-----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, UEKa9NiW9ypgEsjMDvbrqWe593Z+KBUmOah8CB4i+vrI2dxmV/xJPJezlARFxFXi /lIZb2PxOsyDAOcLGUvu4g== 0000950005-00-000325.txt : 20000215 0000950005-00-000325.hdr.sgml : 20000215 ACCESSION NUMBER: 0000950005-00-000325 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000214 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: 000-24784 FILM NUMBER: 540744 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 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 December 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 February 2, 2000 was 24,250,210. INDEX
PART I - FINANCIAL INFORMATION ITEM 1 - Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets - December 31, 1999 and June 30, 1999 3 Condensed Consolidated Statements of Operations - Three-month and Six-month Periods Ended December 31, 1999 and 1998 4 Condensed Consolidated Statements of Comprehensive Income Three-month and Six-month Periods Ended December 31, 1999 and 1998 5 Condensed Consolidated Statements of Cash Flow - Six-months Ended - December 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 12 ITEM 3 - Quantitative and Qualitative Disclosures About Market Risk 23 PART II - OTHER INFORMATION ITEM 1 - Legal Proceedings 24 ITEM 4 - Submission of Matters to a Vote of Security Holders 25 ITEM 6 - Exhibits and Reports on Form 8-K 25 Signatures 26
PART 1 - FINANCIAL INFORMATION Item 1. Financial Statements PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)
December 31, June 30, 1999 1999 ------------------ ------------------- Assets Current assets: Cash and cash equivalents $ 60,449 $ 48,654 Marketable securities 24,625 31,058 Accounts receivable, trade net 44,461 35,442 Other receivables, net 805 7 Inventories 23,375 22,221 Deferred income taxes 12,453 10,653 Prepaid expenses and other assets 2,823 2,500 ------------------ ------------------- Total current assets 168,991 150,535 Marketable securities 3,803 9,266 Property and equipment, net 14,254 10,809 Goodwill and other intangibles 50,333 25,503 Other assets 679 356 ------------------ ------------------- $ 238,060 $ 196,469 ================== =================== Liabilities and Shareholders' Equity Current liabilities: Accounts payable $ 16,121 12,744 Accrued expenses 15,508 14,530 Accrued income taxes 4,021 2,936 ------------------ ------------------- Total current liabilities 35,650 30,210 ------------------ ------------------- Commitments Shareholders' equity: Preferred stock, no par value; authorized 5,000 shares; none issued and outstanding - - Common stock, no par value; authorized 60,000 shares; 24,103 and 22,763 issued and outstanding as of December 31 and June 30, 1999, respectively 198,116 169,078 Retained earnings (accumulated deficit) 7,790 (389) Accumulated other comprehensive losses (3,496) (2,430) ------------------ ------------------- Total shareholders' equity 202,410 166,259 ------------------ ------------------- $ 238,060 $ 196,469 ================== =================== 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-months Ended Six-months Ended December 31, December 31, 1999 1998 1999 1998 ---- ---- ---- ---- Net sales $ 62,562 $ 39,172 $113,008 $ 71,445 Cost of sales 30,415 18,197 52,714 33,210 -------- -------- -------- -------- Gross profit 32,147 20,975 60,294 38,235 -------- -------- -------- -------- Operating expenses: Engineering and product development 6,244 3,352 12,213 6,653 Sales and marketing 13,819 10,287 25,545 18,460 General and administrative 2,257 1,885 4,969 3,394 Amortization of acquisition-related intangible assets 4,021 275 7,082 689 In-process research and development - - 2,000 - -------- -------- -------- -------- Total operating expenses 26,341 15,799 51,809 29,196 -------- -------- -------- -------- Operating income 5,806 5,176 8,485 9,039 Interest income and other, net 804 1,128 1,612 2,275 -------- -------- -------- -------- Income before income taxes 6,610 6,304 10,097 11,314 Income tax expense 1,221 1,264 1,918 2,266 -------- ------- ------- ------- Net income $ 5,389 $ 5,040 $ 8,179 $ 9,048 ======== ======== ======== ======== Net income per share Basic $ 0.23 $ 0.24 $ 0.35 $ 0.44 ======== ======== ======== ======== Diluted $ 0.20 $ 0.22 $ 0.30 $ 0.40 ======== ======== ======== ======== Shares used to compute net income per share Basic 23,922 21,048 23,612 20,726 ======== ======== ======== ======== Diluted 27,227 23,002 26,855 22,604 ======== ======== ======== ======== See accompanying notes to condensed consolidated financial statements 4
PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In thousands)
Three-months Ended Six-months Ended December 31, December 31, 1999 1998 1999 1998 ---- ---- ---- ---- Net income $ 5,389 $ 5,040 $ 8,179 $ 9,048 Foreign currency translation adjustment (2,183) (55) (1,066) 791 -------- -------- -------- -------- Comprehensive income $ 3,206 $ 4,985 $ 7,113 $ 9,839 ======== ======== ======== ======== See accompanying notes to condensed consolidated financial statements 5
PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (In thousands)
Six-months Ended December 31, 1999 1998 ---- ---- Cash flows from operating activities: Net income $ 8,179 $ 9,048 Adjustments to reconcile net income to net cash provided by (used in) operating activities: In-process research and development 2,000 - Depreciation and amortization 9,020 2,059 Deferred taxes (1,444) - Changes in operating assets and liabilities: Accounts receivable (6,495) (4,879) Inventories (2,043) (5,993) Accounts payable 2,102 3,303 Accrued expenses (3,715) 1,060 Accrued income taxes 3,220 1,632 Other (845) (1,112) -------- -------- Net cash provided by operating activities 9,979 5,118 -------- -------- Cash flows from investing activities: Purchases of property and equipment (5,103) (2,883) Cash paid for acquisitions (12,597) - Net proceeds (payments) from maturity (purchase) of marketable securities 11,850 (28,077) -------- -------- Net cash used in investing activities (5,850) (30,960) -------- -------- Cash flows from financing activities: Payments on note payable (42) (150) Proceeds from issuance of common stock 5,748 2,465 -------- -------- Net cash provided from financing activities 5,706 2,315 -------- -------- Effects of exchange rate changes on cash 1,960 500 -------- -------- Net increase (decrease) in cash and cash equivalents 11,795 (23,027) Cash and cash equivalents at beginning of period 48,654 47,478 -------- -------- Cash and cash equivalents at end of period $ 60,449 $ 24,451 ======== ======== Supplemental disclosures of cash paid during the period for: Income taxes $ - $ 490 ======== ======== Non-cash transactions: Common stock issued in business acquisitions $ 20,632 $ 7,834 ======== ======== See accompanying notes to condensed consolidated financial statements 6
1. Notes To Condensed Consolidated Financial Statements General The accompanying condensed consolidated financial statements are unaudited and 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. These condensed consolidated financial statements reflect all adjustments that, in the opinion of management, are necessary for a fair statement of the consolidated financial position, results of operations, comprehensive income, 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, 1999 included in the Company's Annual Report on Form 10-K as filed with the Securities and Exchange Commission. Results of operations for interim periods are not necessarily indicative of results for a full year. Currency Translation The Company considers the functional currency of its foreign subsidiaries to be the local currency. These functional currencies are translated into U.S. dollars using exchange rates in effect at period end for assets and liabilities and average exchange rates during each reporting period for the results of operations. Adjustments resulting from the translation of foreign subsidiary financial statements are reported within accumulated other comprehensive losses which is reflected as a separate component of shareholders' equity. Foreign currency transaction gains and losses are included in results of operations. Comprehensive Income (Loss) The Company's comprehensive income (loss) includes net income and foreign currency translation adjustments. Accounting Pronouncements In June, 1998 the Financial Accounting Standards Board 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, as amended, in the first quarter of its fiscal year ending June 30, 2001. The Company has not determined the impact if any that SFAS No. 133 will have on its results of operations or financial position. Subsequent Event - Stock Split On February 4, 2000 the Company's announced a two-for-one stock split (to be effective in the form of a stock dividend) to be paid on March 27, 2000 for shareholders of record on March 2, 2000. The accompanying consolidated financial statements do not give effect to the pending stock split. 7 2. Acquisitions Hewlett-Packard On August 2, 1999, the Company completed the purchase of the Video Communications Division ("VID") of the Hewlett-Packard Company ("HP"). Under the terms of an asset purchase agreement dated June 30, 1999, Pinnacle Systems acquired substantially all of the assets of HP's Video Communications Division, including key technologies and intellectual property, the MediaStream family of products and selected additional assets, as well as most managers and employees. In consideration, Pinnacle paid HP $12.6 million in cash and issued 773,172 shares of its common stock valued at $20.6 million. The Company incurred acquisition costs of approximately $0.4 million for a total purchase price of $33.6 million and assumed liabilities totaling $4.7 million. Pursuant to a stock restriction and registration rights agreement entered into by the parties, Pinnacle filed with the Securities and Exchange Commission a registration statement on Form S-3 with respect to one-half of the Pinnacle Shares issued to HP. HP has agreed to certain restrictions with respect to the disposition of the remainder of such shares. The acquisition was accounted for under the purchase method of accounting. Accordingly, the results of operations of VID and the fair market value of the acquired assets and assumed liabilities have been included in the financial statements of the Company as of August 2, 1999. As of August 2, 1999, the Company recorded $4.4 million in assets, $2.0 million in in-process research and development, $19.1 million in other identifiable intangibles including core/developed technology, customer base, trademarks, favorable contracts and assembled workforce, assumed $4.7 million in liabilities and allocated $12.8 million to goodwill. Goodwill represents the amount by which the cost of acquired net assets exceeds the fair values of the net assets on the date of purchase. Goodwill and other intangibles are being amortized using the straight-line method over periods ranging from six-months to five years. 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 within one year of the acquisition date, if any, will be recorded as adjustments to goodwill. APB 16 requires the preparation of a pro-form condensed statements of operations. Pro-forma statements are intended to represent a modification of historical financial statements as though a current event occurred at an earlier date. Separate, historical statements of operations for VID were never prepared by HP due to the de minimus nature of the VID business in proportion to HP as a whole. Thus, in order to derive such historical pro-forma information, Pinnacle would need to make assumptions based on current and forward-looking estimates. Such estimates could bear little relation to historical reality and could be misleading. Therefore, disclosure of such pro-forma condensed statements of operations have been omitted. Truevision 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 824,206 shares of common stock valued at $11.5 million. In addition, Pinnacle issued to Truevision employees and Directors 139,678 options, valued at $0.7 million, to purchase common stock at an exercise price of $11.98. The Company also assumed 53,836 warrants valued at $0.1 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 June 30, 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 $13.0 million in liabilities and allocated $13.2 million to goodwill. Goodwill and other intangibles are being amortized using the straight-line method over periods ranging from three to seven years. 8 The following table presents unaudited pro forma information as if Pinnacle and Truevision had been combined as of the beginning of the six-month period ended December 31, 1998. The pro forma data is presented for illustrative purposes only and is 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 said period. 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.
Pro Forma (in thousands, except per share amounts) Three-months Ended Six-months Ended December 31, 1998 December 31, 1998 ----------------- ----------------- Net revenue $ 45,651 $ 85,245 Net income 3,597 7,041 Net income per common share - basic $ 0.16 $ 0.33 Net income per common share - diluted $ 0.15 $ 0.30 Weighted average common share outstanding - basic 21,866 21,546 Weighted average common share outstanding - diluted 23,820 23,424
Shoreline 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 consolidated results. Analysis of In-Process Research and Development The portion of the Hewlett-Packard, Truevision and Shoreline purchase prices allocated to in-process research and development represent 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 these analyses and computations, $2.0 million, $6.2 million and $0.4 million were charged to operations at the date of acquisition for the Hewlett-Packard, Truevision and Shoreline acquisitions, respectively. 9 3. Supplemental Cash Flow Information The following table reflects supplemental cash flow from investing activities related to the March 1999 Truevision and Shoreline acquisitions combined and the VID acquisition from Hewlett-Packard in August 1999.
Fair value of (in thousands): Truevision Shoreline Total HP - ----------------------------- ---------- --------- ----- -- Assets acquired and goodwill $ 24,981 $ 754 $ 25,735 $ 38,294 Liabilities assumed and fees incurred (13,062) (250) (13,312) (5,065) Common stock, stock options and warrants issued (12,856) - (12,856) (20,632) -------- ----- -------- -------- Cash paid 504 504 12,597 Cash acquired (937) - (937) -------- ----- -------- -------- Net cash (received) paid on acquisitions $ (937) $ 504 $ (433) $ 12,597 ======== ===== ======== ========
4. Per Share Information For all periods presented, there were no adjustments to net income reported in the condensed consolidated statements of operations for determining net income used for basic and diluted earnings per share. The following table reconciles the denominators of the basic and diluted earnings per share computations shown on the Condensed Consolidated Statements of Operations:
Three-months Ended Six-months Ended December 31, December 31, (In thousands) 1999 1998 1999 1998 ---- ---- ---- ---- Basic EPS - weighted average shares of common stock outstanding 23,922 21,048 23,612 20,726 Effect of dilutive common equivalent shares - stock options outstanding 3,305 1,954 3,243 1,878 ----- ----- ----- ----- Diluted EPS - weighted average shares and common equivalent shares outstanding 27,227 23,002 26,855 22,604 ====== ====== ====== ======
5. Customers and Credit Concentrations During the three-month periods ended December 31, 1999 and 1998 and during the six-month period ended December 31, 1999, no customer accounted for greater than 10% of net sales. During the six-month period ended December 31, 1998, Ingram Micro, Inc. accounted for 11.0% of net sales. Ingram Micro, Inc. accounted for approximately 15.4% and 23.2% of accounts receivable at December 31, 1999 and June 30, 1999, respectively. 6. Development of Software for Internal Use Beginning in fiscal 1999, the Company commenced development and implementation of a worldwide information system based on SAP enterprise software. In January 1999, the Company reached the application development stage of the software implementation and began capitalizing costs associated with the SAP implementation project. As of December 31, 1999, the Company had capitalized approximately $2.7 million. The project is expected to be completed in the quarter ending March 31, 2000. 10 7. Segment Information The Company's organizational structure is based on three strategic business groups that sell various products into the principal markets which the Company's products are sold. These business groups equate to three reportable segments: Broadcast, Desktop, and Consumer. Management evaluates the performance of these business groups based on revenues gross profit and operating income before income taxes, interest income, interest expenses, and other income, excluding the effects of nonrecurring charges including in process research and development. Amortization of goodwill and other intangibles related to the Company's acquisitions is included in these results. The following is a summary of the Company's operations by operating segment (in thousands):
Three-months Ended Six-months Ended December 31 December 31, 1999 1998 1999 1998 ---- ---- ---- ---- Broadcast: Revenues $ 19,350 $ 5,254 $ 36,359 $ 11,846 Gross profit 11,914 2,942 22,759 6,599 Operating income (loss) $ 1,310 $ (1,084) $ 3,595 $ (1,393) Desktop: Revenues $ 25,346 $ 20,336 $ 49,892 $ 39,592 Gross profit 13,411 12,431 27,067 23,834 Operating income $ 2,706 $ 4,437 $ 5,621 $ 9,201 Consumer: Revenues $ 17,866 $ 13,582 $ 26,757 $ 20,007 Gross profit 6,822 5,602 10,468 7,802 Operating income (loss) $ 1,790 $ 1,823 $ 1,269 $ 1,231 Consolidated: Revenues $ 62,562 $ 39,172 $113 008 $ 71,445 Gross profit 32,147 20,975 60,294 38,235 Operating income $ 5,806 $ 5,176 $ 10,485 $ 9,039
The following table reconciles revenues and operating income (loss) to total consolidated amounts (in thousands):
Three-months Ended Six-months Ended December 31 December 31, 1999 1998 1999 1998 ---- ---- ---- ---- Total operating income for reportable segments $ 5,806 $ 5,176 $ 10,485 $ 9,039 In-process research and development - - (2,000) - --------- -------- --------- -------- Consolidated operating income $ 5,806 $ 5,176 $ 8,485 $ 9,039 ========= ======== ========= ========
11 8. Commitments and Contingencies On May 28, 1999, an action entitled Hot Key Pty Ltd. v. Pinnacle Systems, Inc., No. 99-20487 (RW) was filed against the Company in the United States District Court for the Northern District of California. The Complaint alleges that the Company breached a distribution agreement with the plaintiff, an Australian company, and alleges various legal causes of action, including fraud, breach of warranty, and breach of the implied covenant of good faith. The Complaint seeks compensatory and punitive damages of unspecified amounts. The Company has asserted a counterclaim for monies owed to it by the plaintiff. A trial date of June 12, 2000 has been set. The Company believes it has meritorious defenses to this action, and intends to vigorously defend itself. As of December 31, 1999, the potential liability, if any, cannot be assessed. Further, there can be no assurance, that if damages are ultimately awarded against the Company, that the financial position and results of operations of the Company will be unaffected. Item 2. Management's Discussion and Analysis of 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". Overview The Company primarily designs, manufactures, markets and supports video post-production tools for high quality real time video processing. These 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. The Company also manufactures, markets and sells products which allow users to watch television programming on their PC and recently, the Company introduced StreamGenie, a new portable Webcasting solution for streaming live video program over the Internet. The Company operates in three strategic business groups--Broadcast, Desktop and Consumer--that target the principal markets in which the Company's products are sold. 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. Currently, DVExtreme, Lightning, Deko, AlladinPRO and Thunder and Media stream servers comprise the Company's suite of high performance real time products designed for on-air, broadcast and high-end, post-production applications. In 1997, the Company commenced shipment of DVExtreme and Lightning. In the same year, the Company also completed the acquisition of the Deko titling and character generation product line from Digital Graphix, Inc. 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 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 1999, the Company commenced shipment of FXDeko; a high performance Windows NT-based product that combines the feature set of Deko with real time digital effect technology. In June 1999, the Company introduced Thunder, the Company's first multi-channel video and audio clip server and iThunder, a real time video server for Internet broadcasting. In August 1999, the Company 12 completed the acquisition of certain of the assets of the Hewlett-Packard Company including the Media Stream server family. Media Stream compliments the Thunder family in providing a complete line of broadcast quality video server solutions. The broadcast market accounted for approximately 30.9% and 13.4% of net sales in the three-month periods ended December 31, 1999 and 1998, respectively and 32.2% and 16.6% of net sales in the six-month periods ended December 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 has two general classes of desktop products. First, the digital video effects products which include the Alladin and Genie product families were released in 1994 and 1996 respectively. Second, the Company has released video capture and editing products, including the ReelTime, ReelTime Nitro, miroVIDEO DC30, miroVIDEO DC50 and miroVIDEO DV300/200 families. In March 1999, the Company completed its acquisition of Truevision, Inc. and added Truevision's TARGA branded products to its catalog. In April 1999, the Company began shipping DV200, its new low-cost DV-based video capture and editing solution. In June 1999, the Company began shipping DC1000, a new dual stream MPEG2 editing product and a companion DVD authoring option and in July 1999 began shipping the companion product DVD1000, which adds the capability to author fully featured DVD titles, one of the fastest growing delivery mediums for video. In December 1999, the Company began shipping DV500, a complete real-time, dual-stream, digital video production system based on the industry standard DV (IEEE 1394 or Firewire) format, providing customers with a native DV editing environment. Also in December 1999, the Company announced StreamGenie, a new portable Web casting solution for streaming live video programming over the Internet. The Company intends to initiate shipment of Stream Genie before the end of fiscal 2000. The desktop market accounted for approximately 40.5% and 51.9% of net sales in the three-month periods ended December 31, 1999 and 1998, respectively and 44.1% and 55.4% of net sales in the six-month periods ended December 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. As of December 31, 1999, the Company's consumer product line included Studio 400, Studio DC10, Studio MP10, Studio PCTV and PCTV USB, and Studio DV. The Company began shipping Studio DV in September 1999. Studio DV enables consumers to edit and create high-quality digital videos right on their PC by taking input directly from DV camcorders. In November 1999, the Company began shipping the USB version of its Studio PCTV. The new USB version is an external device that lets consumers watch TV, listen to FM radio and create their own videos on a PC. 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 consumer products are marketed as computer peripheral products. The consumer market accounted for approximately 28.6% and 34.7% of net sales in the three-month periods ended December 31, 1999 and 1998, respectively and 23.7% and 28.0% of net sales in the six-month periods ended December 31, 1999 and 1998, respectively. 13 Results of Operations Net Sales The Company's net sales increased 59.7% to $62.6 million in the three-month period ended December 31, 1999 compared to $39.2 million in the same period last year. Net sales increased 58.2% to $113.0 million in the six-month period ended December 31, 1999 compared to $71.4 million in the same period last year. Increase Quarter ended December 31: 1999 1998 (Decrease) ---- ---- ---------- Product Group Broadcast $19,350 $ 5,254 268.3% Desktop 25,346 20,336 24.6% Consumer 17,866 13,582 31.5% ------- ------ $62,562 $39,172 59.7% ======= ====== Increase Six-months ended December 31: 1999 1998 (Decrease) ---- ---- ---------- Product Group Broadcast $ 36,359 $11,846 206.9% Desktop 49,892 39,592 26.0% Consumer 26,757 20,007 33.7% -------- ------ $113,008 $71,445 58.2% ======== ====== Sales increased in all three product groups for the three and six-month periods ended December 31, 1999 over the same periods last year. The increase in Broadcast sales was primarily due to the sale of Media Stream products acquired by the Company from Hewlett-Packard in August 1999 in addition to sales of Thunder, released in June 1999 and increased sale of Deko products. For the desktop group, sales in the three-month period ended December 31, 1999 increased 24.6% over the same period last year and sales in the six-month period ended December 31, 1999 increased 26.0% over the same period last year. Decreased sales of Reel-time and DC30 were offset by higher OEM sales, sales of new products such as the DV500, DC1000 and the DVD1000 in addition to the sale of TARGA products, which were acquired from Truevision, Inc. in March 1999. In the consumer group, sales in the three-month period ended December 31, 1999 increased 31.5% over the same period last year and sales in the six-month period ended December 31, 1999 increased 33.7% over the same period last year. Decreased sales of Studio 400 were offset by increased sales of PCTV and DC10 and sales of new products such as Studio MP10 and Studio DV. International Sales. International sales (sales outside of North America) increased 19.1% in the three-month period ended December 31, 1999 compared to the three-month period ended December 31, 1998 and accounted for approximately 57% and 72% of these periods net sales respectively. International sales increased 25.6% in the six-month period ended December 31, 1999 compared to the six-month period ended December 31, 1998 and accounted for approximately 53% and 67% 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. Pinnacle distributes and sells its products to end users through the combination of independent domestic and international dealers and value added resellers ("VARs"), retail distributors, OEMs and, to a lesser extent, a direct sales force. Sales to dealers, VARs, 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. Cost of sales consists primarily of costs related to the procurement of components and subassemblies, labor and overhead associated with procurement, assembly and testing of finished products, warehousing, shipping, warranty costs, royalties and post sale customer support costs. For the three-month periods ended December 31, 1999 and 1998, cost of sales were 48.6% and 46.5%, respectively while for the six-month period ended December 31, 1999 and 1998 cost of sales were 46.6% and 46.5%, respectively. The increase in cost of sales in the December 1999 quarter was primarily due to a large mixture of consumer products sold in the December holiday quarter. 14 Engineering and Product Development. Engineering and product development expenses include costs associated with the development of new products and enhancements of existing products and consist primarily of employee salaries, benefits, depreciation and the cost of development tools. Engineering and product development expenses increased 86.3% to $6.2 million in the three-months ended December 31, 1999 from $3.4 million during the comparable three-month period in the prior year. The Company's engineering and product development expenses increased 83.6% to $12.2 million in the six-months ended December 31, 1999 from $6.7 million during the six-months ended December 31, 1998. As a percentage of sales, engineering and product development expenses increased to 10.0% in the quarter ended December 31, 1999 from 8.6% in the quarter ended December 31, 1998, and to 10.8% from 9.3% in the six-months ended December 31, 1999 and 1998, respectively. The increase was due primarily to the personnel hired in connection with the Truevision and Hewlett-Packard acquisitions in addition to normal growth. 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 located in Mountain View and Grass Valley, California; Paramus, New Jersey; Gainesville, Florida; Braunschweig, Germany; Indianapolis, Indiana and Salt Lake City, Utah. Sales and Marketing. Sales and marketing expenses include compensation and benefits for sales and marketing personnel, commissions paid to independent sales representatives, trade show expenses, advertising and promotional expenses including channel marketing funds and professional fees for marketing services. Sales and marketing expenses increased by 34.3% to $13.8 million in the three-month period ended December 31, 1999 from $10.3 million during the comparable three-month period in the prior year. The Company's sales and marketing expenses increased 38.4% to $25.5 million in the six-months ended December 31, 1999 from $18.5 million in the six-month period ended December 31, 1998. These increases period over period reflect the Company's investment in infrastructure focused on increasing product awareness and market share and on expanding product lines. Although sales and marketing expenditures have increased significantly year to year, as a percentage of net sales expenditures have fallen to 22.1% from 26.3% in the three-month periods ending December 31, 1999 and 1998, and to 22.6% from 25.8% in the six-month periods ending December 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 consist primarily of salaries and benefits for administrative, executive, finance and MIS personnel, occupancy costs and other corporate administrative expenses. General and administrative expenses increased to $2.3 million for the three-months ended December 31, 1999 from $1.9 million for the three-months ended December 31, 1998 and decreased as a percentage of total revenues to 3.6% in the fiscal 1999 period from 4.8% in the fiscal 1999 period. General and administrative expenses increased to $5.0 million for the six-months ended December 31, 1999 from $3.4 million for the six-months ended December 31, 1998 and decreased as a percentage of total revenues to 4.4% in the fiscal 1999 period from 4.8% in the fiscal 1998 period. The increase in the absolute dollar amount of general and administrative expenses was primarily due to increased staffing and associated expenses necessary to manage and support the Company's increased scale of operations. The Company anticipates that for the near future, its general and administrative expenses as a percentage of total revenues should remain at approximately the same percentage as in the first six-months of fiscal 2000. Amortization of Acquisition--Related Intangible Assets. Amortization of acquisition related intangibles consists of goodwill from acquisitions and other identifiable intangibles including core/developed technology, customer base, trademarks, favorable contracts and assembled workforce amongst others. These assets are being amortized using the straight-line method over periods ranging from six-months to nine years. The amortization increased over 1000% from $0.3 million in the three-month period ended December 31, 1998 to $4.0 million in the three-month period ended December 31, 1999 and 928% from $0.7 million to $7.1 million in the six-month periods ended December 31, 1999 and 1998, respectively. These increases are due primarily to the amortization of goodwill and other intangibles acquired in the Truevision and Shoreline acquisitions in March 1999 and the acquisition of the Video Communications Division from the Hewlett-Packard Company in August 1999. In-Process Research and Development. During the six-month period ended December 31, 1999, the Company recorded an in process research and development charge of $2.0 million relating to the acquisition of certain assets of the Video Communications Division of the Hewlett-Packard Company ("HP"). 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. 15 The acquired in-process research and development from HP relates to the development of the next generation of Media Stream products. At the date of acquisition, revenues attributable to these future products were projected for purposes of valuing the acquired in-process research and development. Although 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 research and development 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 and Other, Net. Interest income and other, net consists primarily of interest income generated from the Company's low risk investments in money market funds, government securities and high-grade commercial paper. In the three-months ended December 31, 1999 and 1998, net interest income was $0.8 million and $1.1 million respectively. In the six-months ended December 31, 1999 and 1998, net interest income was $1.6 million and $2.3 million respectively. The decrease reflects a reduction in the Company's cash and marketable securities due primarily to the payment of $12.6 million to HP in connection with the Company's acquisition of HP's video server business. In addition, cash flows generated from Pinnacle's foreign operations and invested overseas obtain lower interest yields than investments made domestically. Income Tax Expense. Income taxes are composed of federal, state and foreign income taxes. The Company recorded a provision for income taxes of $1.2 million and $1.3 million for the three-month periods ended December 31, 1999 and 1998, respectively. The Company recorded a provision for income taxes of $1.9 million and $2.3 million for the six-month periods ended December 31, 1999 and 1998 respectively. The Company has provided a valuation allowance for a portion of its deferred tax assets as it is presently unable to conclude that all of the deferred tax assets are more likely than not to be realized. Total valuation allowance was $6.2 million as of June 30, 1999. As of June 30, 1999, the Company has federal research and experimentation carryforwards of $0.7 million which expire between 2012 and 2014, and state research and experimentation credit carryforwards of $60,000 which have no expiration provision. As of June 30, 1999, the cumulative amount of unremitted earnings of non-U.S subsidiaries on which the Company had not provided U.S taxes approximated $4.5 million. The additional taxes that could arise if those earnings were to be remitted to the U.S. would not be material. It is management's intent that these earnings remain indefinitely invested. 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 December 31, 1999, the Company's principal sources of liquidity included cash, cash equivalents and marketable securities totaling approximately $89 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 $10.0 million in cash during the six-month period ended December 31, 1999. This was primarily attributable to the Company's net income of $19.2 after adjusting for depreciation and in-process research and development. This was partially offset by an increase in accounts receivable and, to a lesser extent, inventories. Increases in these areas are related to the Company's overall growth. During the six-month period ended December 31, 1999, cash flow from investing activities included $5.1 million invested in property and equipment, compared to $2.9 million in the six-months ended December 31, 1998. The higher level of expenditures for the six-months ended December 31, 1999 were primarily for leasehold improvements, furniture and equipment purchased for the Company's Mountain View facility expansion in August 1999 to accommodate increased headcount related to the HP acquisition and $1.7 million in capitalized expenditures related to the its implementation of an SAP enterprise software system. The Company will continue to incur expenditures for the software implementation through March 2000. As the Company continues to grow, it expects to incur 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 HP acquisition payment, which totaled $12.6 million. On August 2, 1999, the Company completed the purchase of HP's Video Communications Division. Under the terms of an asset purchase agreement dated June 30, 1999, Pinnacle Systems acquired substantially all of the assets of the 16 Video Communications Division, including key technologies and intellectual property, the MediaStream family of products and selected additional assets, as well as most managers and employees. In consideration, Pinnacle paid HP $12.6 million in cash and issued 773,172 shares of Pinnacle's common stock valued at $20.6 million. The Company incurred acquisition costs of approximately $0.4 million for a total purchase price of $33.6 million and assumed liabilities totaling $4.7 million. Factors Affecting Operating Results [ ] We have grown rapidly and expect to continue to grow rapidly. If we fail to effectively manage this growth, our financial results could suffer. We have experienced rapid growth and anticipate that we will continue to grow at a rapid pace in the future. For example, net sales in fiscal 1999 were $159.1 million compared to $105.3 million in fiscal 1998, a 51% increase, and net sales in the first six months of fiscal 2000 were $113.0 million compared with $71.4 million in the first quarter of fiscal 1999. As a result of internal growth and recent acquisitions, we have increased the number of employees significantly over the last two fiscal years and many are geographically dispersed, primarily throughout North America and Europe. This growth places increasing demands on our management, financial and other resources. We have built resources and systems to account for such growth, but continued or accelerated growth may require us to increase our investment in such systems, or to reorganize our management team. Such changes, should they occur, could cause an interruption or diversion of focus from our core business activities and have an adverse effect on financial results. [ ] Any failure to successfully integrate the businesses we have acquired could negatively impact us. In August 1999, we acquired the Video Communications Division of the Hewlett-Packard Company and in March 1999, we completed the acquisitions of Truevision, Inc and Shoreline Studios, Inc. We may in the near- or long-term pursue acquisitions of complementary businesses, products or technologies. Integrating acquired operations is a complex, time-consuming and potentially expensive process. All acquisitions involve risks that could materially and adversely affect our business and operating results. These risks include: - Distracting management from the day-to-day operations of our business - Costs, delays and inefficiencies associated with integrating acquired operations, products and personnel - The potential to result in dilutive issuance of our equity securities - Incurring debt and amortization expenses related to goodwill and other intangible assets [ ] There are various factors which may cause our net revenues and operating results to fluctuate. Our 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 our 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 our products are sold - Increased competition and pricing pressure - Accuracy of our and our resellers' forecasts of end-user demand - Accuracy of inventory forecasts - Ability to obtain sufficient supplies from our 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 recent economic downturns in Asia and Latin America. We also experience 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, we attend a number of annual trade shows which can influence the order pattern of products, including CEBIT in March, the NAB convention held in April, and the IBC 17 convention held in September. Our operating expense levels are based, in part, on our expectations of future revenue and, as a result, net income would be disproportionately affected by a shortfall in net sales. Due to these factors, we believe that quarter-to-quarter comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indicators of future performance. [ ] Our stock price may be volatile. The trading price of our 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 us, our customers or competitors - Changes in securities analysts' recommendations - Announcements of acquisitions - Changes in earnings estimates made by independent analysts - General fluctuations in the stock market Our 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 our common stock. With the advent of the Internet, new avenues have been created for the dissemination of information. The Company has no control over the information that is distributed and discussed on electronic bulletin boards and investment chat rooms. The motives of the people or organizations that distribute such information may not be in the best interest of the Company and its shareholders. This, in addition to other forms of investment information including newsletters and research publications, could result in a sharp decline in the market price of our 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 our 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 us, it is possible that similar litigation could be brought against us. 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 us to significant liabilities. [ ] We are dependent on contract manufacturers and single or limited source suppliers for our components. If these manufacturers and suppliers do not meet our demand either in volume or quality, then we could be materially harmed. We rely on subcontractors to manufacture our desktop and consumer products and the major subassemblies of our broadcast products. We and our manufacturing subcontractors are dependent upon single or limited source suppliers for a number of components and parts used in our products, including certain key integrated circuits. Our 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, we will have to identify and qualify acceptable replacements or redesign our products with different components. Additional sources may not be 18 available and product redesign may not be feasible on a timely basis. This could materially harm our 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 our business. [ ] We may fail to sell products in the consumer market. We entered the consumer market with the acquisition of the VideoDirector product line from Gold Disk in June 1996. We aim to continue to invest resources to develop, market and sell products into the consumer market. In this endeavor, we need to continue to develop and maintain the following capabilities: - Marketing and selling products through the consumer distribution channels. - Establishing relationships with distributors and retailers - A fully developed infrastructure to support electronic retail stores and telephone and Internet orders. Additionally, factors beyond our control could hurt consumer product sales and consequently our financial condition. These factors include: - Potential compatibility problems with other manufacturers' electronic components - The risk of obsolete inventory and inventory returns - Difficulty in predicting the growth of the consumer video market [ ] If our products do not keep pace with the technological developments in the rapidly changing video post-production equipment industry, then we 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, our inability 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 our business, particularly on a quarterly basis. We are critically dependent on the successful introduction, market acceptance, manufacture and sale of new products that offer our customers additional features and enhanced performance at competitive prices. Once a new product is developed, we 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 us 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. 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 we do not effectively compete, our business will be harmed. The market for our products is highly competitive. We compete in the broadcast, desktop and consumer video production markets. We anticipate 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 our 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 19 Certain competitors in the broadcast, desktop and consumer video markets have larger financial, technical, marketing, sales and customer support resources, greater name recognition and larger installed customer bases than we do. In addition, some competitors have established relationships with current and potential customers of ours and offer a wide variety of video equipment that can be bundled in certain large system sales. Principal competitors in the broadcast market include: Accom, Inc. Chyron Corporation Leitch Technology Corporation Matsushita Electric Industrial Co. Ltd. Quantel Ltd. (a division of Carlton Communications Plc) SeaChange Corporation Sony Corporation Tektronix, Inc. Principal competitors in the desktop and consumer markets are: Accom, Inc. Adobe Systems, Inc. Avid Technology, Inc. Digitel Processing Systems, Inc. Fast Multimedia Hauppauge Digital, Inc. Matrox Electronics Systems, Ltd. Media 100, Inc. Quantel Ltd. (a division of Carlton Communications Plc) Sony Corporation These lists are not all-inclusive. The consumer market in which certain of our 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 our consumer products by providing some or all of the same features and video editing capabilities. In addition, we expect that existing manufacturers and new market entrants will develop new, higher performance, lower cost consumer video products that may compete directly with our consumer products. We expect that potential competition in this market is likely to come from 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 our business. [ ] We rely heavily on dealers and OEMs to market, sell, and distribute our products. In turn, we depend heavily on the success of these resellers. If these resellers do not succeed in effectively distributing our products, then our financial performance will be negatively affected. These resellers may: - Not effectively promote or market our products - Experience financial difficulties and even close operations Our dealers and retailers are not contractually obligated to sell our products. Therefore, they may, at any time: - Refuse to promote or pay for our products - Discontinue our products in favor of a competitor's product 20 Also, with these distribution channels standing between them and the actual market, we may not be able to accurately gauge current demand for products and anticipate demand for newly introduced products. For example, dealers 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, we have expanded our 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. We also sell our 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 us to the following risks, some of which are out of our control: - We are obligated to provide price protection to such retailers and distributors and, while the agreements limit the conditions under which product can be returned to us, we may be faced with product returns or price protection obligations. - The distributors or retailers may not continue to stock and sell our consumer products. - Retailers and retail distributors often carry competing products. Any of the foregoing events could materially harm our business. [ ] If certain of our key employees leave or are no longer able to perform services for us, it could have a material adverse effect on our business. We may not be able to attract and retain a sufficient number of managerial personnel and technical employees to compete successfully. We believe that the efforts and abilities of our senior management and key technical personnel are very important to our continued success. Only one has an employment agreement and none are the subject of key man life insurance. Our success is dependent upon our 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. We may not be able to retain our 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 our employ and subsequently compete against us, or contractors may perform services for competitors of ours. If we are unable to retain key personnel, our business could be materially harmed. [ ] We may be unable to protect our proprietary information and procedures effectively. We must protect our proprietary technology and operate without infringing the intellectual property rights of others. We rely on a combination of patent, copyright, trademark and trade secret laws and other intellectual property protection methods to protect our proprietary technology. In addition, we generally enter into confidentiality and nondisclosure agreements with our employees and OEM customers and limit access to and distribution of our proprietary technology. These steps may not protect our proprietary information nor give us any competitive advantage. Others may independently develop substantially equivalent intellectual property or otherwise gain access to our trade secrets or intellectual property, or disclose such intellectual property or trade secrets. If we are unable to protect our intellectual property, our business could be materially harmed. [ ] We may be adversely affected if we are sued by a third party or if we decide to sue a third party. 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 us, to protect our trade secrets, trademarks and other intellectual property rights owned by us, or to defend us against claimed infringement. The Company is also exposed to litigation arising from disputes in the ordinary course of business. This litigation may - Divert management's attention away from the operation of our business - Result in the loss of our proprietary rights - Subject us to significant liabilities - Force us to seek licenses from third parties - Prevent us from manufacturing or selling products. Any of these results could materially harm our business. 21 In the course of business, we have in the past received communications asserting that our products infringe patents or other intellectual property rights of third parties. We investigated the factual basis of such communications and negotiated licenses where appropriate. It is likely that in the course of our business, we 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 our products, or relating to current or future technologies, we 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 we sell products internationally, we are subject to additional risks. Sales of our products outside of North America represented approximately 53% of net sales in the six-month period ended December 31, 1999 and 61% of net sales in the year ended June 30, 1999. We expect that international sales will continue to represent a significant portion of our net sales. We make foreign currency denominated sales in many, primarily European, countries. This exposes us 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 and 1999, especially for sales of consumer and desktop products into Europe. In fiscal 2000 and beyond, we expect that a majority of our 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 - Political instability - Trade restrictions - Changes in tariffs - Difficulties in staffing and managing international operations - Potential insolvency of international dealers and difficulty in collecting accounts We are also subject to the risks of generally poor economic conditions in certain areas of the world, most notably Asia. These risks may harm our future international sales and, consequently, our business. 22 Future Y2K problems could hurt our business As of the date of this filing, we have not incurred any business disruptions nor any significant product issues as a result of Year 2000 issues. However, while no such occurrence has developed as of the date of this filing to our knowledge, Year 2000 issues may not become apparent as of this date and therefore, there is no assurance that the Company will not be affected by future disruptions. The Company will continue to monitor the issue vigilantly and work to remedy any issues that arise. It is uncertain to what extent we will be affected by the year 2000 problem, however, if the Company or its customers or if third parties or suppliers experience year 2000 problems, our business may be materially 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, Japan 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 offset 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 U.S. Treasury Notes and high-grade commercial 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 1. Legal Proceedings On May 28, 1999, an action entitled Hot Key Pty Ltd. v. Pinnacle Systems, Inc., No. 99-20487 (RW) was filed against the Company in the United States District Court for the Northern District of California. The Complaint alleges that the Company breached a distribution agreement with the plaintiff, an Australian company, and alleges various legal causes of action, including fraud, breach of warranty, and breach of the implied covenant of good faith. The Complaint seeks compensatory and punitive damages of unspecified amounts. The Company has asserted a counterclaim for monies owed to it by the plaintiff. A trial date of June 12, 2000 has been set. The Company believes it has meritorious defenses to this action, and intends to vigorously defend itself. As of December 31, 1999, the potential liability, if any, cannot be assessed. Further, there can be no assurance, that if damages are ultimately awarded against the Company, that the financial position and results of operations of the Company will be unaffected. 24 Item 4. Submission of Matters to a Vote of Security Holders On October 26, 1999, the Company held its Annual Meeting of Shareholders for which it solicited votes by proxy. The following is a brief description of the matters voted upon at the meeting and a statement of the number of votes cast for and against, and the number of abstentions. There were no broker non-votes with respect to item 1 below. 1. To elect seven directors to serve until the next Annual Meeting of Shareholders and until their successors are duly elected and qualified. VOTES NOMINEE VOTES WITHHELD ------- ----- -------- Mark L. Sanders 19,941,069 523,794 Ajay Chopra 19,938,669 526,194 L. Gregory Ballard 19,940,805 524,058 John Lewis 19,941,055 523,808 L. William Krause 19,939,031 525,832 Glenn E. Penisten 19,941,069 523,794 Charles J. Vaughan 19,941,069 523,794 2. To approve an amendment to the 1996 Stock Option Plan to increase the number of shares of Common Stock reserved for issuance thereunder by 800,000 shares. The meeting was adjourned without approval of this proposal. On Friday, November 12, 1999, the meeting was reconvened with respect to this proposal only. The vote was as follows: FOR: 9,004,279 AGAINST: 12,374,496 ABSTAIN: 15,800 BROKER NON-VOTES: 0 3. To ratify the appointment of KPMG LLP as independent auditors of the Company for the fiscal period ending June 30, 2000. FOR: 20,461,075 AGAINST: 1,948 ABSTAIN: 7,082 BROKER NON-VOTES: 0 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: 27.1 Financial Data Schedule (b) Reports on Form 8-K On August 13, 1999 the Company filed a report on Form 8-K announcing the Company's acquisition of the Video Communications Division of the Hewlett-Packard Company. On October 15, 1999 the Company filed a report on Form 8-K/A relating to the Company's acquisition of the Video Communications Division of the Hewlett-Packard Company. The October filing amended the Form 8-K filing made on August 13, 1999 in order to file required financial statement disclosure of the acquired business and pro-forma financial statement disclosure. 25 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: February 11, 2000 By: /s/Mark L. Sanders ----------------------- Mark L. Sanders President and Chief Executive Officer Date: February 11, 2000 By: /s/Arthur D. Chadwick -------------------------- Arthur D. Chadwick Vice President, Finance and Administration and Chief Financial Officer (principal financial and accounting officer) 26 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: February 11, 2000 By: ------------------------------------------------ Mark L. Sanders President and Chief Executive Officer Date: February 11, 2000 By: ----------------------------------------------- Arthur D. Chadwick Vice President, Finance and Administration and Chief Financial Officer (principal financial and accounting officer) EX-27 2 FINANCIAL DATA SCHEDULE
5 6-MOS JUN-30-2000 JUL-01-1999 DEC-31-1999 60,449,000 28,428,000 45,266,000 4,728,000 23,375,000 168,991,000 20,326,000 6,072,000 238,060,000 35,650,000 0 0 0 198,116,000 (3,496,000) 238,060,000 113,008,000 113,008,000 52,714,000 52,714,000 51,809,000 0 (1,612,000) 10,097,000 1,918,000 8,179,000 0 0 0 8,179,000 0.35 0.30
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