agree- meat of this lease, or after the termination hereof, or after the service of any notice, or after the commencement of any suit, or after final judgment for possession of the demised premises, shall be deemed a waiver of such breach, nor shall it reinstate, continue or extend the term of this lease or affect any such notice, demand or suit. Any demand upon Lessee for rent, wheresoever and whenever made, after the same shall have become due and payable under the provisions hereof shall have the same effect as though made at the time and place such rent became due, any law to the contrary notwithstanding. (b) No delay on the part of Lessor in exercising any right, power or privilege hereunder or to seek redress for violation of, or to insist upon the strict performance of any covenant or condition of this lease, or of any part of the Rules and Regulations described in Article 27 hereof, shall operate as a waiver thereof nor shall any single or partial exercise of any right, power or privilege, preclude any other or further exercise thereof or the exercise of any other right, power or privilege. (c) No act done or thing said by Lessor or Lessor's agent shall constitute a cancellation, termination or modification of, or eviction or surrender under, this lease, or a waiver of any covenant, condition or provision hereof, nor relieve Lessee of Lessor's obligation to pay the rents herein provided. Any acceptance of surrender, waiver or release by Lessor and any cancellation, termination or modification of this lease must be in writing signed by Lessor, by its duly authorized officer. The delivery of keys to any employee or agent of Lessor shall not operate as a surrender or as a termination of the lease, and no such employee or agent shall have any power to accept such keys prior to the termination of the lease. (e) If there be any agreement between Lessor and Lessee providing for the cancellation of this lease upon certain provisions or contingencies, and/or an agreement for the renewal hereof at the expiration of the term first above mentioned, the right to such renewal or the execution of a renewal agreement between Lessor and Lessee prior to the expiration of such first mentioned term shall not be considered an extension thereof or a vested right in Lessee to such further term, so as to prevent Lessor from cancelling this lease and any such extension thereof during the remainder of the original term hereby granted; such privilege, if and when so exercised by Lessor, shall cancel and terminate this lease and any such renewal or extension previously entered into between said Lessor and Lessee or the right of Lessee to any such renewal or extension; any right herein contained on the part of Lessor to cancel this lease shall continue during any extension or renewal hereof; and any option on the part of Lessee herein contained for an extension or renewal hereof shall not be deemed to give Lessee any option for a further extention beyond the first renewal or extended term. (f) No failure by Lessor to enforce any of the said Rules and Regulations against Lessee and/or any other lessee or occupant of the building shall be deemed a waiver thereof. No provision of this lease shall be deemed waived by Lessor unless such waiver be in writing signed by Lessor. (g) No payment by Lessee or receipt by Lessor of a lesser amount than the rent or additional rent herein stipulated and reserved shall be deemed to be other than on account of the earliest stipulated rent or additional rent then due and payable, nor shall any endorsement or statement or any check, or letter accompanying any rent check or payment be deemed an accord and satisfaction, and Lessor may accept the same without prejudice to Lessor's right to recover any balance due or to pursue any other remedy in this lease provided. Rights reserved by Lessor 21. Without abatement or diminution in rent. Lessor reserves and shall have the following additional rights: provided that they do not unreasonably interfere with the Lessee's use of the Premises. (a) To change the street address and/or the name of the building and/or the arrangement and/or location of entrances, passageways, doors, doorways, corridors, elevators, stairs, toilets, or other public parts of the building without liability to Lessee. Lessor agrees to consult Lessee on any name or address change of the building. Except in an emergency upon reasonable advance notice, (c) To enter the demised premises at all reasonable times (1) for the making of inspections, decorations, alterations, improvements and repairs, as Lessor may deem necessary or desirable, (2) to exhibit the premises to prospective purchasers or lessees of the building at any time and to others during the last nine (9) months of the term, or extended term, of this lease, (3) for any purpose whatsoever relating thereto or to the safety, protection or preservation of the demised premises or of the building or of Lessor's interest, and (4) to take material into and upon said premises in connection therewith. *of the industry for said purpose. 10 (d) At any time or times Lessor either voluntarily or pursuant to governmental requirement, may, at Lessor's own expense, make repairs, alterations or improvements in or to the building or any part thereof and during alterations, may close entrances, doors, windows, corridors, elevators or other facilities, provided that such acts shall not unreasonably interfere with Lessee's use and occupancy of the premises as a whole. (e) To erect, use and maintain pipes and conduits in and through the demised premises. (f) To charge to Lessee any expense including overtime cost incurred by Lessor in the event that repairs, alterations, decorating or other work in the premises are made or done after ordinary business hours at Lessee's request. (g) If during the last six months of the term or of a renewal term, Lessee shall have removed all or substantially all of Lessee's property therefrom, Lessor may immediately enter and alter, renovate, and redecorate the premises without reduction or abatement of rent or incurring any liability to Lessee for compensation. (h) to grant to anyone the exclusive right to conduct any particular business or undertaking in the building with the consent of the Lessee, which consent shall not be unreasonably withheld. Lessor may exercise any or all of the foregoing rights hereby reserved to Lessor without being deemed guilty of an eviction, actual or constructive, or disturbance or interruption of Lessee's use or possession and without being liable in any manner toward Lessee and without limitation or abatement of rent or other compensation, and such acts shall have no effect on this lease. Entry by Lessor 23. If a representative of Lessee shall not be personally present to open and permit an entry into said premises at any time when an entry shall be necessary or permissible hereunder, Lessor or its agents *may enter by a master key or may, if the circumstances so warrant, forcibly enter the same without rendering Lessor or its agents liable therefor (provided that, during such entry, reasonable care shall be accorded to avoid damage or injury to Lessee's property), and without in any manner affecting the obligations and covenants of this lease. Nothing contained in this Article however, shall be construed to impose upon Lessee any additional obligations, responsibilities or liability whatsoever for the care, supervision or repair of the building or premises or any part thereof except as elsewhere in this lease provided. *in an emergency Lessee's Damage or Injury to the Premises or Building 24. All damage or injury to the premises or to its fixtures, appurtenances and equipment or to the building, its fixtures, appurtenances or equipment caused by Lessee moving property in or out of the building or by installation removal of furniture, fixtures or other property or from any cause of any kind or nature whatsover of which Lessee, its servants, employees, agents, visitors or licensees shall be the cause, shall be repaired, restored and replaced promptly by Lessee at its sole cost and expense, in quality and class at least equal to the original work or installations, and to the satisfaction of Lessor. If Lessee fails to make such repairs, restorations or replacements, the same may be made by Lessor for the account of Lessee and the cost thereof shall be collectible as additional rent or otherwise after rendition of a bill or statement and payable simultaneously with the next monthly installment of rental due and payable hereunder. Lessee shall not place a load upon any floor of the premises exceeding the floor load per square foot area which such floor was designed to carry and which is allowed by law. Lessor reserves the right to prescribe the weight and position of all safes which must be placed so as to distribute the weight. Business machines and mechanical equipment shall be placed and maintained by and at Lessee's expense in settings sufficient in Lessor's judgment to absorb and prevent vibration, excess heat, noise and annoyance. Except as provided in Article 14 hereof, there shall be no allowance to Lessee for a diminution of rental value and no liability on the part of Lessor by reason of inconvenience, annoyance or injury to business arising from Lessor, Lessee, or others making any repairs, alterations, additions or improvements required or desirable to be made in or to any public portion of the building or to any fixtures, appurtenances or equipment thereof, or to the demised premises or the fixtures, appurtenances, equipment thereof, provided that the same shall be done as expeditiously and with as little inconvenience to Lessee as possible. There shall be no liability in damages upon Lessor for failure of Lessor or others to make any repairs, alterations, additions or improvements in or to any portion of the building or of the premises or of the fixtures, appurtenances or equipment thereof. Lessee shall not move any safe, heavy machinery, heavy equipment, freight, bulky material or fixtures into or out of the building without Lessor's prior written consent; and if any of the same shall require special handling by reason of their bulk, weight, or otherwise, Lessee agrees to employ only persons holding an appropriate license to perform said work, and that all work in connection therewith shall comply with all requirements of law. Bills and Notices 25. Except as otherwise in this lease provided, a bill, statement, notice or communication which Lessor may be required to give to Lessee shall be deemed sufficiently given or rendered if in writing, delivered to Lessee personally or sent by registered or certified mail addressed to Lessee at the building of which the demised premises form a part or at the last known residence address or business address of Lessee or left at any of the aforesaid premises addressed to Lessee and the time of the rendition of such bill or statement and of the giving of such notice Lessor:____________ Lessee:____________ 11 or communication shall be deemed to be the time when the same is delivered to Lessee, deposited in a United States Depositary, postage prepaid, or left at the premises as herein provided. Any notice by Lessee to Lessor shall be served by registered or certified mail addressed to Lessor at the address first hereinabove given or at such other address as Lessor shall designate by written notice, with copy to Lessor, Managing Agent. See "Continuation of Paragraph 25" on Rider attached. ................................................................................ ................................................................................ Inability to Perform 26. This lease and the obligation of Lessee to pay rent hereunder and perform all of the other covenants and agreements hereunder on part of Lessee to be performed shall in no way be affected, impaired or excused because Lessor is unable to fulfill any of its obligations under this lease or to supply or is delayed in supplying any service expressly or impliedly to be supplied or is unable to make, or is delayed in making any repairs, additions, alterations or decorations or is unable to supply or is delayed in supplying any equipment or fixtures if Lessor is prevented or delayed from so doing by reason of strike or labor troubles or any outside* cause whatsoever including, but not limited to, governmental preemption in connection with a National Emergency or by reason of any rule, order or regulation of any department or subdivision thereof or of any government agency or by reason of the conditions of supply and demand which have been or are affected by war or other emergency, or by reason of any fire or other casualty or act of God beyond Lessor's control. Rules and Regulations 27. Lessee and Lessee's servants, employees, agents, visitors and licensees shall observe faithfully, and comply strictly with, the Rules and Regulations hereto annexed, and such other and further reasonable Rules and Regulations as Lessor or Lessor's agents may, after notice to Lessee, from time to time adopt. Nothing in this lease contained shall be construed to impose upon Lessor any duty or obligation to enforce the Rules and Regulations or terms, convenants or conditions in any other lease, as against any other lessee and Lessor shall not be liable to Lessee for violation of the same by any other lessee, its servants, employees, agents, visitors or licensees. Sprinklers 28. If there now is or shall be installed in the building a "sprinkler system" and such system or any of its appliances shall be damaged or injured, or not in proper working order by reason of any act or omission of Lessee, or Lessee's agents, servants, employees, licensees or visitors, Lessee shall forthwith restore the same to good working conditions at its own expense; and if the Board of Fire Underwriters or any bureau, department or official of the state or city government having jurisdiction shall require or recommend that any changes, modifications, alterations or additional sprinkler heads or other equipment be made or supplied by reason of Lessee's business, or the location of partitions, trade fixtures, or other contents of the demised premises, or for any other reason, or if any such changes, modifications, alterations, additional sprinkler heads or other equipment, become necessary to prevent the imposition of a penalty or charge against the full allowance for a sprinkler system in the fire insurance rate as fixed by said Board, or by any Fire Insurance Company, Lessee shall, at Lessee's expense, promptly make and supply such changes, modifications, alterations, additional sprinkler heads or other equipment. See "Continuation of Paragraph 28" on Rider attached. Offer by Managing Agent 29. If this lease is offered to Lessee by the managing agent of the building, such offer is made solely in the capacity as such agent and subject to Lessor's acceptance and approval; and Lessee has executed this lease upon the understanding that this lease shall not in any way bind Lessor until such time as the same has been approved and executed by Lessor and a counterpart delivered to or received by Lessee. No Representations by Lessor 30. Lessor or Lessor's agents have made no representations or promises with respect to the said building or the demised premises except as herein expressly set forth. The taking possession of the demised premises shall be conclusive evidence, as against Lessee, that Lessee accepts the same "as is," and that said premises and the building of which the same form a part were in good and satisfactory condition at the time such possession was so taken. Marginal Notes 31. The marginal notes are inserted only as a matter of convenience and for reference and in no way define, limit or describe the scope or intent of this lease; nor in any way affect this lease. Broker 32. As part of the consideration for the granting of this lease, Lessee represents and warrants to Lessor that no broker negotiated or was instrumental in negotiating or consummating this lease except Edward S. Gordon Company of New Jersey, Inc. Quiet Enjoyment 33. Upon Lessee's paying the rent and additional rent and observing and performing all of the terms, covenants, agreements, conditions and provisions on Lessee's part to be paid, observed or performed, Lessee shall quietly enjoy the demised premises, subject, however, to the terms of this lease and to any leases or mortgages provided for in Article 9 hereof, free of hindrance and molestation by Lessor. Under no circumstances shall the Lessor be liable to the Lessee, or any of its servants, agents, or employees for damage, loss or injury resulting from civil disorder, riot, or insurrection. Assigns 34. The terms, covenants and conditions contained in this lease shall bind and inure to the benefit of Lessor, Lessee and their respective heirs, legal representatives, successors and assigns, subject, however, to the provisions hereof requiring the consent of Lessor to any assignment of this lease or subletting of the demised premises. Definitions 35 The term "office" or "offices" wherever used in this lease shall not be construed to mean premises used as a store or stores, or permit the use for the sale, display, or auction at any time, of goods, wares, or merchandise of any kind, or as a restaurant, shop, booth, boot-black or other stand barber shop or for other similar purposes or for manufacturing. The term "Lessor" as used in this lease, so far as covenants or obligations on the 12 part of Lessor are concerned, shall be limited to mean and include only the owner or owners, at the time in question, of the fee of the demised premises or of the building, a mortgagee in possession for the time of the land and building or of the building of which the demised premises form a part, or the lessee under a lease of the entire building or of the land and building of which the demised premises form a part, so that in the event of any subsequent sale or sales of said building or of said land and building or of said lease or in the event of a lease of said building, or of the land and building, the said lessor shall be and hereby is entirely freed and relieved thereafter with respect to the performance of all covenants and obligations on the part of Lessor hereunder; and it shall be deemed and construed without further agreement between the parties or their successors in interest or between the parties and the purchaser at any such sale, or the said lessee of the building, or of the land and building, that the purchaser, mortgagee in possession or the lessee of the building or of said land and building has assumed and agreed to carry out any and all covenants and obligations of Lessor hereunder thereafter to be performed, it being intended hereby that the covenants and obligations contained in this lease on the part of Lessor shall, subject as aforesaid, be binding on Lessor, its successors and assigns, only during and in respect of their respective successive periods as Lessor under this lease, and the retention of fee ownership by a lessor under an underlying lease which now or hereafter may affect the Land and building or building of which the demised premises form a part, shall not be deemed to impose on such underlying lessor any liability, initial or continuing, for the performance of the covenants and obligations of Lessor hereunder. The words "re-enter" and "re-entry" as used in this lease are not restricted to their technical legal meaning. Certificate of Lessee 36. At request of Lessor and without charge therefor, Lessee will execute, acknowledge and deliver to Lessor a Certificate to the effect that: (a) The Lease is in full force and effect and has not been modified (or if modified, modifications will be set forth). (b) Dates on which rent and additionals rents have been paid. (c) Any defaults on the part of the Lessor. Entire Agreement 37. This lease contains the entire agreement between the parties and shall not be modified in any manner except by an instrument in writing executed by the parties or their respective successors in interest. IN WITNESS WHEREOF, Lessor and Lessee have hereunto respectively executed duplicate originals of this Lease as of the day and year first above written. Lessor ALLIED SECURITIES CO. By /s/ JOHN R. GABRIEL ------------------------- JOHN R. GABRIEL, Partner Lessee DIGITAL GRAPHIX INCORPORATED By /s/ Keith Trickett ------------------------- KEITH TRICKETT, PRESIDENT and ------------------------------------ (Title) CONTINUED ON RIDER ATTATCHED HERETO AND MADE A PART HEREOF. 13 RULES AND REGULATIONS 1. The sidewalks. entrances. passages, courts, elevators, vestibules, stairways, corridors, or halls shall not be obstructed or encumbered by any Tenant or used for any purpose other than ingress and egress to and from the demised premises. 2. No awnings or other projections shall be attached to the outside walls of the buildings without the prior written consent of the Landlord. No curtains, blinds, shades, or screens shall be attached to or hung in, or used in connection with any window or door of the demised premises, without the prior written consent of the Landlord. Such awnings, projections, curtains, blinds, shades, screens or other fixtures must be of a quality, type, design and color, and attached in the manner approved by Landlord. All electrical fixtures hung in offices or spaces along the perimeter of the demised premises must be flourescent, of a quality, type, design and bulb color approved by the Landlord. 3. No sign, advertisement, notice or other lettering shall be exhibited, inscribed, painted or affixed by any Tenant on any part of the outside or inside of the demised premises or building without prior written consent of the Landlord. In the event of the violation of the foregoing by any Tenant, Landlord may remove same without any liability, and may charge the expense incurred by such removal to the Tenant or Tenants violating this rule. Interior signs on doors and directory tablet shall be inscribed, painted or affixed for each Tenant by the Landlord at the expense of such Tenant, and shall be of a size, color and style acceptable to the Landlord. 4. The sashes, sash doors, skylights, windows, and doors that reflect or admit light and air into the halls, passageways or other public places in the building shall not be covered or obstructed by any Tenant, nor shall any bottles, parcels, or other articles be placed on the windowsills. 5. No show cases or other articles shall be put in front of or affixed to any part of the exterior of the building, nor placed in the halls, corridors or vestibules without the prior written consent of the Landlord. 6. The water and wash closets and other plumbing fixtures shall not be used for any purposes other than those for which they were constructed, and no sweepings, rubbish, rags, or other substances shall be thrown therein. All damages resulting from any misuse of the fixtures shall be borne by the Tenant who, or whose servants, employees, agents, visitors or licensees, shall have caused the same. 7. No tenant shall mark, paint, drill into, or in any way deface any part of the demised premises or the building of which they form a part. No boring, cutting or stringing of wires shall be permitted, except with the prior written consent of the Landlord, and as the Landlord may direct. No Tenant shall lay linoleum, or other similar floor covering, so that the same shall come in direct contact with the floor of the demised premises, and, if linoleum, rug or other similar floor covering is desired to be used an interlining of builder's deadening felt shall be first affixed to the floor, by a paste or other material, soluble in water, the use of cement or other similar adhesive material being expressly prohibited. 8. No space in the building shall be used for manufacturing, for the storage of merchandise, or for the sale of merchandise, goods or property of any kind at auction. 9. No Tenant shall make, or permit to be made, any unseemly or disturbing noises or disturb or interfere with occupants of this or neighboring buildings or premises or those having business with them whether by the use of any musical instrument, radio, television set, talking machine. unmusical noise, whistling, singing. or in any other way. No Tenant shall throw anything out of the doors, windows or skylights or down the passageways. 10. No Tenant, or any of Tenant's servants, employees, agents, visitors or licensees, shall at any time bring or keep upon the demised premises any inflammable, combustible or explosive fluid, chemical or substance. 11. No additional locks or bolts of any kind shall be placed upon any of the doors or windows by any Tenant. nor shall any changes be made in existing locks or the mechanism thereof. Each Tenant must, upon the termination of his tenancy. restore to the Landlord all keys of stores, offices and toilet rooms, either furnished to, or otherwise procured by, such Tenant, and in the event of the loss of any keys, so furnished, such Tenant shall pay to the Landlord the cost thereof. 12. All removals, or the carrying in or out of any safes, freight, furniture or bulky matter of any description must take place during the hours which the Landlord or its Agent may determine from time to time. The Landlord reserves the right to inspect all safes, freight or other bulky articles to be brought into the building and to exclude from the building all safes, freight or other bulky articles which violate any of these Rules and Regulations or the lease of which these Rules and Regulations are a part. 13. No Tenant shall occupy or permit any portion of the premises demised to him to be occupied as an office for a public stenographer or typist, or a small loan company or for the possesion, storage, manufacture, or sale of liquor, narcotics, dope, tobacco, in any form, or as a barber, beauty parlor or manicure shop. or as an employment bureau. No Tenant shall engage or pay any employees on the demised premises. except those actually working for such Tenant on said premises, nor advertise for laborers giving an address at said premises. 15. Landlord shall have the right to prohibit any advertising by any Tenant which, in Landlord's opinion, tends to impair the reputation of the building or its desirability as a building for offices, and upon written notice from Landlord, Tenant shall refrain from or discontinue such advertising. 16. The Landlord reserves the right to exclude from the building between the hours of 6 P.M. and 8 A.M. and at all hours on Sundays and legal holidays all persons who do not present a pass to the building signed by the Landlord. The Landlord will furnish passes to persons for whom any Tenant requests same in writing. Each Tenant shall be responsible for all persons for whom he requests such pass and shall be liable to the Landlord for all acts of such persons. 17. Unless Landlord shall furnish electricity hereunder as a service included in the rent, each Tenant shall, at its expense, provide artificial light for the employees of the Landlord while doing janitor service or other cleaning, and in making repairs or alterations in said demised premises. 18. The requirements of Tenants will be attended to only upon application at the office of the building. Employees shall not perform any work or do anything outside of the regular duties, unless under special instruction from the office of the landlord. 19. Canvassing, soliciting and peddling in the building is prohibited and each Tenant shall cooperate to prevent the same. 20. There shall not be used in any space, or in the public halls of any building, either by Tenant or by jobbers or others in the delivery or receipt of merchandise, any hand trucks, except those equipped with rubber tires and side guards. 21. Tenant shall not do any cooking, conduct any restaurant, luncheonette or cafeteria for the sale or service of food or beverages to its employees or to others, or cause or permit any odors of cooking or other processes or any unusual or objectionable odors to emanate from the demised premises. Tenant shall not install or permit the installation or use of any food, beverage, cigarette, cigar or stamp dispensing machine; or permit the delivery of any food or beverage to the demised premises, except by such persons delivering the same as shall be approved by Landlord. 22. Each Tenant, before closing and leaving the said premises at anytime shall see that all awnings are pulled up and all windows closed. 14 RIDER TO LEASE BETWEEN ALLIED SECURITIES CO., as Lessor and DIGITAL GRAPHIX, INCORPORATED, as Lessee ________________________________________________________________________________ Continuation of 4(a)(iii) - Expenses: "Expenses for maintaining and operating the building" shall mean those expenses paid or incurred by or on behalf of the Lessor (whether directly or through independent contractors) in respect of the operation, maintenance and management of the land and/or Building and the sidewalks and areas adjacent thereto (hereinafter "Operation of the Property") which, in accordance with the accounting practice used by the Lessor, are properly chargeable to the Operation of the Property, together with and including (without limitation) the cost of electricity (including any taxes paid thereon) used in operating all Building equipment and servicing common areas of the Building, which costs shall be determined (if such electricity is not separately metered) on the basis of an electrical survey of such equipment and common area facilities and the then prevailing rates, and financial expenses incurred in connection with the Operation of the Property such as insurance premiums and legal, auditing and other professional fees and expenses, but specifically excluding (1) taxes, (2) franchise or income taxes imposed on the Lessor, (3) mortgage interest, (4) leasing commission, (5) the cost of electrical energy furnished directly to lessees of the building, (6) cost of lessee installations and decorating incurred in connection with preparing space for a new lessee, and (7) capital improvements, except, however, that (1) if any capital improvement results in reducing any Operating Expenses (as, for example, a labor-saving improvement), then with respect to the calendar year in which the improvement is made and each subsequent calendar year during the term of the Lease, the amount by which the Operating Expenses have been reduced shall be deemed deducted from the Base Operating Expenses, and (2) if the Lessor is not furnishing any particular work or service (the cost of which if performed by the Lessor would constitute an operating Expense) to a lessee who has undertaken to perform such work or service in lieu of the performance thereof by the Lessor, Operating Expenses shall be deemed to be increased by an amount equal to the additional Operating Expenses which would reasonably have been incurred during such period by the Lessor if it had at its own expense furnished such work or service to such Lessee. Continuation of 5 - Repairs, Replacements and Alterations: Lessor shall maintain and keep in good repair the common areas of the building of which the leased premises are a part, including stairwells, lobbies, elevators and bathrooms, plumbing, heating, ventilation and air conditioning systems located within the leased premises, as well as the common areas within and without the building, including parking lots, landscaping and lighting. Continuation of 6(h) - Business Days: Notwithstanding the foregoing, Lessee will utilize the leased premises and will receive appropriate utilities from 8:00 a.m. to 7 p.m. Monday through Friday, and will also be entitled to use the premises from time to time on Saturdays and holidays by giving Lessor 24 hours' notice. Lessee shall be entitled to receive standard heat and air conditioning service on these occasions. It is clearly understood that Lessee shall not occupy the leased premises on Sundays per the Sunday closing ordinances of the Borough of Paramus. Notwithstanding the limitation on the Lessor's obligation to provide building services only during specific hours, Lessee shall have unlimited access to the premises at any time. In this regard Lessee shall have the right to secure the premises with an appropriate alarm security system. 1 Continuation of 25 - Bills and Notices: any and all notices or demands under the terms of this Lease shall be sent by Certified Mail, Return Receipt Requested, if to Lessee to: Digital Graphix, Inc. 6 Forest Avenue Paramus, NJ 07652 with a copy to Lessee's attorney at: and if to Lessor, to: Allied Securities Co. One East Ridgewood Avenue Paramus, NJ 07653 Same shall be deemed delivered upon the date of the return receipt stated as the dated delivered. The addressed of the parties to which notices are to be delivered may be changed by delivery of notice to each other in like manner. Continuation of 28 - Sprinklers: Lessee will be responsible for any changes, modifications, alterations or additional sprinkler heads required because of Lessee's business or where the location of its partitions and/or trade fixtures results in such requirement; however, Lessee will not be responsible for such expenses for any other reasons or for the reasons set forth in the remainder of this paragraph 28. 38th: Option to Renew: If this lease shall be in full force and effect on the date for the expiration of the original term, or any extended term, as the case may be, and the Lessee shall on that date have fully complied with all the conditions contained herein, the Lessee may elect to renew this lease for two (2) additional five (5) year terms, beginning with the expiration of such original term. To exercise such election the Lessee shall give the Lessor notice in writing of such election at least nine (9) months prior to the expiration of the original term, or extended term, as the case may be. The renewal of the lease shall be in accordance with all terms and conditions of this lease, except that the annual rental shall be determined as follows: During the extension periods provided for above, the base rent shall be set at the commencement of the extension term or terms, as the case may be at the rate of ninety (90%) percent of the fair market rental value of the leased premises determined as follows: If Lessee and Lessor do not agree on the fair market rental value, each party shall appoint an arbitrator who shall be a licensed real estate broker of the State of New Jersey, who shall be active in commercial retail rentals in the Greater Paramus Area or an appraiser qualified as an M.A.I. having an office in New Jersey. Such appointment shall be made by each party within thirty (30) days after notice of the necessity of arbitration, and each party shall advised the other of the choice. On the failure of either party to 2 appoint an arbitrator within ten (10) days after notification of the appointment by the other party, the person appointed arbitrator may appoint an arbitrator to represent the party in default, which arbitrator shall not have served previously in a similar capacity for, or been otherwise employed by, the non-defaulting party. The two arbitrators appointed in either manner shall then proceed to make the determination of Fair Market Rental for the renewal period and the mutual decision of the two arbitrators shall be binding on the parties. In the event of their inability to reach a result, they may select a third arbitrator, who shall not have served previously in a similar capacity for, or been employed by, either party. If the two arbitrators are unable to agree on a third arbitrator, an then sitting Judge of the Superior Court of New Jersey shall appoint the third arbitrator. In no event shall the base rent paid during the extension terms be less than the base rent paid during the initial, or any extended term, as the case may be. 39th: Electricity: In addition to other conditions of this lease to be performed by the Lessee, except where there exists a separate electric meter pursuant to which there will be direct billings to the Lessee as a usage charge, Lessee agrees to pay to Lessor as additional rent, The cost of all electric energy consumed in the leased premises for the term. It is estimated that such consumption will amount to an annual charge of $1.25 per square foot of leased space. Pending determination of the amount consumed, the Lessee shall pay estimated annual charge in monthly installments in advance as additional rent. On or about the first anniversary of the commencement of the lease, and annually thereafter during the term of the lease, Lessor, at the request of the Lessee, or under its own volition, shall verify the Lessee's consumption for the preceding period, by a method designated by Lessor, and generally accepted in similar circumstances in the trade area (e.g., Certificate of Licensed Electrical Engineer, engaging a recognized device for such purpose, such as amprobe, or causing an electrical meter to be placed as required to make such determination). The results of such determination shall be furnished to the Lessee as soon as available, and the charges paid by Lessee during the applicable preceding period shall be adjusted accordingly. All credits due Lessee shall be made against rents next accruing and all credits due Lessor, if any, shall be paid, within ten (10) days of billing. During the balance of the then current cycle, the amount to be paid shall be estimated to be the same as the final determination for the preceding cycle. All reasonable costs incurred by Lessor to determine the amount of consumption shall be shared equally by the Lessor and the Lessee. 40th: Assignment and Subletting: Subject to the prior written consent of the Lessor, which consent shall not be unreasonably withheld, Lessee may assign this Lease in whole or in part or sublease all or part of the premises to any party subject to the following: Lessor's consent shall not be required with respect to any assignment or transfer of this lease, or a subletting to any firm, corporation or other organization affiliated with the Lessee or to any firm, corporation or other organization which shall succeed to substantially all of the Lessee's business. Notwithstanding the foregoing, Lessee shall have the right to assign or sublet all or any portion of the premises during the lease term or any extensions thereof, with the prior written consent of the Lessor, which consent shall not be unreasonably withheld. 3 41st: Signage: The Lessee shall be permitted to place their sign and logo on the interior of the building. 42nd: Workletter. The workletter is incorporated in site plan attached hereto and made a part hereof. All of the Lessor's work shall be completed in a good and workmanlike manner and shall be substantially completed prior to the commencement of the term. 43rd: Delayed Commencement of Term. If the completion of the work is delayed beyond the commencement date set forth herein, the actual term shall commence on the date an unrestricted certificate of occupancy is issued by the Borough of Paramus, and the initial term shall be five (5) years from the date thereof. The parties shall execute an amendment to the lease setting forth the actual commencement and termination dates. 44th: Lessee's Fixtures. Anything in this lease to the contrary notwithstanding, Lessee shall have the right to remove and replace any trade fixtures located in the leased premises. Lessee shall make any and all repairs to the leased premises arising out of the removal of such fixtures, restoring the premises to its original condition, normal wear and tear excepted. 45th: Lessor's Representations. Lessor warrants and represents, upon which warranty and representation Lessee has relied in the execution of this Lease, that: (A) Lessor has full right and authority to execute this Lease for the term, in the manner and upon the conditions and provisions herein contained, and that no consent to same is required; and (B) there is no default existing under any mortgage or Lease or other agreement to which this Lease is subject on the part of any of the parties thereto. 46th: Lessor's Consent: Whenever this Lease provides for requirement of consent or approval by Lessor, such consent or approval will not be unreasonably withheld or delayed. In the event Lessee shall request such consent or approval, it is agreed that if Lessor shall not answer such request within thirty (30) days from the date of such written request by Certified Mail, Return Receipt Requested, it shall be deemed that Lessor's consent and approval has been granted. Whenever under this Lease Lessee is required to do anything to the satisfaction of Lessor, the reasonable satisfaction of Lessor shall be deemed implied. 47th: UCC Assignments: Nothing herein contained is intended to prevent Lessee from executing and delivering assignments without Lessor's consent for security purposes under the UCC covering chattels, fixtures and equipment owned by Lessee, or is anything contained herein intended to prevent the filing of any UCC financing statement in connection therewith. 48th: Notices of Violation: Lessor represents that there are no notes of notices of violation of any kind outstanding as of the date hereof which relate to the leased premises. If any such violations exist, Lessor agrees to cure same promptly at its cost and expense. 4 49th:(1) Lessor's Representations Concerning Compliance With Environmental Laws: Lessor represents and warrants to Lessee that the premises is in full compliance with all federal, state and municipal environmental laws, ordinances, rules, regulations and requirements and that there is no hazardous substance or waste at the premises. (2) Lessor's Indemnification of Lessee. Lessor shall indemnify, defend and hold harmless Lessee from and against all claims, liability, losses, damages and costs, foreseen and unforeseen, including, without limitation, counsel, engineering and other professional or expert fees, which Lessee may incur by reason of Lessor's action or non-action with regard to Lessor's obligations under this paragraph or breach of Lessor's representations and warranties under this paragraph. (3) Survival, This paragraph shall survive the expiration or earlier termination of this Lease. 50th: Leasehold Mortgages. Lessor hereby represents there is no leasehold mortgage presently encumbering the property of which the leased premises are a part. Lessor represents it is the fee owner in absolute of the land and building of which the premises are a part and that there are no mortgages or leases to which this Lease is subject and subordinate, except the following, and that there are no defaults by either Lessor or mortgagee as the case may be under any of the following agreements: __________________________________________________. 51st: Subordination of Lease. This lease is subject and subordinate to all mortgages and leases which may not or hereafter affect the premises, provided that: (1) prior to the commencement of the term hereof, and contemporaneously with the execution of any future mortgage or lease, the mortgagee and Lessor shall execute and deliver an instrument in recordable form for the benefit of the Lessee to the effect that in the event of foreclosure or action taken under such mortgage by the holders thereof or the Lessor under any lease, this Lease and the right of Lessee hereunder shall not be disturbed by reason of any such foreclosure or other action or proceeding provided Lessee is not in default hereunder in the payment of any rent or additional rent (such instrument hereinafter referred to as "Non-Disturbance Agreement"); (2) that the lien of such mortgage shall not cover any of Lessee's fixtures, alterations or improvements which, by law or the terms of this Lease, Lessee is permitted to remove from the leased premises; (3) subject to the approval of the mortgagees, that the proceeds of any insurance on the mortgaged premises payable by reason of fire or other casualty so insured, and of any award for a taking, in whole or in part, by eminent domain, or for a change in grade of any public street or highway on which said premises abut, may be applied, first in payment of the cost of restoring the premises after such injury, taking or change of grade before any part of such proceeds or award may be applied on account of any part of the mortgage debt. 52nd: Applications and Permits. Lessor agrees that it shall fully cooperate with Lessee and execute all applications and permits that Lessee shall request Lessor to sign in 5 order that Lessee may operate its business at the premises as it intends. Lessor represents that there are no zoning or certificate of occupancy requirements which would interfere with or in any way restrict Lessee's operations. 53rd: Use of Common Areas. Lessor agrees that Lessee, its customers and invitees, shall have the use of all common areas and of the parking area. Lessor will use diligence to enforce the parking rules. 54th: Maintenance of Common Areas. Lessor agrees to provide and maintain at its own cost and expense, adequate lighting for the common areas and to keep said areas and the draining and lighting systems and sidewalks, aisles, streets, driveways and services in common areas in good order and repair, and to keep said sidewalks, aisles, streets, driveways, services and common areas, unobstructed, properly drained, and in a clean and sanitary condition. Anything in this Lease to the contrary notwithstanding, Lessor shall, at its sole cost make all repairs and replacements to the sidewalk and curbs and keep said sidewalks free from snow, ice, etc. 55th: Exclusions from Real Estate Taxes. Excluded from the computation of real estate taxes or deducted therefrom in determining Lessee's obligation under this lease are: penalties, interest, income taxes, franchise taxes, use taxes, transfer taxes, inheritance taxes, capital stock transfer taxes, and the like and any substitutions of the aforesaid 56th Lessor's Default. (1) If Lessor defaults in observing or performing any of its obligations hereunder, lessee may remedy the default after giving thirty (30) days' notice to Lessor and in connection therewith may pay expenses thereby incurred, except Lessee may remedy Lessor's default without notice in case of an emergency. Lessor shall reimburse Lessee on demand for all sums expended or obligations incurred by Lessee in connection with such default. If Lessor fails to do so, Lessee, in addition to its other rights and remedies, may submit its demand to an arbitrator directed by the Bergen County Bar Association, which arbitration shall be held within three (3) business days of the default. Such decision shall be final and binding upon the parties; (2) Lessor shall in no event be charged with default in performing any of its obligations hereunder unless it has failed to perform them within thirty (30) days after Lessee gives it notice properly specifying the details of its nonperformance, or within such additional time as may be reasonably required to correct the default. 57th: Damage to Leased Premises. If the leased premises shall be damaged by fire or other cause, the damages shall be repaired by and at the expense of the Lessor, and the rent until such repairs shall be made, shall be apportioned according to the part of the demised premises are so severely damaged or are rendered wholly untenantable by fire or other cause, either party shall have the option to terminate the lease by written notice to the other within thirty (30) days of the occurrence. "Severely damaged" shall be defined as not capable of being restored within one hundred eighty (180) days from the date of the occurrence. 58th: Condition of Premises upon Delivery to Lessee. Lessor agrees to deliver possession of the leased premises upon the execution hereof, broom clean, free and clear of all fixtures, equipment, machinery and personal property of prior lessee and free and clear of all liens, encumbrances, violations, lessees, leases and occupants. 6 59th: Early Termination of Lease. Notwithstanding the term of the term of the lease, the Lessee shall have two distinct and separate options to terminate the lease, one effective at the end of the third year of the initial term and the other at the end of the fourth year of the initial lease term, and the lease shall so terminate to the same effect as it would on the expiration date provided in this lease. Each option to terminate shall be exercised by notice in writing from the Lessee to the Lessor delivered not less than six (6) months prior to the respective early termination date. Failure to give such written notice within said period shall constitute a waiver of the respective option. In consideration for the early termination options, in the event the option is exercised, Lessee shall pay to the Lessor all unamortized costs of the Lease as computed in the workletter attached hereto and made a part hereof. Said costs shall be limited to Lessee improvements, brokerage, legal fees and permits. 60th: Lobby Restoration: In addition to the workletter to be completed within the Lessee's premises, Lessor will complete alterations to the lobby area including stairs and elevators in the south entrance so that the lobby will be improved to the standard of similar office buildings in the general area. The standard will include repainting, marble repair where necessary, removal of the current reception partition, refurbishing of lighting fixtures and replacement of bulbs where necessary, and replacement of entrance carpet. 6lst: Amendment to Lease: In addition to the leased premises, the Lessee shall have the option to lease an additional 1,409 square feet of storage space contiguous to the leased premises as noted on lease plan attached. The additional space shall be leased under all terms and conditions of this lease, except that the Lessee may cancel, as it relates to the additional space, upon six (6) months prior written notice to terminate the lease for the additional space. Further, the Lessor shall have the option to terminate the lease, as it relates to the additional space, upon sixty (60) days prior notice, provided the Lessor has procured a replacement lessee for the additional space. In the event of such cancellation, the Lessor shall complete the Lessee's remaining premises with a demising wall consistent with the remainder of the interior. NOTE: The rental for the additional space shall be identical to the rent provided for in this lease, i.e. $14.75 per square foot. The total rentable area of 8643 square feet and the resulting 31.45% proportion of the premises as per clause 4(b) and 4(c) of the lease shall be amended in the event that the amount of the additional space is reduced below 1409 square feet. 7 EX-11.1 3 COMPUTATION OF NET INCOME (LOSS) PER SHARE PINNACLE SYSTEMS, INC. AND SUBSIDIARIES EXHIBIT 11.1--STATEMENT OF COMPUTATION OF NET INCOME (LOSS) PER SHARE (In thousands, except per share date)
Fiscal year ended June 30, -------------------------- 1997 1996 1995(1) ---- ---- ------- Weighted average shares of common stock outstanding 7,402 7,165 4,266 Common stock equivalents -- 524 800 Shares related to Staff Accounting Bulletin No. 83 -- -- 44 -------- -------- -------- Shares used to compute net income (loss) per share 7,402 7,689 5,110 ======== ======== ======== Net income (loss) used in per share calculation $(14,935) $ 3,684 $ 2,240 ======== ======== ======== Net income (loss) per share $ (2.02) $ 0.48 $ 0.44 ======== ======== ======== - -------- (1) See Note 1 of Notes to Consolidated Financial Statements.
EX-13.1 4 A/R TO SECURITY HOLDERS CONSOLIDATED BALANCE SHEETS - ------------------------------------------------------------------------------------
(In thousands) June 30, 1997 1996 - ------------------------------------------------------------------------------------ Assets Current assets: Cash and cash equivalents $ 32,788 $ 27,846 Marketable securities 15,024 29,315 Accounts receivable, less allowance for doubtful accounts and returns of $1,754 and $840 as of June 30, 1997 and 1996, respectively 10,646 7,526 Inventories 5,497 9,611 Deferred taxes -- 2,091 Prepaid expenses and other assets 528 311 -------- -------- Total current assets 64,483 76,700 Property and equipment, net 4,395 2,204 Marketable securities -- 3,973 Deferred taxes -- 1,154 Other assets 1,129 530 -------- -------- $ 70,007 $ 84,561 ======== ======== Liabilities and Shareholders' Equity Current liabilities: Accounts payable $ 3,955 $ 1,495 Accrued expenses 2,584 2,621 Deferred revenue 282 247 -------- -------- Total current liabilities 6,821 4,363 -------- -------- Long-term obligations 475 -- Commitments Shareholders' equity: Common stock; authorized 15,000 shares; 7,303 and 7,468 issued and outstanding as of June 30, 1997 and 1996, respectively 75,316 77,902 Deferred compensation, net -- (34) Retained earnings (deficit) (12,605) 2,330 -------- -------- Total shareholders' equity 62,711 80,198 -------- -------- $ 70,007 $ 84,561 ======== ======== - ------------------------------------------------------------------------------------ See accompanying notes to consolidated financial statements
F-1 CONSOLIDATED STATEMENTS OF OPERATIONS - ------------------------------------------------------------------------------------------------
(In thousands, except per share data) FISCAL YEAR ENDED JUNE 30, 1997 1996 1995 - ------------------------------------------------------------------------------------------------ Net sales $ 37,482 $ 46,151 $ 22,193 Cost of sales 23,997 23,854 11,291 -------- -------- -------- Gross profit 13,485 22,297 10,902 -------- -------- -------- Operating expenses: Engineering and product development 7,579 5,140 2,405 Sales and marketing 12,667 8,907 5,340 General and administrative 3,702 2,186 1,088 In process research and development 4,894 3,991 -- -------- -------- -------- Total operating expenses 28,842 20,224 8,833 -------- -------- -------- Operating income (loss) (15,357) 2,073 2,069 Interest income, net 2,867 3,345 738 -------- -------- -------- Income (loss) before income taxes (12,490) 5,418 2,807 Income tax expense (2,445) (1,734) (567) -------- -------- -------- Net income (loss) $(14,935) $ 3,684 $ 2,240 ======== ======== ======== Net income (loss) per share $ (2.02) $ 0.48 $ 0.44 ======== ======== ======== Shares used to compute net income (loss) per share 7,402 7,689 5,110 ======== ======== ======== - ------------------------------------------------------------------------------------------------ See accompanying notes to consolidated financial statements
F-2 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
- ------------------------------------------------------------------------------------------------------------------------- Convertible Retained Total preferred stock Common stock Deferred earnings shareholders' (In thousands) Shares Amount Shares Amount compensation (deficit) equity - ------------------------------------------------------------------------------------------------------------------------- Balances as of June 30, 1994 1,551 $ 6,504 1,057 $ 328 $ (113) $ (3,594) $ 3,125 Conversion of preferred stock to common stock (1,551) (6,504) 1,600 6,504 -- Issuance of common stock in initial public offering, net of issuance costs of $2,268 -- -- 2,395 21,682 -- -- 21,682 Issuance of common stock related to stock plans and warrants -- -- 204 269 -- -- 269 Tax benefit from common stock option exercise -- -- -- 387 -- -- 387 Amortization of deferred compensation -- -- -- -- 40 -- 40 Net income -- -- -- -- -- 2,240 2,240 ------- -------- ------- -------- --------- -------- -------- Balances as of June 30, 1995 -- $ -- 5,256 $ 29,170 $ (73) $ (1,354) $ 27,743 Issuance of common stock in secondary public offering, net of issuance costs of $2,831 -- -- 1,810 43,787 -- -- 43,787 Issuance of common stock related to stock plans -- -- 402 1,248 -- -- 1,248 Tax benefit from common stock option exercise -- -- -- 3,697 -- -- 3,697 Amortization of deferred compensation -- -- -- -- 39 -- 39 Net income -- -- -- -- -- 3,684 3,684 ------- -------- ------- -------- --------- -------- -------- Balances as of June 30, 1996 -- $ -- 7,468 $ 77,902 $ (34) $ 2,330 $ 80,198 Issuance of common stock related to stock plans -- -- 152 1,041 -- -- 1,041 Repurchase of common stock -- -- (317) (3,627) -- -- (3,627) Amortization of deferred compensation -- -- -- -- 34 -- 34 Net loss -- -- -- -- -- (14,935) (14,935) ------- -------- ------- -------- --------- -------- -------- Balances as of June 30, 1997 -- $ -- 7,303 $ 75,316 $ -- $(12,605) $ 62,711 ======= ======== ======= ======== ========= ======== ======== - ------------------------------------------------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements.
F-3 CONSOLIDATED STATEMENTS OF CASH FLOWS
- ----------------------------------------------------------------------------------------------------------------------- (In thousands) Year Ended June 30, 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income (loss) $(14,935) $ 3,684 $ 2,240 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Acquired research and development 4,894 3,991 -- Depreciation and amortization 1,599 736 285 Deferred taxes 3,245 (3,245) -- Tax benefit from exercise of common stock options -- 3,697 387 Loss on disposal of property and equipment 448 -- -- Changes in operating assets and liabilities: Accounts receivable (3,120) (2,980) (2,755) Inventories 4,649 (4,073) (2,924) Accounts payable 2,460 (1,916) 2,350 Accrued expenses (512) 1,307 526 Deferred revenue 35 (170) (674) Other (349) (152) (93) -------- -------- -------- Net cash provided by (used in) operating activities (1,586) 879 (658) -------- -------- -------- Cash flows from investing activities: Cash payment for acquistions (5,270) (4,412) -- Purchase's of property and equipment (3,880) (1,834) (931) Purchase's of marketable securities (14,644) (37,448) (9,840) Proceeds from maturity of marketable securities 32,908 13,000 1,000 -------- -------- -------- Net cash provided by (used in) investing activities 9,114 (30,694) (9,771) -------- -------- -------- Cash flows from financing activities: Proceeds from issuance of common stock 1,041 45,035 21,951 Purchase of common stock (3,627) -- -- -------- -------- -------- Net cash provided by (used in) financing activities (2,586) 45,035 21,951 -------- -------- -------- Net increase in cash and cash equivalents 4,942 15,220 11,522 Cash and cash equivalents at beginning of period 27,846 12,626 1,104 -------- -------- -------- Cash and cash equivalents at end of period $ 32,788 $ 27,846 $ 12,626 ======== ======== ======== Supplemental disclosures of cash paid during the period: Interest $ 11 $ 9 $ 23 ======== ======== ======== Income taxes $ 442 $ 312 $ 2 ======== ======== ======== Non-cash transactions: Liabilities assumed in acquistion of certain assets and liabilities $ 978 $ 161 -- ======== ======== ======== - ----------------------------------------------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements
F-4 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 Summary of the Company and Significant Accounting Policies Company Pinnacle Systems, Inc. and its subsidiaries (the Company) design, manufacture and sell video post-production tools for high quality real time video processing. Basis of Presentation The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Intercompany balances and transactions have been eliminated in consolidation. The Company's first three fiscal quarters end on the last Friday in September, December and March, respectively. For financial statement presentation, the Company has indicated its fiscal quarters as ending on the month-end. Cash and Marketable Securities The Company considers all highly liquid investments with a remaining maturity of three months or less at the date of purchase to be cash equivalents. Marketable securities consist principally of government securities with maturities between three and eighteen months and are carried at cost which approximates fair value. These investments are typically short-term in nature and therefore bear minimal interest rate risk. All investments are classified as held-to-maturity and are carried at amortized cost as the Company has both the positive intent and the ability to hold to maturity. Interest income is recorded using an effective interest rate, with the associated premium or discount amortized to "Interest income." Due to the relatively short term until maturity, the fair value of marketable securities is substantially equal to their carrying value as of June 30, 1997. Such investments mature through December 1997. Inventories Inventories are stated at the lower of first-in, first-out cost or market. Raw materials inventory represents purchased materials, components and assemblies, including fully assembled circuit boards purchased from outside vendors. Property and Equipment Purchased property and equipment are recorded at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the respective assets, generally three to five years. The Company adopted Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," effective as of the beginning of fiscal 1997. This adoption had no material effect on the Company's financial statements. Revenue Recognition Revenue on product sales is recognized upon shipment. Warranty costs are accrued at the time sales are recognized. Provision is made currently for estimated product returns and price allowances which may occur under programs the Company has with certain distributors. Income Taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Net Income (Loss) Per Share Net income per share is computed using the weighted average number of common shares and dilutive common stock equivalents outstanding using the treasury stock method. Dilutive common stock equivalents include convertible preferred stock, stock options and warrants. Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 83, common stock issued for consideration below the assumed initial public offering (IPO) price and stock options granted with exercise prices below the IPO price during the 12-month period preceding the date of the initial filing of the Company's IPO, even when antidilutive, have been included in the calculation of common equivalent shares, using the treasury stock method based on the IPO price, as if they were outstanding for all periods presented prior to the IPO date. The 1995 net income per share amounts are presented on a pro forma basis using the pro forma weighted average number of common shares outstanding and common share F-5 equivalents outstanding during the period, after giving retroactive effect to the automatic conversion of all series of preferred stock into shares of common stock at the IPO date. Recent Accounting Pronouncements The Financial Accounting Standards Board recently issued SFAS No. 128, "Earnings Per Share." SFAS No. 128 requires the presentation of basic earnings per share ("EPS") and, for companies with complex capital structures (or potentially dilutive securities, such as convertible debt, options and warrants), diluted EPS. SFAS No. 128 is effective for annual and interim periods ending after December 15, 1997. The Company has not yet determined the impact of adopting SFAS No. 128. The Financial Accounting Standards Board recently issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 requires the reporting of comprehensive income and its components in a full set of general-purpose financial statements. SFAS No. 130 is effective for annual and interim periods beginning after December 15, 1997. The Company has not yet determined the impact of adopting SFAS No. 130. The Financial Accounting Standards Board recently issued SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information." The Statement establishes standards for the way public business enterprises are to report information about operating segments in annual Financial Statements and requires those enterprises to report selected information about operating segments in interim financial reports issued to shareholders. This Statement is effective for financial statements for periods beginning after December 31, 1997. The Company has not yet determined whether it has any separately reportable business segments. Stock-Based Compensation The Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation" beginning with the fiscal year ended June 30, 1996. Upon adoption of SFAS No. 123, the Company continued to measure compensation expense for its stock-based employee compensation plans using the intrinsic value method prescribed by APB (Accounting Principles Board) Opinion Number 25, "Accounting for Stock Issued to Employees," and has provided in Note 6 pro forma disclosures of the effect on net income and earnings per share as if the fair value-based method prescribed by SFAS 123 had been applied in measuring compensation expense. Concentration of Credit Risk The Company distributes and sells its products to end users primarily through a combination of independent domestic and international dealers and original equipment manufacturers ("OEMs"). The Company performs periodic credit evaluations of its customers' financial condition and generally does not require collateral. The Company maintains cash and cash equivalents, short and long-term investments with various financial institutions. Company policy is designed to limit exposure with any one institution. As part of its cash and risk management process, the Company performs periodic evaluations of the relative credit standing of the financial institutions. The Company has not sustained material credit losses from these institutions. Use of Estimates in Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Note 2 Balance Sheet Components - -------------------------------------------------------------------------------- June 30, In thousands 1997 1996 ---- ---- - -------------------------------------------------------------------------------- Marketable securities: Amortized cost $ 14,982 $ 32,872 Accrued interest 42 416 -------- -------- $ 15,024 $ 33,288 ======== ======== Inventories: Raw materials $ 3,554 $ 7,695 Work in process 771 405 Finished goods 1,172 1,511 -------- -------- $ 5,497 $ 9,611 ======== ======== Property and equipment: Machinery and equipment $ 3,462 $ 3,072 Office furniture and fixtures 2,917 747 -------- -------- 6,379 3,819 Accumulated depreciation (1,984) (1,615) -------- -------- $ 4,395 $ 2,204 ======== ======== F-6 Accrued expenses: Payroll and commission related $ 508 $ 382 Taxes payable -- 1,145 Warranty reserve 613 388 Other 1,463 706 -------- -------- $ 2,584 $ 2,621 ======== ======== - -------------------------------------------------------------------------------- Note 3 Acquisitions In April 1997, the Company purchased the Deko titling systems product line and technology from Digital GraphiX, Inc. The Company paid $5,270,000 in cash, and assumed liabilities of $978,000. The assets acquired primarily included intangible assets consisting of software in the development stage and existing software. The Company acquired inventory and other tangible property of $593,000; intangible assets including the Deko Brand name, work force-in-place, and source code technology totaling $762,000; and in process research and development of $4,894,000. The capitalized intangible assets and purchased software are being amortized over a seven year period. In June 1996, the Company purchased certain assets and liabilities from Gold Disk Inc., a developer and marketer of software products for video editing and assembly. The Company paid $4,412,000 in cash and assumed liabilities of $161,000. The assets acquired primarily included intangible assets consisting of software in the development stage and existing software. The Company acquired inventory, accounts receivable, and other tangible property of $240,000; intangible assets including the VideoDirector Brand name, user list, and source code technology totaling $342,000; and in process research and development of $3,991,000. The capitalized intangible assets and purchased software are being amortized over a three year period. To determine the value of the software in the development stage for both acquisitions, the Company considered, among other factors, the stage of development of each project, the time and resources needed to complete each project, expected income and associated risks. Associated risks include the inherent difficulties and uncertainties in completing the project and thereby achieving technological feasibility and risks related to the viability of and potential changes in future target markets. Note 4 Commitments The Company's future minimum commitments under all noncancelable leases at June 30, 1997 are $1,316,000, $1,316,000, $1,307,000, $1,228,000, $1,210,000 and $1,151,000 for 1998, 1999, 2000, 2001, 2002 and thereafter, respectively. Rental income from noncancelable subleases will be $305,000 and $40,000 for 1998 and 1999, respectively. Rent expense was $817,000, $343,000 and $256,000 for the years ended June 30, 1997, 1996, and 1995, respectively. Note 5 Shareholders' Equity Common Stock In November 1994, the Company completed its initial public offering (IPO) selling 2,395,000 shares of common stock for net proceeds of $21,682,000 after underwriting discounts and associated costs. In conjunction therewith, 1,551,000 shares of preferred stock outstanding were converted to 1,600,000 shares of common stock. In July 1995, the Company completed a public selling offering selling an additional 1,810,000 shares of common stock for net proceeds of $43,787,000 after underwriting discounts and associated costs. Stock Repurchase Program In January 1997, the Board of Directors authorized a stock repurchase program pursuant to which the Company may repurchase up to 750,000 shares of its common stock on the open market. Through June 30, 1997, the Company has repurchased and retired 317,000 shares at an average purchase price of $11.43 per share for a total cost of $3,627,000. F-7 Shareholder Rights Plan In December 1996, the Company adopted a Shareholder Rights Plan pursuant to which one Right was distributed for each outstanding share of common stock. Each Right entitles stockholders to buy one one-thousandth of a share of Series A Participating Preferred Stock at an exercise price of $65.00 upon certain events. The Rights become exercisable if a person acquires 15% or more of the Company's common stock or announces a tender offer that would result in such person owning 15% or more of the Company's common stock. If the Rights become exercisable, the holder of each Right (other than the person whose acquisition triggered the exercisability of the Rights) will be entitled to purchase, at the Right's then-current exercise price, a number of shares of the Company's common stock having a market value of twice the exercise price. In addition, if the Company were to be acquired in a merger or business combination after the Rights became exercisable, each Right will entitle its holder to purchase, at the Right's then-current exercise price, common stock of the acquiring company having a market value of twice the exercise price. The Rights are redeemable by the Company at a price of $0.001 per Right at any time within ten days after a person has acquired 15% or more of the Company's common stock. Note 6 Employee Benefit Plans Stock Option Plans The Company's 1987 Stock Option Plan (the "1987 Plan") provides for the grant of both incentive and nonstatutory stock options to employees, directors and consultants of the Company. Pursuant to the terms of the 1987 Plan, after April 1997 no further shares are available for future grants. In September 1994, the shareholders approved the 1994 Directors' Option Plan (the "Director Plan"), reserving 100,000 shares of common stock for issuance. The Plan provides for the granting of nonstatutory stock options to non-employee directors of the Company. Under the Director Plan, upon joining the Board, each non-employee director automatically receives an option to purchase 5,000 shares of the Company's common stock vesting over four years. Following each annual shareholders meeting, each non-employee director receives an option to purchase 1,250 shares of the Company's common stock vesting over a twelve month period. All Director Plan options are granted at an exercise price equal to fair market value on the date of grant and have a ten year term. There were 75,000 and 80,000 shares available for grants under the Director Plan at June 30, 1997 and 1996, respectively. In October 1996, the shareholders approved the 1996 Stock Option Plan (the "1996 Plan"), reserving 370,000 shares of common stock for issuance thereunder. The 1996 Plan provides for grants of both incentive and nonstatutory common stock options to employees, directors and consultants to purchase common stock at a price equal to the fair market value of such shares on the grant dates. Options pursuant to the 1996 Plan are generally granted for a 10-year term and generally vest over a four-year period. At June 30, 1997, there were 325,000 shares available for grant under the 1996 Plan. Subject to shareholder approval at the 1997 annual meeting of Shareholders, the Board of Directors approved increasing the number of shares available for exercise by 365,000 shares. In November 1996, the Board of Directors approved the 1996 Supplemental Stock Option Plan (the "1996 Supplemental Plan"), reserving 350,000 shares of common stock for issuance thereunder. The 1996 Supplemental Plan provides for grants of nonstatutory common stock options to employees and consultants other than officers and directors at a price determined by the Board of Directors. Options pursuant to the 1996 Supplemental Plan are generally granted for a 10-year term and generally vest over a four-year period. At June 30, 1997, there were 39,000 shares available for grant under the 1996 Supplemental Plan. In July 1997, the Board of Directors increased the number of shares available for exercise by 500,000. In addition to the above mentioned plans, an officer of the Company holds 73,000 options at an exercise price of $1.00 and 140,000 options at an exercise price of $2.25, all of which are outside of the Plan and were exercisable as of June 30, 1997 and 1996. Stock option activity under stock option plans was as follows: Available Options Weighted Average (shares in thousands) For Grant Outstanding Exercise Price - -------------------------------------------------------------------------------- F-8 Balance at June 30, 1994 597 956 $ 1.45 Additional shares reserved 100 -- -- Exercised -- (188) $ 1.02 Granted (494) 494 $ 11.77 Canceled 14 (14) $ 3.54 - -------------------------------------------------------------------------------- Balance at June 30, 1995 217 1,248 $ 5.57 Additional shares reserved 360 -- -- Exercised -- (367) $ 2.12 Granted (516) 516 $ 20.71 Canceled 139 (139) $ 26.33 - -------------------------------------------------------------------------------- Balance at June 30, 1996 200 1,258 $ 10.50 Additional shares reserved 720 -- -- Exercised -- (81) $ 4.71 Granted (708) 708 $ 11.22 Canceled 227 (248) $ 15.41 - -------------------------------------------------------------------------------- Balance at June 30, 1997 439 1,637 $ 10.35 The following table summarizes stock options outstanding and execisable at June 30, 1997.
Outstanding Exercisable . ------------------------------------------- -------------------------- Weighted Weighted Weighted Average Average Average Exercise Shares Remaining Exercise Shares Exercise Price Range in thousands Life in years Price In thousands Price $ 0.85 to 6.25 512 4.1 $ 3.05 441 $ 2.67 $10.00 to 11.19 437 9.2 $10.19 17 $10.49 $11.50 to 16.00 507 8.9 $14.27 97 $15.30 $17.00 to 31.75 181 8.2 $20.38 79 $19.81 - ----------------------------------------------------------------------------------------------------------- Total 1,637 7.4 $10.35 634 $6.96
Stock Compensation The Company has elected to follow APB Opinion No. 25, "Accounting for Stock Issued to Employees". In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock Issued to Employees" which established a fair value based method of accounting for employee stock option plans. The Company has elected to adopt the disclosure method of SFAS No. 123. The fair value of options at date of grant was estimated using the Black-Scholes option pricing model with the following assumptions: Employee Stock Options Stock Purchase Plan Year ended June 30, Year ended June 30, ------------------- ------------------- 1997 1996 1997 1996 ---- ---- ---- ---- - -------------------------------------------------------------------------------- Expected life (in years) 6 6 .5 .5 Risk-free interest rate 6.33% 6.01% 5.89% 5.46% Volatility 55.5% 55.5% 55.5% 55.5% Dividend yield 0% 0% 0% 0% Had compensation expense for the Company's stock based compensation plans been determined consistent with SFAS No. 123, the Company's net income (loss) and net income (loss) per share would have been as follows: Year ended June 30, ------------------- F-9 1997 1996 ---- ---- - -------------------------------------------------------------------------------- Net income (loss) As reported $ (14,935,000) $ 3,684,000 Pro forma $ (17,245,000) $ 2,418,000 Earnings (loss) per share As reported $ (2.02) $ 0.48 Pro forma $ (2.33) $ 0.31 Because the method of accounting prescribed by SFAS No. 123 has not been applied to options granted prior to July 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. Retirement Plan The Company has a defined contribution 401(k) plan covering substantially all of its domestic employees. Participants may elect to contribute up to 15% of their eligible earnings to this plan (up to the statutory maximum amount). The Company can make discretionary contributions to the plan determined solely by the Board of Directors. The Company has not made any such contributions to the plan to date. Stock Purchase Plan The Company has a 1994 Employee Stock Purchase Plan (the "Purchase Plan") under which all eligible employees may acquire Common Stock at the lesser of 85% of the closing sales price of the stock at specific, predetermined dates. In April 1997, the shareholders increased the number of shares authorized to be issued under the Purchase Plan to 350,000 shares, of which 238,000 are available for issuance at June 31, 1997. Employees purchased 72,000, 34,000 and 6,000 shares for the years ended June 30, 1997, 1996 and 1995, respectively. Note 7 Income Taxes A summary of the components of income tax expense follow: - -------------------------------------------------------------------------------- Year ended June 30, ------------------------------- 1997 1996 1995 ---- ---- ---- (in thousands) - -------------------------------------------------------------------------------- Current: U.S federal $ (841) $ 1,185 $ 886 State 5 539 242 Foreign 36 15 5 Less: benefit of net operating losses -- (457) (953) ------- ------- ------- Total current 1,282 180 Deferred: U.S. Federal 2,467 (2,467) -- State 778 (778) -- ------- ------- ------- Total deferred 3,245 (3,245) -- F-10 Charge in lieu of taxes attributable to employer stock option plans -- 3,697 387 ------- ------- ------- Total tax expense $ 2,445 $ 1,734 $ 567 ======= ======= ======= - -------------------------------------------------------------------------------- Total income tax expense differs from expected income tax expense (computed by applying the U.S. federal corporate income tax rate of 34% to profit (loss) before taxes) as follows: - -------------------------------------------------------------------------------- Year ended June 30, ------------------- 1997 1996 1995 ---- ---- ---- (in thousands) - -------------------------------------------------------------------------------- Income tax expense (benefit) at federal statutory rate $(4,246) $ 1,842 $ 954 State income taxes, net of federal income tax benefit 5 738 143 Domestic international sales corporation benefit -- -- (215) Termination of domestic international sales corporation election -- 566 -- Unutilized net operating loss 3,305 -- -- Research tax credit -- -- (81) Change in beginning of the year valuation allowance 3,245 (1,572) (311) Other, net 136 160 77 ------- ------- ------- $ 2,445 $ 1,734 $ 567 ======= ======= ======= - -------------------------------------------------------------------------------- The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities as of June 30, 1997, 1996 and 1995, are as follows: - -------------------------------------------------------------------------------- Year ended June 30, ------------------- 1997 1996 1995 ---- ---- ---- (in thousands) - -------------------------------------------------------------------------------- Deferred tax assets: Accrued expense and reserves $ 3,965 $ 1,682 $ 811 Acquired intangibles 3,410 1,622 -- Net operating loss carry forwards 1,121 122 792 Tax credit carryforwards 1,225 286 560 Other 53 146 -- ------- ------- ------- Total gross deferred tax assets 9,774 3,858 2,163 Less: valuation allowance (9,243) -- (2,115) ------- ------- ------- Net deferred tax assets 531 3,858 48 ------- ------- ------- Deferred tax liabilities: Accumulated domestic international sales corporation income (503) (566) -- Fixed assets and other assets (28) (47) (48) ------- ------- ------- Total gross deferred tax liabilities (531) (613) (48) ------- ------- ------- Net deferred tax assets $ -- $ 3,245 $ -- ======= ======= ======= - -------------------------------------------------------------------------------- As of June 30, 1997, the Company has federal and state net operating loss carryforwards of $3,065,000 and $1,349,000, respectively, which expire from 2002 to 2012. The Company also has federal research and F-11 experimentation and alternative minimum tax credit carryforwards of $886,000 which expire between 2006 and 2012, and state research and experimentation credit carryforwards of $339,000 which have no expiration provision. Included in gross deferred tax assets above is approximately $300,000 related to stock option compensation for which the benefit, when realized, will be recorded to equity. Note 8 Industry and Geographic Information The Company markets its products in North America and in foreign countries through its sales personnel, dealers, distributors and subsidiaries. Export sales account for a significant portion of the Company's net sales. Net sales are summarized by geographic areas as follows: - -------------------------------------------------------------------------------- Year ended June 30, ------------------- 1997 1996 1995 ----------------------------------------- - -------------------------------------------------------------------------------- North America 60% 61% 53% Europe 26 26 26 Rest of World 14 13 21 ----- ----- ---- 100% 100% 100% - -------------------------------------------------------------------------------- One customer, Avid Technology, Inc. (Avid), accounted for approximately 26.4% and 43.3% of the Company's net sales for the years ended June 30, 1997 and 1996, respectively. Avid also accounted for approximately 20.0% and 36.7% of net accounts receivable at June 30, 1997 and 1996, respectively. No customer accounted for 10% of the Company's net sales at the year ended June 30, 1995. Note 9 Related Parties The Company and Bell Microproducts Inc. ("Bell") are parties to an agreement ("the Agreement") under which value-added turnkey services are performed by Bell on behalf of the Company. Pursuant to the Agreement, Bell builds certain products in accordance with the Company's specifications. A director of the Company is also a director of Bell. During the years ended June 30, 1997, 1996 and 1995, the Company purchased materials totaling $4,451,000, $16,466,000 and $8,286,000, respectively, from Bell pursuant to the Agreement. Note 10 Subsequent Events On July 22, 1997, the Company signed a letter of intent to acquire the miro Digital Video Products from miro Computer Products AG. In the anticipated acquisition, the Company will acquire the assets of the miro Digital Video Products group, including the miroVIDEO and miroMOTION product lines, certain technology and other assets. The Company expects to pay approximately $15 million in cash, $5 million in common stock, assume liabilities of between $2 million and $3 million, and incur approximately $2 million in costs associated with executing the transaction and integrating the businesses. The Company anticipates that a significant portion of the purchase price will be charged as in-process research and development and other non-recurring costs in the quarter ending September 30, 1997. The agreement also includes an earnout provision in which miro Computer Products AG will receive additional consideration equal to 50% of sales generated in excess of $37 million during the first twelve full months following the acquisition as long as operating profits related to such sales exceed 3% of sales, increasing to 85% of sales for those sales which exceed $59 million during the same twelve month period. Any earnout payments will be paid in common stock of the Company. F-12 Note 11 Quarterly Financial Data (Unaudited) Summarized quarterly financial information for fiscal 1997 and 1996 is as follows:
- ----------------------------------------------------------------------------------------- (thousands, except per share amounts) 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter - ----------------------------------------------------------------------------------------- Fiscal 1997: Net sales $ 11,443 $ 5,345 $ 8,265 $ 12,430 Gross profit (loss) 5,447 (1,983) 3,556 6,466 In process research and development -- -- -- (4,894) Income (loss) from operations 207 (7,986) (2,038) (5,539) Net income (loss) 612 (9,344) (1,319) (4,883) Net income (loss) per share 0.08 (1.25) (0.18) (0.67) Shares used to compute net income (loss) per share 7,823 7,505 7,353 7,276 Market price range for Common Stock High 21.00 13.25 14.75 18.75 Low 11.19 9.50 9.75 13.00 Fiscal 1996: Net sales $ 9,321 $ 11,845 $ 12,766 $ 12,219 Gross profit 4,510 5,706 6,192 5,889 In process research and development -- -- -- (3,991) Income (loss) from operations 1,261 1,639 1,820 (2,647) Net income (loss) 1,263 1,732 1,822 (1,133) Net income (loss) per share 0.17 0.22 0.23 (0.15) Shares used to compute net income (loss) per share 7,534 7,911 7,894 7,417 Market price range for Common Stock High 32.50 34.75 25.25 29.25 Low 22.50 24.38 16.00 17.75 - -----------------------------------------------------------------------------------------
The Company has not paid any dividends since its inception and does not intend to pay any dividends in the foreseeable future. The common stock of the Company has been traded on the Nasdaq National market under the symbol PCLE since the Company's initial public offering in November 1994. Prior to that time, there was no public market for the Company's common stock. At August 19, 1997, there were 76 shareholders of record. F-13 Independent Auditors' Report INDEPENDENT AUDITORS' REPORT THE BOARD OF DIRECTORS AND SHAREHOLDERS PINNACLE SYSTEMS, INC.: We have audited the accompanying consolidated balance sheets of Pinnacle Systems, Inc. and subsidiaries as of June 30, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended June 30, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pinnacle Systems, Inc. and subsidiaries as of June 30, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 1997, in conformity with generally accepted accounting principles. /s/ KMPG PEAT MARWICK LLP Palo Alto, California July 22, 1997 F-14 - ---------------------------------------------------------------------------------------------------------------- (In thousands, except per share data) FISCAL YEAR ENDED JUNE 30,
1997 1996 1995 1994 1993 - ---------------------------------------------------------------------------------------------------------------- STATEMENT OF OPERATIONS DATA: Net sales $ 37,482 $ 46,151 $ 22,193 $ 10,230 $ 7,331 Cost of sales 23,997 23,854 11,291 5,057 3,816 -------- -------- -------- -------- -------- Gross profit 13,485 22,297 10,902 5,173 3,515 -------- -------- -------- -------- -------- Operating expenses: Engineering and product development 7,579 5,140 2,405 1,806 1,447 Sales and marketing 12,667 8,907 5,340 3,274 2,054 General and administrative 3,702 2,186 1,088 567 546 In process research and development 4,894 3,991 -- -- -- -------- -------- -------- -------- -------- Total operating expenses 28,842 20,224 8,833 5,647 4,047 -------- -------- -------- -------- -------- Operating income (loss) (15,357) 2,073 2,069 (474) (532) Interest income (expense), net 2,867 3,345 738 (90) (282) Income (loss) before income taxes (12,490) 5,418 2,807 (564) (814) Income tax expense (2,445) (1,734) (567) (2) (2) -------- -------- -------- -------- -------- Net income (loss) $(14,935) $ 3,684 $ 2,240 $ (566) $ (816) ======== ======== ======== ======== ======== Net income (loss) per share $ (2.02) $ 0.48 $ 0.44 $ (0.21) ======== ======== ======== ======== Shares used to compute net income (loss) per share 7,402 7,689 5,110 2,745 ======== ======== ======== ======== - ---------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------- (In thousands) JUNE 30, 1997 1996 1995 1994 1993 - ---------------------------------------------------------------------------------------------------------------- BALANCE SHEET DATA: Working capital $ 57,662 $ 72,337 $ 26,588 $ 2,647 $ 275 Total assets 70,007 84,561 32,724 5,904 3,731 Long-term debt 475 -- -- -- -- Retained earnings (deficit) (12,605) 2,330 (1,354) (3,594) (3,028) Shareholders' equity 62,711 80,198 27,743 3,125 677 - ----------------------------------------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSES OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain Forward-Looking Information Certain statements in this Management's Discussions and Analysis, elsewhere in this Annual Report to Shareholders and in the Company's 1997 Annual Report on Form 10-K into which this discussion and analysis is incorporated are forward-looking statements based on current expectations, and entail various risks and uncertainties that could cause actual results to differ materially from those expressed in such forward-looking statements. Such risks and uncertainties are set forth below under "Risks and Uncertainties." These forward-looking statements include the last sentences of the paragraphs below relating to "Engineering and Product Development" and "Sales and Marketing," the "Expanding Product Line" section below under "Overview," the statements regarding the Company's expected investment in property, machinery and equipment under "Liquidity and Capital Resources" below, among others. Overview The Company designs, manufactures, markets and supports video post-production tools for high quality real time video processing. The Company's products are used to perform a variety of video manipulation functions, including the addition of special effects, graphics and titles to multiple streams of live or previously recorded video material. Pinnacle's strategy is to leverage its existing market and technological position to continue to provide innovative, real time, computer based solutions for three video post production markets which the Company characterizes as the Broadcast, Desktop and the Consumer video markets. Broadcast Market The Broadcast market generally requires very high technical performance such as real time 10-bit processing, control of multiple channels of live video and specialized filtering and interpolation. From the Company's inception in 1986 until 1994, substantially all of the Company's revenues were derived from the sale of products into the Broadcast Market. The primary broadcast products sold during fiscal 1997 were the Prizm and Flashfile family of products. In June 1997, the Company commenced shipment of DVExtreme and Lightning, two new Windows NT based products designed to serve the traditional Broadcast market. The introduction of the DVExtreme and Lightning is expected to slow or replace sales of Prizm and FlashFile in the fiscal year ending June 30, 1998. The Broadcast market accounted for approximately 25.4%, 26.1% and 43.3% of net sales in the years ended June 30, 1997, 1996 and 1995, respectively. Desktop Market The Company's Desktop products are designed to provide high quality real time video manipulation capabilities for computer based video post-production systems at significantly lower price points than broadcast products. The Company's first desktop product was the Alladin, which commenced shipment in June 1994. The Company further expanded the desktop product line with the introduction of Genie in June 1996. The Desktop market accounted for approximately 59.8%, 73.5% and 56.7% of net sales in the fiscal years ending June 30, 1997, 1996 and 1995, respectively. Consumer Market The Company's Consumer products provide complete video editing solutions which allow consumers to edit their home videos using their home PC, camcorder and VCR. The Company's Consumer products are sold at lower price points than the Company's other products and are sold as software packages or as computer peripheral products. The Company entered the Consumer video editing market by acquiring the VideoDirector product line from Gold Disk, Inc. in June 1996, and commenced shipment of its first internally developed consumer editing product, the VideoDirector Studio 200, in March 1997. The Consumer market accounted for approximately 14.8% and 0.4% of net sales in the fiscal years ending June 30, 1997 and 1996, respectively. Expanding Product Line In April 1997, the Company purchased the Deko titling systems product line and technology from Digital GraphiX, Inc. TypeDeko, in conjunction with DVExtreme and Lightning furthers Pinnacle's strategy of offering an interconnected family of Windows NT-based video production systems. In addition, the Company hired 27 employees from Digital Graphix to help support the ongoing development, marketing and sales of the Deko product line. The Company paid $5.3 million in cash, and assumed liabilities of $978,000 for the purchase of the Deko products, technology and assets. The Company recorded an in process research and development charge of $4.9 million, and incurred $315,000 related to the integration of the Deko product line into the Company. To further Pinnacle's strategy of providing an expanded line of easy to use computer based video production products, in July 1997, the Company signed a letter of intent to acquire the miro Digital Video Products from miro Computer Products AG. In the anticipated acquisition, the Company will acquire the assets of the miro Digital Video Products group, including the miroVIDEO and miroMOTION product lines, certain technology and other assets. The Company expects to pay approximately $15 million in cash, $5 million in common stock, assume liabilities of between $2 million and $3 million, and incur approximately $2 million in costs associated with executing the transaction and integrating the businesses. The Company anticipates that a significant portion of the purchase price will be charged as in-process research and development and other non-recurring costs in the quarter ending September 30, 1997. The agreement also includes an earnout provision in which miro Computer Products AG will receive additional consideration equal to 50% of sales generated in excess of $37 million during the first twelve full months following the acquisition as long as operating profits related to such sales exceed 3% of sales, increasing to 85% of sales for those sales which exceed $59 million during the same twelve month period. Any earnout payments will be paid in common stock of the Company. Pinnacle distributes and sells its products to end users through the combination of independent domestic and international dealers, retail distributors, OEMs and, to a lesser extent, a direct sales force. Sales to dealers, distributors and OEMs are generally at a discount to the published list prices. Generally, products sold to OEMs are integrated into systems sold by the OEMs to their customers. The amount of discount, and consequently the Company's gross profit, varies depending on the product and the channel of distribution through which it is sold, the volume of product purchased and other factors. Results of Operations The following table sets forth, for the periods indicated, certain consolidated statement of operations data as a percentage of net sales: - -------------------------------------------------------------------------------- FISCAL YEAR ENDED JUNE 30, ------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------- Net sales 100.0% 100.0% 100.0% Cost of sales 64.0 51.7 50.9 ------ ------ ------ Gross profit 36.0 48.3 49.1 Operating expenses: Engineering and product development 20.2 11.1 10.8 Sales and marketing 33.8 19.3 24.1 General and administrative 9.9 4.7 4.9 In process research and development 13.1 8.7 -- ------ ------ ------ Total operating expenses 77.0 43.8 39.8 ------ ------ ------ Operating income (loss) (41.0) 4.5 9.3 Interest income, net 7.7 7.2 3.3 ------ ------ ------ Income (loss) before income taxes (33.3) 11.7 12.6 Income tax expense (6.5) (3.8) (2.6) ------ ------ ------ Net income (loss) (39.8)% 7.9% 10.0% - -------------------------------------------------------------------------------- Fiscal 1997 Compared to Fiscal 1996 Net Sales. The Company's net sales decreased by 18.8% to $37.5 million in fiscal 1997 from $46.2 million in fiscal 1996. The decrease was attributable to a decline in sales of both Broadcast and Desktop products, partially offset by an increase in sales of Consumer products. The most significant decline in sales was of desktop products to OEMs, in particular Avid. Sales to Avid were approximately 26.4% and 43.3% of the Company's net sales for the years ended June 30, 1997 and 1996, respectively. Sales outside of North America were approximately 39.7% and 38.7% of the Company's net sales in fiscal 1997 and 1996, respectively. Cost of sales. Cost of sales consists primarily of costs related to the acquisition of components and subassemblies, labor and overhead associated with procurement, assembly and testing of finished products, warehousing, shipping and warranty costs. Gross profit as a percentage of net sales was 36.0% and 48.3% in fiscal 1997 and 1996, respectively. The decrease in gross profit percentage is due primarily to a significant charge to cost of sales totaling $4.0 million relating primarily to inventory write downs. Engineering and Product Development. Engineering and product development expenses increased by 47.5% to $7.6 million in fiscal 1997 from $5.1 million in fiscal 1996. The increases was primarily attributable to increased expenditures in connection with the continued expansion of the Company's engineering design teams and product development costs for DVExtreme, Lightning and VideoDirector Studio 200. Engineering and product development expenses as a percentage of net sales were 20.2% and 11.1% in fiscal 1997 and 1996, respectively. The Company expects to continue to allocate significant resources to engineering and product development efforts, including the Deko engineering team located in Paramus, New Jersey. Sales and Marketing. Sales and marketing expenses include compensation and benefits for sales and marketing personnel, commissions paid to independent sales representatives, trade show and advertising expenses and professional fees for marketing services. Sales and marketing expenses increased by 42.2% to $12.7 million in fiscal 1997 from $8.9 million in fiscal 1996. The increase in sales and marketing expenses was primarily attributable to promotional costs for the introduction of several new Broadcast and Consumer video products. Sales and marketing expenses as a percentage of net sales were 33.8% and 19.3% in fiscal 1997 and 1996, respectively. The Company expects to continue to allocate significant resources to sales and marketing. General and Administrative. General and administrative expenses increased by 69.4% to $3.7 million in fiscal 1997 compared to $2.2 million in fiscal 1996. General and administrative expenses as a percentage of net sales were 9.9% and 4.7%, respectively. Included in general and administrative expenses in fiscal 1997 were $315,000 of non-recurring spending related to the acquisition of the Deko group, and approximately $500,000 relating to the disposal of leasehold improvements and other capital equipment, moving costs and rent overlap incurred as a result of the move to the Company's new facility in Mountain View, California. In Process Research and Development. In April 1997, the Company purchased the Deko titling systems product line and technology from Digital GraphiX, Inc. The Company paid $5.3 million in cash, and assumed liabilities of $978,000. The assets acquired primarily included inventory and other tangible property of $593,000; intangible assets including the Deko Brand name, work force-in-place, and source code technology totaling $762,000; and in process research and development of $4.9 million. The in process research and development was recorded as an expense during the fourth quarter of fiscal 1997. The intangible assets and purchased software are being amortized over a seven year period. In June 1996, the Company purchased certain assets for $4.5 million from Gold Disk, Inc., a developer and marketer of software products for video editing and assembly. The assets acquired primarily included tangible assets of $240,000, intangible assets including the VideoDirector Brand name, user list, and source code technology totaling $342,000, and in process research and development of $4.0 million. The in process research and development were recorded as an expense during the fourth quarter of 1996. The intangible assets are being amortized over a three year period. Interest Income Net. Net interest income decreased 14.3% to $2.9 million in fiscal 1997 from $3.3 million in fiscal 1996. The decrease was due to a decline in cash and marketable securities as well as a decline in investment yields. Cash was used by operations and by the repurchase of common stock. Income Tax Benefit (Expense). The Company recorded provisions for income taxes of $2.4 million and $1.7 million for the fiscal years ended 1997 and 1996, respectively. Included in income tax expense for the year ended June 30, 1997 is a charge of $3,245,000 resulting from the establishment of a valuation allowance against the Company's deferred tax asset due to significant operating losses in the current year and the introduction of new products for which market acceptance is uncertian. As of June 30, 1997, the Company has federal and state net operating loss carryforwards of $3,065,000 and $1,349,000, respectively, which expire from 2002 to 2012. The Company also has federal research and experimentation and alternative minimum tax credit carryforwards of $886,000 which expire between 2006 and 2012, and state research and experimentation credit carryforwards of $339,000 which have no expiration provision. Fiscal 1996 Compared to Fiscal 1995 Net Sales. The Company's net sales increased by 108.0% in fiscal 1996 from $22.2 million fiscal 1995. The increase in net sales were primarily attributable to the Alladin product, particularly to Avid. See "Overview." Sales outside of North America were approximately 38.7% and 46.5% of the Company's net sales in fiscal 1996 and 1995, respectively. The decrease in sales outside of North America was primarily attributable to the significant increase in sales of Alladin to Avid's North American facility. Cost of sales. Cost of sales consists primarily of costs related to the acquisition of components and subassemblies, labor and overhead associated with procurement, assembly and testing of finished products, warehousing, shipping and warranty costs. Gross profit as a percentage of net sales was 48.3% and 49.1% in fiscal 1996 and 1995, respectively. The decrease in gross profits percentage of net sales was due primarily to an increase in sales to OEM customers, which typically carry a lower gross profit percentage, partially offset by increased efficiency due to higher production volume. Engineering and Product Development. Engineering and product development expenses increased by 113.7% to $5.1 million in fiscal 1996 from $2.4 million in fiscal 1995. The increase in each period was primarily attributable to increased expenditures in connection with the continued expansion of the Company's design engineering team. Engineering and product development expenses as a percentage of net sales were 11.1% and 10.8% in fiscal 1996 and 1995, respectively. Sales and Marketing. Sales and marketing expenses include compensation and benefits for sales and marketing personnel, commissions paid to independent sales representatives, trade show and advertising expenses and professional fees for marketing services. Sales and marketing expenses increased by 67.9% to $8.9 million in fiscal 1996 from $5.3 million in fiscal 1995. The increase in sales and marketing expenses was primarily attributable to increased expenditures related to continued promotion of the Alladin including expenditures for trade shows, advertising creation and placement, professional fees for marketing services and increases in the number of sales and marketing personnel. Sales and marketing expenses as a percentage of net sales were 19.3% and 24.1% in fiscal 1996 and 1995, respectively. The decrease of sales and marketing as a percentage of net sales was due primarily to the increase in sales through the OEM distribution channel, in particular through Avid, which requires less direct sales and marketing expenditures by the Company. General and Administrative. General and administrative expenses increased by 100.9% to $2.2 million in fiscal 1996 from $1.1 million in fiscal 1995. General and administrative expenses as a percentage of net sales were 4.7% and 4.9% in fiscal 1996 and 1995. The increase in general and administrative expenses in each period resulted from an increase in expenditures related to the overall growth of the Company's operations including the Company's expanded facility in fiscal 1995 and increased administrative costs associated with being a public company. In Process Research and Development. In June 1996, the Company purchased certain assets for $4.5 million from Gold Disk, Inc., a developer and marketer of software products for video editing and assembly. The assets acquired primarily included tangible assets of $240,000, intangible assets including the VideoDirector Brand name, user list, and source code technology totaling $342,000, and in process research and development of $3,991,000. The intangible assets are being amortized over a 3 year period. Interest Income (Expense), Net. Net Interest income increased to $3.3 million in fiscal 1996 from $0.7 million in fiscal 1995. The increase was due to interest earned on the investment of cash proceeds received from the Company's public offerings in November 1994 and July 1995. Income Tax Benefit (Expense). The Company recorded provisions for income taxes of $1.7 million and $0.6 million for the fiscal year ended 1996 and 1995, respectively, at effective rates of 32.0% and 20.2%, respectively. The Company's general business credit carryforwards were estimated to be approximately $0.3 million for federal tax purposes, expiring in various amounts from 2006 through 2011. Inflationary Impact Since the inception of operations, inflation has not significantly affected the operations results of the Company. However, inflation and changing interest rates have had a significant effect on the economy in general and therefore could affect the operating results of the Company in the future. Liquidity and Capital Resources The Company completed its initial and follow-on public offerings in November 1994 and July 1995 raising approximately $65.5 million, net of offering expenses. The Company's operating activities used $1.6 million in fiscal 1997, provided $900,000 in fiscal 1996 and used $700,000 in fiscal 1995, respectively. The cash used by operating activities during fiscal 1997 was the result of the net loss of $14.9 million as adjusted by the acquired research and development charge of $4.9 million, an increase in the valuation allowance on deferred tax assets of $3.2 million, depreciation and amortization of $1.6 million, and a loss on disposal of property and equipment of $448,000, partially offset by net decreases in the components of working capital, primarily inventory. In fiscal 1996 cash provided by operating activities was the result of net income as adjusted for the effects of depreciation and amortization, tax benefits from the exercise of common stock options, partially offset by net increases in the components of working capital. During fiscal 1997, $3.9 million was invested in property and equipment, compared to $1.8 million in fiscal 1996. The increase over the prior year is primarily related to leasehold improvements, furniture and equipment for the new Mountain View facility. The Company expects to continue to purchase property and equipment, however at a reduced rate following the completion of improvements to the Mountain View facility. Such capital expenditures will be financed from working capital. In January 1997, the Company's board of directors authorized a stock repurchase program pursuant to which the Company may purchase up to 750,000 shares of its common stock on the open market. Through June 30, 1997, the Company had repurchased and retired approximately 317,000 shares of its common stock in the open market at an average purchase price of $11.43 for a total cost of $3,627,000. In April 1997, the Company purchased the Deko product line and technology, including the TypeDeko product from Digital GraphiX. The Company paid $5.3 million in cash and assumed liabilities of $978,000 to consummate the transaction. See "Overview." In July 1997, the Company signed a letter of intent to acquire the miro Digital Video Products from miro Computer Products AG. In the anticipated purchase, the Company expects to pay approximately $15 million in cash, $5 million in common stock, assume liabilities of between $2 million and $3 million, and incur approximately $2 million in costs associated with executing the transaction and integrating the businesses. The Company will also pay additional consideration if certain revenue and profitability objectives are achieved during the first twelve months following the acquisition. See "Overview." As of June 30, 1997, the Company had working capital of approximately $57.7 million, including $32.8 million in cash and cash equivalents and $15.0 million in marketable securities. The Company believes that the existing cash and cash equivalent balances as well as marketable securities and anticipated cash flow from operations will be sufficient to support the Company's working capital requirements for the foreseeable future. Risks and Uncertainties Risks Associated with Acquisition. In July 1997, the Company signed a letter of intent to acquire the miro Digital Video Products from miro Computer Products AG. In the anticipated acquisition, the Company will acquire the assets of the miro Digital Video Products Group, including the miroVIDEO and miroMOTION product lines, certain technology and other assets. Anticipated benefits of the acquisition will not be achieved unless the operations being acquired are successfully combined with those of the Company in a timely manner. Such combination will require substantial attention from management. The diversion of the attention of management and any difficulties encountered in the transition process could have a material adverse impact on the revenues and operating results of the Company. The integration of the Digital Video Products Group will also require integration of the newly acquired product offerings and the coordination of the research and development and sales and marketing efforts of the Digital Video Group and the Company. The difficulties of assimilation may be increased by the necessity of coordinating geographically separated organizations, integrating personnel with disparate business backgrounds and combining two different corporate cultures. In addition, the process of assimilating the Digital Video Products Group into the Company could cause the interruption of, or a loss of momentum in, the activities of the Company's business, which could have a material adverse effect on the Company. There can be no assurance that the Company will realize any of the anticipated benefits of the acquisition. In addition, the announcement and consummation of the acquisition could cause customers and potential customers of the Company or the Digital Video Products Group to delay or cancel orders for products as a result of customer concerns and uncertainty over product evaluation, integration and support. Such a delay or cancellation of orders could have a material adverse effect on the business, results of operations and financial condition of the Company. The Company anticipates that a significant portion of the purchase price will be charged as in-process research and development and other non-recurring costs in the quarter ending September 30, 1997. In addition, the negotiation and implementation of the acquisition will result in aggregate [pre-tax] expenses to the Company of approximately $2.0 million for costs associated with executing the transaction and integrating the businesses. Although the Company does not believe costs will exceed the aforementioned amount, there can be no assurance that the Company's estimate is correct or that unanticipated contingencies will not occur that could substantially increase the costs of combining the operations of the miro Digital Video Products Group with those of the Company. In any event, costs associated with the acquisition will negatively impact the Company's results of operations in the quarter in which the transaction closes, currently expected to be the quarter ending September 30, 1997. Concentration of Sales With OEMs. The Company has been highly dependent on sales of Alladin and Genie products through OEM's, in particular Avid Technology, Inc. ("Avid"). This concentration of net sales subjects the Company to a number of risks, in particular the risk that its operating results will vary on a quarter to quarter basis as a result of variations in the ordering patterns of the OEM customers. Variations in the timing of revenues can cause significant fluctuations in quarterly results of operations. The Company's results of operations have in the past and could in the future be materially adversely affected by the failure of anticipated orders to materialize, by deferrals or cancellations of orders, or if overall OEM demand were to decline. For example, sales to Avid decreased sequentially for the quarters ended June 30, September 30, and December 31, 1996 contributing to the overall decline in net sales for the Company during those same periods, and then sales to Avid increased sequentially for the quarter ended March 31, 1997, and then again in the quarter ended June 30, 1997. If orders from OEM customers, and in particular Avid, were to decrease, the Company's business, operating results and financial condition would be materially adversely affected. Significant Fluctuations in Quarterly Operating Results. The Company's quarterly operating results have in the past varied, and are expected to vary in the future as a result of a number of factors, including the timing of significant orders from and shipments to major OEM customers, in particular Avid, the timing and market acceptance of new products or technological advances by the Company and its competitors, the mix of distribution channels through which the Company's products are sold, changes in pricing policies by the Company and its competitors, the accuracy of resellers' forecasts of end user demand, the ability of the Company to obtain sufficient supplies of the major subassemblies used in its products from its subcontractors, the ability of the Company and its subcontractors to obtain sufficient supplies of sole or limited source components for the Company's products, and general economic conditions both domestically and internationally. The Company's expense levels are based, in part, on its expectations as to future revenue and, as a result, net income would be disproportionately affected by a reduction in net sales. The Company experiences significant fluctuations in orders and sales, due mainly to reduced customer purchasing activity during the summer months the timing of major trade shows and the sale of consumer products in anticipation of the holiday season. Sales usually slowdown during the summer months, especially in Europe. The Company attends a number of trade shows which can influence the order pattern of products shown at those shows including the National Association of Broadcasters (NAB) convention held in April, the International Broadcasters Convention (IBC) held in September and the COMDEX show held in November of each year. The Company expects that its operating results will fluctuate in the future as a result of these and other factors, including changes in the rate of sales to OEM customers, in particular Avid, and the Company's success in developing, introducing and shipping new products, in particular DVExtreme, Lightning, and VideoDirector Studio 200. Due to these factors and the potential quarterly fluctuations in operating results, the Company believes that quarter-to-quarter comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indicators of future performance. Risks Associated with the Consumer Market. The Company recently entered the Consumer market with the purchase of Video Director product in June 1996 and began shipping the VideoDirector Studio 200 product in March 1997. In addition, the Company expects to expend considerable resources to develop, market and sell products into the consumer video market. The Company has limited prior experience developing, marketing and selling products into this market which has certain risks. Because the VideoDirector Studio 200 must be used with a personal computer, a camcorder and a VCR not supplied by the Company, consumer acceptance will be adversely affected to the extent end users experience difficulties installing and using the VideoDirector Studio 200 with these components. The Company has limited experience selling products through the consumer distribution channel. To be successful in this market it is necessary that the Company establish and maintain an effective consumer distribution channel including consumer distributors, electronic retail stores and the ability to effectively handle phone and Internet orders. Although the Company believes that the consumer video market will continue to develop for products which offer consumers the ability to edit home videos, there can be no assurance that this market will continue to develop, or that the Company can successfully compete in this market. There can also be no assurance that the Company will be able to compete successfully against current and future competitors in the consumer video market, and to the extent the Company is not successful with the development, introduction and sale of products in this market segment, the Company's business, operating results and financial condition could be adversely affected. Risks Associated with Recent Product Introductions. The Company is critically dependent on the successful introduction, market acceptance, manufacture and sale of its recently introduced products to increase revenues and return to profitability. These products include the VideoDirector Studio 200 which is sold into the Consumer market and which began shipping in March 1997, and DVExtreme and Lightning which are sold into the Broadcast market both of which began shipping in June 1997. There can be no assurance that these products will achieve significant market acceptance, and to the extent they do not, the Company's business, operating results and financial condition could be materially adversely affected. In addition, as is typical with any new product introduction, quality and reliability problems may arise and any such problems could result in reduced bookings, manufacturing rework costs, delays in collecting accounts receivable, additional service warranty costs and a limitation on market acceptance of the product. Competition. The market for the Company's products is highly competitive and is characterized by rapid technological change, new product development and obsolescence, evolving industry standards and significant price erosion over the life of a product. The Company anticipates increased competition in all three markets into which Pinnacle products are sold: the Broadcast, Desktop, and Consumer video production markets. In particular, the consumer video production market in which VideoDirector Studio 200 competes is an emerging market and the sources of competition are not yet well defined. There are several established video companies that are currently offering products or solutions that compete indirectly with VideoDirector Studio 200 by providing some of the same features and video editing capabilities. In addition, the Company expects that existing manufacturers and new market entrants will develop new, higher performance, lower cost consumer video products that may compete directly with VideoDirector Studio 200. The Company expects that competition will intensify significantly as the market for consumer video editing products develops. The Company expects that potential competition in this market is likely to come from existing video editing companies, software application companies, or new entrants into the market. Suppliers of existing video editing equipment have the financial resources and technical know-how to develop products for the consumer video market. Suppliers of computer application software also compete in the Consumer editing market. Increased competition could result in price reductions, reduced margins and loss of market share, all of which would materially and adversely affect the Company's business, operating results and financial condition. There can be no assurance that the Company will be able to compete successfully against current and future competitors. Dependence on Key Personnel. The Company's success depends in part upon the continued service of its senior management and key technical personnel, none of whom is bound by an employment agreement or the subject of key man life insurance. The Company's success is also dependent upon its ability to attract and retain qualified technical and managerial personnel. Significant competition exists for such personnel and there can be no assurance that the Company can retain its key technical and managerial employees or that it will be able to attract, assimilate and retain such other highly-qualified technical and managerial personnel as may be required in the future. There can be no assurance that employees will not leave the employ of the Company and compete against the Company, or that contractors will not perform services for competitors of the Company. If the Company is unable to retain key personnel, its business, operating results and financial condition could be adversely affected. Technological Change and Obsolescence: Risks Associated with Development and Introduction of New Products. The video post-production equipment industry is characterized by rapidly changing technology, evolving industry standards and frequent new product introductions. The introduction of products embodying new technologies or the emergence of new industry standards can render existing products obsolete or unmarketable. The Company's future operating results will depend to a considerable extent on its ability to continually develop, introduce and deliver new hardware and software products that offer its customers additional features and enhanced performance at competitive prices. Inherent in this process are a number of risks. The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation, as well as accurate anticipation of technological market trends. Once a new product is developed, such as the Companies most recently introduced products, VideoDirector Studio 200, DVExtreme, and Lightning, the Company must rapidly bring it into volume production, a process that requires accurate forecasting of customer requirements and the attainment of acceptable manufacturing costs. The introduction of new or enhanced products also requires the Company to manage the transition from older, displaced products in order to minimize disruption in customer ordering patterns, avoid excessive levels of older product inventories and ensure that adequate supplies of new products can be delivered to meet customer demand. For example, the Company expects that the introduction of DVExtreme and Lightning will result in a significant decline in sales of Prizm and Flashfile. In addition, since the Company's products are based in part on proprietary, internally-developed software, delays in software development could delay the ability of the Company to ship new products. The Company has experienced delays in the shipment of new products in the past, and these delays adversely affected sales of existing products and results of operations. Delays in the introduction or shipment of new or enhanced products, the inability of the Company to timely develop and introduce such new products, the failure of such products to gain market acceptance or problems associated with new product transitions could adversely affect the Company's business, operating results and financial condition, particularly on a quarterly basis. Dependence on Contract Manufacturers and Single Source Suppliers. The Company relies on manufacturing subcontractors to manufacture major subassemblies of the Company's products. The Company and its manufacturing subcontractors are dependent upon single or limited source suppliers for a number of components and parts used in the Company's products, including certain key integrated circuits. The Company's strategy to rely on subcontractors for major subassemblies and single source suppliers involves a number of significant risks, including the loss of control over the manufacturing process, the potential absence of adequate capacity, the unavailability of or interruptions in access to certain process technologies and reduced control over delivery schedules, manufacturing yields, quality and costs. In the event that any significant subcontractor or single source suppliers were to become unable or unwilling to continue to manufacture these subassemblies or provide critical components in required volumes, the Company would have to identify and qualify acceptable replacements. The process of qualifying manufacturing subcontractors and suppliers could be lengthy and no assurance can be given that any additional sources would be available to the Company on a timely basis. Any extended interruption in the future supply of or increase in the cost of the subassemblies manufactured by third party subcontractors could materially and adversely affect the Company's business, operating results and financial condition. Dependence on Resellers; the Absence of Direct Sales Force. The Company distributes its products primarily through a network of dealers, original equipment manufacturers ("OEMs") and other resellers. Accordingly, the Company is dependent upon these resellers to assist it in promoting market acceptance of the Broadcast, Desktop, and Consumer video products. There can be no assurance that these dealers, OEMs and retailers will devote the resources necessary to provide effective sales and marketing support to the Company. The Company's dealers and retailers are generally not contractually committed to make future purchases of the Company's products and therefore could discontinue carrying the Company's products in favor of a competitor's product or for any other reason. Because the Company sells a significant portion of its products through dealers and retailers, it is difficult to ascertain current demand for existing products and anticipated demand for newly introduced products such as DVExtreme, Lightning and Studio 200 regardless of the level of dealer inventory for the Company's products. Moreover, initial orders for a new product may be caused by the interest of dealers to have the latest product on hand for potential future sale to end users. As a result, initial stocking orders for a new product, such as DVExtreme, Lightning, and Studio 200 may not be indicative of long term end user demand. In addition, the Company is dependent upon the continued viability and financial stability of these dealers and retailers, some of which are small organizations with limited capital. The Company believes that its future growth and success will continue to depend in large part upon its dealer and retail channels. Accordingly, if a significant number of its dealers and/or retailers were to experience financial difficulties, or otherwise become unable or unwilling to promote, sell or pay for the Company's products, the Company's results of operations could be adversely affected. 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 the Company to protect trade secrets, trademarks and other intellectual property rights owned by the Company, to defend the Company against claimed infringement of the rights of others and to determine the scope and validity of the proprietary rights of others. Any such litigation could be costly and a diversion of management's attention, which could have material adverse effects on the Company's business, operating results and financial condition. Adverse determination in such litigation could result in the loss of the Company's proprietary rights, subject the Company to significant liabilities, require the Company to seek licenses from third parties or prevent the Company from manufacturing or selling its products, any of which could have a material adverse effect on the Company's business, operating results and financial condition. International Sales are Subject to a Number of Risks. Sales of the Company's products outside of North America represented approximately 39.7%, 38.7% and 46.5% of the Company's net sales in fiscal 1997, 1996 and 1995, respectively. The Company expects that international sales will continue to represent a significant portion of its net sales. International sales and operations may also be subject to risks such as the imposition of governmental controls, export license requirements, restrictions on the export of critical technology, currency exchange fluctuations, generally longer receivable collection periods, political instability, trade restrictions, changes in tariffs, difficulties in staffing and managing international operations, potential insolvency of international dealers and difficulty in collecting accounts receivable. There can be no assurance that these factors will not have an adverse effect on the Company's future international sales and, consequently, on the Company's business, operating results and financial condition. EX-22.1 5 LIST OF SUBSIDIARIES OF THE REGISTRANT PINNACLE SYSTEMS, INC. AND SUBSIDIARIES EXHIBIT 22.1--LIST OF SUBSIDIARIES OF THE REGISTRANT 1. Pinnacle Domestic International Sales Corporation, a California Corporation 2. Pinnacle Systems Ltd., a United Kingdom Incorporated Company 3. Pinnacle Foreign Sales Corporation, U.S. Virgin Islands Corporation EX-23.1 6 CONSENT OF INDEPENDENT AUDITORS Report on Financial Statement Schedule and Consent of Independent Auditors The Board of Directors and Shareholders Pinnacle Systems, Inc.: The audits referred to in our report dated July 22, 1997, include the related consolidated financial statement schedule as of June 30, 1997, and for each of the years in the three-year period ended June 30, 1997. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this consolidated financial statement schedule based on our audits. In our opinion, this consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects the information set forth therein. We consent to incorporation by reference in the registration statements (Numbers 33-89706, 333-02816, 333-25697 and 333-16999) on Form S-8 of Pinnacle Systems, Inc. of our reports dated July 22, 1997, relating to the consolidated balance sheets of Pinnacle Systems, Inc. and subsidiaries as of June 30, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows and related consolidated financial statement schedule for each of the years in the three-year period ended June 30, 1997, which reports appear in this June 30, 1997 annual report on Form 10-K of Pinnacle Systems, Inc. /s/ KPMG PEAT MARWICK LLP Palo Alto, California August 28, 1997 EX-27 7 FINANCIAL DATA SCHEDULE
5 12-MOS JUN-30-1997 JUL-01-1996 JUN-30-1997 32,788,000 15,024,000 10,646,000 1,754,000 5,497,000 64,483,000 6,379,000 1,984,000 70,007,000 6,821,000 0 0 0 75,316,000 (12,605,000) 70,007,000 37,482,000 37,482,000 23,997,000 23,997,000 28,842,000 0 2,867,000 (12,490,000) 2,445,000 (14,935,000) 0 0 0 (14,935,000) (2.02) (2.02)
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