-----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, JJl70I4Hl3l1s2ZAPpebPWlhQiywguuEnOgmiWfXR3N6iRl3kj7ezyXxRGFT3jUa KI8CvIGJvlfsbE3O+2O3JA== 0000950005-99-000473.txt : 19990518 0000950005-99-000473.hdr.sgml : 19990518 ACCESSION NUMBER: 0000950005-99-000473 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990517 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-Q SEC ACT: SEC FILE NUMBER: 333-71959 FILM NUMBER: 99626351 BUSINESS ADDRESS: STREET 1: 280 N BERNARDO AVE CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043 BUSINESS PHONE: 6502371600 MAIL ADDRESS: STREET 1: 280 N BERNARDO AVE CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043 10-Q 1 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1999 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 No. 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 No.) incorporation or organization) 280 N. Bernardo Ave. Mountain View, CA 94043 - --------------------- ----- (Address of principal executive offices) (Zip Code) (650)237-1600 ------------- (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No_ The number of shares of common stock outstanding as of March 31, 1999 was 11,156,854. Page 1 INDEX
PART I - FINANCIAL INFORMATION ITEM 1 - Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets - March 31, 1999 and June 30, 1998 3 Condensed Consolidated Statements of Operations - Three Month and Nine Month Periods Ended 4 March 31, 1999 and 1998 Condensed Consolidated Statements of Comprehensive Income (Loss) - Three Month and Nine Month Periods Ended 5 March 31, 1999 and 1998 Condensed Consolidated Statements of Cash Flows - Nine Months Ended March 31, 1999 and 1998 6 Notes to Condensed Consolidated Financial Statements 7 ITEM 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 11 ITEM 3 - Quantitative and Qualitative Disclosures About Market Risk 23 PART II - OTHER INFORMATION ITEM 4 - Submission of Matters to a Vote of Security Holders 24 ITEM 6 - Exhibits and Reports on Form 8-K 24 Signatures 25 See accompanying notes to condensed consolidated financial statements.
2 PART 1 - FINANCIAL INFORMATION Item 1. Financial Statements PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)
March 31, June 30, 1999 1998 --------- --------- Assets Current assets: Cash and cash equivalents $ 19,594 $ 47,478 Marketable securities 54,340 39,307 Accounts receivable, net 26,284 18,459 Inventories 20,875 11,960 Prepaid expenses and other assets 2,675 1,674 --------- --------- Total current assets 123,768 118,878 Marketable securities 16,762 4,521 Property and equipment, net 8,027 5,411 Goodwill 25,093 3,390 Other assets 326 737 --------- --------- $ 173,976 $ 132,937 ========= ========= Liabilities and Shareholders' Equity Current liabilities: Accounts payable $ 9,273 $ 8,143 Accrued expenses and other 14,918 8,729 Income taxes payable 2,687 1,510 --------- --------- Total current liabilities 26,878 18,382 --------- --------- Long-term obligations -- 163 Commitments Shareholders' equity: Preferred stock, no par value; authorized 5,000 shares; none issued and outstanding -- -- Common stock; authorized 15,000 shares; 11,157 and 10,073 issued and outstanding as of March 31, 1999, and June 30, 1998, respectively 158,242 133,332 Accumulated deficit (9,767) (18,825) Accumulated other comprehensive loss (1,377) (115) --------- --------- Total shareholders' equity 147,098 114,392 --------- --------- $ 173,976 $ 132,937 ========= ========= See accompanying notes to condensed consolidated financial statements.
3 PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
Three Nine Months Ended Months Ended March 31, March 31, ---------------------- ---------------------- 1999 1998 1999 1998 --------- --------- --------- --------- Net sales $ 40,147 $ 29,332 $ 111,592 $ 73,727 Cost of sales 18,442 13,631 51,652 34,484 --------- --------- --------- --------- Gross profit 21,705 15,701 59,940 39,243 --------- --------- --------- --------- Operating expenses: Engineering and product development 4,282 3,165 10,935 8,155 Sales and marketing 10,300 7,947 29,449 21,332 General and administrative 1,671 1,455 5,065 3,858 In-process research and development 6,579 -- 6,579 16,960 --------- --------- --------- --------- Total operating expenses 22,832 12,567 52,028 50,305 --------- --------- --------- --------- Operating income (loss) (1,127) 3,134 7,912 (11,062) Interest income, net 1,135 1,026 3,410 2,094 --------- --------- --------- --------- Income (loss) before income taxes 8 4,160 11,322 (8,968) Income tax expense -- (832) (2,264) (1,598) --------- --------- --------- --------- Net income (loss) $ 8 $ 3,328 $ 9,058 $ (10,566) ========= ========= ========= ========= Net income (loss) per share Basic $ 0.00 $ 0.34 $ 0.86 $ (1.23) ========= ========= ========= ========= Diluted $ 0.00 $ 0.31 $ 0.79 $ (1.23) ========= ========= ========= ========= Shares used to compute net income (loss) per share Basic 10,771 9,780 10,497 8,570 ========= ========= ========= ========= Diluted 11,927 10,810 11,515 8,570 ========= ========= ========= ========= See accompanying notes to condensed consolidated financial statements.
4 PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (In thousands)
Three Months Ended Nine Months Ended March 31, March 31, 1999 1998 1999 1998 ---- ---- ---- ---- Net income (loss) $ 8 $ 3,328 $ 9,058 $(10,566) Foreign currency translation adjustment (2,051) (147) (1,262) (121) -------- -------- -------- -------- Comprehensive income (loss) $ (2,043) $ 3,181 $ 7,796 $(10,687) ======== ======== ======== ======== See accompanying notes to condensed consolidated financial statements.
5 PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Nine Months Ended March 31, --------------------------- 1999 1998 -------- -------- Cash flows from operating activities: Net income (loss) $ 9,058 $(10,566) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Acquired research and development 6,579 16,960 Depreciation and amortization 3,301 2,072 Changes in operating assets and liabilities: Accounts receivable (8,124) (5,942) Inventories (6,634) (4,517) Accounts payable (2,825) 984 Accrued expenses 316 4,445 Accrued income taxes 1,095 -- Prepaid and other (1,151) (1,084) -------- -------- Net cash provided by operating activities 1,615 2,352 -------- -------- Cash flows from investing activities: Net cash acquired (paid) on acquisitions 120 (15,150) Purchases of property and equipment (4,192) (1,735) Net purchases of marketable securities (27,274) (1,231) -------- -------- Net cash used in investing activities (31,346) (18,116) -------- -------- Cash flow from financing activities: Payment on notes payable (2,237) -- Proceeds from issuance of common stock 4,872 49,097 -------- -------- Net cash provided by financing activities 2,635 49,097 -------- -------- Effects of exchange rate changes on cash (788) -- Net increase in cash and cash equivalents (27,884) 33,333 Cash and cash equivalents at beginning of period 47,478 32,788 -------- -------- Cash and cash equivalents at end of period $ 19,594 $ 66,121 ======== ======== Supplemental disclosures of cash paid during the period for: Interest $ 5 $ 2 ======== ======== Income taxes $ 1,088 $ (263) ======== ======== Non-cash transactions: Liabilities associated with the acquisition of certain net assets $ -- $ 3,810 ======== ======== Common Stock issued for Miro acquisition $ 7,834 $ 4,352 ======== ======== See accompanying notes to condensed consolidated financial statements.
6 PINNACLE SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. General The accompanying condensed consolidated financial statements include the accounts of Pinnacle Systems, Inc. and its wholly owned subsidiaries ("Pinnacle" or "the Company"). Intercompany transactions and related balances have been eliminated in consolidation. These financial statements have been prepared in conformity with generally accepted accounting principles. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reported periods. The most significant estimates included in these financial statements include accounts receivable and sales allowances, inventory valuation and the income tax valuation allowance. Actual results could differ from those estimates. The information furnished in this report reflects all adjustments that, in the opinion of management, are necessary for a fair statement of the consolidated financial position, results of operations and cash flows as of and for the interim periods. Such adjustments consist of items of a normal recurring nature. Certain information or footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. Certain prior period amounts have been reclassified to conform to the current period's presentation. The condensed consolidated financial statements included herein should be read in conjunction with the financial statements and notes thereto, which include information as to significant accounting policies, for the fiscal year ended June 30, 1998 included in the Company's Annual Report on Form 10-K as filed with the Securities and Exchange Commission on September 11, 1998. Results of operations for interim periods are not necessarily indicative of results for the full year. Stock Split On April 15, 1999, the Company announced a two-for-one stock split. Stockholders of record on May 14, 1999 will be entitled to one additional share of common stock for each share of Pinnacle Systems Common Stock held on that date. The payment date will be June 4, 1999 Fiscal Year and Interim Reporting Dates Pinnacle reports on a fiscal year that ends June 30. In fiscal 1998 and prior, the Company's three interim quarters (September, December and March) ended on the last Friday of the respective months. Beginning July 1, 1998, the Company's fiscal year and interim quarters will end on the last day of the respective months. Prior periods have not been adjusted to reflect this change. Currency Translation The results of operations for non-U.S. subsidiaries are translated into U.S. dollars using average exchange rates for the period, while assets and liabilities are translated using period-end rates. Resulting translation adjustments are recorded in shareholders' equity as accumulated other comprehensive loss. Comprehensive Income Effective January 1, 1998, the Company adopted the provisions of SFAS No. 130, "Reporting of Comprehensive Income." SFAS No. 130 establishes standards for the display of comprehensive income and its components in a full set of financial statements. Comprehensive income includes all changes in equity during a period except those resulting from the issuance of shares of stock and distributions to stockholders. Recent Accounting Pronouncements The Financial Accounting Standards Board recently issued SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information." The statement establishes standards for public companies to report operating segment 7 information in annual financial statements and requires those enterprises to report selected operating segment information in interim financial reports issued to shareholders. This statement is effective for financial statements with fiscal years beginning after December 31, 1997. The Company will disclose segment information beginning with its annual report on Form 10-K for the fiscal year ending June 30, 1999. The Financial Accounting Standards Board recently issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133 addresses the accounting for derivative instruments, including certain derivative instruments embedded in other contracts. Under SFAS No. 133, entities are required to carry all derivative instruments in the balance sheet at fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, if so, the reason for holding it. The Company must adopt SFAS 133 by the fiscal year ending June 30, 1999. The Company has not determined the impact that SFAS No. 133 will have on its financial statements. 2. Acquisitions On March 12, 1999, the Company acquired all the outstanding common stock of Truevision, Inc., a supplier of digital video products ("Truevision"). In connection with the acquisition, Pinnacle issued 412,103 shares of common stock valued at $11.5 million. In addition, Pinnacle issued to Truevision employees and Directors 69,839 options, valued at $.7 million, to purchase common stock at an exercise price of $23.97. The Company also assumed 26,918 warrants valued at $.1 million. The Company incurred acquisition costs of approximately $.5 million for a total purchase price of $12.8 million and assumed liabilities totaling $11.5 million. The acquisition was accounted for under the purchase method of accounting. Accordingly, the results of operations of Truevision and the fair market value of the acquired assets and assumed liabilities have been included in the financial statements of the Company as of March 12, 1999. Goodwill represents the amount by which the cost of acquired net assets exceeded the fair values of net assets on the date of purchase. As of March 12, 1999, the Company recorded $3.8 million in assets, $6.2 million in in-process research and development, $2.7 million in other identifiable intangibles including patents, trademarks and assembled workforce, assumed $11.5 million in liabilities and allocated $11.6 million to goodwill. The amounts allocated to identifiable intangible assets and acquired in-process research and development, were based on results of an independent appraisal using established valuation techniques in the high-technology industry. Such allocations, as well as those made to the remaining net assets, are preliminary and subject to further analysis. Subsequent changes to the purchase price allocation, if any, will be recorded as adjustments to goodwill. The portion of the purchase price allocated to in-process research and development represents development projects that have not yet reached technological feasibility and have no alternative future use. Technological feasibility was determined based on: (i) an evaluation of the products status in the development process with respect to utilization and contribution of the individual products as of the date of valuation and (ii) the expected dates in which the products would be commercialized. It was determined that technologically feasibility was achieved when a product is at beta stage. The value assigned to purchased in-process research and development was determined by estimating the costs to develop the purchased in-process research and development into commercially viable products; estimating the resulting net cash flows from such projects; discounting the net cash flows back to the time of acquisition and applying an attribution rate based on the estimated percent complete considering the approximate stage of completion of the in-process technology at the date of acquisition. Based on this analysis and computation, $6.2 million was charged to operations at the date of acquisition. The Company did not record any deferred tax assets at the acquisition date due to the uncertainty of their realization. If any benefit of these unrecorded tax credits and carryforwards is realized in the future, the non-current assets recorded upon the acquisition will be reduced at that time by a corresponding amount, before any benefit is recognized in the statement of operations. Accumulated amortization associated with identifiable intangible assets was approximately $16,000. At March 31, 1999, accumulated amortization associated with goodwill was approximately $70,000. The following table presents unaudited pro forma information as if Pinnacle and Truevision had been combined as of the beginning of the periods presented. The pro forma data are presented for illustrative purposes only and are not necessarily indicative of the combined financial position or results of operations of future periods or the results that actually would have resulted had Pinnacle and Truevision been a combined company during the specified periods. The pro forma results include the effects of the purchase price allocation from amortization of acquisition-related intangible assets and exclude the charge for the purchased in-process technology. 8 Pro Forma Unaudited (in thousands, except per share amounts) For the Nine Months Ended March 31 1999 1998 --------- --------- Net revenue $ 126,638 $ 101,200 Net loss (786) (10,690) Net loss per common share -- basic $ (.07) $ (1.19) Weighted average common share outstanding -- basic 10,881 8,982 In March, 1999, the Company acquired Shoreline Studios, Inc., a provider of real-time 3D graphics software for use in live broadcasts. The cash price was $754,000 including related goodwill of $375,000. The transaction was accounted for by the purchase method of accounting. Pro forma comparative results of operations are not presented because they are not material to the Company's results. In August 1997, the Company acquired the miro Digital Video Products from miro Computer Products AG. The terms of the acquisition included an earnout provision in which miro Computer Products AG would receive additional consideration equal to 50% of sales generated in excess of $37 million during the first twelve full months following the acquisition. In September 1998, pursuant to this earnout provision, the Company issued an aggregate of 307,534 shares of its common stock to miro Computer Products AG. Upon the issuance of these shares, the Company recorded goodwill of $7.8 million or approximately $25.50 per share to be amortized into income over nine years using the straight-line method. 3. Supplemental Cash Flow Information The following table reflects supplemental cash flow from investing activities related to the Truevision and Shoreline acquisitions. Fair value of: Truevision Shoreline Total - -------------- ---------- --------- ----- Assets acquired and goodwill $ 24,415 $ 754 $ 25,169 Liabilities assumed (11,397) (250) (11,647) Common stock, stock options and warrants issued (12,704) -- (12,704) -------- -------- --------- Cash paid 314 504 818 Cash acquired (938) -- (938) -------- -------- --------- Net cash (received) paid on acquisitions $ (624) $ 504 $ (120) 4. Net Income Per Share The Company computes basic and diluted earnings per share in accordance with Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS128"). The following tables reconcile the numerator and denominator of the basic and diluted earnings per share computations shown on the Condensed Consolidated Statements of Operations: 9
Three Months Ended Nine Months Ended (In thousands) March 31, March 31, 1999 1998 1999 1998 ---- ---- ---- ---- Basic EPS - weighted average shares of common stock outstanding 10,771 9,780 10,497 8,570 Effect of dilutive common equivalent shares - stock options outstanding 1,156 1,030 1,018 -- ------ ------ ----- ------ Diluted EPS - weighted average shares and common equivalent shares outstanding 11,927 10,810 11,515 8,570 ====== ====== ====== ====== Options to purchase shares of common stock excluded due to anti-dilution 0 0 75 1,022 ====== ====== ====== ======
5 Customers and Credit Concentrations During the three and nine month periods ended March 31, 1999, Ingram Micro Inc. accounted for approximately 9.5% and 10.5% of net sales, respectively, compared to 10.2% and 10.9% for the comparable periods in 1998. No other customer accounted for greater than 10% of sales. Ingram Micro Inc. accounted for approximately 25.3% and 18.5% of accounts receivable at March 31, 1999 and June 30, 1998, respectively. 6 Inventories A summary of inventories follows: (in thousands) March 31, June 30, 1999 1998 ---- ---- Raw materials $ 10,946 $ 6,418 Work in process 3,834 2,946 Finished goods 6,095 2,596 -------- -------- $ 20,875 $ 11,960 ======== ======== Raw materials inventory represents purchased materials, components and assemblies, including fully assembled circuit boards purchased from outside vendors. 7 Development of Software for Internal Use Beginning in January 1999, the Company commenced development and implementation of a worldwide information system based on enterprise software. The project is expected to be completed by January 2000. Pursuant to SOP 98-1, the Company reached the application development stage of the software implementation and began capitalizing costs associated with the project. As of March 31, 1999, the Company had capitalized approximately $330,000. 8 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 three month period ended March 31, 1999 and 1998, the Company purchased materials totaling $4,102,000 and $748,000 respectively, from Bell pursuant to the Agreement. During the nine month period ended March 31, 1999 and 1998, the Company purchased materials totaling $9,683,000 and $3,180,000 respectively from Bell pursuant to the Agreement. Item 2. Management's Discussion and Analysis of 10 Financial Condition and Results of Operations Certain Forward-Looking Information Certain statements in this Management's Discussions and Analysis and elsewhere in this Quarterly Report on Form 10-Q 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 "Factors Affecting Operating Results". These forward-looking statements include the last sentences of the paragraphs below relating to "Engineering and Product Development" and "Sales and Marketing," "International Sales," and 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 capture, compress and store and edit video and 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 broadcast, desktop and consumer. Pinnacle distributes and sells its products to end users through the combination of independent domestic and international dealers, retail distributors, OEMs and a growing direct sales force. Sales to dealers, distributors and OEMs are generally at a discount to the published list prices. 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. Generally, products sold to OEMs are integrated into systems sold by the OEMs to their customers. 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. Four product families, DVExtreme, Lightning, Deko and AlladinPRO comprise the Company's suite of high performance real time Windows NT-based products designed for on-air, broadcast and high-end, post-production applications. In June 1997, the Company commenced shipment of DVExtreme and Lightning, two Windows NT based products designed to address the markets previously addressed by Prizm and Flashfile respectively, the primary broadcast products sold throughout fiscal 1997. In April 1997, the Company completed the acquisition of the Deko titling and character generation product line from Digital Graphix, Inc. ("Deko Acquisition"). Currently the Company sells three products in the Deko line, FXDeko, TypeDeko and WriteDeko, and has recently announced the release of six additional products including FXDekoHD, a high definition character and graphics generator. In fiscal 1998, substantially all of the broadcast revenue came from the sale of DVEtreme, Lightning and Deko products. In June 1998, the Company commenced shipment of AlladinPRO; a high-performance Windows NT based digital video effects system designed for live and on-line applications. In September 1998, the Company commenced shipment of FXDeko; a new high performance Windows NT based product that combines the feature set of Deko with real-time digital effect technology. In March 1999, the Company announced the introduction of Thunder, the Company's first multi-channel video and audio clip server and iThunder, a realtime video server for Internet Broadcasting. In April 1999 the Company announced the introduction of the Lightning 200 stillstore and image management system and the DVEXtremePlus digital effects system. The broadcast market accounted for approximately 16.1% and 24.1% of net sales in the three-month periods ended March 31, 1999 and 1998, respectively, and approximately 16.4% and 25.0% of net sales in the nine month periods ended March 31, 1999 and 1998, respectively. Desktop Market The Company's desktop products are designed to provide high quality video capture, compression/decompression, editing, and real time video manipulation capabilities for computer based video post-production systems. They are generally offered at significantly lower price points than traditional editing suites and are integrated into the computer by a value-added reseller, an OEM, or the end user. The Company's first desktop product was the Alladin, which commenced shipment in June 1994. The Company expanded its desktop product line with the introduction of Genie in June 1996. In August 1997 the 11 company acquired the miroVIDEO desktop product lines and during fiscal 1998 the Company introduced additional new desktop products. The Company has two general classes of desktop products: digital video effects products, which include the Alladin and Genie families, and video capture and editing products, which include the ReelTime, ReelTime Nitro, miroVIDEO DC30, miroVIDEO DC50 and miroVIDEO DV300 families. In September 1998, the Company commenced shipment of ReelTime Nitro which combines the video capture and editing capabilities of ReelTime with the digital video effects capabilities of Genie. In March 1999, the Company announced the introduction of DC1000, a new dual stream MPEG2 editing product and a companion DVD authoring option. The Company also announced the introduction of DV200, its new low-cost DV-based video capture and editing solution. Also in March 1999, the Company completed its acquisition of Truevision, Inc. by adding Truevision's TARGA branded products to its catalog. TARGA boards, which provide 4:2:2 video sampling and M-JPEG compression with user-selectable image quality are being integrated into Pinnacle's Desktop Group of products. The desktop market accounted for approximately 57.4% and 60.4% of net sales in the three-month periods ended March 31, 1999 and 1998, respectively, and approximately 56.1% and 56.4% of net sales in the nine month periods ended March 31, 1999 and 1998, respectively. Consumer Market The Company's consumer products provide complete video editing solutions that allow consumers to edit their home videos using their personal computer, camcorder and VCR. 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. In June 1998 the Company commenced shipment of Studio 400, which expands the capabilities of and replaces VideoDirector Studio 200. In November 1998 the Company commenced shipment of Studio DC10 Plus. In March 1999, the Company commenced shipment of Studio MP10, the company's third product in the Studio line. As of March 31, 1999 the Company's consumer product line included Studio 400, Studio DC10+, miroVIDEO DC10, miroVIDEO DC20, miroVIDEO PCTV, and StudioMP10. Consumer products are distributed direct to retail outlets and through retail distributors such as Ingram Micro. The Company also sells directly to end-users by accepting orders via the telephone and Internet. Price points of consumer products are lower than the Company's broadcast and desktop products and are marketed as both software packages and computer peripheral products. The consumer market accounted for approximately 26.5% and 15.5% of net sales in the three-month periods ended March 31, 1999 and 1998, respectively, and approximately 27.5% and 18.6% of net sales in the nine month periods ended March 31, 1999 and 1998, respectively. Results of Operations Net Sales. The Company's net sales increased 36.9% to $40.1 million in the three-month period ended March 31, 1999 compared to $29.3 million in the same period last year. Net sales increased by 51.4% to $111.6 million in the nine months ended March 31, 1999 from $73.7 million in the nine months ended March 31, 1998 (see below). Increase Group 1999 1998 (Decrease) ----- ---- ---- ---------- Quarter end March 31: - --------------------- Broadcast $ 6,480 $ 7,078 (8.4)% Desktop 23,034 17,702 30.1% Consumer 10,633 4,552 133.6% -------- -------- $ 40,147 $ 29,332 36.9% ======== ======== Nine months ended March 31: - --------------------------- Broadcast $ 18,326 $ 18,418 (0.5)% Desktop 62,626 41,563 50.7% Consumer 30,640 13,746 122.9% -------- -------- $111,592 $ 73,727 51.4% ======== ======== In both the quarter and nine-month period ended March 31, 1999, sales increases in the consumer and desktop groups over the prior year were partially offset by a decrease in the broadcast sales. For the desktop group, the growth in these periods was attributable to an expanded product line, which added DC50 and the DV300 to an already strong base of DC30 revenue. In the quarter ended March 31, 1999 the desktop sales also included approximately $1.5 million from the sale of Truevision products. The Consumer sales increased due to growing sales of PCTV in Europe and worldwide sales of Studio 400 which began shipping in June 1998. Revenues in the 12 broadcast group decreased in quarter ended March 31, 1999 and decreased slightly in the nine month period ended March 31, 1999 compared to the corresponding periods last year as the industry focuses its attention and resources on evolving technologies in areas such as high definition digital television (HDTV). International sales (sales outside of North America) increased 40.5% in the three month period ended March 31, 1999 compared to the three month period ended March 31, 1998 and accounted for approximately 59.2% and 57.7% of net sales in those periods, respectively. International sales increased 70.6% in the nine month period ended March 31, 1999 compared to the nine month period ended March 31, 1998 and accounted for approximately 64.2% and 57.0% of the Company's net sales respectively. The Company expects that international sales will continue to represent a significant portion of its net sales. Cost of Sales and Gross Profit. 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, warranty costs and post sale customer support costs. For the three and nine month periods ended March 31, 1999 and 1998, cost of sales were approximately 46% of sales and related gross margins held at 54%. Engineering and Product Development. Engineering and product development expenses increased 35.3% to $4.3 million in the three months ended March 31, 1999 from $3.2 million during the comparable three months period in the prior year. The Company's engineering and product development expenses increased 34.1% to $10.9 million in the nine months ended March 31, 1999 from $8.2 million during the nine months ended March 31, 1998. As a percentage of sales, engineering and product development expenses decreased to 10.7% in the quarter ended March 31, 1999 from 10.8% in the quarter ended March 31, 1998, and to 9.8% from 11.1% in the nine months ended March 31, 1999 and 1998, respectively. Management believes that investment in research and development is crucial to its future growth and position in the industry. The Company expects to continue to allocate significant resources to engineering and product development efforts in Mountain View and Grass Valley, California, the Deko engineering team located in Paramus, New Jersey, the Miro engineering team located in Braunschweig, Germany, and the Truevision engineering team located in Indianapolis, Indiana. 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 29.6% to $10.3 million in the three months ended March 31, 1999 from $7.9 million during the comparable three months period in the prior year. The growth during the three-month period was due primarily to increased spending in North America. The Company's sales and marketing expenses increased 38.1% to $29.4 million in the nine months ended March 31, 1999 from $21.3 million in the nine month period ended March 31, 1998 as the Company continues to invest in its infrastructure to promote is products worldwide. Although sales and marketing expenditures have increased significantly year to year, as a percentage of net sales expenditures have fallen to 25.7% from 27.1% in the three month periods ending March 31, 1999 and 1998, and to 26.4% from 28.9% in the nine month periods ending March 31, 1999 and 1998, respectively. These decreases reflect a growth in sales exceeding incremental sales and marketing expenditures. Although management continues to invest substantial amounts in the Company's sales and marketing efforts, there can be no assurance that these current or increased sales and marketing expenditures will enable the Company to maintain or grow its current level of sales. General and Administrative. General and administrative expenses increased 14.8% to $1.7 million in the three months ended March 31, 1999 from $1.5 million during the comparable three months period in the prior year. General and administrative expenditures increased 31.3% to $5.1 million in the nine months ended March 31, 1999 from $3.9 million during the comparable nine months period in the prior year. As a percentage of net sales, general and administrative expenses were 4.2% and 5.0% during the three months ended March 31, 1999 and 1998 and 4.5% and 5.2% during the nine months ended March 31, 1999 and 1998, respectively. In Process Research and Development. During the three month period ended March 31, 1999, the Company recorded an in process research and development charge of approximately $6.6 million relating to the Truevision and Shoreline acquisitions. The value assigned to purchased in-process research and development was determined by estimating the costs to develop the purchased in-process research and development into commercially viable products; estimating the resulting net cash flows from such projects; discounting the net cash flows back to the time of acquisition and applying an attribution rate based on the estimated percent complete considering the approximate stage of completion of the in-process technology at the date of acquisition. The acquired in-process research and development from Truevision, Inc. relates to the development of the next generation of Targa products. At the date of acquisition, revenues attributable to these future products were projected for 13 purposes of valuing the acquired in-process R&D. Though the Company currently expects that the acquired in process technology will be successfully developed, there can be no assurance that commercial or technical viability of the product will be achieved. If the project is not successfully developed, the Company may not realize the value assigned to the in-process R&D project. In addition, the value of goodwill and other acquired intangible assets may also become impaired. Ongoing operations and financial results are subject to a variety of factors which may or may not have been known or estimable at the time of the acquisition, and the estimates discussed above are subject to change. Interest Income, Net. Interest income, net consists primarily of interest income, other income and interest expense. Interest income is generated primarily from the Company's low risk investments in money market funds, government securities and high-grade commercial paper. In the three and nine months ended March 31, 1999, net interest income was $1.1 million and $3.4 million respectively, as compared to net interest income of $1.0 million and $2.1 million in the comparable periods a year ago. The increase reflects the investment of proceeds from the Company's common stock offering in November 1997 and investment of cash generated from operations. Income Tax Expense. The Company recorded a provision for income taxes of $0 and $832,000 for the three month period ended March 31, 1999 and 1998, respectively. Income tax expenses were $2.3 million and $1.6 million for the nine months ended March 31, 1999 and 1998, respectively. As of June 30, 1998, the Company had federal research and experimentation and alternative minimum tax credit carryforwards of $1.3 million that expire between 2009 to 2013, and state research and experimentation credit carryforwards of $546,000 that have no expiration provision. Liquidity and Capital Resources The Company has funded its operations to date through sales of equity securities as well as through cash flows from operations. As of March 31, 1999, the Company's principal sources of liquidity included cash, cash equivalents and marketable securities totaling approximately $90.7 million. 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 current operations and growth for the foreseeable future. The Company's operating activities generated cash of $1.6 million in the nine months ended March 31, 1999. Cash was generated primarily from net income of $9.1 million. Cash generated from operations was offset by increases in accounts receivable, inventories and prepaids and a decrease in accounts payable. Accounts receivable has increased primarily due to the Company's sales growth. Specifically, continued growth in the Company's sales into retail distribution could have a negative impact on cash flow as retail distributors normally pay within 60 to 120 days. Currently, this has not adversely impacted cash flow as DSO's have been stable. Inventories increased due to higher levels of broadcast and certain consumer inventories on hand due to lower than expected revenues from these products during the first nine months of the fiscal year. Excluding inventories acquired in the Truevision acquisition , inventories have remained at approximately the same level they were at December 31, 1998. Increase in prepaid and other expenses was due to payments made for the April 1999 NAB tradeshow and an increase in royalty advances. Cash flow decreased from payments on accounts payable due to approximately $3.0 in payments related to Truevision. During the nine months period ended March 31, 1999, cash flow from investing activities included $4.2 million invested in property and equipment, compared to $1.7 million in the nine months ended March 31, 1998. The high level of expenditures for the nine months ended March 31, 1999 were primarily for leasehold improvements, furniture and equipment purchased for the Company's Mountain View facility expansions in September 1998 and January 1999. The Company also incurred approximately $330,000 in capitalized expenditures related to the Company's enterprise software implementation which began in January 1999. The Company will continue to incur expenditures for the implementation at least through January 2000. Such expenses will increase in the late summer and fall of 1999 as the implementation process moves closer to final implementation. In addition, as the Company continues to grow it expects ongoing purchases of property and equipment. Such capital expenditures will be financed from working capital. Cash flow from investing activities also decreased due to the Company's' increased investment in marketable securities. On March 12, 1999, the Company acquired all the outstanding common stock of Truevision, Inc., a supplier of digital video products ("Truevision"). In connection with the acquisition, Pinnacle issued 412,103 shares of common stock valued at $11.5 million. In addition, Pinnacle issued to Truevision employees and Directors 69,839 options, valued at $.7 million, to purchase common stock at an exercise price of $23.97. The Company also assumed 26,918 warrants valued at $.1 million. The Company incurred acquisition costs of approximately $.5 million for a total purchase price of $12.8 million and assumed liabilities totaling $11.5 million. The acquisition was accounted for under the purchase method of accounting. Accordingly, the results of operations of Truevision and the fair market value of the acquired assets and assumed liabilities have been included in the financial statements of the Company as of March 12, 1999. Goodwill represents the amount by which the cost of acquired net assets exceeded the fair values of net assets on the date of purchase. As of March 12, 1999, the Company recorded $3.8 million in assets, $6.2 million in in-process research and development, $2.7 million in other identifiable intangibles including patents, trademarks and assembled workforce, assumed $11.5 million in liabilities and allocated $11.6 million to goodwill. 14 The amounts allocated to identifiable intangible assets and acquired in-process research and development, were based on results of an independent appraisal using established valuation techniques in the high-technology industry. Such allocations, as well as those made to the remaining net assets, are preliminary and subject to further analysis. Subsequent changes to the purchase price allocation, if any, will be recorded as adjustments to goodwill. In March, 1999, the Company acquired Shoreline Studios, Inc., a provider of real-time 3D graphics software for use in live broadcasts. The cash price was $754,000 including related goodwill of $375,000. The transaction was accounted for by the purchase method of accounting. Factors Affecting Operating Results PINNACLE SYSTEMS HAS GROWN RAPIDLY AND CONTINUES TO GROW RAPIDLY. IF PINNACLE SYSTEMS FAILS TO EFFECTIVELY MANAGE THIS GROWTH, ITS FINANCIAL RESULTS COULD SUFFER. Pinnacle Systems has in the past experienced rapid growth and anticipates that it may grow at a rapid pace in the future. For example, net sales in fiscal 1998 were $105.3 million compared to $37.5 million in fiscal 1997 and net sales in the nine-month period ended March 31, 1999 increased 51.4% over the same period last year. As a result of recent acquisitions, Pinnacle Systems has increased the number of its employees, including the addition of approximately 175 employees in connection with the Truevision and Miro acquisitions, and many are now geographically dispersed. This growth places increasing demands on Pinnacle Systems' management, financial and other resources. Pinnacle Systems has built these resources and systems to account for such growth, but continued growth may require Pinnacle Systems to increase its investment in such systems, or to reorganize its management team. Such changes, should they occur, could cause an interruption or diversion of focus from Pinnacle Systems' core business activities and have an adverse effect on financial results. PINNACLE SYSTEMS' FAILURE TO ACQUIRE AND SUCCESSFULLY INTEGRATE THE BUSINESSES IT ACQUIRES COULD NEGATIVELY IMPACT IT. In March 1999, Pinnacle Systems completed the acquisition of Truevision, Inc and Shoreline Studios, Inc. Pinnacle Systems may in the near- or long-term pursue acquisitions of complementary businesses, products or technologies. Integrating acquired operations is a complex, time-consuming and expensive process. All acquisitions involve risks that could materially and adversely affect Pinnacle Systems' business and operating results. These risks include: - Distracting management from the day-to-day operations of Pinnacle Systems' business - Costs, delays and inefficiencies associated with integrating acquired operations, products and personnel - The potential to result in dilutive issuance of Pinnacle Systems' equity securities - The incurrence of debt and amortization expenses related to goodwill and other intangible assets THERE ARE VARIOUS FACTORS WHICH MAY CAUSE PINNACLE SYSTEMS' NET REVENUES AND OPERATING RESULTS TO FLUCTUATE. Pinnacle Systems' quarterly and annual operating results have varied significantly in the past and may continue to fluctuate because of a number of factors, many of which are outside Pinnacle Systems' control. These factors include: - Timing of significant orders from and shipments to major OEM customers - Timing and market acceptance of new products - Success in developing, introducing and shipping new products - Dependence on distribution channels through which Pinnacle Systems' products are sold - Increased competition and pricing pressure - Accuracy of Pinnacle Systems' and resellers' forecasts of end user demand 15 - Accuracy of inventory forecasts - Ability to obtain sufficient supplies from its subcontractors - Timing and level of consumer product returns - Foreign currency fluctuations - Costs of integrating acquired operations - General domestic and international economic conditions, such as the current economic downturn in Asia Pinnacle Systems also experiences significant fluctuations in orders and sales due to seasonal fluctuations, the timing of major trade shows and the sale of consumer products in anticipation of the holiday season. Sales usually slow down during the summer months of July and August, especially in Europe. Also, Pinnacle Systems attends a number of annual trade shows which can influence the order pattern of products, including CEBIT in March, the NAB convention held in April, the IBC convention held in September and the COMDEX exhibition held in November. Pinnacle Systems' operating expense levels are based, in part, on its expectations of future revenue and, as a result, net income would be disproportionately affected by a shortfall in net sales. Due to these factors, Pinnacle Systems 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. PINNACLE SYSTEMS' STOCK PRICE MAY BE VOLATILE. The trading price of Pinnacle Systems' common stock has in the past and could in the future fluctuate significantly. The fluctuations have been or could be in response to numerous factors including: - Quarterly variations in results of operations - Announcements of technological innovations or new products by Pinnacle Systems, their customers or competitors - Changes in securities analysts' recommendations - Announcements of acquisitions - Earnings estimates for Pinnacle Systems - General fluctuations in the stock market Pinnacle Systems' revenues and results of operations may be below the expectations of public market securities analysts or investors. This could result in a sharp decline in the market price of Pinnacle Systems' common stock. In addition, stock markets have from time to time experienced extreme price and volume fluctuations. The market prices for high technology companies have been particularly affected by these market fluctuations and such effects have often been unrelated to the operating performance of such companies. These broad market fluctuations may cause a decline in the market price of Pinnacle Systems' common stock. In the past, following periods of volatility in the market price of a company's stock, securities class action litigation has been brought against the issuing company. Although no such litigation has been brought against Pinnacle Systems, it is possible that similar litigation could be brought against Pinnacle Systems. Such litigation could result in substantial costs and would likely divert management's attention and resources. Any adverse determination in such litigation could also subject Pinnacle Systems to significant liabilities. 16 PINNACLE SYSTEMS MAY FAIL TO SELL PRODUCTS IN THE CONSUMER MARKET. Pinnacle Systems entered the consumer market with the purchase of the VideoDirector product line from Gold Disk in June 1996. Pinnacle Systems began shipping its first internally developed consumer product, the VideoDirector Studio 200, in March 1997 and began shipping a successor product, the Studio 400 in June 1998. In addition, with the Miro Acquisition in August 1997, Pinnacle Systems acquired Miro's consumer products and European sales organization. Pinnacle Systems aims to continue to expend resources to develop, market and sell products into the consumer market. Pinnacle Systems expects to devote considerable effort and resources to continue developing its consumer market. In this endeavor, Pinnacle Systems needs to continue to develop and maintain the following capabilities: - Marketing and selling products through the consumer distribution channels. - Established relationships with distributors and retailers - A fully developed infrastructure to support electronic retail stores and telephone and Internet orders. Additionally, factors beyond Pinnacle Systems' control could hurt consumer product sales and consequently Pinnacle Systems' financial condition. These factors include: - Potential compatibility problems with other manufacturers' electronic components - The risk of obsolete inventory and inventory returns - The growth of the consumer video market is difficult to predict PINNACLE SYSTEMS' SALES ARE CONCENTRATED AMONGST OEM CUSTOMERS AND PINNACLE SYSTEMS COULD BE NEGATIVELY AFFECTED IF SALES TO THESE CUSTOMERS WERE TO DECLINE. Pinnacle Systems has been highly dependent on sales of its Alladin and Genie products to OEMs. Sales to Avid Technology, Inc. accounted for approximately 7.6% in the nine months ended March 31, 1999, 10.7% of net sales in fiscal 1998 and 26.4% of sales in fiscal 1997. Though this concentration has decreased in recent years, it still subjects Pinnacle Systems to some risk. In particular, its operating results will vary on a quarter-to-quarter basis as a result of variations in the ordering patterns of OEM customers. Pinnacle Systems' results of operations have in the past and could in the future be materially harmed by the failure of anticipated orders to materialize, by deferrals or cancellations of orders, or if overall OEM demand were to decline. For example, since sales to Avid began in fiscal 1996, quarterly sales to Avid have fluctuated substantially from a high of $5.6 million to a low of $1.0 million, and Pinnacle Systems anticipates that such fluctuations may continue. If sales to OEM customers were to decrease, Pinnacle's business could be materially harmed. IF PINNACLE SYSTEMS' PRODUCTS DO NOT KEEP PACE WITH THE TECHNOLOGICAL DEVELOPMENTS IN THE RAPIDLY CHANGING VIDEO POST-PRODUCTION EQUIPMENT INDUSTRY, THEN IT MAY BE ADVERSELY AFFECTED. 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. Delays in the introduction or shipment of new or enhanced products, the inability of Pinnacle Systems to timely develop and introduce such new products, the failure of such products to gain significant market acceptance or problems associated with new product transitions could materially harm Pinnacle Systems' business, particularly on a quarterly basis. Pinnacle Systems is critically dependent on the successful introduction, market acceptance, manufacture and sale of new products that offer its customers additional features and enhanced performance at competitive prices. Once a new product is developed, Pinnacle Systems must rapidly commence volume production. This process requires accurate forecasting of customer requirements and attainment of acceptable manufacturing costs. The introduction of new or enhanced products also requires Pinnacle Systems 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 introduction of DVExtreme, Lightning and Studio 400 has resulted 17 in a significant decline in sales of Prizm, Flashfile and Studio 200 and a write down of inventory. In addition, as is typical with any new product introduction, quality and reliability problems may arise. 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. IF PINNACLE SYSTEMS DOES NOT EFFECTIVELY COMPETE, ITS BUSINESS WILL BE HARMED. The market for Pinnacle's products is highly competitive. Pinnacle Systems competes in the broadcast, desktop and consumer video production markets. Pinnacle anticipates increased competition in each of the broadcast, desktop and consumer video production markets, particularly since the industry is undergoing a period of technological change and consolidation. Competition for Pinnacle Systems' broadcast, consumer and video products is generally based on: - Product performance - Breadth of product line - Quality of service and support - Market presence - Price - Ability of competitors to develop new, higher performance, lower cost consumer video products Certain competitors in the broadcast, consumer and video market have larger financial, technical, marketing, sales and customer support resources, greater name recognition and larger installed customer bases than Pinnacle Systems. In addition, some competitors have established relationships with current and potential customers of Pinnacle Systems and offer a wide variety of video equipment that can be bundled in certain large system sales. Principal competitors in the broadcast market include: Chyron Corporation Matsushita Electric Industrial Co. Ltd. Quantel Ltd. (a division of Carlton Communications Plc) Accom, Inc. Sony Corporation Principal competitors in the desktop and consumer markets are: Quantel Ltd. (a division of Carlton Communications Plc) Accom, Inc. Sony Corporation Avid Technology, Inc. Digitel Processing Systems, Inc. Fast Multimedia Iomega Corp. Matrox Electronics Systems, Ltd. Media 100, Inc. Adobe Systems, Inc. These lists are not all-inclusive. The consumer market in which certain of Pinnacle Systems' products compete 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 directly or indirectly with Pinnacle Systems' consumer products by providing some or all of the same features and video editing capabilities. In addition, Pinnacle Systems expects that existing manufacturers and new market entrants will develop new, higher performance, lower cost consumer video products that may compete directly with Pinnacle Systems' consumer products. Pinnacle Systems expects that potential competition in this market is likely to come from 18 existing video editing companies, software application companies, or new entrants into the market, many of which have the financial resources, marketing and technical ability to develop products for the consumer video market. Increased competition in any of these markets could result in price reductions, reduced margins and loss of market share. Any of these effects could materially harm Pinnacle Systems' business. PINNACLE SYSTEMS IS DEPENDENT ON CONTRACT MANUFACTURERS AND SINGLE OR LIMITED SOURCE SUPPLIERS FOR ITS COMPONENTS. IF THESE MANUFACTURERS AND SUPPLIERS DO NOT MEET PINNACLE SYSTEMS' DEMAND EITHER IN VOLUME OR QUALITY, THEN PINNACLE SYSTEMS COULD BE MATERIALLY HARMED. Pinnacle Systems relies on subcontractors to manufacture its consumer products and the major subassemblies of its broadcast and desktop products. Pinnacle Systems and its manufacturing subcontractors are dependent upon single or limited source suppliers for a number of components and parts used in Pinnacle Systems' products, including certain key integrated circuits. Pinnacle Systems' strategy to rely on subcontractors and single or limited source suppliers involves a number of significant risks, including: - Loss of control over the manufacturing process - Potential absence of adequate capacity - Potential delays in lead times - Unavailability of certain process technologies - Reduced control over delivery schedules, manufacturing yields, quality and costs - Unexpected increases in component costs If any significant subcontractor or single or limited source suppliers becomes unable or unwilling to continue to manufacture these subassemblies or provide critical components in required volumes, Pinnacle Systems will have to identify and qualify acceptable replacements or redesign its products with different components. Additional sources may not be available and product redesign may not be feasible on a timely basis. This could materially harm Pinnacle Systems' business. Any extended interruption in the supply of or increase in the cost of the products, subassemblies or components manufactured by third party subcontractors or suppliers could materially harm Pinnacle Systems' business. PINNACLE SYSTEMS RELIES HEAVILY ON DEALERS AND OEMS TO MARKET, SELL, AND DISTRIBUTE ITS PRODUCTS. IN TURN, PINNACLE SYSTEMS DEPENDS HEAVILY ON THE SUCCESS OF THESE RESELLERS. IF THESE RESELLERS DO NOT SUCCEED IN EFFECTIVELY DISTRIBUTING PINNACLE SYSTEMS' PRODUCTS, THEN PINNACLE SYSTEMS' FINANCIAL PERFORMANCE WILL BE NEGATIVELY AFFECTED. These resellers may: - Not effectively promote or market Pinnacle Systems' products - Experience financial difficulties and even close operations Pinnacle Systems' dealers and retailers are not contractually obligated to sell Pinnacle Systems' products. Therefore, they may, at any time: - Refuse to promote or pay for Pinnacle Systems' products - Discontinue Pinnacle Systems' products in favor of a competitor's product Also, with these distribution channels standing between them and the actual market, Pinnacle Systems may not be able to accurately gauge current demand for products and anticipate demand for newly introduced products. For example, dealers 19 may place large initial orders for a new product just to keep their stores stocked with the newest products and not because there is a significant demand for them. As to consumer products offerings, Pinnacle Systems has expanded its distribution network to include several consumer channels, including large distributors of products to computer software and hardware retailers, which in turn sell products to end users. Pinnacle Systems also sells its consumer products directly to certain retailers. Rapid change and financial difficulties of distributors have characterized distribution channels for consumer retail products. These arrangements have exposed Pinnacle Systems to the following risks, some of which are out of Pinnacle Systems' control: - Pinnacle Systems is obligated to provide price protection to such retailers and distributors and, while the agreements limit the conditions under which product can be returned to Pinnacle Systems, Pinnacle Systems may be faced with product returns or price protection obligations. - The distributors or retailers may not continue to stock and sell Pinnacle Systems consumer products. - Retailers and retail distributors often carry competing products. Any of the foregoing events could materially harm Pinnacle Systems' business. IF CERTAIN KEY EMPLOYEES OF PINNACLE SYSTEMS LEAVE OR ARE NO LONGER ABLE TO PERFORM SERVICES FOR PINNACLE SYSTEMS, IT COULD HAVE A MATERIAL ADVERSE EFFECT ON PINNACLE SYSTEMS' BUSINESS. Pinnacle Systems believes that the efforts and abilities of its senior management and key technical personnel are very important to its continued success. Only one of Pinnacle Systems senior management or key technical personnel is bound by an employment agreement and none are the subject of key man life insurance. PINNACLE SYSTEMS MAY NOT BE ABLE TO ATTRACT AND RETAIN A SUFFICIENT NUMBER OF MANAGERIAL PERSONNEL AND TECHNICAL EMPLOYEES TO COMPETE SUCCESSFULLY. Pinnacle Systems' success is dependent upon its ability to attract and retain qualified technical and managerial personnel. There are not enough engineers, technical support, software services and managers available to meet the current demands of the computer industry. Pinnacle Systems may not be able to retain its key technical and managerial employees or attract, assimilate and retain such other highly qualified technical and managerial personnel as required in the future. Also, employees may leave Pinnacle Systems and subsequently compete against Pinnacle Systems, or contractors may perform services for competitors of Pinnacle Systems. If Pinnacle Systems is unable to retain key personnel, its business could be materially harmed. PINNACLE SYSTEMS MAY BE UNABLE TO PROTECT ITS PROPRIETARY INFORMATION AND PROCEDURES EFFECTIVELY. Pinnacle Systems must protect its proprietary technology and operate without infringing the intellectual property rights of others. Pinnacle Systems 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, Pinnacle Systems generally enters into confidentiality and nondisclosure agreements with its employees and OEM customers and limits access to and distribution of its proprietary technology. These steps may not protect Pinnacle Systems proprietary information nor give it any competitive advantage. Others may independently develop substantially equivalent intellectual property or otherwise gain access to Pinnacle Systems' trade secrets or intellectual property, or disclose such intellectual property or trade secrets. Pinnacle Systems has an application pending with the United States Patent and Trademark Office, which may not be granted, and any future patent applications may not be allowed. If Pinnacle Systems is unable to protect its intellectual property, Pinnacle Systems' business could be materially harmed. 20 PINNACLE SYSTEMS MAY BE ADVERSELY AFFECTED IF IT IS SUED BY A THIRD PARTY OR IF PINNACLE DECIDES TO SUE A THIRD PARTY FOR INFRINGEMENT. There has been substantial 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 Pinnacle Systems, to protect its trade secrets, trademarks and other intellectual property rights owned by Pinnacle Systems, or to defend Pinnacle Systems against claimed infringement. This litigation may - Divert management's attention away from the operation of Pinnacle Systems' business - Result in the loss of Pinnacle Systems' proprietary rights - Subject Pinnacle Systems to significant liabilities - Force Pinnacle Systems to seek licenses from third parties - Prevent Pinnacle Systems from manufacturing or selling its products. Any of these results could materially harm Pinnacle Systems' business. In the course of its business, Pinnacle Systems has in the past received communications asserting that Pinnacle Systems products infringe patents or other intellectual property rights of third parties. Pinnacle Systems investigated the factual basis of such communications and negotiated licenses where appropriate. It is likely that in the course of its business, Pinnacle Systems will receive similar communications in the future. 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, Pinnacle Systems may not be able to do so on commercially reasonable terms or at all. These disputes may not be settled on commercially reasonable terms and may result in long and costly litigation. BECAUSE PINNACLE SYSTEMS SELLS PRODUCTS INTERNATIONALLY, IT IS SUBJECT TO ADDITIONAL RISKS. Sales of Pinnacle Systems' products outside of North America represented approximately 64% of net sales in the nine month period ended March 31, 1999 compared to 57.6%, 39.7% and 38.7% of net sales in the fiscal years that ended June 30, 1998, 1997 and 1996 respectively. Pinnacle Systems expects that international sales will continue to represent a significant portion of its net sales, particularly in light of it's increased European sales as a result of the Miro Acquisition and the addition of the Miro European sales channel. Pinnacle Systems makes foreign currency denominated sales in many, primarily European, countries. This exposes Pinnacle Systems to risks associated with currency exchange fluctuations. Although the dollar amount of such foreign currency denominated sales was nominal during fiscal 1997, it increased substantially during fiscal 1998, especially for sales of consumer and desktop products into Europe. In fiscal 1999 and beyond, Pinnacle Systems expects that a majority of its European sales will be denominated in local foreign currency including the Euro. The Company has developed natural hedges for some of this risk in that most of the European selling expenses are also denominated in local currency. In addition to foreign currency risks, international sales and operations may also be subject to the following risks: - Unexpected changes in regulatory requirements - Export license requirements - Restrictions on the export of critical technology - Generally longer receivable collection periods and difficulty in collecting accounts receivable; - Political instability - Trade restrictions 21 - Changes in tariffs - Difficulties in staffing and managing international operations - Potential insolvency of international dealers - Difficulty in collecting accounts receivable Pinnacle Systems is also subject to the risks of generally poor economic conditions in certain areas of the world, most notably Asia. These risks may harm Pinnacle Systems' future international sales and, consequently, Pinnacle Systems' business. PINNACLE SYSTEMS IS NOT SURE WHAT THE EFFECT THE RECENT ESTABLISHMENT OF THE EURO WILL BE ON PINNACLE SYSTEMS' FINANCIAL OR RESULTS OF OPERATIONS. On January 1, 1999, eleven of the fifteen member countries of the European Union established fixed conversion rates between their sovereign currencies and the Euro. As of that date, the participating countries have agreed to adopt the Euro as their common legal currency. However, the legacy currencies will also remain legal tender in the participating countries for a transition period between January 1, 1999 and January 1, 2002. During this transition period, public and private parties may elect to pay or charge for goods and services using either the Euro or the participating country's legacy currency. Pinnacle Systems is not sure what the effect of the recent establishment of the Euro will be on Pinnacle Systems' financial condition or results of operations. Pinnacle Systems' European operations have conformed to the requirements of this transition and are currently invoicing customers in both legacy currencies and the Euro. Due to numerous uncertainties, Pinnacle Systems can not reasonably estimate the effects one common currency will have on pricing and the resulting impact, if any, on Pinnacle Systems' financial condition or results of operations. COMPUTER SOFTWARE, COMPONENTS AND SYSTEMS USED BY OR DESIGNED BY PINNACLE SYSTEMS OR USED BY THIRD PARTIES WITH WHOM PINNACLE SYSTEMS REGULARLY DEALS MAY NOT BE ABLE TO PROCESS DATE/TIME INFORMATION BETWEEN THE TWENTIETH AND TWENTY-FIRST CENTURY. THIS INABILITY COULD CAUSE THE DISRUPTION OR FAILURE OF SUCH COMPUTER SYSTEMS. PINNACLE SYSTEMS' BUSINESS COULD BE INTERRUPTED MATERIALLY AS A RESULT OF SUCH DISRUPTION OR FAILURE. Like many other companies, Pinnacle Systems is potentially susceptible to the year 2000 problem, i.e., computer systems will not correctly recognize and process date information beyond the year 1999. In addition, moving from 1999 to 2000 may cause problems since some systems' programming assigns special meaning to certain dates, such as 9/9/99, and the year 2000 is a leap year. Pinnacle Systems has initiated a special program to confront those potential problems. This program will involve assessing all areas that may be affected by or responsible for the year 2000 problem and initiating changes wherever necessary. Some of the activities include: - Assessing all major categories of systems used by Pinnacle Systems, including manufacturing, sales and financial systems - Working with key suppliers of products and services to determine that their operations and products are year 2000 capable, or to monitor their progress toward year 2000 capability - Internal discussions concerning contingency planning to address potential problem areas with internal systems and with suppliers and other third parties - Implementing a program to assess the capability of its products to handle the year 2000 It is expected that assessment, remediation and contingency planning activities will be ongoing throughout 1999 with the goal of appropriately resolving all material internal systems and third party issues. However, if these activities fail and problems occur, Pinnacle Systems' business will likely be materially harmed. Further, Pinnacle Systems does not have any 22 contingency plans if these planning activities fail. It is uncertain to what extent Pinnacle Systems will be affected by the year 2000 problem, and if third parties or suppliers have year 2000 problems, Pinnacle Systems' business may be materially harmed. To assist customers in evaluating their year 2000 issues, Pinnacle Systems is currently assessing the capability of its current products and products no longer being produced to handle the year 2000 problem, and expects to complete that assessment by mid 1999. Products will be assigned to one of the four following categories: "Year 2000 Compliant," "Year 2000 Compliant with minor issues" "Year 2000 non-compliant," "No evaluation done--will not test." "Year 2000 Compliant" means that when used properly and in conformity with the product information provided by Pinnacle Systems', and when used with "Year 2000 Compliant" computer systems, the product will accurately store, display, process, provide, and/or receive data from, into, and between the twentieth and twenty-first centuries, including leap year calculations, provided that all other technology used in combination with the Pinnacle Systems' product properly exchanges date data with the Pinnacle Systems' product. Testing has not yet been completed, but based on preliminary tests, Pinnacle Systems believes that all current products shipping, which run under Microsoft Windows NT or Windows 95, will be "Year 2000 compliant." Testing of older products that are no longer shipping has only recently been initiated and Pinnacle Systems considers it likely that some older products may not be year 2000 Compliant. The costs incurred to date related to year 2000 compliance have been immaterial. The cost which will be incurred by Pinnacle Systems regarding the implementation of year 2000 compliant internal information systems, testing of current or older products for year 2000 compliance, and answering and responding to customer requests related to year 2000 issues, including both incremental spending and redeployed resources, is currently not expected to exceed $500,000. The total cost estimate does not include potential costs related to any customer or other claims or the cost of internal software and hardware replaced in the normal course of business. In some instances, the installation schedule of new software and hardware in the normal course of business is being accelerated to also afford a solution to year 2000 capability issues. The total cost estimate is based on the current assessment of the projects and is subject to change as the project progress. Pinnacle Systems' estimate as to cost of year 2000 compliance may prove to be wrong. If actual cost of year 2000 compliance exceeds Pinnacle Systems' current estimate, Pinnacle Systems' business could be harmed. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Foreign Currencies The Company transacts business in various foreign currencies but primarily in those of Germany, France and the U.K. Accordingly, the Company is subject to exposure from adverse movements in foreign currency exchange rates. The Company currently does not use financial instruments to hedge local currency activity at any of its foreign locations. Instead, the Company believes that a natural hedge exists, in that local currency revenues substantially offsets the local currency denominated operating expenses. The Company assesses the need to utilize financial instruments to hedge foreign currency exposure on an ongoing basis. Fixed Income Investments The Company's exposure to market risk for changes in interest rates relates primarily to its investment portfolio of marketable securities. The Company does not use derivative financial instruments for speculative or trading purposes. The Company investments primarily in US Treasury Notes and high-grade commerical paper. The Company does not expect any material loss with respect to its investment portfolio. The Company does not use derivative financial instruments in its investment portfolio to manage interest rate risk. The Company does, however, limit its exposure to interest rate and credit risk by establishing and strictly monitoring clear policies and guidelines for its fixed income portfolios. At the present time, the maximum duration of all portfolios is two years. The guidelines also establish credit quality standards, limits on exposure to any one issue, as well as the type of instruments. Due to the limited duration and credit risk criteria established in the Company's guidelines, the exposure to market and credit risk is not expected to be material. 23 PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders On February 25, 1999, the Company reconvened its October 1998 Annual Shareholders Meeting in order to hold a vote on Proposal #2 which had been postponed from the October meeting. Votes on this proposal as for all the other proposals for the October 1998 had been solicited by proxy. The following is a brief description of the matter voted upon and a statement of the number of votes cast for and against, and the number of abstentions o To approve the reincorporation of the Company as a Delaware corporation by means of a merger of the Company with and into a wholly owned Delaware subsidiary of the Company. FOR: 4,637,984 AGAINST: 3,866,313 ABSTAIN: 13,152 BROKER NON-VOTES: 638,253 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: 27.1 Financial Data Schedule (b) Reports on Form 8-K On March 26, 1999, the Registrant filed a Report on Form 8-K regarding the acquisition of Truevision, Inc. by the Registrant pursuant to an Agreement and Plan of Reorganization dated December 16, 1998. The Form 8-K incorporated by reference from the Registrant's Registration Statement on Form S-4 (File No. 333-71959) certain financial statements of the business acquired and certain pro forma financial information. 24 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. PINNACLE SYSTEMS, INC. Date: May 12, 1999 By: /s/Mark L. Sanders --------------------------------------- Mark L. Sanders President, Chief Executive Officer and Director Date: May 12, 1999 By: /s/Arthur D. Chadwick --------------------------------------- Arthur D. Chadwick Vice President, Finance and Administration and Chief Financial Officer 25 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. PINNACLE SYSTEMS, INC. Date: May 10, 1999 By: --------------------------------------- Mark L. Sanders President, Chief Executive Officer and Director Date: May 10, 1999 By: --------------------------------------- Arthur D. Chadwick Vice President, Finance and Administration and Chief Financial Officer EX-27.1 2 FIANCIAL DATA SCHEDULE
5 9-MOS JUN-30-1999 JUL-01-1998 MAR-31-1999 19,594,000 71,102,000 26,284,000 5,838,000 20,875,000 123,768,000 13,640,000 5,613,000 173,976,000 26,878,000 0 0 0 158,242,000 (11,144,000) 173,976,000 111,592,000 111,592,000 51,652,000 51,652,000 52,028,000 0 (3,410,000) 11,322,000 2,264,000 9,058,000 0 0 0 9,058,000 0.86 0.79
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