10-K 1 0001.txt FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K |X| Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended June 30, 2000 or |_| Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ________________ to _______________. Commission file number: 0-24784 PINNACLE SYSTEMS, INC. (Exact name of registrant as specified in its charter) California 94-3003809 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 280 North Bernardo, Mountain View, CA 94043 (Address of principal executive office) (zip code) Registrant's telephone number, including area code: (650) 526-1600 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class On which registered ------------------- ------------------- None None Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value Preferred Share Purchase Rights (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X__ No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.|_| The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock on September 13, 1999 as reported on the Nasdaq National Market System, was approximately $586,513,116. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of September 13, 2000, registrant had outstanding 50,798,641 shares of Common Stock. DOCUMENTS INCORPORATED BY REFERENCE The Registrant has incorporated by reference into Part III of this Form 10-K portions of its Proxy Statement for Registrant's Annual Meeting of Shareholders to be held October 30, 2000. PART I Special Note Regarding Forward-Looking Statements Certain statements in this Report constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, the following: the Company's ability to manage growth; the risks associated with successfully integrating acquired businesses; the risks associated with dependence on resellers, contract manufacturers and other third-party relationships; the uncertainty of continued market acceptance of professional video products; significant fluctuations in the Company's operating results; the historical absence of backlog; the Company's highly competitive industry and rapid technological change within the Company's industry; the risks associated with development and introduction of new products; the need to manage product transitions; the risks associated with product defects and reliability problems; the risks associated with single source suppliers; the uncertainty of patent and proprietary technology protection and reliance on technology licensed from third parties; the risks of third party claims of infringement; the Company's dependence on retention and attraction of key employees; the risks associated with future acquisitions; the risks associated with international licensing and operations; general economic and business conditions; and other factors referenced in this Report. ITEM 1. BUSINESS Pinnacle Systems, Inc. (the "Company") is a supplier of video authoring, storage, distribution and Internet streaming solutions for broadcasters, business and professional "desktop" users, and consumers. Pinnacle's products are used to create, store, and distribute video content from television programs, TV commercials, pay-per-view, sports videos, corporate films to home movies. In addition, Pinnacle's products are increasingly being used to stream video over the Internet. Expanding distribution channels including cable television, direct satellite broadcast, video-on-demand, digital video disks (DVD) and the Internet have led to a rapid increase in demand for video content. This increasing demand for content to supply new and existing distribution channels is driving a need for affordable, easy-to-use video creation, storage, distribution and streaming tools. The Company's products use real time video processing and editing technologies to apply a variety of video post-production and on-air functions to multiple streams of live or recorded video material. These editing applications include the addition of special effects, graphics and titles. To address the broadcast market, the Company offers high performance, specialized computer based solutions for high-end, production, post-production, team sports analysis, broadcast on-air and Internet streaming applications. For the desktop market, the Company provides computer based video editing and media creation products, products used to create video content and solutions used to stream live and recorded video over the Internet. To address the consumer market, the Company offers low cost, easy to use video editing and viewing solutions that allow consumers to view TV on their computer and to edit their home videos using a personal computer, camcorder and VCR. Many of the Company's consumer products enable content to be created that is suitable for the Internet. Industry Background The development of a video program involves three distinct processes: pre-production, which involves planning and preparation for the recording of the video program; production, which involves the 2 acquisition of video material (shooting); and post-production, which involves the organization of raw video segments acquired in the production phase into a cohesive and appealing program (editing). During the post-production phase, elements such as titles, graphics, and transitions between video segments are incorporated to enhance the overall quality and impact of a video program. Historically, the video production industry has focused on providing program material for broadcast television and advertising. To create high quality video programs, producers have traditionally used expensive, dedicated video production equipment linked together in a complex interconnected system to form a "video-editing suite." Typical editing suites incorporate video recorders, switchers, digital video affects systems, still image management systems, character generators, electronic paint systems and other products, often provided by multiple manufacturers. These editing suites require highly skilled personnel to operate and maintain. Recently, new and expanding channels of video content distribution, including cable television, direct satellite broadcast, video rentals, CD-ROM, DVD, video-on-demand, and now the Internet, have led to a rapid increase in demand for video content for a wide variety of applications. This demand has driven the market for editing approaches that are less expensive and easier to use. New commercial and industrial applications for this market include multimedia entertainment, video games, music videos, special event videos, education and training and corporate communications. In addition, the popularity of camcorders, VCRs and personal computers has fueled the growth of an emerging consumer market for low cost video production technology that enables consumers to create and edit home videos. These expanding channels of video content distribution and new applications are increasing the demand for video content production and distribution tools. Computer-based video solutions combining personal computers with specialized video processing technology can now provide video quality comparable to that of traditional editing suites at significantly lower cost. As a result, these computer-based video solutions are replacing the traditional editing suites. In addition, such solutions are often easier to use since they incorporate common graphical user interfaces. The lower cost and ease of use of computer-based video tools enable large numbers of creative individuals, previously untrained in video production, to produce professional quality video programming. This programming can be used in traditional ways, such as broadcasting over the air, via satellite, or used in homes and businesses, and now the Internet provides entirely new channels and ways of communicating through the use of video. With the widening deployment of broadband networks, video on the Interet has expanded tremendously. The use of the Internet has already enjoyed remarkable growth. The Internet has rapidly transitioned from text to still images and now to video, as users demonstrate an appetite for more information, presented in more persuasive and powerful ways. Video on the Internet is fundamentally different than television. Broadcast, cable and satellite delivery systems are ideal for reaching very broad markets, delivering content with mass appeal. Video over the Internet represents a basic shift in how we can communicate by providing the ability to affordably reach narrow targeted markets, anywhere in the world. Streaming video on the Internet is still in its infancy, but as broadband capability expands, these limitations should diminish, and the ability to create, store, stream and display high-quality video on the web will be an essential element for high-quality communications and entertainment. The Pinnacle Approach The Company designs, manufactures, markets and supports computer-based video products to serve the broadcast, desktop and consumer markets. The Company's products are based on its proprietary software and hardware technologies that offer the following benefits: 3 Sophisticated Video Processing. Pinnacle's products provide advanced video processing and manipulation capabilities, such as the creation and addition of special effects, graphics and titles. Videographers constantly seek effects to give their programs a new look and to allow them to differentiate and enhance their end product. Real Time Interactivity. Pinnacle's products allow users to create video productions in real time. This real time interactivity gives users the flexibility to try many different effects and fine-tune the resulting content. Open Systems. Pinnacle's products conform to generally accepted industry standards for video input/output and control, allowing interoperability with a wide variety of video processing and storage equipment. Furthermore, the Company has developed and published, and is encouraging others to adopt, open interface specifications for computer-based video post-production products. These specifications include video input/output, manipulation and control. Ease of Use. Pinnacle's products include menu-driven interfaces for selecting and controlling the various video manipulation functions. This reduces technical obstacles to the operation of the system, permitting the user to focus on the artistic aspects of the post-production process. Favorable Price/Performance Ratio. Pinnacle's products have a favorable price to performance ratio, in part because the Company uses the same proprietary components across its product lines. The Company intends to continue lowering the cost of its products by further integrating its video manipulation and video capture technologies into application specific integrated circuits ("ASICs"). Operating Structure. The Company is organized into three separate business groups to serve the broadcast, desktop and consumer markets. The Company believes this organizational structure enables it to effectively address varying product requirements, rapidly implement its core technologies, efficiently manage different distribution channels and anticipate and respond to changes in each of these markets. Company Strategy Pinnacle's goal is to take advantage of the growing traditional and Internet video opportunities and become the leading supplier of solutions for the creation, storage, streaming and viewing of video for a wide variety of purposes and applications. As broadband capability continues to increase, the need to create, store, stream and view high-quality video becomes more urgent. Pinnacle Systems has a proven ability to successfully migrate technology developed for broadcasters down to the desktop and even the consumer markets, and is now moving aggressively toward web based solutions in each of its businesses. To pursue its goal, the Company intends to implement the following strategies: Expand and Leverage Core Technologies. The Company intends to expand its core software and hardware technological base through both internal development and acquisitions. The Company uses a modular approach to product development. This allows it to leverage its investment in research and development across multiple product designs and minimize time to market. Establish an Industry Standard Video Processing Platform. The Company believes that as the desktop market continues to move toward an open architecture environment, companies will either provide an open architecture video-processing platform or develop end user editing applications. The Company's strategy is to establish an industry standard video-processing platform compatible 4 with a broad range of applications. The platform technology combines real time video manipulation, video capture technology and a unified API. Develop and Expand Worldwide Sales and Distribution Organization. The Company's sales organization focuses on a variety of distribution channels, including OEMs, value-added resellers, distributors, retail stores and other resellers. The Company believes that its development of a worldwide sales and distribution organization gives it a strategic advantage in the rapidly changing video post-production industry. The Company intends to persist in strengthening and developing this organization and to continue to develop strong strategic relationships with key OEMs and resellers. Acquire Complementary Businesses, Products and Technologies. The Company has grown and intends to continue to grow both internally as well as through the acquisition of complementary businesses, product lines or technologies. The Company frequently evaluates strategic acquisition opportunities that could enhance the Company's existing product offerings or provide an avenue for developing new complementary product lines. The Company believes that the video production industry is in a period of consolidation and that strategic acquisition opportunities may arise. For example, in August 1999, the Company completed the acquisition of certain assets of the Video Communications Division of the Hewlett-Packard Company. The HP business was integrated with Pinnacle's video server group to provide a broad and powerful suite of video server solutions for traditional broadcast and Internet applications. In March 2000 the Company acquired Puffin Designs, Inc. which provides an extended suite of video software applications, and combined with Pinnacle's titling, character generator and graphics applications, allows the Company to offer a very powerful and complete set of software tools that further enhance the Company's leading position in video content creation. In March 2000 and June 2000, the Company acquired Digital Editing Services, Inc. and Avid Sports, Inc., respectively, adding technology and software related to sports editing, and in April 2000, the Company acquired the Montage Group, a leading supplier of news editing systems to the broadcast market. Products The Company's products are designed to provide computer-based creation, streaming, storage and viewing products for broadcasters, professional "desktop" users and consumers. Broadcast Market For the broadcast market, the Company currently offers products that provide systems solutions to broadcasters. This includes products that provide real time digital effects, still image management and storage, and real time video character generation. Pinnacle also sells digital video servers for on-air video content distribution. These products generally include proprietary hardware and software and specialized control surfaces for rapid execution, especially for on-air applications. The primary broadcast products sold during fiscal 2000 were the DVExtreme, Lightning, Deko and Thunder and the Media Stream family of products. In addition, the Company sells BroadNet solutions, which is a network technology that enables the Company's broadcast products to be networked together for easy interoperability, and to exchange information through the Internet. In August 1999, the Company completed the acquisition of certain assets of the Video Communications Division of the Hewlett-Packard Company. The acquisition included key technologies, intellectual property, the MediaStream server family of products as well as most managers and employees from that division. The MediaSteam server family complements the Company's Thunder family, to provide a more complete line of broadcast quality video-server solutions. In March 2000 and in June 2000, the Company acquired DES and Avid Sports, respectively. These companies supply sports editing software used by professional and school teams around the world. Combined, these businesses give Pinnacle a leading position in this important video market. In April 2000, the Company acquired the Montage Group, a leading supplier of news 5 editing systems to the broadcast market. In April 2000, the Company announced the PDS9000, which is a new digital video production switcher for live on-air broadcasts. DVExtreme Family. DVExtreme is the Company's high performance, real time digital video effects system for broadcast and high-end, post-production customers which seek to incorporate unique special effects into their programming. DVExtreme, a Windows NT-based, multi-channel system, can simultaneously manipulate up to three channels of live video and can generate real time effects such as four-corner page peels and turns, highlights and shadows, water ripples, ball effects, wave patterns and other visual effects. The suggested list price for a DVEtreme ranges from $44,990 to $63,990, depending on the configuration. Lightning Family. Lightning is the Company's high performance, networkable image management system designed for broadcast and high-end, post-production applications such as news and sports programs. Lightning is a Windows NT-based system that can accommodate up to three channels of video, plus additional virtual channels for previewing. It has internal storage capacity for over 10,000 images, and an interface to external disks for expanded capacity. Lightning can also perform digital video effects on captured video images. The suggested list price for a Lightning ranges from $25,990 to $31,780, depending on the configuration. Deko Family. The Deko family of products is designed to provide high performance titling, real time effects and character generation for broadcast and on-air applications. Deko is a Windows NT-based system that includes powerful text and graphics tools such as real time text scrolling, text manipulation, font enhancement, multiple layers for text composition and supports a wide range of standard and international character fonts. The suggested list price for a Deko ranges from $26,900 to $31,900, depending on the configuration. Thunder Family. The Thunder family of digital video servers is designed to record, store, retrieve and process digital video content for broadcast over conventional mediums or the Internet. The Thunder server family currently includes the four-channel Thunder MCS 4000 server, the two-channel MCS 2000 server, and iThunder. Thunder uses MPEG-2 and native DV video formats. Thunder's on-air application offers sophisticated asset management capabilities for identifying clips, transitions and stills and sequencing their play-out to air. By pairing the Thunder system with its Internet companion, iThunder, clips and programs can be instantly 'broadcast' over the World Wide Web. Through the iThunder HTML browser, remote Internet users can access and view video proxies via standard streaming technologies directly from their remote desktop location. The suggested list prices range from $11,000 to $69,000, depending on configuration. Media Stream Server Family. The Media Stream digital video server is designed to record, store, retrieve and process digital video content for broadcast over conventional mediums or the Internet. The Media Stream servers can handle up to 16 channels of MPEG-2 I/O. It includes a RAID disk expansion chassis that can be expanded to provide over 1000 hours of online storage. The RAIDs are protected with hot swappable power supplies and the entire system can be networked with high-speed Fibre channel to allow multiple servers to access the same content. The suggested list prices range from $11,000 to $69,000. PDS9000 Digital Video Switcher Family. The PDS 9000 family provides real time image processing for live on-air products. It includes nine integrated 3D digital effects systems, real time color correction, and is Broadnet compliant to provide the abilitiy to share graphic images over the Internet. The PDS9000 began production shipments in September 2000, and has a suggested list prices range from $89,000 to $110,000, depending on configuration. 6 Desktop Market The Company's desktop products are designed to provide video professionals tools to create high quality digital video productions and to distribute those products in the form of video tape, CD or DVD, or over the Internet. The Company has two general classes of desktop products: video creation and streaming products. The creation products allow users to create professional video productions and include the Alladin and Genie family of DVE's, the Reeltime family, DC30, DC50, DV500, DVD 2000 and the TARGA family of products. The streaming products allow users to send or "stream" live or previously recorded material over the internet and include the StreamGenie which is used to broadcast live events over the internet, and the StreamFactory, which encodes and streams previously recorded video content over the internet. The Company sells its desktop products through professional video dealers and through OEM arrangements. The primary OEM products are Genie and the TARGA family of products. OEM's who choose the TARGA family have a wide selection of configuration options to choose from. These options range from the TARGA 3200 with dual channel video capture, quad DVCPRO 50 decompression and 24 channel audio mixing, to less expensive versions without hardware codecs or audio DSP. A key competitive advantage of the Targa products is the robust real-time API written specifically for the TARGA 3000 family called CODI. The Company publishes an extensive software developers kit (SDK) for CODI and supports OEM and other developers through a dedicated Developer Services Group. Alladin and Genie Family. The Genie family of products offers a complete set of professional quality, real time 3D digital effects, switching, character generation, paint and still storage on a single personal computer interface ("PCI") board. While offering much of the functionality of Alladin, Genie does so at a much lower price point and is installed inside the computer rather than through an external port. GeniePlus integrates into linear desktop editing environments and includes input/output and software allowing the user to process up to two simultaneous streams of live video. In addition, a non-linear version of Genie is sold to OEM vendors who integrate and sell it with their non-linear editing products. A custom version of the GeniePlus is a key component of the Company's StreamGenie webcasting system. The suggested list price for a Genie is $5,990. ReelTime and ReeltimeNitro Family. ReelTime is a dual stream video and audio capture and playback card with real time special effects. ReelTime supports the Adobe Premiere editing software and additionally, ReelTime's open architecture is intended to support a wide variety of third-party video applications. ReelTime features real time transitions, along with real time chroma, luma and linear keying, titling, and a scalable architecture that supports the Company's Genie RT option. The Genie RT option incorporates the Pinnacle Genie add-in card and enables picture-in-picture motion and real time 3D effects, including page turns, ripples, spheres and hourglasses. This combined product has been named ReeltimeNitro. The suggested list price for Reeltime is $4,990 for an NTSC version and $5,990 for a PAL version. ReeltimeNitro lists for between $7,990 and $8,990. DC/DV Family. The DC/DV family of products is comprised of complete non-linear video and audio editing systems for professional videographers. These products include the DC 30, DC50, DV200, DV300, and DV500 product lines. The various products in this family consist of PCI-bus video capture and compression cards bundled with Adobe Premiere editing software. Different members of the DC/DV product line offer different combinations of composite video input/output, component video input/output, 1394 digital video input/output, and audio input/output. All targeted at the professional videographer products in the DC/DV family of video editing solutions are based on either the motion-JPEG, MPEG-2 or DV video compression/decompression standards. Some products in the DC/DV product family offer dual-stream playback with simultaneous real-time video effects. Products in the DC/DV family range in price from $499 to $1,999. 7 DVD Family. The DVD 2000 is a professional quality video encoding and editing solution with real-time editing and DVD output capabilities. It combines frame accurate dual stream MPEG-2 video editing and DVD authoring. The DVD2000 is designed for corporate, event, and professional digital video artists who create marketing presentations, product demonstrations, training, entertainment, or educational DVDs. The dual stream nature of the product allows higher productivity by reducing the need to render video segments to finish a production. The product uses Pinnacle's "Smart GOP" MPEG-2 technology, and is capable of real time processing of titles and transitions, including more than 300 real time video effects. The suggested list price is $9,990. The TARGA Family. In April 2000, the Company introduced TARGA 3000 and Targa Cine products based on the memory-centric HUB3 architecture, a Pinnacle-designed technology for very high bandwidth video processing. The TARGA products are designed to power the next generation of non-linear video and audio editing solutions targeted at professional videographers and digital content creation applications. These new TARGA products can support uncompressed video processing, multiple codec formats such as DV and MPEG2, variable picture resolutions and aspect ratios for both standard definition and high definition television, variable frame rates, and very high precision color processing in both YUB and RGB. The first retail model in the TARGA 3000 family is the TARGA 3100 single-slot PCI card. TARGA 3100 is capable of realtime wipes, dissolves, color correction, scaling, keying and compositing of up to three streams of uncompressed video with up to seven full-color graphics streams. The TARGA 3100 comes bundled with Adobe Premiere for non-linear editing, augmented with custom Pinnacle software for real time performance, a critical competitive advantage. List price is $6995 for a basic system. Targa Cine is designed for the Apple Macintosh platform and comes bundled with Pinnacle's Commotion Pro and Hollywod FX software packages. The combination of the TARGA Cine engine and these three software applications all working together under the QuickTime API will be marketed as CineWave, the next wave in digital cinema. CineWave is targeted at digital cinematographers, broadcast designers, post-production specialists, webcasters and special effects artists, as well as the large community of video and multimedia producers working exclusively on the Macintosh platform. The products require professional audio/video tools at an affordable price. The CineWave system has a list price of $7995 for standard definition. High definition systems, including the computer and a modest amount of storage, start as low as $30,000, a price low enough to change the economic model of high definition post-production and stimulate the wider adoption of these advanced digital video formats. StreamGenie Family. The Stream Genie is designed to broadcast live events over the internet. It is a portable internet broadcast station in a box and supports multiple camera switching, simultaneous output for the Internet and video archiving, integrated professional titling, graphics, 3-D video effects, pro-audio and built-in network I/O. StreamGenie is ideally suited for webcasting corporate events, distance learning, conferences and concerts in both Real Networks SureStream and Microsoft Windows Media formats. StreamGenie is more versatile, more powerful, better integrated, more compact, less expensive and easier to use than competitive products. List price ranges from $19,995 to $24,995 depending on system configuration. StreamFactory. The StreamFactory is a real-time web stream encoder that accepts professional video and audio inputs. StreamFactory supports multiple data rate output in either Microsoft Windows Media or Real Networks SureStream formats. Designed to be a rack-mounted realtime streaming encoder, StreamFactory can be configured remotely, either from a LAN, or from across the country. Simply connect a VTR, video camera, or other A/V source direct to StreamFactory and convert to popular streaming formats in real-time. Pinnacle has designed StreamFactory from the ground up expressly for the 24x7 demands of Internet broadcasters. The StreamFactory was announced in April 8 2000, but production units are not expected to begin shipping until November 2000. It is expected to have a suggested list price of approximately $10,000. Consumer Market The Company's consumer products allows consumers to edit their home video to create a professional looking "home movie" using a personal computer and camcorder. The Company has developed an easy to use software interface called the Studio application, which serves as the primary interface for all of the Studio products. The Company currently focuses on three Studio products: Studio DV, Studio DC10 and Studio PCTV. Studio DV. The Studio DV is a consumer non-linear editing system, which uses DV technology. Video can be downloaded from a DV camcorder directly onto the computer hard drive. With the use of the Studio software, users can "drop and drag" video clips in the order they desire, add simple transitions between scenes and simple graphic, titles and music or audio to the production. The suggested list price for the Studio DV is $99. Studio DC10. The Studio DC10 is a consumer non-linear editing system, which uses JPEG compression technology. It allows the users to load their video on to a computer hard drive using a single stream PCI-bus video product which captures, compresses and decompresses video signals using a standard computer. The suggested list price for the Studio DC10 is $99. Studio PCTV. The Studio PCTV allows users to view television programming on their computer monitor. The television program can be viewed alone or while the user is working on the computer or surfing the internet. The suggested list price is $99. Technology The Company is a technological leader in digital video processing, which includes real time video manipulation, video capture, digital video editing and storage. The National Academy of Television Arts and Sciences' Outstanding Technical Achievement EMMY award has been awarded to Pinnacle on three occasions. In 1990, the Company received an EMMY for pioneering the concept of the video workstation. In 1994, the Company received an EMMY for developing technology which allows real time mapping of live video onto animated 3D surfaces and, in 1997, the Company received an EMMY for utilization of real time video manipulation technology in non-linear editing applications. In addition, the technology that the Company acquired from Digital Graphix was awarded two Emmy's prior to its acquisition by the Company. Many of the Company's products share a common internal architecture. This design approach allows the Company to leverage its research and development expenditures by utilizing similar hardware and software modules in multiple products. The Company's video manipulation architecture is fundamental to the performance and capabilities of the Company's products. As a result of the acquisition of Miro Computer Products AG in August 1997, the Company acquired video capture technology which allows high quality live video and audio to be captured and played back from a standard personal computer. This technology was further developed within Pinnacle, and further augmented with the acquisition of Truevision in March 1999. All of the Company's products use or work with a standard personal computer for control of video manipulation functions. In all products targeting the broadcast market, the control microprocessor is embedded within the product. The desktop and consumer products are inserted into or connect externally to a personal computer. The use of industry standard microprocessors offers three main 9 advantages over traditional video products: lower software development costs due to the availability of powerful off-the-shelf software development tools; lower product manufacturing costs due to the low costs of standard microprocessors; and the ability to integrate third party software such as networking or 3D rendering software to provide additional functionality. Essentially all real time video manipulation must be performed on uncompressed video data. Since uncompressed digital video rates are too high to be processed by a microprocessor in real time, video signals are internally distributed over a separate high-speed digital video bus ("DVB") and processed using the Company's proprietary real time video manipulation hardware. The video data on the DVB is processed in the standard digital component format that fully complies with the highest digital component video standards of the International Radio Consultation Committee, an organization that develops and publishes standards for international telecommunication systems. The software in the Company's video capture and video manipulation products is divided into two layers: the user interface application and the API. The user interface application is different and has been optimized for each product family. The API is, for the most part, common to most of the Company's products and incorporates all the proprietary low level routines that allow the Company's products to perform high quality, real time video manipulations. This software architecture has three main advantages: real time video manipulation algorithms that are complex and difficult to develop can be used in multiple products; the user interface can be tailored to meet specific user requirements; and applications can be quickly ported to the Company's products using the API. The Company's core technical expertise is in real time digital video processing, video capture technology, real time software algorithms, video input/output, advanced user interfaces and software control of commercially available camcorders and VCRs. Real Time Digital Video Processing. The Company has devoted significant resources to the development of proprietary technology for real time video processing, including high-speed digital filters, image transformation buffers, plane and perspective addressing, and non-linear image manipulation. The Company has patented technology related to real time mapping of live video onto multiple, complex, animated 3D shapes and surfaces. This technology includes a proprietary data compression algorithm that compresses the address information and allows decompression of this data in real time. CODEC Technology. The Company has devoted significant resources to developing and acquiring hardware and software for real time video capture. This technology includes audio/video effect synchronization methodologies, compression algorithms, drivers and software for real time playback from disks. Real Time Software Algorithms. The digital video manipulation functions of the Company's products use common core software that performs complex computations in real time under user control. The Company has developed certain algorithms that enable the high-speed computation of multiple complex equations which are required for real time video effects. Video Input/Output. The Company has developed technology for video input and output of composite analog, component analog and component digital video data streams. All of the Company's products work with NTSC and PAL video standards. In addition, the Company has developed interfaces to support input/output of video streams stored on computer disks. 10 User Interface Design. The Company has extensive experience in the design of graphical user interfaces for video control and manipulation. The Company uses interactive, menu-driven user interfaces to control video manipulation functions. Camcorder and VCR Control. With the acquisition of the VideoDirector product line from Gold Disk, Inc. in June 1996, the Company obtained software code which enables a computer to control most commercially available camcorders and VCRs. The Company has historically devoted a significant portion of its resources to engineering and product development programs and expects to continue to allocate significant resources to these efforts. In addition, the Company has acquired certain products and technologies which have aided the Company's ability to more rapidly develop and market new products. The Company's future operating results will depend to a considerable extent on its ability to continually develop, acquire, introduce and deliver new hardware and software products that offer its customers additional features and enhanced performance at competitive prices. Delays in the introduction or shipment of new or enhanced products, the inability of the Company to timely develop and introduce such new products, the failure of such products to gain market acceptance or problems associated with product transitions could adversely affect the Company's business, financial condition and results of operations, particularly on a quarterly basis. As of June 30, 2000, the Company had 162 people engaged in engineering and product development. The Company's engineering and product development expenses (excluding purchased in-process research and development) in fiscal 2000, 1999 and 1998 were $27.8 million, $16.1 million and $11.7 million respectively, and represented 11.7%, 10.1% and 11.1%, respectively, of net sales. Customers End users of the Company's products range from individuals to major corporate and government entities, and to video production and broadcast facilities worldwide. Broadcast customers include domestic and international television and cable networks, local broadcasters and program creators. Desktop customers include corporations seeking to develop internal video post-production capabilities, professional videographers including those who cover weddings and other special events, and small production houses serving cable and commercial video markets. Marketing, Sales and Service Marketing The Company's marketing efforts are targeted at users of broadcast and desktop post-production suites, and home video editing enthusiasts. In order to increase awareness of its products, the Company attends a number of trade shows, the major ones being the National Association of Broadcasters ("NAB") show and the COMDEX exhibition, both in the United States, and the International Broadcasters Convention ("IBC") show and the CEBIT show in Europe. Pinnacle also uses targeted direct mail campaigns and advertisements in trade and computer publications for most of its product lines and also participates in joint marketing activities with its OEM partners and other desktop video companies. Sales The Company maintains a sales organization consisting of regional sales managers in the United States, Europe and other international territories. The Company currently has sales offices in 9 countries 11 worldwide. The regional sales managers are primarily responsible for supporting independent dealers and value added resellers (VARs) and making direct sales in geographic regions without dealer coverage. They also service customers who prefer to transact directly with the Company. The Company sells its broadcast and desktop products to end users through an established domestic and international network of independent video product dealers and VARs in addition to direct sales. The independent dealers and VARs are selected for their ability to provide effective field sales and technical support to the Company's customers. Dealers and VARs carry the Company's broadcast and desktop products as demonstration units, advise customers on system configuration and installation and perform ongoing post-sales customer support. The Company believes that many end users depend on the technical support offered by these dealers in making product purchase decisions. The Company continues to invest resources in developing and supporting its network of independent dealers and VARs. These groups eagerly promote the Company's products and considerably expand its market coverage. The Company also sells and distributes its desktop products to OEMs that incorporate the Company's products into their video editing products and resell these products to other resellers and end users. These OEMs generally purchase the Company's products and are responsible for conducting their own marketing, sales and support activities. The Company attempts to identify and align itself with OEMs that are market share and technology leaders in the Company's target markets. In recent years the Company has been dependent on sales of primarily Genie products to Avid Technologies, Inc. ("Avid") which is a leading supplier of digital, non-linear video and audio editing systems for the professional video and film editing market. However, sales to Avid as a percentage of total Company sales has declined or remained flat during the last three years. Sales to Avid accounted for approximately 7.3% of net sales in fiscal 2000, 6.8% of net sales in fiscal 1999, 10.7% of net sales in fiscal 1998. Though the concentration of the net sales to a single OEM customer has decreased substantially during the last three years, it still subjects the Company to risks, in particular the risk that its operating results can vary on a quarter-to-quarter basis as a result of variations in the ordering patterns of OEM customers. The Company's consumer or Studio products and certain lower priced desktop products are sold primarily through the consumer retail channel via large distributors, such as Ingram Micro Inc., and large computer and electronic retailers in addition to direct telemarketing, mail order and over the Internet. The consumer retail channel is characterized by long payment terms and sales returns. There can be no assurance that any particular computer retailers will continue to stock and sell the Company's consumer products. If a significant number of computer retailers were to discontinue selling those products or if sales returns are higher than anticipated, the Company's results of operations would be adversely affected. Sales into the consumer retail channel entail a number of risks including the limited experience of the Company in this market, inventory obsolescence, product returns and potential price protection obligations. Sales outside of North America represented approximately 55.0%, 60.8%, 57.6% of the Company's net sales for fiscal 2000, 1999, and 1998, respectively. The Company expects that sales outside of the United States will continue to account for a significant portion of its net sales. The Company makes foreign currency denominated sales in many countries, especially in Europe, exposing itself to risks associated with foreign currency fluctuations, though this risk is partially hedged since all local selling and marketing expenses are also denominated in those same currencies. International sales and operations may also be subject to risks such as the imposition of governmental controls, export license requirements, restrictions on the export of critical technology, political instability, trade restrictions, changes in tariffs, difficulties in staffing and managing international operations, potential insolvency of international dealers and difficulty in collecting accounts receivable. There 12 can be no assurance that these factors will not have an adverse effect on the Company's future international sales and, consequently, on the Company's business, financial condition and results of operations. Service and Support The Company believes that its ability to provide customer service and support is an important element in the marketing of its products. Its customer service and support operation also provides the Company with a means of understanding customer requirements for future product enhancements. The Company maintains an in-house repair facility and also provides telephone access to its technical support staff. The Company's technical support engineers not only provide assistance in diagnosing problems, but also work closely with customers to address system integration issues and to assist customers in increasing the efficiency and productivity of their systems. The Company supports its customers in Europe and Asia primarily through its international sales offices, European logistic center and local dealers. The Company typically warrants its products against defects in materials and workmanship for varying periods depending on the product and the nature of the purchaser. The Company believes its warranties are similar to those offered by other video production equipment suppliers. To date, the Company has not encountered any significant product maintenance problems. Competition The video production equipment market is highly competitive and is characterized by rapid technological change, new product development and obsolescence, evolving industry standards and significant price erosion over the life of a product. Competition is fragmented with several hundred manufacturers supplying a variety of products to this market. The Company anticipates increased competition in the video post-production equipment market from both existing manufacturers and new market entrants. Increased competition could result in price reductions, reduced margins and loss of market share, any of which could materially and adversely affect the Company's business, financial condition and results of operations. There can be no assurance that the Company will be able to compete successfully against current and future competitors. Competition for the Company's broadcast products is generally based on product performance, breadth of product line, service and support, market presence and price. The Company's principal competitors in this market include Chyron Corporation, Leitch Technology Corporation, Matsushita Electric Industrial Co. Ltd. ("Matsushita"), Quantel Ltd. (a division of Carlton Communications Plc) SeaChange Corporation, Sony Corporation ("Sony"), and Tektronix Inc., some of whom have greater financial, technical, marketing, sales and customer support resources, greater name recognition and larger installed customer bases than the Company. In addition, some of these companies have established relationships with current and potential customers of the Company. Some of the Company's competitors also offer a wide variety of video equipment, including professional video tape recorders, video cameras and other related equipment. In some cases, these competitors may have a competitive advantage based upon their ability to bundle their equipment in certain large system sales. The Company's competition in the desktop and consumer markets comes from a number of groups of video companies such as traditional video equipment suppliers, providers of desktop editing solutions, video software application companies and others. Suppliers of traditional video equipment such as Matsushita and Sony have the financial resources and technical know-how to develop high quality, real time video manipulation products for the desktop video market. Suppliers 13 of desktop video editing systems or components such as Avid, Matrox Electronics Systems, Ltd., Media100, Inc., have established desktop video distribution channels, experience in marketing video products and significant financial resources. The Company believes that the consumer video editing market is still emerging and as well the sources of competition. There are several established video companies that are currently offering products or solutions that compete directly or indirectly with the Company's consumer products by providing some or all of the same features and video editing capabilities. In addition, the Company expects that existing manufacturers and new market entrants will develop new, higher performance, lower cost consumer video products that may compete directly with the Company's consumer products. The Company may also face competition from other computer companies that lack experience in the video production industry but that have substantial resources to acquire or develop technology and products for the video production market. There can be no assurance that any of these companies will not enter into the video production market or that the Company could successfully compete against them if they did. Manufacturing and Suppliers The Company's manufacturing and logistics operations, located in Mountain View, California and Braunschweig, Germany, consist primarily of testing printed circuit assemblies, final product assembly, configuration and testing, quality assurance and shipping for the Company's broadcast and desktop products. Manufacturing of the Company's consumer and desktop products is performed by independent subcontractors from where products are often shipped directly to the distributor or retailer. Each of the Company's products undergoes quality inspection and testing at the board level and final assembly stage. The Company manages its materials with a software system that integrates purchasing, inventory control and cost accounting. The Company relies on independent subcontractors who manufacture to the Company's specifications its consumer and certain desktop products and major subassemblies used in the Company's broadcast and other desktop products. This approach allows the Company to concentrate its manufacturing resources on areas where it believes it can add the most value, such as product testing and final assembly, and reduces the fixed costs of owning and operating a full scale manufacturing facility. The Company has manufacturing agreements with a number of U.S.-based subcontractors which include Pemstar, Flash Electronics and Sales Link (formerly PacLink), for the manufacture of Company's consumer and desktop products, and with Streiff & Helmold GmbH, which is located in Braunschweig, Germany. The Company's reliance on subcontractors to manufacture products and major subassemblies involves a number of significant risks including the loss of control over the manufacturing process, the potential absence of adequate capacity, the unavailability of or interruptions in access to certain process technologies and reduced control over delivery schedules, manufacturing yields, quality and costs. In the event that any significant subcontractor were to become unable or unwilling to continue to manufacture these products or subassemblies in required volumes, the Company's business, financial condition and results of operations would be materially adversely affected. To the extent possible, the Company and its manufacturing subcontractors use standard parts and components available from multiple vendors. However, the Company and its subcontractors are dependent upon single or limited source suppliers for a number of key components and parts used in its products, including integrated circuits manufactured by Altera Corporation, AuraVision Corporation, C-Cube Microsystems, LSI Logic Corp., Maxim Integrated Products, Inc., National Semiconductor Corporation, Philips Electronics, Inc., Raytheon Corporation and Zoran 14 Corporation, boards and modules manufactured by Adaptec, Inc., and Sony, field programmable gate arrays manufactured by Altera Corporation, serial RAM memory modules manufactured by Hitachi, Ltd. and software applications from Adobe. The Company's manufacturing subcontractors generally purchase these single or limited source components pursuant to purchase orders placed from time to time in the ordinary course of business, do not carry significant inventories of these components and have no guaranteed supply arrangements with such suppliers. In addition, the availability of many of these components to the Company's manufacturing subcontractors is dependent in part on the Company's ability to provide its manufacturers, and their ability to provide suppliers, with accurate forecasts of its future requirements. The Company and its manufacturing subcontractors endeavor to maintain ongoing communication with their suppliers to guard against interruptions in supply. The Company and its subcontractors have in the past experienced delays in receiving adequate supplies of single source components. Also, because of the reliance on these single or limited source components, the Company may be subject to increases in component costs which could have an adverse effect on the Company's results of operations. Any extended interruption or reduction in the future supply of any key components currently obtained from a single or limited source could have a significant adverse effect on the Company's business, financial condition and results of operations in any given period. The Company's broadcast and desktop customers generally order on an as-needed basis. The Company typically ships its products within 30 days of receipt of an order, depending on customer requirements, although certain customers, including OEMs, may place substantial orders with the expectation that shipments will be staged over several months. A substantial majority of product shipments in a period relate to orders received in that period, and accordingly, the Company generally operates with a limited backlog of orders. The absence of a significant historical backlog means that quarterly results are difficult to predict and delays in product delivery and in the closing of sales near the end of a quarter can cause quarterly revenues to fall below anticipated levels. In addition, customers may cancel or reschedule orders without significant penalty and the prices of products may be adjusted between the time the purchase order is booked into backlog and the time the product is shipped to the customer. As a result of these factors, the Company believes that the backlog of orders as of any particular date is not necessarily indicative of the Company's actual sales for any future period. Proprietary Rights and Licenses The Company's ability to compete successfully and achieve future revenue and profit growth will depend, in part, on its ability to protect its proprietary technology and operate without infringing the rights of others. The Company relies on a combination of patent, copyright, trademark and trade secret laws and other intellectual property protection methods to protect its proprietary technology. In addition, the Company generally enters into confidentiality and nondisclosure agreements with its employees and OEM customers and limits access to and distribution of its proprietary technology. The Company currently holds a number of United States patents covering certain aspects of its technologies. Although the Company intends to pursue a policy of obtaining patents for appropriate inventions, the Company believes that the success of its business will depend primarily on the innovative skills, technical expertise and marketing abilities of its personnel, rather than upon the ownership of patents. Certain technology used in the Company's products is licensed from third parties on a royalty-bearing basis. Such royalties to date have not been, and are not expected to be, material. Generally, such agreements grant to the Company nonexclusive, worldwide rights with respect to the subject technology and terminate only upon a material breach by the Company. In the course of its business, the Company may receive and in the past has received communications asserting that the Company's products infringe patents or other intellectual property rights of third parties. 15 The Company's policy is to investigate the factual basis of such communications and to negotiate licenses where appropriate. While it may be necessary or desirable in the future to obtain licenses relating to one or more of its products, or relating to current or future technologies, there can be no assurance that the Company will be able to do so on commercially reasonable terms or at all. There can be no assurance that such communications can be settled on commercially reasonable terms or that they will not result in protracted and costly litigation. There has been substantial industry litigation regarding patent, trademark and other intellectual property rights involving technology companies. In the future, litigation may be necessary to enforce any patents issued to the Company, to protect its trade secrets, trademarks and other intellectual property rights owned by the Company, or to defend the Company against claimed infringement. Any such litigation could be costly and a diversion of management's attention, either of which could have material adverse effect on the Company's business, financial condition and results of operations. Adverse determinations in such litigation could result in the loss of the Company's proprietary rights, subject the Company to significant liabilities, require the Company to seek licenses from third parties or prevent the Company from manufacturing or selling its products, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. ITEM 2. PROPERTIES The Company's principal administrative, marketing, manufacturing and product development facility is located in Mountain View, California. This facility occupies approximately 106,000 square feet pursuant to a lease which commenced August 15, 1996 and which will terminate December 31, 2003. The Company also leases space in Braunschweig, Germany which houses engineering, administrative, logistics and marketing operations for the Company's consumer and desktop products. The Braunschweig lease expires in April 2004. The Company also houses certain engineering and support operations in Indianapolis, Indiana and Paramus, New Jersey. Additionally, the Company leases facilities in Lowell, Massachusetts and Orlando, Florida, which house operations for the Company's recently acquired sports businesses. The Company also maintains sales and marketing support offices in leased facilities in various other locations throughout the world. ITEM 3. LEGAL PROCEEDINGS On July 18, 2000, a lawsuit entitled Jiminez v. Pinnacle Systems, Inc. et al., No. 00-CV-2596 was filed in the United States District Court for the Northern District of California against the Company and certain officer and director defendants. The action is a putative class action and alleges that defendants violated the federal securities laws by making false and misleading statements concerning the Company's business prospects during an alleged class period of April 18, 2000 through July 10, 2000. The Complaint does not specify damages. The Company intends to defend the case vigorously. We are engaged in other legal actions arising in the ordinary course of business. We believe we have adequate legal defenses and that the ultimate outcome of these actions will not have a material effect on our financial position or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 16 Not Applicable. ITEM 4a. EXECUTIVE OFFICERS OF THE REGISTRANT
Name Age Position ---- --- -------- Mark L. Sanders.................. 57 President, Chief Executive Officer and Director Ajay Chopra...................... 43 Chairman of the Board, Vice President, General Manager, Desktop Products Arthur D. Chadwick............... 43 Vice President, Finance and Administration and Chief Financial Officer Georg Blinn...................... 54 Vice President, General Manager, Pinnacle Systems GmbH James E. Dunn.................... 55 Vice President, Consumer Marketing and Sales, Americas William Loesch................... 46 Vice President, General Manager, Consumer Products Robert Wilson.................... 46 Vice President, General Manager, Broadcast Products
There is no family relationship between any director or executive officer of the Company. Mr. Sanders has served as President, Chief Executive Officer and a director of the Company since January 1990. Mr. Chopra, a founder of the Company, has served as Chairman of the Board of Directors since January 1990, and has served as a director of the Company since its inception in May 1986. Mr. Chopra has served as Vice President, General Manager, Desktop Products since April 1997. He previously served as Chief Technology Officer from June 1996 to April 1997, Vice President of Engineering from January 1990 to June 1996, and President and Chief Executive Officer of the Company from its inception to January 1990. Mr. Chadwick has served as Vice President, Finance and Administration and Chief Financial Officer of the Company since January 1989. Mr. Blinn has served as Vice President, General Manager, Pinnacle Systems GmbH since August 1997. Prior to joining the Company, Mr. Blinn was the Chief Financial Officer of Miro AG, a provider of video capture cards, from December 1996 to August 1997. From January 1993 to December 1996, Mr. Blinn was an independent business consultant. Mr. Dunn has served as Vice President, Business and Consumer Marketing and Sales, Americas, since August 1999. From August 1996 to May 1999, Mr. Dunn served as Chief Operating Officer of the Automotive Performance Group, an automotive aftermarket marketing and distribution company. From April 1988 to February 1996, Mr. Dunn served as the Director of Business and Government Marketing for Apple Computer, Inc., a computer manufacturer. Mr. Loesch has served as Vice President, General Manager, Consumer Products since April 1997. Prior to that Mr. Loesch served as Vice President, New Business Development of the Company from May 1994 to April 1997. 17 Mr. Wilson has served as Vice President, Broadcast Products since April 1997. From May 1994 to April 1997, Mr. Wilson served as Executive Vice President, Chief Operating Officer and Chief Financial Officer of Accom, Inc., a video company. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Pinnacle Systems made its initial public offering on November 8, 1994. Its Common Stock is traded on the Nasdaq National Market under the symbol PCLE. The following table sets forth for the fiscal periods indicated the range of high and low sales prices per share of the common stock as reported on the Nasdaq National Market. ------------------------------------ ---------------------- ------------------- High Low ------------------------------------ ---------------------- ------------------- Fiscal Year Ended June 30, 2000 ------------------------------------ ---------------------- ------------------- First Quarter................. 21.190 13.000 ------------------------------------ ---------------------- ------------------- Second Quarter................ 23.000 12.940 ------------------------------------ ---------------------- ------------------- Third Quarter................. 35.500 19.000 ------------------------------------ ---------------------- ------------------- Fourth Quarter................ 31.438 18.438 ------------------------------------ ---------------------- ------------------- ------------------------------------ ---------------------- ------------------- Fiscal Year Ended June 30, 1999 ------------------------------------ ---------------------- ------------------- First Quarter................. 9.563 4.641 ------------------------------------ ---------------------- ------------------- Second Quarter................ 9.563 4.750 ------------------------------------ ---------------------- ------------------- Third Quarter................. 11.813 8.047 ------------------------------------ ---------------------- ------------------- Fourth Quarter................ 16.938 10.125 ------------------------------------ ---------------------- ------------------- ------------------------------------ ---------------------- ------------------- As of September 13, 2000 there were approximately 412 stockholders of record of the common stock. The Company has never paid cash dividends on its capital stock. The Company currently expects that it will retain its future earnings for use in the operation and expansion of its business and does not anticipate paying cash dividends in the foreseeable future. On February 4, 2000, the Company announced a two-for-one stock split of the Company's common shares. This was paid in the form of a 100% stock distribution on March 27, 2000 to stockholders of record on March 2, 2000. Accordingly, all share and per share data for the periods presented have been restated to reflect the stock split. During the quarter ended June 30, 2000, the Company issued an aggregate of approximately 1,069,437 shares of its common stock in exchange for the outstanding capital stock of the Montage Group, Ltd. and Avid Sports, Inc. The shares were issued pursuant to an exemption by reason of Section 4(2) of the Securities Act of 1933. These sales were made without general solicitation or advertising. Each purchaser was an accredited investor or a sophisticated investor (either alone or through its representative) with access to all relevant information necessary. ITEM 6. SELECTED FINANCIAL DATA 18 The following tables set forth selected consolidated financial data for each of the years in the five-year period ended June 30, 2000. The consolidated statements of operations data and balance sheet data are derived from the consolidated financial statements of Pinnacle Systems, Inc. and its subsidiaries, which have been audited by KPMG LLP, independent auditors. The results for the fiscal year ended June 30, 2000 are not necessarily indicative of the results for any future period. The selected consolidated financial data set forth below should be read in conjunction with the consolidated financial statements as of June 30, 2000 and 1999 and for each of the years in the three year period ended June 30, 2000 and notes thereto set forth on Pages F-1 to F-27 and "Management's Discussion and Analysis of Financial Condition and Results of Operations." CONSOLIDATED STATEMENTS OF OPERATIONS DATA: (In thousands, except per share data)
2000 1999 1998 1997 1996 --------- --------- --------- --------- --------- Net sales $ 237,967 $ 159,098 $ 105,296 $ 37,482 $ 46,151 Cost of sales 113,573 74,022 48,715 23,997 23,854 --------- --------- --------- --------- --------- Gross profit 124,394 85,076 56,581 13,485 22,297 --------- --------- --------- --------- --------- Operating expenses: Engineering and product development 27,767 16,137 11,652 7,579 5,140 Sales and marketing 56,126 38,871 28,365 12,464 8,907 General and administrative 10,554 6,840 5,342 3,702 2,186 Legal settlement 2,102 -- -- Amortization of goodwill and other intangibles 18,382 2,289 936 203 In process research and development 3,500 6,579 16,960 4,894 3,991 --------- --------- --------- --------- --------- Total operating expenses 118,431 70,716 63,255 28,842 20,224 --------- --------- --------- --------- --------- Operating income (loss) 5,963 14,360 (6,674) (15,357) 2,073 Interest income, net 3,403 4,742 3,139 2,867 3,345 --------- --------- --------- --------- --------- Income (loss) before income taxes 9,366 19,102 (3,535) (12,490) 5,418 Income tax expense (1,779) (666) (2,685) (2,445) (1,734) --------- --------- --------- --------- --------- Net income (loss) $ 7,587 $ 18,436 $ (6,220) $ (14,935) $ 3,684 ========= ========= ========= ========= ========= Net income (loss) per share Basic $ 0.16 $ 0.43 $ (0.17) $ (0.50) $ 0.13 ========= ========= ========= ========= ========= Diluted $ 0.14 $ 0.39 $ (0.17) $ (0.50) $ 0.12 ========= ========= ========= ========= ========= Shares used to compute net income (loss) per share Basic 48,311 42,780 35,628 29,608 28,632 ========= ========= ========= ========= ========= Diluted 55,442 46,966 35,628 29,608 31,212 ========= ========= ========= ========= ========= 2000 1999 1998 1997 1996 --------- --------- --------- --------- --------- CONSOLIDATED BALANCE SHEET DATA: (In thousands) Working capital $ 127,719 $ 120,325 $ 100,496 $ 57,662 $ 72,337 Total assets 322,799 196,469 132,937 70,007 84,561 Long-term debt -- -- 163 475 -- Retained earnings (accumulated deficit) 7,198 (389) (18,825) (12,605) 2,330 Shareholders' equity 259,620 166,259 114,392 62,711 80,198
19 ITEM 7. 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 Report on Form 10-K are forward-looking statements based on current expectations, including each of the last sentence of "Gross Profit", the last sentence of "Engineering and Product Development" and the last sentence of "General and Administrative" under "Comparison of the Years Ended June 2000 and 1999" and the last sentence of the first paragraph under "Liquidity and Capital Resources". These statements 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 Pinnacle Systems Inc. (the "Company") is a leading supplier of video authoring, storage, distribution and Internet streaming solutions for broadcasters, business and professional "desktop" users, and consumers. Pinnacle's products are used to create, store, and distribute video content from television programs, TV commercials, pay-per-view, sports videos, corporate films to home movies. Pinnacle's products are increasingly being used to stream video over the Internet. Expanding distribution channels including cable television, direct satellite broadcast, video-on-demand, digital video disks (DVD) and the Internet have led to a rapid increase in demand for video content. This increasing demand for content to supply new and existing is driving an urgent need for affordable, easy-to-use video creation, storage, distribution and streaming tools. The Company's products use real time video processing and editing technologies to apply a variety of video post-production and on-air functions to multiple streams of live or recorded video material. These editing applications include the addition of special effects, graphics and titles. To address the broadcast market, the Company offers high performance, specialized computer based solutions for high-end, production, post-production, team sports analysis, broadcast on-air, and Internet streaming applications. For the desktop market, the Company provides computer-based video editing and media creation products and products used to create video content and solutions used to stream live and recorded video over the Internet. To address the consumer market, the Company offers low cost, easy to use video editing and viewing solutions that allow consumers to view TV on their computer and to edit their home videos using a personal computer, camcorder and VCR. Many of the Company's consumer products enable users to create content that is suitable for the Internet. Acquisitions Avid Sports, Inc. On June 30, 2000, the Company acquired all the outstanding common stock of Avid Sports, Inc., a leading provider of sports editing and online sports media management solutions ("ASports"). In connection with the acquisition, Pinnacle issued 944,213 shares of its common stock valued at $22.7 million and assumed 138,158 options valued at $1.9 million. Pinnacle also incurred approximately $350,000 in transaction costs. In September 2000, the Company agreed to issue additional stock to certain former shareholders of ASports if the closing price of the Company's Common stock does not equal or exceed $23 per share for four consecutive trading days prior to May 31, 2001. If the share price does not reach this level, the value of the additional shares to be issued shall be equal to 944,213 multiplied by the difference between the average closing stock during the month of May 2001 and $23 per share. 20 The acquisition was accounted for under the purchase method of accounting. Accordingly, the results of operations of ASports and the fair market value of the acquired assets and liabilities assumed have been included in the consolidated financial statements of the Company as of June 30, 2000. On June 30, 2000, the Company recorded $5.8 million in tangible assets and $13.4 million in other identifiable intangibles including core/developed technology, customer base and other intangibles, assumed $15.5 million in liabilities, including $5.4 million in deferred taxes, and allocated $21.2 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 identifiable intangibles are being amortized using the straight-line method over five-year and three-year periods respectively. Propel Ahead, Inc. On June 30, 2000, the Company acquired all the outstanding common stock of Propel Ahead, Inc. a provider of sports editing and online sports media management solutions ("Propel"). In connection with the acquisition, Pinnacle agreed to pay the former shareholder of Propel $3.2 million. Pinnacle also incurred approximately $100,000 in transaction costs. The acquisition was accounted for under the purchase method of accounting. Accordingly, the results of operations of Propel and the fair market value of the acquired assets and liabilities assumed have been included in the consolidated financial statements of the Company as of June 30, 2000. On June 30, 2000, the Company recorded $0.1 million in tangible assets and $3.0 million in identifiable intangibles including core/developed technology assumed $1.3 million in liabilities including $1.2 million in deferred taxes, and allocated $1.5 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 identifiable intangibles are being amortized using the straight-line method over five-year and three-year periods respectively. Montage Group, Ltd. On April 7, 2000 the Company acquired all the outstanding common stock of Montage Group, Ltd., a provider of networked non-linear editing solutions ("Montage"). In connection with the acquisition, Pinnacle issued 125,224 shares of its common stock valued at $3.7 million ("initial payment") and incurred approximately $325,000 in transaction costs. The terms of the acquisition also included an earnout provision wherein the former shareholders of Montage could receive additional consideration, net of the initial payment, upon achieving certain gross margin levels for each year of a two-year period beginning April 7, 2000. Gross margins ranging between 40% to 50% of revenues would result in an additional payout of between 100% to 150% of related revenues respectively. However, in the second year of the earnout, assuming the 40% gross margin threshold has been met, consideration will be paid only to the extent that the second year earnout calculation exceeds that of the first year. No earnout payment will be made in either year if gross margins do not exceed 40% of revenues exclusively. Earnout payments, if any, will be paid in shares of the Company's common stock. The acquisition was accounted for under the purchase method of accounting. Accordingly, the results of operations of Montage and the fair market value of the acquired assets and assumed liabilities have been included in the consolidated financial statements of the Company as of April 7, 2000. On April 7, 2000, the Company recorded $2.8 million in tangible assets, $0.4 million in in-process research and development, $1.6 million in other identifiable intangibles including core/developed technology and assumed $4.2 million in liabilities and allocated $3.5 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 identifiable intangibles are being amortized using the straight-line method over five-year and three-year periods, respectively. 21 Digital Editing Services, Inc. On March 30, 2000 the Company acquired all the outstanding common stock of Digital Editing Services, Inc., a provider of real-time video analysis and database solutions ("DES"). In connection with the acquisition, Pinnacle paid $300,000 in cash and issued 287,752 shares of its common stock valued at $9.1 million ("initial payment")and incurred $270,000 in transaction costs. The terms of the acquisition include an earnout provision wherein the former shareholders of DES could receive additional consideration, net of the initial payment, upon achieving certain profitability levels for the one-year period ending March 30, 2001 ("earnout period"). Operating profits for DES ranging between 10% to 20% of revenues would result in an additional payout of between 100% to 175% of those associated revenues respectively. No earnout payment will be made if operating profit does not exceed 10% of revenues during the earnout period. Any earnout will be paid in shares of the Company's common stock. The acquisition was accounted for under the purchase method of accounting. Accordingly, the results of operations of DES and the fair market value of the acquired assets and assumed liabilities have been included in the consolidated financial statements of the Company as of March 30, 2000. As of March 30, 2000, the Company recorded $1.8 million in tangible assets, $0.5 million in in-process research and development, and $8.2 million in other identifiable intangibles including core/developed technology assumed $4.6 million in liabilities, including $3.3 million in deferred taxes, and allocated $3.8 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 identifiable intangibles are being amortized using the straight-line method over five-year and three-year periods, respectively. Puffin Designs, Inc. On March 24, 2000, the Company acquired all the outstanding common stock of Puffin Designs, Inc., a provider of content creation solutions ("Puffin"). In connection with the acquisition, Pinnacle issued 360,352 shares of its common stock valued at $11.2 million. In addition, Pinnacle assumed outstanding stock options and warrants representing 51,884 and 4,155 shares of stock respectively and valued at $336,000. The acquisition has been accounted for under the purchase method of accounting. Accordingly, the results of operations of Puffin and the fair market value of the acquired assets and assumed liabilities have been included in the consolidated financial statements of the Company as of March 24, 2000. As of March 24, 2000, the Company recorded $0.5 million in tangible assets, $0.6 million in-process research and development, $1.2 million in identifiable intangibles including core/developed technology assumed $1.7 million in liabilities and allocated $11.2 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 identifiable intangibles are being amortized using the straight-line method over five-year and three-year periods, respectively. Synergy, Inc. On January 11, 2000, the Company acquired all the outstanding common stock of Synergy, Inc. makers of the popular, award-winning Hollywood FX software for video content creation applications ("Synergy"). In connection with the acquisition, Pinnacle paid Synergy $200,000. The acquisition was accounted for under the purchase method of accounting. Accordingly, the results of operations of Synergy and the fair market value of the acquired assets and liabilities assumed have been 22 included in the financial statements of the Company as of January 11, 2000. Goodwill of $233,500 is being amortized using the straight-line method over a five-year period. Video Communications Division of 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 VID, 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 1,546,344 shares of its common stock valued at $20.6 million. The Company incurred acquisition costs of approximately $0.5 million for a total purchase price of $33.6 million and assumed liabilities totaling $10.1 million. 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 $7.3 million in tangible 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 $10.1 million in liabilities and allocated $15.4 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 nine months to five years. 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, the Deko line 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, which began shipping in September 1999, TypeDeko and WriteDeko and has recently announced additional products including FXDekoHD, a high definition character and graphics generator, HDDeko500, a real-time high definition character generator, and ClipDeko, an integrated clip option for the Company's complete line of character generators. In March 2000, the Company began shipping Rocket for FXDEko, a template-based tool that allows the generation of real-time 3D elements that can be automatically updated by live data streams. 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 completed the acquisition of VID from HP including the Media Stream server family. Media Stream compliments the Thunder family in providing a complete line of broadcast quality video server solutions. In February 2000, the Company introduced MediaStream 300, the newest member of the MediaStream family. The MediaStream 300 offers the high-quality, reliable playback and the 23 comprehensive networking needed by today's broadcasters in an extremely compact, two-rack-unit package that is more affordable and more space efficient than previous MediaStream servers. On April 7, 2000, Pinnacle announced the acquisitions of DES a provider of real-time video analysis and database solutions, and Montage, a provider of networked non-linear editing solutions. On June 30, 2000 the Company announced the acquisition of ASports, a leading provider of sports editing and online sports media management solutions. VorteXNews(TM) from Montage, gives users the ability to ingest, edit, store, broadcast and stream to the Internet live news and sports content entirely in the digital domain. The video solutions from ASports and DES have been chosen by many leading professional and college teams for their video server and image database needs. These newly acquired companies are expected to form the basis of Pinnacle's new Totally Networked News(TM) solutions family to create powerful and comprehensive media management, editing and streaming solutions for broadcasters and sports organizations. The broadcast market accounted for approximately 36.0%, 16.9% and 24.2% of net sales in the fiscal years ended June 30, 2000, 1999 and 1998, respectively. Desktop Market The Company's desktop products are designed to provide high quality video capture, compression and 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 equipment included in traditional editing suites and are integrated into the computer by a value-added reseller, an OEM, or the end user. The Company traditionally has had two general classes of desktop products - digital video effects products and video capture and editing products. In January 2000, Pinnacle announced the formation of its new webcasting solutions business within its desktop products group, emphasizing the Company's drive to introduce a suite of solutions for the internet media-streaming marketplace. Digital video effects products which include the Alladin and Genie product families were released in 1994 and 1996 respectively. The Company's class of video capture and editing products, including ReelTime, ReelTime Nitro, miroVIDEO DC30, miroVIDEO DC50, miroVIDEO DV300/200 families and the TARGA family. In June 1999, the Company began shipping DC1000, a 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. 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. In January 2000, Pinnacle acquired Synergy, makers of Hollywood FX software for video content creation applications. Hollywood FX products are currently being bundled with Pinnacle's DV500 or sold separately. In March 2000, the Company acquired Puffin a provider of content creation solutions. Puffin has developed and sells an advanced set of software tools for real-time paint, rotoscoping and visual motion tracking. In June 2000, the Company began shipping Commotion 3.0 and TARGA 3000. Commotion 3.0, developed by Puffin, is an all-in-one solution that combines the power of the paintbrush with intuitive composting and effects tools to deliver superior performance on the desktop. TARGA 3000 is the Company's newest content creation and streaming platform. TARGA 3000 allows users to choose processing in DV, MPEG-2 or true uncompressed digital 601 format, and even lets them mix these formats on a single timeline. The system delivers three real-time uncompressed video streams, plus five real-time graphics streams simultaneously. For its class of webcasting solutions, in December 1999, the Company announced StreamGenie, a new portable Web casting solution for streaming live video programming over the Internet. The 24 Company began shipping StreamGenie in June 2000. In March 2000, the Company announced the StreamFactory(TM) Web Media Encoder that targets Internet broadcasters who require real-time web encoding of live or previously produced content. The desktop market accounted for approximately 42.7%, 56.5% and 57.5% of net sales in the fiscal years ended June 30, 2000, 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 (PC), camcorder and VCR. In addition, the Company recently announced a solution for capturing, editing and sharing video over the Internet. The Company also sells a product line that allows consumers to watch TV, listen to FM radio and create their own videos on a PC. As of June 30, 2000, the Company's consumer product line included 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, a device that lets consumers watch TV, listen to FM radio and create their own videos on a PC. Consumer products are distributed directly 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 21.3%, 26.6% and 18.3% of net sales in the fiscal years ended June 30, 2000, 1999 and 1998, respectively. Results of Operations The following table sets forth, for the periods indicated, certain consolidated statement of operations data as a percentage of net sales:
Fiscal Years Ended June 30, --------------------------- 2000 1999 1998 ---- ---- ---- Net sales 100.0% 100.0% 100.0% Cost of sales 47.7 46.5 46.3 ------ ------ ------ Gross profit 52.3 53.5 53.7 Operating expenses: Engineering and product development 11.7 10.1 11.1 Sales and marketing 23.6 24.4 26.9 General and administrative 4.4 4.3 5.1 Legal settlement 0.9 - - Amortization of goodwill and other intangibles 7.7 1.5 0.9 In-process research and development 1.5 4.1 16.1 ------ ------ ------ Total operating expenses 49.8 44.4 60.1 ------ ------ ------ Operating income (loss) 2.5 9.1 (6.4) Interest income, net 1.4 3.0 3.0 ------ ------ ------ Income (loss) before income taxes 3.9 12.1 (3.4) Income tax expense 0.7 0.4 2.5 ------ ------ ------ Net income (loss) 3.2% 11.7% (5.9)% ====== ====== ======
25 The tables below include sales data by business group: Net Sales Fiscal Years Ended June 30, '00 - '99 '99 - '98 Group 2000 1999 1998 % Change % Change ----- ---- ---- ---- -------- -------- Broadcast $ 85,618 $ 26,917 $ 25,521 218.1% 5.5% Desktop 101,698 89,798 60,335 13.3% 48.8% Consumer 50,651 42,383 19,440 19.5% 118.0% -------- -------- -------- ---- ---- $237,967 $159,098 $105,296 49.6% 51.1% ======== ======== ======== ==== ==== Sales Percentages Group 2000 1999 1998 ----- ---- ---- ---- Broadcast 36.0% 16.9% 24.2% Desktop 42.7% 56.5% 57.5% Consumer 21.3% 26.6% 18.3% ------ ------ ------ 100.0% 100.0% 100.0% ====== ====== ====== Comparison of the Years Ended June 30, 2000 and 1999 Net Sales. Net sales increased in all three product groups in the fiscal year ended June 30, 2000, compared to fiscal 1999. Broadcast sales increased 218.1% primarily due to the sale of products obtained through acquisition. These included the sale of MediaStream products acquired from Hewlett-Packard and from sports and news solutions acquired from DES, Asports, and Montage. In the desktop group, sales increased 13.3% in the fiscal year ended June 30, 2000, over fiscal 1999. Sales of new generation products such as DV500 and DC1000 plus the sale of TARGA products acquired from Truevision, Inc. in March 1999 more than compensated for a decrease in sales of DC30, DV300, DC50 and Reel-time. In the consumer group, sales increased 19.5% in the fiscal year ended June 30, 2000 over fiscal 1999. Decreased sales of Studio 400 were offset by sales of newer products such as Studio DV, Studio USB1 and Studio MP10. International sales (sales outside of North America) increased 35.4% in the fiscal year ended June 30, 2000 and accounted for approximately 55.0% and 60.8% of the Company's net sales in fiscal 2000 and 1999, respectively. The increase in absolute sales in fiscal 2000 was derived primarily from increased sales into the United Kingdom and the Asia Pacific regions. Sales into continental Europe also increased. As a percentage of Pinnacle's total net sales, international sales decreased primarily due to an increase in domestic sales from the broadcast group. The Company expects that international sales will continue to represent a significant portion of its total net sales. 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, the channel of distribution, the volume of product purchased, and other factors. Cost of sales consists primarily of costs 26 related to the procurement of components and subassemblies, labor and overhead associated with procurement, assembly and testing of finished products, inventory management, warehousing, shipping, warranty costs, royalties, provisions for obsolescence and shrinkage. In the fiscal year ended June 30, 2000, total gross profit decreased to 52.3% from 53.5% in the fiscal year ended June 30, 1999. While broadcast margins increased slightly from year to year, desktop margin dropped to 52.5% from 59.5% in the fiscal years ended June 30, 2000 and 1999, respectively. The drop in desktop margin was primarily due to a change in product mix. Broadcast margins increased slightly due to a favorable product mix which included sales of Media Stream products. Consumer margins for the fiscal year ended June 30, 2000 were generally unchanged from fiscal 1999. The Company has experienced and expects to continue to experience pricing pressures on its products as the industry matures and competition increases. 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 and benefits, prototype and development expenses, depreciation and facility costs. Engineering and product development expenses increased 72.1% to $27.8 million in the fiscal year ended June 30, 2000 from $16.1 million in fiscal 1999. As a percentage of sales, engineering and product development expenses were 11.7% in the fiscal year ended June 30, 2000 versus 10.1% in fiscal 1999. The increase was due primarily to the personnel hired in connection with the HP and Truevision acquisitions which occurred in August 1999 and March 1999, respectively. Pinnacle believes that investment in research and development is crucial to its future growth and position in the industry. In addition to the Company's recent acquisitions which added research and development facilities in Orlando, Florida (DES), New York City (Montage), and Lowell Massachusetts (ASports), the Company expects to continue to allocate significant resources to all of its engineering and product development locations including Mountain View, Grass Valley and Sausalito, 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, travel, advertising and promotional expenses including channel marketing funds and trade shows, and professional fees for marketing services. Sales and marketing expenses increased 44.4% to $56.1 million in the fiscal year ended June 30, 2000 from $38.9 million last fiscal year. These increases reflect expenditures to achieve the Company's goal of increased sales and market share and expanded product awareness. Sales and marketing expenses also increased due to acquisitions, notably the video communications division of Hewlett Packard, expanded operations in Japan and new expenditures in connection with product releases. Although sales and marketing expenditures increased significantly year to year, as a percentage of net sales, expenditures dropped to 23.6% in fiscal 2000 from 24.4% in fiscal 1999. This decrease reflects a growth in sales exceeding incremental sales and marketing expenditures. 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 54.3% to $10.6 million in the fiscal year ended June 30, 2000 from $6.8 million in the fiscal year ended June 30, 1999. As a percentage of total revenue, general and administrative expenses were 4.4% and 4.3% in the fiscal years ended June 30, 2000 and 1999, respectively. The increase in the absolute dollar amount of general and administrative expenses was primarily due to increased investment necessary to manage and support the Company's increased scale of operations. These included staffing and associated benefits, non-capitalized expenses related to the Company's new SAP information system, and legal and professional fees. The Company anticipates that for the near future, its general and administrative expenses, excluding the legal settlement, as a percentage of net sales, should remain at approximately the same percentage as in fiscal 2000. In-Process Research and Development. During the year ended June 30, 2000, the Company recorded an in-process research and development charge of approximately $3.5 million mostly related to the acquisitions of the VID from HP, Puffin, DES and Montage. During the year ended June 30, 1999, the 27 Company recorded an in-process research and development charge of approximately $6.6 million mostly related to the Truevision acquisition. The amounts charged to in-process research and development were based on results of independent appraisals using established valuation techniques in the high-technology industry. 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 product's 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 technological feasibility was achieved when a product reached beta stage. The values assigned to purchased in-process research and development were 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 using a risk-adjusted discount rate and then 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. A discount and attribution rate of 35% was used in the VID valuation and a 30% rate was used on the valuations of Puffin, DES and Montage. Amortization of Acquisition - Related Intangible Assets. Amortization of acquisition related intangibles consists of amortization of goodwill and 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 nine-months to nine years. The amortization increased from $2.3 million in the fiscal year ended June 30, 1999 to $18.4 million in the year ended June 30, 2000. This increase is due primarily to the amortization of goodwill and other intangibles acquired in the Truevision and VID acquisitions March and August 1999, respectively. Interest Income, net. Net interest income and other 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 fiscal year ended June 30, 2000, interest income decreased approximately 28.2% to $3.4 million from $4.7 million in fiscal 1999. The decrease reflects a reduction in the Company's cash and marketable securities due to an acquisition payment of $12.6 million paid to HP in August 1999. In addition, positive 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 comprised of federal, state and foreign income taxes. The Company recorded provisions for income taxes of $1.8 million and $0.7 million for the fiscal years ended 2000 and 1999, respectively. The provision for income taxes as a percentage of pretax income was 19% and 3.5%, respectively. The tax rates in both fiscal years ended 2000 and 1999 are lower than the statutory tax rate mainly due to the reduction of the Company's valuation allowance. The tax rate in fiscal year 1999 was significantly lower than the rate in fiscal year 2000 as a larger portion of valuation allowance was written down during fiscal 1999. The tax rate in fiscal year 2000 was also increased by nondeductible in-process R&D and goodwill amortization as a result of various acquisitions during the year. The total valuation allowance was $9.3 million and $6.2 million as of June 30, 2000 and 1999, respectively. As of June 30, 2000, the Company had federal and state net operating loss carryforwards of approximately $13.9 million and $5.7 million , respectively. The Company's federal net operating loss carryforwards expire in the years 2012 through 2020, if not utilized. The Company's state net operating loss expires in the years 2002 through 2005, if not utilized. In addition, the Company had federal research and experimentation credit carryforwards of $3.1 million which expire in the years 2001 through 2020, and state research and experimentation credit carryforwards of $2.3 million which have no expiration provision. 28 Comparison of the Years Ended June 30, 1999 and 1998 Net Sales. The Company's net sales increased 51.1% to $159.1 million in fiscal 1999 from $105.3 million in fiscal 1998. The increase is primarily attributable to increases in desktop and consumer product sales. Broadcast sales increased slightly and were augmented by the release of Thunder and FXDeko. Desktop sales in fiscal 1999 increased 48.8% over fiscal 1998. This was driven primarily by increased sales from existing products including the DC30, DC50, Reeltime and DV300 in addition to sales generated from new product releases notably the DC1000. Desktop sales also increased due to the acquisition of Truevision in March 1999 which added the TARGA and Ready-to-Edit products. Consumer sales increased 118.0% due to a full year of sales of the Studio 400 which was released at the end of fiscal 1998. Consumer sales also grew due to increased sales of PCTV and the introduction of Studio DC10 and Studio MP10. International Sales (sales outside of North America) were approximately 60.8% and 57.6% of the Company's net sales in fiscal 1999 and 1998, respectively. The increase in fiscal 1999 was primarily attributable to an increase in European sales of consumer products. The Company expects that international sales will continue to represent a significant portion of its net sales. Gross Profit. Cost of revenues consists primarily of costs associated with the procurement of components; tooling, assembly, testing, and distribution of finished products; warehousing; warranty and service costs; product reworks, provisions for inventory obsolescence and shrinkage, and royalties. The resulting gross profit fluctuates based on factors such as product mix, licensing fees or royalties paid to third parties, the offering of product upgrades, price discounts and other sales promotion programs, and the distribution channels through which products are sold. Gross profit as a percentage of net sales was 53.5% and 53.7% in fiscal 1999 and 1998, respectively. Gross margins were aided in fiscal 1999 by a favorable product mix. However, the Company has experienced and expects to continue to experience pricing pressures on its products as the industry matures and competition increases. Engineering and Product Development. Engineering and product development expenses increased 38.5% to $16.1 million for the fiscal year ended June 30, 1999 from $11.7 million during fiscal 1998. As a percentage of sales, engineering and product development expenses decreased to 10.1% in the fiscal year ended June 30, 1999 from 11.1% in fiscal 1999. 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; Paramus, New Jersey; Gainesville, Florida; Braunschweig, Germany; and 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 shows, cooperative marketing and advertising expenses and professional fees for marketing services. Sales and marketing expenses increased by 40.5% to $41.2 million in fiscal 1999 from $29.3 million in fiscal 1998. The increase in sales and marketing expenses was attributable to promotional costs for the introduction of several new desktop and consumer products in addition to the release of Thunder in June 1999. Sales and marketing expenses as a percentage of net sales were 25.9% and 27.8% in fiscal 1999 and 1998, respectively. The decrease reflects a growth in sales exceeding incremental sales and marketing expenditures. General and Administrative. General and administrative expenses increased by 28.0% to $6.8 million in fiscal 1999 compared to $5.3 million in fiscal 1998. This increase in the June 99 fiscal 29 year, is partly due to the inclusion of a full twelve months of expenses from the German operations which were acquired from Miro in August 1997. Additional increases were related to the Company's overall growth. General and administrative expenses as a percentage of net sales were 4.3% and 5.1%, respectively. In-Process Research and Development. During the year ended June 30, 1999, the Company recorded an in-process research and development charge of approximately $6.6 million mostly related to the acquisition of Truevision. During the year ended June 30, 1998, the Company recorded an in-process research and development charge of approximately $17.0 million related to the Miro acquisition. The amounts to acquired in-process research and development, were based on results of an independent appraisal using established valuation techniques in the high-technology industry. 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 product's 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 technological feasibility was achieved when a product reached beta stage. The values assigned to purchased in-process research and development were 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; and discounting the net cash flows back to the time of acquisition using a risk-adjusted discount rate. Discount rates of 35% and 43% were used for the Truevision and Miro valuations, respectively. Interest Income, net. Net interest income increased 51.1% to $4.7 million in fiscal 1999 from $3.1 million in fiscal 1998. The increase was due to an increase in cash and marketable securities due primarily to the completion of a public offering in November 1997. Thus, fiscal 1999 includes one full year of interest income from these proceeds. Income Tax Expense. The Company recorded provisions for income taxes of $0.7 million and $2.7 million for the fiscal years ended 1999 and 1998, respectively. The provision for income taxes as a percentage of pretax income was 3.5% and 75.6% respectively. The tax rate in fiscal 1999 was significantly lower than the rate in fiscal 1998 mainly due to the reduction of the Company's valuation allowance as management determined that it was likely that the Company would realize a portion of its deferred tax asset. The tax rate in fiscal 1998 reflects the exclusion of non-deductible expenses related to acquisitions. As of June 30, 1999, the Company has federal research and experimentation and alternative minimum tax credit carryforwards of $0.7 million which expire between 2012 and 2014, and state research and experimentation credit carryforwards of $0.6 million which have no expiration provision. Liquidity and Capital Resources The Company has funded its operations to date through the sale of equity securities as well as through cash flows from operations. As of June 30, 2000, the Company's principal sources of liquidity included cash, cash equivalents and marketable securities totaling approximately $82.1 million. The Company believes that 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. 30 The Company's operating activities generated $4.6 million in cash in the fiscal year ended June 30, 2000. This was primarily attributable to the Company generating $36.4 million after adjusting net income for in-process research and development charges, depreciation and amortization, and the tax benefit from exercised options net of deferred taxes. This amount was largely offset by an increase in accounts receivable and inventories and a decrease in accounts payable and accrued expenses. Net trade accounts receivable increased 55.4% from June 30, 1999 to June 30, 2000 and days sales outstanding in receivables increased to 70 days at June 30, 2000 from 62 days at June 30, 1999. The increase in accounts receivable is primarily due to sales growth which was 49.6% in fiscal 2000. Inventory increased due to overall growth and from acquisitions including the purchase of approximately $5.0 million in inventory from HP pursuant to the acquisition of VID in August 1999. This inventory purchase occurred in February and March of 2000 and was paid in April 2000. Inventory management remains an area of focus as Pinnacle balances the need to maintain strategic inventory levels to ensure competitive lead times and provide timely customer service versus the risk of inventory obsolescence because of rapidly changing technology and customer requirements. Cash was used also to pay down accounts payable and accrued obligations assumed through acquisitions. During the year ended June 30, 2000, cash flow from investing activities included net payments of $12.3 million related to acquisitions versus net receipts of $0.4 in fiscal 1999. The majority of the payment in fiscal 2000 related to the VID acquisition from HP. Amounts invested in property and equipment in fiscal 2000 were $8.6 million compared to $7.7 million in the year ended June 30, 1999. The high level of expenditures in fiscal 2000 was primarily for leasehold improvements, furniture and equipment purchased for the Company's Mountain View facility expansions in August 1999 to accommodate increased headcount related to the HP VID acquisition and the implementation of the SAP enterprise software system. As the Company continues to grow, it expects to incur ongoing purchases of property and equipment. Such capital expenditure are planned to be financed from working capital. Cash flows from financing activities consist mostly of proceeds from the purchase of the Company's common stock through the employee stock purchase plan ("ESPP") and the exercise of employee stock options. Financing activities provided $13.5 million in fiscal 2000 versus $6.5 million in fiscal 1999. The Company recently experienced a sharp drop in the market price of its common stock. The Company may experience a decrease in the cash proceeds from the ESPP and stock option exercises if the stock maintains a moderately low price level. On July 14, 2000 the Company's Board of Directors authorized the repurchase of up to 3.0 million shares of the Company's common stock. The shares would be purchased in the open market from time to time. FACTORS AFFECTING OPERATING RESULTS 31 |X| 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: - Increased competition and pricing pressure - Timing of significant orders from and shipments to major customers, including OEM's and our large broadcast accounts. - 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 - 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 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. |X| 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 2000 were $238.0 million compared to $159.1 million in fiscal 1999, a 49.6% increase. 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. |X| Any failure to successfully integrate the businesses we have acquired could negatively impact us. In June 2000, we acquired Avid Sports, Inc., and in April 2000, we acquired Montage Group, Ltd. In March 2000, we acquired Digital Editing Services, Inc. and Puffin Designs, Inc. Also, in 1999, we acquired the Video Communications Division of the Hewlett-Packard Company, Truevision, Inc. and Shoreline Studios, Inc. We may in the near-or long-term pursue additional 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: 32 - 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 |X| 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. In July 2000, we announced that financial results for the fourth quarter of Fiscal 2000, which ended June 30, 2000, would be lower than the then current analyst consensus estimates regarding Pinnacle's quarterly results. In the day following this announcement, our share price lost more than 59% of its value and our shares continue to trade in a price range significantly lower than the range held by our shares before this announcement. With the advent of the Internet, new avenues have been created for the dissemination of information. Pinnacle 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 Pinnacle 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. On July 18, 2000, a lawsuit entitled Jiminez v. Pinnacle Systems, Inc., et al., No. 00-CV-2596 was filed in the United States District Court for the Northern District of California against Pinnacle and certain officer and director defendants. 33 We have publicly announced that we intend to defend the case vigorously. It is possible that additional similar litigation could be brought against us in the future. The securities class action lawsuit described above and any similar litigation which may be brought against Pinnacle could result in substantial costs and will likely divert management's attention and resources. Any adverse determination in such litigation could also subject us to significant liabilities. |X| 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 supplier 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 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. |X| 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 34 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. |X| 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 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 Grass Valley Group 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. Apple Computer Avid Technology, Inc. Dazzle Multimedia Digitel Processing Systems, Inc. Fast Multimedia Hauppauge Digital, Inc. Matrox Electronics Systems, Ltd. Media 100, Inc. 35 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 or they may 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 Also, with these distribution channels standing between us 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 |X| We must retain key employees to remain competitive. 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 36 and abilities of our senior management and key technical personnel are very important to our continued success. 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 are 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. |X| 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. |X| 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. We are 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. 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. |X| Because we sell products internationally, we are subject to additional risks. 37 Sales of our products outside of North America represented approximately 55% of net sales in the period ended June 30, 2000 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. In fiscal 2000 and beyond, we expect that a majority of our European sales will continue to be denominated in local foreign currency, including the Euro. Pinnacle has developed natural hedges for some of this risk in that most of the European operating 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. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Foreign Currencies The Company transacts business in various foreign currencies, primarily the Euro and those of Germany, France, the U.K., and Japan. 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 invests primarily in US Treasury Notes 38 and high-grade commercial paper and generally holds them to maturity. Consequently, 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. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Company's consolidated financial statements and the independent auditors' report appear on pages F-1 through F-27 of this Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item concerning the Company's directors is incorporated by reference from the section captioned "Election of Directors" contained in the Company's Proxy Statement related to the Annual Meeting of Shareholders to be held October 30, 2000, to be filed by the Company with the Securities and Exchange Commission within 120 days of the end of the Company's fiscal year pursuant to General Instruction G(3) of Form 10-K (the "Proxy Statement"). The information required by this item concerning executive officers is set forth in Part I of this Report. The information required by this item concerning compliance with Section 16(a) of the Exchange Act is incorporated by reference from the section captioned "Compliance with Section 16(a) of the Exchange Act" contained in the Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference from the section captioned "Executive Compensation and Other Matters" contained in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference from the section captioned "Record Date and Principal Share Ownership" contained in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 39 The information required by this item is incorporated by reference from the sections captioned "Compensation Committee Interlocks and Insider Participation" and "Certain Transactions With Management" contained in the Proxy Statement. 40 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a)(1) Financial Statements The following financial statements are incorporated by reference in Item 8 of this Report: Independent Auditors' Report F-2 Consolidated Balance Sheets, June 30, 2000 and 1999 F-3 Consolidated Statements of Operations for years ended June 30, 2000, 1999 and 1998 F-4 Consolidated Statements of Comprehensive Income (Loss) for years ended June 30, 2000, 1999 and 1998 F-5 Consolidated Statements of Shareholders' Equity for the years ended June 30, 2000, 1999 and 1998 F-6 Consolidated Statements of Cash Flows for the years ended June 30, 2000, 1999 and 1998 F-7 Notes to Financial Statements F-8 (a)(2) Financial Statement Schedules Schedule II - Valuation and Qualifying Accounts Schedules, other than those listed above, have been omitted since the required information is not present, or not present in amounts sufficient to require submission of the schedule, is inapplicable, or because the information required is included in the consolidated financial statements or the notes thereto. (a)(3) Exhibits 3.1(1) Restated Articles of Incorporation of the Registrant. 3.2(1) Bylaws of the Registrant, as amended to date. 4.1(2) Preferred Share Rights Agreement, dated December 12, 1996, between Registrant and ChaseMellon Shareholder Services, L.L.C. 4.1.1(2) Amendment No.1 to Preferred Shares Right Agreement dated as of April 30, 1998 by and between the Registrant and ChaseMellon Shareholder Services, L.L.C. 4.2(4) Stock Restriction and Registration Rights Agreement dated August 2, 1999 by and between the Registrant and the Hewlett-Packard Company. 4.3(5) Registration Rights Agreement dated March 29, 2000 by and between the registrant and Puffin Designs, Inc. 4.4(6) Registration Rights Agreement dated March 29, 2000 by and between the registrant and Digital Editing Services, Inc. 4.5(7) Stock acquisition and Exchange Agreement dated as of June 29, 2000 by and among Pinnacle Systems, Inc., Avid Sports, Inc., the Stockholders of Avid Sports, Inc. and David Grandin, as Stockholders' Representative. 10.31 1987 Stock Option Plan, as amended, and form of agreements thereto. 10.43 1994 Employee Stock Purchase Plan, and form of agreement thereto. 10.51 1994 Director Stock Option Plan, and form of agreement thereto. 10.61 Form of Indemnification Agreement between the Registrant and its officers and directors. 10.11*(1) Development and Original Equipment Manufacturing and Supply Agreement, dated March 16, 1994, between Registrant and Avid Technology, Inc. 41 10.14(1) Master Agreement, dated March 4, 1994, between Registrant and Bell Microproducts, Inc. 10.17(1) Agreement, dated September 8, 1994, between Registrant and Mark L. Sanders. 10.21(3) 1996 Stock Option Plan, and form of agreements thereto. 10.22(3) 1996 Supplemental Stock Option Plan, and form of agreements thereto. 22.1 List of subsidiaries of the Registrant. 23.1 Consent of Independent Auditors and Report on Schedule. 24.1 Power of Attorney (See Page 31). 27.1 Financial Data Schedule. * Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission. 1 Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form S-1 (Reg. No. 33-83812) as declared effective by the Commission on November 8, 1994. 2 Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form 8-A (Reg. No. 000-24784) as declared effective by the Commission on February 17, 1997 and as amended by Amendment No.1 thereto on Form 8-A/A filed on May 19, 1998. 3 Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form S-8 (Reg. No. 333-74071) as filed on March 8, 1999. 4 Incorporated by reference to the exhibits to the Registration Statement on Form S-3 (File No. 333-84739) filed by the Registrant with the Securities and Exchange Commission. 5. Incorporated by reference to the exhibits to the Registration Statement on Form S-3 filed by the Registrant on April 24, 2000. 6. Incorporated by reference to the exhibits to the Registration Statement on Form S-3 filed by the Registrant on July 27, 2000. 7. Incorporated by reference to the exhibits to the Registration Statement on Form 8-K filed by the Registrant on July 14, 2000. (b) Reports on Form 8-K. On April 13, 2000, the Company filed a report on Form 8-K announcing the Company's acquisition of Puffin Designs, Inc., Digital Editing Services, Inc. and the Montage Group, Ltd. (c) Exhibits. See Item 14(a)(3) above. (d) Financial Statement Schedule. See Item 14(a)(2) above. 42 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. PINNACLE SYSTEMS, INC. By: /s/ MARK L. SANDERS ------------------------------------------ Mark L. Sanders President, Chief Executive Officer and Director Date: September 25, 2000 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Mark L. Sanders and Arthur D. Chadwick, and each of them, his true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, to sign any and all amendments (including post-effective amendments) to this Annual Report on Form 10-K and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or their substitute or substitutes, or any of them, shall do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
Signature Title Date --------- ----- ---- /s/ Mark L. Sanders President, Chief Executive Officer and Director September 25, 2000 ------------------------- (Principal Executive Officer) Mark L. Sanders /s/ Arthur D. Chadwick Vice President, Financial and Administration and September 25, 2000 ------------------------- Chief Financial Officer (Principal Financial and Arthur D. Chadwick Accounting Officer) /s/ Ajay Chopra Chairman of the Board, Vice President, Desktop September 25, 2000 ------------------------- Products Ajay Chopra /s/ L. Gregory Ballard Director September 25, 2000 ------------------------- L. Gregory Ballard 43 /s/ L. William Krause Director September 25, 2000 ------------------------- L. William Krause /s/ John Lewis Director September 25, 2000 ------------------------- John Lewis /s/ Glenn E. Penisten_ Director September 25, 2000 ------------------------- Glenn E. Penisten /s/ Charles J. Vaughan Director September 25, 2000 ------------------------- Charles J. Vaughan
44 INDEX TO FINANCIAL STATEMENTS - Independent Auditors' Report F-2 - Consolidated Balance Sheets F-3 - Consolidated Statements of Operations F-4 - Consolidated Statements of Comprehensive Income (Loss) F-5 - Consolidated Statements of Changes in Shareholders' Equity F-6 - Consolidated Statements of Cash Flows F-7 - Notes to Consolidated Financial Statements F-8 F-1 Independent Auditors' Report The Board of Directors and Shareholders Pinnacle Systems, Inc.: We have audited the accompanying consolidated balance sheets of Pinnacle Systems, Inc. and subsidiaries as of June 30, 2000 and 1999, and the related consolidated statements of operations, comprehensive income (loss), shareholders' equity, and cash flows for each of the years in the three-year period ended June 30, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pinnacle Systems, Inc. and subsidiaries as of June 30, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 2000, in conformity with accounting principles generally accepted in the United States of America. /s/ KPMG LLP Mountain View, California July 24, 2000, except as to the second paragraph of Note 5(a), which is as of September 27, 2000 F-2 PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------------- (In thousands) June 30, ------- 2000 1999 --------------------------------------------------------------------------------------- Assets Current assets: Cash and cash equivalents $ 58,433 $ 48,654 Marketable securities 19,366 31,058 Accounts receivable, less allowance for doubtful accounts and returns of $5,783 and $5,057 as of June 30, 2000 and 1999, respectively 55,072 35,449 Inventories 36,824 22,221 Deferred income taxes 17,103 10,653 Prepaid expenses and other assets 4,100 2,500 --------- --------- Total current assets 190,898 150,535 Marketable securities 4,346 9,266 Property and equipment, net 16,143 10,809 Goodwill and other intangibles 109,810 25,503 Other assets 1,602 356 --------- --------- $ 322,799 $ 196,469 ========= ========= Liabilities and Shareholders' Equity Current liabilities: Accounts payable $ 22,422 $ 12,744 Accrued expenses 30,146 17,466 --------- --------- Total current liabilities 52,568 30,210 --------- --------- Deferred income taxes 10,611 -- --------- --------- Total liabilities 63,179 30,210 --------- --------- Shareholders' equity: Preferred stock, no par value; authorized 5,000 shares; none issued and outstanding -- -- Common stock, no par value; authorized 120,000 shares; 51,293 and 45,526 issued and outstanding as of June 30, 2000 and 1999, respectively 257,496 169,078 Retained earnings (accumulated deficit) 7,198 (389) Accumulated other comprehensive loss (5,074) (2,430) --------- --------- Total shareholders' equity 259,620 166,259 --------- --------- $ 322,799 $ 196,469 ========= ========= -------------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements.
F-3 PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
----------------------------------------------------------------------------------------- (In thousands, except per share data) Years ended June 30, --------------------------------- 2000 1999 1998 ----------------------------------------------------------------------------------------- Net sales $ 237,967 $ 159,098 $ 105,296 Cost of sales 113,573 74,022 48,715 --------- --------- --------- Gross profit 124,394 85,076 56,581 --------- --------- --------- Operating expenses: Engineering and product development 27,767 16,137 11,652 Sales and marketing 56,126 38,871 28,365 General and administrative 10,554 6,840 5,342 Legal settlement 2,102 -- -- Amortization of goodwill and other intangibles 18,382 2,289 936 In-process research and development 3,500 6,579 16,960 --------- --------- --------- Total operating expenses 118,431 70,716 63,255 --------- --------- --------- Operating income (loss) 5,963 14,360 (6,674) Interest income, net 3,403 4,742 3,139 --------- --------- --------- Income (loss) before income taxes 9,366 19,102 (3,535) Income tax expense 1,779 666 2,685 --------- --------- --------- Net income (loss) $ 7,587 $ 18,436 $ (6,220) ========= ========= ========= Net income (loss) per share: Basic $ 0.16 $ 0.43 $ (0.17) ========= ========= ========= Diluted $ 0.14 $ 0.39 $ (0.17) ========= ========= ========= Shares used to compute net income (loss) per share: Basic 48,311 42,780 35,628 ========= ========= ========= Diluted 55,442 46,966 35,628 ========= ========= ========= ----------------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements.
F-4 PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
-------------------------------------------------------------------------------------- (In thousands) Years ended June 30, -------------------------------- 2000 1999 1998 -------------------------------------------------------------------------------------- Net income (loss) $ 7,587 $ 18,436 $ (6,220) Foreign currency translation adjustment (2,644) (2,315) (115) -------- -------- -------- Comprehensive income (loss) $ 4,943 $ 16,121 $ (6,335) ======== ======== ======== -------------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements.
F-5 PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
------------------------------------------------------------------------------------------------------------------ Common stock Retained Accumulated Total ------------------ earnings other compre- shareholders' (In thousands) Shares Amount (deficit) hensive loss equity ------------------------------------------------------------------------------------------------------------------ Balances as of June 30, 1997 29,212 $ 75,316 $ (12,605) $ -- $ 62,711 Issuance of common stock in secondary public offering, net of issuance costs of $3,078 8,000 46,922 -- -- 46,922 Issuance of common stock related to stock option and stock purchase plans 2,264 4,755 -- -- 4,755 Issuance of common stock related to miro acquisition 816 4,352 -- -- 4,352 Tax benefit from common stock option exercise -- 1,987 -- -- 1,987 Net loss -- -- (6,220) -- (6,220) Foreign currency translation adjustment -- -- -- (115) (115) ------ --------- --------- --------- --------- Balances as of June 30, 1998 40,292 $ 133,332 $ (18,825) $ (115) $ 114,392 Issuance of common stock related to miro acquisition 1,230 7,834 -- -- 7,834 Issuance of common stock related to stock option and stock purchase plans 2,354 8,831 -- -- 8,831 Issuance of common stock related to Truevision acquisition 1,650 12,089 -- -- 12,089 Tax benefit from common stock option exercise -- 6,992 -- -- 6,992 Net income -- -- 18,436 -- 18,436 Foreign currency translation adjustment -- -- -- (2,315) (2,315) ------ --------- --------- --------- --------- Balances as of June 30, 1999 45,526 $ 169,078 $ (389) $ (2,430) $ 166,259 Issuance of common stock related to stock option and stock purchase plans 2,458 13,231 -- -- 13,231 Issuance of common stock related to the Hewlett Packard video communications division acquisition 1,546 20,570 -- -- 20,570 Acquisition of Puffin 361 11,529 -- -- 11,529 Acquisition of Digital Editing Services 288 9,375 -- -- 9,375 Acquisition of Montage 125 3,743 -- -- 3,743 Acquisition of Avid Sports 944 24,554 -- -- 24,554 Warrants exercised 45 270 -- -- 270 Tax benefit from common stock option exercise -- 5,146 -- -- 5,146 Net income -- -- 7,587 -- 7,587 Foreign currency translation adjustment -- -- -- (2,644) (2,644) ------ --------- --------- --------- --------- Balances as of June 30, 2000 51,293 $ 257,496 $ 7,198 $ (5,074) $ 259,620 ====== ========= ========= ========= ========= ----------------------------------------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements.
F-6 PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
------------------------------------------------------------------------------------------------------------- (In thousands) Years ended June 30, ------------------------------------ 2000 1999 1998 ------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income (loss) $ 7,587 $ 18,436 $ (6,220) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: In-process research and development 3,500 6,579 16,960 Depreciation and amortization 22,616 4,773 2,679 Deferred taxes (3,408) (10,070) (583) Tax benefit from exercise of common stock options 5,146 6,992 1,987 Changes in operating assets and liabilities, net of effects of acquisitions: Accounts receivable (16,025) (17,771) (7,472) Inventories (8,012) (8,281) (4,696) Accounts payable (2,073) 900 4,052 Accrued expenses (4,428) (1,431) 2,767 Accrued income taxes (127) 1,313 746 Other (146) (1,655) (472) --------- --------- --------- Net cash provided by (used in) operating activities 4,630 (215) 9,748 --------- --------- --------- Cash flows from investing activities: Cash (paid) acquired from acquisitions (12,325) 433 (15,150) Purchases of property and equipment (8,642) (7,681) (2,469) Purchases of marketable securities (83,041) (128,831) (53,804) Proceeds from maturity of marketable securities 99,653 132,335 25,000 Other investments (1,200) -- -- --------- --------- --------- Net cash used in investing activities (5,555) (3,744) (46,423) --------- --------- --------- Cash flows from financing activities: Proceeds from issuance of common stock 13,502 8,831 51,677 Repayment of long-term obligations (163) (2,319) (312) --------- --------- --------- Net cash provided by financing activities 13,339 6,512 51,365 --------- --------- --------- Effects of exchange rate changes on cash (2,635) (1,377) -- --------- --------- --------- Net increase in cash and cash equivalents 9,779 1,176 14,690 Cash and cash equivalents at beginning of year 48,654 47,478 32,788 --------- --------- --------- Cash and cash equivalents at end of year $ 58,433 $ 48,654 $ 47,478 ========= ========= ========= Cash paid during the year: Interest $ 19 $ 5 $ 2 ========= ========= ========= Income taxes $ 561 $ 1,062 $ 1,839 ========= ========= ========= Non-cash financing and investing activities: Common stock issued and options and warrants assumed in the acquisition of certain net assets $ 69,771 $ 19,923 $ 4,352 ========= ========= ========= ------------------------------------------------------------------------------------------------------------ See accompanying notes to consolidated financial statements.
F-7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 Summary of the Company and Significant Accounting Policies Organization and Operations Pinnacle Systems Inc. (the "Company") is a supplier of video authoring, storage, distribution and Internet streaming solutions for broadcasters, business and professional "desktop" users, and consumers. Pinnacle's products are used to create, store, and distribute video content from television programs, TV commercials, pay-per-view, sports videos, corporate films to home movies. Pinnacle's products are also used to stream video over the Internet. The Company's products use real time video processing and editing technologies to apply a variety of video post-production and on-air functions to multiple streams of live or recorded video material. These editing applications include the addition of special effects, graphics and titles. To address the broadcast market, the Company offers high performance, specialized computer based solutions for high-end, production, post-production, team sports analysis, broadcast on-air, and Internet streaming applications. For the desktop market, the Company provides computer based video editing and media creation products and products used to create video content and solutions used to stream live and recorded video over the Internet. To address the consumer market, the Company offers low cost, easy to use video editing and viewing solutions that allow consumers to view TV on their computer and to edit their home videos using a personal computer, camcorder and VCR. Many of the Company's consumer products enable content to be created that is suitable for the internet. Basis of Presentation The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Intercompany balances and transactions have been eliminated in consolidation. Stock Split On February 4, 2000, the Company announced a two-for-one stock split of the Company's common shares. This was paid in the form of a 100% stock distribution on March 27, 2000 to stockholders of record on March 2, 2000. Accordingly, all share and per share data for prior periods presented have been restated to reflect the stock split. Use of Estimates The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Translation of Foreign Currencies 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 translation of foreign subsidiary financial statements are reported within accumulated other comprehensive income (loss) which is reflected as a separate component of shareholders' equity. Foreign currency transaction gains and losses are included in results of operations. Revenue Recognition The Company recognizes revenue upon shipment of its products. The Company offers discounts on purchases of certain products or on purchasing volume. These are accounted F-8 for as offsets to revenue upon shipment. When telephone support is provided at no additional charge during the product's initial warranty period, and no other product enhancements or upgrades are provided, the revenue allocated to the telephone support is recognized at time of product shipment, and the costs of providing the support are accrued. The Company recognizes revenue from service contracts ratably over the term of the contract. Revenue from services has been insignificant in relation to product revenue for all periods presented. Included in accounts receivable allowances are sales allowances provided for expected returns and credits and an allowance for doubtful accounts. The Company estimates these allowances based on analysis and historical experience. Actual returns and uncollectible have not differed materially from management's estimates. Financial Instruments The Company considers all highly liquid investments with a remaining maturity of three months or less at the date of purchase to be cash equivalents. The Company maintains its cash balances in various currencies but primarily in U.S. Dollars, Euros, Deutsche Marks, French Francs and the Japanese Yen. Marketable securities are instruments that mature within three to eighteen months and consist principally of U.S. Treasury bills, government agency notes and high-grade commercial paper. These investments are typically short-term in nature and therefore bear minimal interest rate risk. All investments are classified as held-to-maturity and are carried at amortized cost as the Company has both the positive intent and the ability to hold to maturity. Interest income is recorded using an effective interest rate, with the associated premium or discount amortized to "Interest income." Due to the relatively short term until maturity, the fair value of marketable securities is substantially equal to their carrying value as of June 30, 2000. Such investments mature through June 2001. Inventories Inventories are stated at the lower of cost (first-in, first-out) or market. Raw materials inventory represents purchased materials, components and assemblies, including fully assembled circuit boards purchased from outside vendors. Property and Equipment Purchased property and equipment are recorded at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the respective assets, generally three to five years. Leasehold improvements are amortized over the shorter of the estimated useful lives of the assets or the remaining lease term. Acquisition-related Intangible Assets Acquisition-related intangible assets result from the Company's acquisitions of businesses accounted for under the purchase method and consist of the values of identifiable intangible assets including completed technology, work force and trade name as well as goodwill. Goodwill is the amount by which the cost of acquired net assets exceeded the fair values of those net assets on the date of purchase. Acquisition-related intangible assets are reported at cost, net of accumulated amortization, and are amortized on a straight-line basis over their estimated useful lives ranging from three to nine years. Impairment of Long-Lived Assets The Company evaluates long-lived assets, including goodwill and other identifiable intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future expected undiscounted cash flows attributable to that asset. The amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. The Company does not have any long-lived assets it considers to be impaired. Income Taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. F-9 Net Income (Loss) Per Share Earnings per share (EPS) is computed using the weighted-average number of common shares outstanding. Diluted EPS is computed using the weighted average number of common shares outstanding and dilutive common share equivalents from the assumed exercise of warrants and options outstanding during the period, if any, using the treasury stock method. The following is a reconciliation of the shares used in the computation of basic and diluted EPS (in thousands):
Years Ended June 30, -------------------- 2000 1999 1998 ---- ---- ---- Basic EPS - weighted average shares of common stock outstanding 48,311 42,780 35,628 Effect of dilutive common equivalent shares - stock options outstanding 7,131 4,186 -- --------- --------- --------- Diluted EPS - weighted average shares and common equivalent shares outstanding 55,442 46,966 35,628 ========= ========= =========
The Company excludes securities from its diluted net income (loss) per share computation when either the exercise price of the securities exceeds the average fair value of the Company's common stock or the Company reported net losses because the effect would be anti-dilutive. For the fiscal years ended June 30, 2000 and 1999, the Company excluded options to purchase 113,534 and 22,000 shares of common stock, respectively, from the earnings per share computation as their exercise prices exceeded the average fair value of the Company's common stock during the respective years and, accordingly, their inclusion would have been anti-dilutive. For the fiscal year ended June 30, 1998 the Company excluded 4,048,000 employee stock options from the earnings per share computation as their inclusion would have been anti-dilutive due to the Company's reported net loss. Comprehensive Income (Loss) The Company's comprehensive income (loss) includes net income (loss) and foreign currency translation adjustments. Stock-Based Compensation The Company accounts for its employee stock-based compensation plans using the intrinsic value method. Advertising Advertising costs are expensed as incurred. Advertising expenses are included in sales and marketing expense and amounted to approximately $10.1 million, $7.8 million and $3.8 million in the fiscal years ended June 30, 2000, 1999 and 1998, respectively. Concentration of Credit Risk The Company distributes and sells its products to end users primarily through a combination of independent domestic and international dealers and original equipment manufacturers ("OEMs"). The Company performs periodic credit evaluations of its customers' financial condition and generally does not require collateral. The Company maintains allowances for potential credit losses, but historically has not experienced any significant losses related to any one business group or geographic area. No single customer accounted for more than 10% of the Company's total revenues or receivables in fiscal 2000. In the fiscal year ended June 30, 1999, one customer accounted for more than 10% of revenues and in the fiscal year ended June 30, 1998, two customers accounted for more than 10% of revenues. The Company maintains cash and cash equivalents, short- and long-term investments with various financial institutions. The Company's investment policy is designed to limit exposure with any one institution. As part of its cash and risk management process, the Company performs periodic evaluations of the relative credit standing of the financial institutions. Recent Accounting Pronouncements In June 1998, the Financial Accounting Standards Boards ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for F-10 derivative instruments and for hedging activities. This statement becomes effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company has adopted SFAS No. 133 effective July 1, 2000. The Company does not expect the adoption of SFAS No. 133 to have a material affect on its financial statements. In December 1999, the Securities and Exchange Commission ("SEC") released Staff Accounting Bulletin ("SAB") No. 101 "Revenue Recognition in Financial Statements". SAB No. 101 summarizes certain of the SEC's views in applying generally accepted accounting principles to revenue recognition. The Company will adopt SAB No. 101 in the forth quarter of fiscal 2001. The SEC has indicated that it intends to issue further guidance with respect to adoption of specific issues addressed by SAB No. 101. Until this additional guidance is issued, the Company is unable to assess the impact, if any, it may have on its financial position or results of operations. In March 2000, the FASB issued Interpretation No. 44 "Accounting for Certain Transactions Involving Stock Compensation: an Interpretation of APB opinion No. 25." This interpretation clarifies the application of Opinion 25 for certain issues including: (a) the definition of employee for purposes of applying Opinion 25, (b) the criteria for determining whether a plan qualifies as a non-compensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or warrant, and (d) the accounting for an exchange of stock compensation awards in a business combination. In general, the interpretation is effective July 1, 2000. The adoption of Interpretation No. 44 did is not expected to have a material effect on the Company's financial statements. In July 2000, the Emerging Issues Task Force ("EITF") reached a consensus on Issue No. 00-10, "Accounting for Shipping and Handling Fees and Costs." The EITF concluded that amounts billed to a customer related to shipping and handling represent revenues. Issue No. 00-10 is expected to be implemented in the same quarter as SAB No. 101. The Company does not expect the adoption of Issue No. 00-10 to have a material impact on its financial statements. In May 2000, the EITF reached a consensus on Issue No. 00-14, "Accounting for Certain Sales Incentives." Issue No. 00-14 addresses the recognition, measurement, and income statement classification for sales incentives offered voluntarily by a vendor without charge to customers that can be used in, or that are exercisable by a customer as a result of a single exchange transaction. Issue No. 00-14 is expected to be implemented in the same quarter as SAB No. 101. The Company does not expect the adoption of Issue No. 00-14 to have a material impact on its financial statements. Note 2 Financial Instruments Marketable Securities The Company's policy is to diversify its investment portfolio to reduce risk to principal that could arise from credit, geographic and investment sector risk. At June 30, 2000, investments were placed with a variety of different financial institutions or other issuers and no individual security or obligation from a direct issuer exceeded ten percent of total investments. Investments with a maturity of less than one year have a rating of A1/P1 or better. Investment with a maturity of more than one year have a minimum rating of AA/Aa2. The Company's investment portfolio generally matures within eighteen months or less. Long-term marketable securities have maturity dates through February 2002. Cash, cash equivalents and short-term and long-term investments consist of the following: F-11 Gross (In thousands) Amortized Unrealized Cost Gain (Loss) Fair Value -------- -------- -------- 2000 Cash and cash equivalents Cash $ 50,077 $ -- $ 50,077 Commercial paper 8,356 (28) 8,328 -------- -------- -------- $ 58,433 $ (28) $ 58,405 ======== ======== ======== Short-term investments Governmental agencies $ 5,024 $ -- $ 5,024 Commercial paper 14,342 (27) 14,315 -------- -------- -------- Total short-term investments $ 19,366 $ (27) $ 19,339 ======== ======== ======== Long-term investments Governmental agencies 4,346 20 4,366 -------- -------- -------- Total long-term investments $ 4,346 $ 20 $ 4,366 ======== ======== ======== 1999 Cash and cash equivalents Cash $ 32,604 $ -- $ 32,604 Commercial paper 16,050 1 16,051 -------- -------- -------- $ 48,654 $ 1 $ 48,655 ======== ======== ======== Short-term investments Corporate bonds $ 10,253 $ -- $ 10,253 Commercial paper 14,526 -- 14,526 Governmental agencies 6,279 (7) 6,272 -------- -------- -------- Total short-term investments $ 31,058 $ (7) $ 31,051 ======== ======== ======== Long-term investments Governmental agencies 9,266 (50) 9,216 -------- -------- -------- Total long-term investments $ 9,266 $ (50) $ 9,216 ======== ======== ======== F-12 Note 3 Balance Sheet Components June 30, ------------------------- (In thousands) 2000 1999 -------- -------- Inventories, net: Raw materials $ 22,634 $ 12,018 Work in process 4,224 4,186 Finished goods 9,966 6,017 -------- -------- 36,824 22,221 ======== ======== Property and Equipment: Computers and equipment $ 12,142 $ 8,568 Leasehold improvement 5,153 2,815 Office furniture and fixtures 4,683 3,181 Internal use software 3,968 951 Construction in progress 249 1,498 -------- -------- 26,195 17,013 Accumulated depreciation (10,052) (6,204) -------- -------- $ 16,143 $ 10,809 ======== ======== Goodwill and other tangibles: Goodwill $ 74,263 $ 17,920 Core Technology 31,589 1,480 Other Intangibles 25,396 9,135 -------- -------- 131,248 28,535 Accumulated amortization (21,438) (3,032) -------- -------- $109,810 $ 25,503 ======== ======== Accrued expenses: Payroll and commission related $ 4,497 $ 3,067 Deferred taxes payable 2,845 3,680 Accrued acquisition payment 3,325 -- Deferred revenue 3,878 64 Other 15,601 10,655 -------- -------- $ 30,146 $ 17,466 ======== ======== Note 4 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 installation was completed in March 2000. Pursuant to AICPA Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use", the Company reached the application development stage of the software implementation and began capitalizing costs associated with the project. As of June 30, 2000 and 1999, the Company had capitalized $3.9 million and $1.0 million respectively. Note 5 Acquisitions (a) Avid Sports, Inc. On June 30, 2000, the Company acquired all the outstanding common stock of Avid Sports, Inc., a leading provider of sports editing and online sports media management solutions ("ASports"). In connection with the acquisition, Pinnacle issued 944,213 shares of its common stock valued at $22.7 million and assumed 138,158 options valued at $1.9 million. Pinnacle also incurred approximately $350,000 in transaction costs. In September 2000, the Company agreed to issue additional stock to certain former shareholders of Avid Sports, Inc. if the closing price of the Company's common stock does not equal or F-13 exceed $23 per share for four consecutive trading days prior to May 31, 2001. If the share price does not reach this level, the value of the additional shares to be issued shall be equal to 944,213 multipled by the difference between the average closing stock during the month of May, 2001 and $23 per share. The acquisition was accounted for under the purchase method of accounting. Accordingly, the results of operations of ASports and the fair market value of the acquired assets and liabilities assumed have been included in the consolidated financial statements of the Company as of June 30, 2000. On June 30, 2000, the Company recorded $5.8 million in tangible assets, $13.4 million in identifiable intangibles including core/developed technology, customer base and other intangibles, assumed $15.5 million in liabilities, including $5.4 million in deferred taxes, and allocated $21.2 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 identifiable intangibles are being amortized using the straight-line method over five-year and three-year periods, respectively. (b) Propel Ahead, Inc. On June 30, 2000, the Company acquired all the outstanding common stock of Propel Ahead, Inc. ("Propel"). In connection with the acquisition, Pinnacle agreed to pay the former shareholder of Propel $3.2 million. Pinnacle also incurred approximately $100,000 in transaction costs. The acquisition was accounted for under the purchase method of accounting. Accordingly, the results of operations of Propel and the fair market value of the acquired assets and liabilities assumed have been included in the consolidated financial statements of the Company as of June 30, 2000. On June 30, 2000, the Company recorded $0.1 million in tangible assets and $3.0 million in identifiable intangibles including core/developed technology assumed $1.3 million in liabilities including $1.2 million in deferred taxes, and allocated $1.5 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 identifiable intangibles are being amortized using the straight-line method over five-year and three-year periods respectively. (c) Montage Group, Ltd. On April 7, 2000 the Company acquired all the outstanding common stock of Montage Group, Ltd., a provider of networked non-linear editing solutions ("Montage"). In connection with the acquisition, Pinnacle issued 125,224 shares of its common stock valued at $3.7 million ("initial payment") and incurred approximately $325,000 in transaction costs. The terms of the acquisition also included an earnout provision wherein the former shareholders of Montage could receive additional consideration, net of the initial payment, upon achieving certain gross margin levels for each year of a two-year period beginning April 7, 2000. Gross margins ranging between 40% to 50% of revenues would result in an additional payout of between 100% to 150% of related revenues respectively. However, in the second year of the earnout, assuming the 40% gross margin threshold has been met, consideration will be paid only to the extent that the second year earnout calculation exceeds that of the first year. No earnout payment will be made in either year if gross margins do not exceed 40% of revenues exclusively. Earnout payments, if any, will be paid in shares of the Company's common stock. The acquisition was accounted for under the purchase method of accounting. Accordingly, the results of operations of Montage and the fair market value of the acquired assets and assumed liabilities have been included in the consolidated financial statements of the Company since April 7, 2000. On April 7, 2000, the Company recorded $2.8 million in tangible assets, $0.4 million in in-process research and development, $1.6 million in identifiable intangibles including core/developed technology assumed $4.2 million in liabilities and allocated $3.5 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 F-14 identifiable intangibles are being amortized using the straight-line method over five-year and three-year periods, respectively. (d) Digital Editing Services, Inc. On March 30, 2000 the Company acquired all the outstanding common stock of Digital Editing Services, Inc., a provider of real-time video analysis and database solutions ("DES"). In connection with the acquisition, Pinnacle paid $300,000 in cash and issued 287,752 shares of its common stock valued at $9.1 million ("initial payment") and incurred $270,000 in transaction costs. The terms of the acquisition include an earnout provision wherein the former shareholders of DES could receive additional consideration, net of the initial payment, upon achieving certain profitability levels for the one year period ending March 30, 2001 ("earnout period"). Operating profits from DES ranging between 10% to 20% of revenues would result in an additional payout of between 100% to 175% of those associated revenues respectively. No earnout payment will be made if operating profit does not exceed 10% of revenues during the earnout period. Any earnout will be paid in shares of the Company's common stock. The acquisition was accounted for under the purchase method of accounting. Accordingly, the results of operations of DES and the fair market value of the acquired assets and assumed liabilities have been included in the consolidated financial statements of the Company since March 30, 2000. As of March 30, 2000, the Company recorded $1.8 million in tangible assets, $0.5 million in in-process research and development, $8.2 million in identifiable intangibles including core/developed technology, assumed $4.6 million in liabilities, including $3.3 million in deferred taxes, and allocated $3.8 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 identifiable intangibles are being amortized using the straight-line method over five-year and three-year periods, respectively. (e) Puffin Designs, Inc. On March 24, 2000, the Company acquired all the outstanding common stock of Puffin Designs, Inc., a provider of content creation solutions ("Puffin"). In connection with the acquisition, Pinnacle issued 360,352 shares of its common stock valued at $11.2 million. In addition, Pinnacle assumed outstanding stock options and warrants covering 51,884 and 4,155 shares of stock respectively and valued at $336,000. The acquisition has been accounted for under the purchase method of accounting. Accordingly, the results of operations of Puffin and the fair market value of the acquired assets and assumed liabilities have been included in the consolidated financial statements of the Company since March 24, 2000. As of March 24, 2000, the Company recorded $0.5 million in tangible assets, $0.6 million in-process research and development, $1.2 million in identifiable intangibles including core/developed technology, assumed $1.7 million in liabilities and allocated $11.2 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 identifiable intangibles are being amortized using the straight-line method over five-year and three-year periods, respectively. (f) Synergy, Inc. On January 11, 2000, the Company acquired all the outstanding common stock of Synergy, Inc. makers of the popular, award-winning Hollywood FX software for video content creation applications ("Synergy"). In connection with the acquisition, Pinnacle paid Synergy $200,000. The acquisition was accounted for under the purchase method of accounting. Accordingly, the results of operations of Synergy and the fair market value of the acquired assets and liabilities assumed have been included in the financial statements of the Company as of January 11, 2000. Goodwill of $233,500 is being amortized using the straight-line method over a five-year period. F-15 (g) Video Communications Division of 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 VID, 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 1,546,344 shares of its common stock valued at $20.6 million. The Company incurred acquisition costs of approximately $0.5 million for a total purchase price of $33.6 million and assumed liabilities totaling $10.1 million. 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 June 30, 2000, the Company recorded $7.3 million in tangible 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 $10.1 million in liabilities and allocated $15.4 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 nine months to five years. (h) Truevision, Inc. 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 1,648,412 shares of common stock valued at $11.5 million. In addition, Pinnacle issued to Truevision employees and Directors 279,356 options, valued at $0.7 million, to purchase common stock at an exercise price of $5.99. The Company also assumed 107,672 warrants valued at $0.1 million. The Company incurred acquisition costs of approximately $0.5 million for a total purchase price of $12.8 million and assumed liabilities totaling $13.0 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 since 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 has recorded $3.8 million in tangible 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. (i) Shoreline Studios, Inc. 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 $0.8 million including related goodwill of $0.4 million. The transaction was accounted for by the purchase method of accounting. The results of operations of Shoreline, Inc. did not have a material effect on the Company's results of operations. (j) Miro Computer Products, AG In August 1997, the Company acquired the Digital Video Products Group from miro Computer Products AG. In the acquisition, the Company acquired the miroVIDEO product line, certain technology and other assets. The Company paid $15.2 million in cash in October 1997, issued 814,260 shares of common F-16 stock, valued at $4.4 million, assumed liabilities of $2.7 and incurred transaction costs of $1.1 million. The fair value of assets acquired included tangible assets, primarily inventories, of $2.4 million, goodwill and other intangibles of $3.9 million, and the Company expensed $17.0 million of in-process research and development. In addition, the Company incurred $465,000 of other nonrecurring costs for the year ended June 30, 1998. To determine the value of the software in the development stage, the Company considered, among other factors, the stage of development of each project, the time and resources needed to complete each project, expected income and associated risks. Associated risks include the inherent difficulties and uncertainties in completing the project and thereby achieving technological feasibility and risks related to the viability of and potential changes in future target markets. As a result of this analysis, the Company recorded an expense of $17.0 million for in process research and development on the August 1997 acquisition date. The terms of the acquisition also 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 1,230,136 shares of its common stock to miro Computer Products AG and recorded additional goodwill of $7.8 million to be amortized into income over nine years using the straight-line method. (k) Pro Forma Financial Information The following unaudited pro forma results of operations for fiscal 2000 and 1999 are as if the acquisitions of Synergy, Puffin, DES, ASports and occurred at the beginning of fiscal 2000 and 1999, after giving effect to certain adjustments, including amortization of goodwill and related income tax effects. The pro forma information excludes charges for acquired in-process research and development. The pro forma information has been prepared for comparative purposes only and is not indicative of what operating results would have been if the acquisitions had taken place at the beginning of fiscal 1999 or of future operating results. Separate, historical statements of operations of VID were never prepared by HP due to the de minimus nature of the VID business in proportion to HP as a whole. Therefore, such pro-forma condensed statements of operations have not been included in this pro-forma information. Year Ended June 30, (In thousands, except per share data, unaudited) 2000 1999 ---- ---- Net sales ......................................... $ 258,463 $187,620 ========= ======== Net loss .......................................... $ (7,287) $ (5,404) ========= ======== Basic net loss per share .......................... $ (0.15) $ (0.12) ========= ======== Diluted net loss per share ........................ $ (0.13) $ (0.11) ========= ======== (l) In-Process Research and Development The amounts allocated to identifiable intangible assets and acquired in-process research and development were based on results of an independent appraisals using established valuation techniques. 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 product's 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 technological feasibility was achieved when a product is at beta stage. The values assigned to purchased in-process research and development were 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 using a risk-adjusted discount rate of 35% and then 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. A discount and attribution rate of 35% was used in the VID valuation and a 30% rate was used on the valuations of Puffin, DES and Montage. Note 6 Commitments and Contingencies Lease Obligations As of June 30, 2000, the Company leased facilities and vehicles under non-cancelable operating leases. Future minimum lease payments are as follows (in thousands): Years Ending June 30, 2001 $ 4,100 2002 4,068 2003 3,876 2004 3,112 2005 1,493 Thereafter 2,529 --------- Total $ 19,178 F-17 Rent expense for the years ended June 30, 2000, 1999 and 1998, was $2.3 million, $1.8 million and $1.1 million, respectively. Legal Actions On July 18, 2000, a lawsuit entitled Jiminez v. Pinnacle Systems, Inc. et al., No. 00-CV-2596 was filed in the United States District Court for the Northern District of California against the Company and certain officer and director defendants. The action is a putative class action and alleges that defendants violated the federal securities laws by making false and misleading statements concerning the Company's business prospects during an alleged class period of April 18, 2000 through July 10, 2000. The complaint does not specify damages. The Company intends to defend the case vigorously. The Company is engaged in certain legal actions arising in the ordinary course of business. The Company believes it has adequate legal defenses and believes that the ultimate outcome of these actions will not have a material effect on the Company's consolidated financial position or results of operations, although there can be no assurance as to the outcome of such litigation. Note 7 Employee Benefit Plans Stock Option Plans The Company's 1987 Stock Option Plan (the "1987 Plan") provides for the grant of both incentive and non-statutory stock options to employees, directors and consultants of the Company. Pursuant to the terms of the 1987 Plan, after April 1997 no further shares are available for future grants. In September 1994, the shareholders approved the 1994 Directors' Option Plan (the "Director Plan"), reserving 400,000 shares of common stock for issuance. The Plan provides for the granting of non-statutory stock options to non-employee directors of the Company. Under the Director Plan, upon joining the Board, each non-employee director automatically receives an option to purchase 20,000 shares of the Company's common stock vesting over four years. Following each annual shareholders' meeting, each non-employee director receives an option to purchase 5,000 shares of the Company's common stock vesting over a twelve- month period. All Director Plan options are granted at an exercise price equal to fair market value on the date of grant and have a ten-year term. There were 190,000 and 235,000 shares available for grant under the Director Plan at June 30, 2000 and 1999, respectively. In October 1996, the shareholders approved the 1996 Stock Option Plan (the "1996 Plan"). The 1996 Plan provides for grants of both incentive and non-statutory common stock options to employees, directors and consultants to purchase common stock at a price equal to the fair market value of such shares on the grant dates. Options granted pursuant to the 1996 Plan are generally granted for a ten-year term and generally vest over a four-year period. At June 30, 2000, there were 287,692 shares available for grant under the 1996 Plan. The Board of Directors has approved an increase in the number of shares available for grant by 800,000 shares. However, this increase is subject to shareholder approval at the 2000 annual meeting of shareholders. In November 1996, the Board of Directors approved the 1996 Supplemental Stock Option Plan (the "1996 Supplemental Plan"). The 1996 Supplemental Plan provides for grants of non-statutory common stock options to employees and consultants other than officers and directors at a price determined by the Board of Directors. Options granted pursuant to the 1996 Supplemental Plan are generally granted for a ten-year term and generally vest over a four-year period. At June 30, 2000, there were 168,692 shares available for grant under the 1996 Supplemental Plan. In July 2000, the Board of Directors increased the number of shares available for grant by 2,200,000. F-18 In addition to the above mentioned plans, an officer of the Company holds 345,172 options at an exercise price of $0.56, all of which are outside of the plans and were exercisable as of June 30, 2000. Stock option activity under these employee and director option plans was as follows:
Available Options Weighted Average (shares in thousands) For Grant Outstanding Exercise Price -------------------------------------- --------------- ---------------- ---------------------- Balance at June 30, 1997 1,756 6,548 $ 2.59 Additional shares reserved 3,460 -- -- Exercised -- (1,812) $ 1.94 Granted (4,716) 4,716 $ 5.70 Canceled 872 (1,064) $ 4.55 -------------------------------------- --------------- ---------------- ---------------------- Balance at June 30, 1998 1,372 8,388 $ 4.22 Additional shares reserved 3,200 -- -- Exercised -- (1,906) $ 3.64 Granted (3,896) 3,896 $ 7.49 Assumed in Truevision acquisition -- 280 $ 5.99 Canceled 568 (652) $ 5.67 -------------------------------------- --------------- ---------------- ---------------------- Balance at June 30, 1999 1,244 10,006 $ 5.57 Additional shares reserved 5,000 -- -- Exercised -- (2,117) $ 4.87 Granted (6,214) 6,214 $15.10 Assumed in Puffin acquisition -- 52 $24.65 Assumed in Avid Sports acquisition -- 139 $ 5.82 Canceled 617 (635) $ 7.55 -------------------------------------- --------------- ---------------- ---------------------- Balance at June 30, 2000 647 13,659 $10.00 -------------------------------------- --------------- ---------------- ----------------------
Assumptions used in determining the fair value of stock options granted using the Black-Scholes option-pricing model were as follows: for fiscal 2000, volatility of 75.2%, no expected dividends, an average risk-free interest rate of 6.15% and an average expected option term of 3.4 years; for fiscal 1999, volatility of 57.0%, no expected dividends, an average risk-free interest rate of 4.93% and an average expected option term of 3.4 years; and for fiscal 1998, volatility of 55.5%, no expected dividends, an average risk-free interest rate of 5.80% and an average expected option term of 4.4 years. The weighted average fair value of options granted for the fiscal years ended June 30, 2000, 1999 and 1998 was $8.35, $3.32 and $2.88 respectively. F-19 The following table summarizes stock options outstanding and exercisable at June 30, 2000.
Outstanding Exercisable --------------------------------------------------- ---------------------------------- Weighted Weighted Weighted Average Average Average Exercise Shares Remaining Exercise Shares Exercise Price Range (In thousands) Life in years Price (In thousands) Price ------------------------- ----------------- ----------------- --------------- ------------------ --------------- $ 0.21 to 5.06 3,098 6.07 $ 3.52 2,143 $ 3.28 $ 5.16 to 8.16 3,221 8.01 $ 6.53 1,437 $ 6.54 $ 8.31 to 10.63 1,118 8.68 $ 9.04 294 $ 9.06 $13.00 to 13.00 3,425 9.10 $ 13.00 8 $ 13.00 $13.19 to 33.79 2,797 9.59 $ 17.83 70 $ 22.29 ------------------------- ----------------- ----------------- --------------- ------------------ --------------- Total 13,659 8.22 $ 10.00 3,952 $ 5.24
Had compensation expense for the Company's stock based compensation plans been determined consistent with SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's net income (loss) and net income (loss) per share would have been as follows (in thousands except per share data): Years ended June 30, -------------------- 2000 1999 1998 ---- ---- ---- Net income (loss); As reported $ 7,587 $ 18,436 $ (6,220) Pro forma $ (11,332) $ 10,922 $ (12,100) Earnings per share: Basic-----As reported $ 0.16 $ 0.43 $ (0.17) ------Pro forma $ (0.23) $ 0.26 $ (0.34) Diluted---As reported $ 0.14 $ 0.39 $ (0.17) ------Pro forma $ (0.20) $ 0.24 $ (0.34) Stock Purchase Plan The Company has a 1994 Employee Stock Purchase Plan (the "Purchase Plan") under which all eligible employees may acquire common stock at the lesser of 85% of the closing sales price of the stock at specific, predetermined dates. In October 1999, the shareholders increased the number of shares authorized to be issued under the Purchase Plan to 3,550,391 shares, of which 1,856,931 were available for issuance at June 30, 2000. Annual increases to the Purchase Plan are calculated as the of the lesser of 1,200,000 shares or 2% of the Company's outstanding shares of common stock. Employees purchased 340,000, 448,000 and 452,000 shares in the years ended June 30, 2000, 1999 and 1998, respectively. F-20 The fair value of employees' stock purchase rights under the Purchase Plan was estimated using the Black-Scholes model with the following weighted average assumptions used for purchases in each of the following fiscal years ended June 30: -------------------------- ---------------- ----------------- ----------------- 2000 1999 1998 ---- ---- ---- -------------------------- ---------------- ----------------- ----------------- Risk-free interest rate 5.97% 4.8% 5.5% -------------------------- ---------------- ----------------- ----------------- Expected life (in years) 0.5 0.5 0.5 -------------------------- ---------------- ----------------- ----------------- Expected volatility 75.2% 57.0% 55.0% -------------------------- ---------------- ----------------- ----------------- Retirement Plan The Company has a defined contribution 401(k) plan covering substantially all of its domestic employees. Participants may elect to contribute up to 15% of their eligible earnings to this plan up to the statutory maximum amount. The Company can make discretionary contributions to the plan determined solely by the Board of Directors. The Company has not made any such contributions to the plan to date. Note 8 Shareholders' Equity Stock Repurchase Plan. On July 14, 2000 the Company's Board of Directors had authorized the repurchase of up to 3.0 million shares of the Company's common stock. The shares would be purchased in the open market from time to time. Shareholder Rights Plan In December 1996, the Company adopted a Shareholder Rights Plan pursuant to which one Right was distributed for each outstanding share of common stock. Each Right entitles stockholders to buy one one-thousandth of a share of Series A Participating Preferred Stock at an exercise price of $65.00 upon certain events. The Rights become exercisable if a person acquires 15% or more of the Company's common stock or announces a tender offer that would result in such person owning 15% or more of the Company's common stock. If the Rights become exercisable, the holder of each Right (other than the person whose acquisition triggered the exercisability of the Rights) will be entitled to purchase, at the Right's then-current exercise price, a number of shares of the Company's common stock having a market value of twice the exercise price. In addition, if the Company were to be acquired in a merger or business combination after the Rights became exercisable, each Right will entitle its holder to purchase, at the Right's then-current exercise price, common stock of the acquiring company having a market value of twice the exercise price. The Rights are redeemable by the Company at a price of $0.001 per Right at any time within ten days after a person has acquired 15% or more of the Company's common stock. F-21 Note 9 Income Taxes A summary of the components of income tax expense follow: -------------------------------------------------------------------------------- Years ended June 30, --------------------------------- 2000 1999 1998 ---- ---- ---- (in thousands) -------------------------------------------------------------------------------- Current: Federal $ (2,683) $ 2,260 $ 1,511 State 365 2 120 Foreign 2,328 1,482 771 Less: benefit of net operating losses -- -- (1,121) -------- -------- -------- Total current 10 3,744 1,281 Deferred: U.S. Federal (1,248) (8,427) (583) State (2,129) (2,031) -- Foreign -- 388 -- -------- -------- -------- Total deferred (3,377) (10,070) (583) Charge in lieu of taxes attributed to employee stock option plans 5,146 6,992 1,987 -------- -------- -------- Total tax expense $ 1,779 $ 666 $ 2,685 ======== ======== ======== -------------------------------------------------------------------------------- Total income tax expense differs from expected income tax expense (computed by applying the U.S. federal corporate income tax rate of 35% for the years ended June 30, 2000 and 1999, and 34% for the year ended June 30, 1998 to profit (loss) before taxes as follows:
Years ended June 30, -------------------------------- 2000 1999 1998 ---- ---- ---- (in thousands) -------------------------------------------------------------------------------------------------- Income tax expense (benefit) at federal statutory rate $ 3,278 $ 6,685 $(1,202) State income taxes, net of federal income tax benefits 332 505 228 In-process research and development 525 Non deductible goodwill and intangible amortization 340 Foreign tax rate differentials 391 288 182 Research tax credit (155) (333) (430) Change in beginning of the year valuation allowance (3,100) (6,400) 3,714 Other, net 168 (79) 193 ------- ------- ------- $ 1,779 $ 666 $ 2,685 ======= ======= ======= -------------------------------------------------------------------------------------------------
F-22 The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities as of June 30, 2000, 1999, and 1998 are as follows:
------------------------------------------------------------------------------------- Years ended June 30, --------------------------------- 2000 1999 1998 ---- ---- ---- (in thousands) ------------------------------------------------------------------------------------- Deferred tax assets: Accrued expense and reserves $ 7,165 $ 2,973 $ 3,873 Acquired intangibles 7,554 8,682 3,868 Net operating loss carry forwards 5,244 4,105 5,746 Tax credit carry forwards 6,116 1,346 1,861 Fixed assets 243 -- -- Other 127 132 60 -------- -------- -------- Total gross deferred tax assets 26,449 17,238 15,408 Less: valuation allowance (9,346) (6,197) (14,385) -------- -------- -------- Net deferred tax assets 17,103 11,041 1,023 -------- -------- -------- Deferred tax liabilities: Acquired intangibles (9,899) -- -- Accumulated domestic international sales corporation income (324) (388) (440) Unrealized foreign exchange gain (388) -- -- -------- -------- -------- Total gross deferred tax liabilities (10,611) (388) (440) -------- -------- -------- Net deferred tax assets $ 6,492 $ 10,653 $ 583 ======== ======== ======== --------------------------------------------------------------------------------------
The Company is presently unable to conclude that all of the deferred tax assets are more likely than not to be realized. Accordingly, a valuation allowance was provided for a significant portion of the deferred tax assets. Total valuation allowance was $9.3 million, $6.2 million and $14.4 million as of June 30, 2000, 1999, and 1998, respectively. During the year ended June 30, 2000, the Company increased the valuation allowance by a net $3.1 million of which $6.2 million was a debit relating to the tax benefit arising from the exercise of stock options and $3.1 million was a credit attributable to change of beginning of the year valuation allowance. The $6.2 million will be credited to stockholders' equity when recognized in the form of a reduction of the valuation allowance. As of June 30, 2000, the Company had federal and state net operating loss carryforwards of approximately $13.9 million and $5.7 million respectively. The Company's federal net operating loss carryforwards expire in the years 2012 through 2020, if not utilized. The Company's state net operating loss expires in the years 2002 through 2005, if not utilized. In addition, the Company had federal research and experimentation credit carryforwards of $3.1 million which expire in the years 2001 through 2020, and state research and experimentation credit carryforwards of $2.3 million which have no expiration provision. Federal and state tax impose substantial restrictions on the utilization of net operating loss and tax credit carryforwards in the event of an "ownership change" as defined in Internal Revenue Code Section 382. If the Company has such an ownership change, the Company's ability to utilize the above mentioned carryforwards could be significantly reduced. F-23 Note 10 Segment Information At June 30, 2000, the Company's organizational structure is based on three strategic business groups that sell various products into the principle markets which the Company's products are sold. These business groups equate to three reportable segments: Broadcast, Desktop or Professional, and Consumer. The Company's chief operating decision maker ("CODM") reviews financial information presented on a consolidated basis, accompanied by disaggregated information by business group for purposes of making operating decisions and assessing financial performance. The CODM evaluates the performance of the business groups based on revenues and operating income before income taxes, interest income, interest expenses, and other income, excluding the effects of nonrecurring charges including a legal settlement and in-process research and development. Common costs not directly attributable to a particular business group are allocated among segments based on management's best estimates, including an allocation of depreciation expense without a corresponding allocation of the related assets. Although the Company does include depreciation expense in its segmented information, amounts allocated to each business group are insignificant. The Company is not capital intensive and aggregate depreciation is approximately 2% of net sales. The Company currently does not present assets of the business groups as part of the assessment of performance. Therefore such information is not being disclosed. The following is a summary of the Company's operations by operating segment for the years ended June 30 (in thousands): 2000 1999 1998 --------- --------- --------- Broadcast: Revenues $ 85,618 $ 26,917 $ 25,521 Gross profit 51,790 15,483 15,309 Operating income (loss) $ 3,424 $ (2,398) $ 508 Desktop: Revenues $ 101,698 $ 89,798 $ 60,335 Gross profit 53,368 53,430 35,403 Operating income $ 7,340 $ 20,352 $ 17,355 Consumer: Revenues $ 50,651 $ 42,383 $ 19,440 Gross profit 19,236 15,803 5,869 Operating income (loss) $ 801 $ 1,985 $ (7,577) Combined : Revenues $ 237,967 $ 159,098 $ 105,296 Gross profit 124,394 85,076 56,581 Operating income $ 11,565 $ 20,939 $ 10,286 F-24 The following table reconciles combined operating income (loss) to total consolidated operating income (loss) for the years ended June 30 (in thousands): 2000 1999 1998 -------- -------- -------- Combined operating income for reportable segments $ 11,565 $ 20,939 $ 10,286 Unallocated amounts: Legal settlement (2,102) In process research and development (3,500) (6,579) (16,960) -------- -------- -------- Consolidated operating income (loss) $ 5,963 $ 14,360 $ (6,674) ======== ======== ======== The Company markets its products globally through its network of sales personnel, dealers, distributors and subsidiaries. Export sales account for a significant portion of the Company's net sales. The following table presents a summary of revenue and long-lived assets by geographic region as of and for years ended June 30 (in thousands): 2000 1999 1998 -------- -------- -------- Revenues -------- North America (US and Canada) $107,019 $ 62,393 $ 44,621 United Kingdom 21,307 8,629 3,622 Germany 18,230 20,430 9,596 France 16,373 12,501 6,753 Spain, Italy, Benelux 23,500 18,070 9,374 Japan, China, Hong Kong, Singapore 22,637 12,265 9,584 Other foreign countries 28,901 24,810 21,746 -------- -------- -------- Total $237,967 $159,098 $105,296 ======== ======== ======== Long-lived assets ----------------- North America (US and Canada) $ 13,851 $ 9,055 $ 4,462 Germany 1,598 1,361 506 Other foreign countries 694 392 443 -------- -------- -------- $ 16,143 $ 10,808 $ 5,411 ======== ======== ======== Foreign revenue is reported based on where the sale originates. Avid Technology, Inc. (Avid) accounted for approximately 7.3%, 6.8%, and 10.7% of the Company's net sales for the years ended June 30, 2000, 1999 and 1998 respectively. Sales to Avid are included in the Company's desktop business segment. Ingram Micro Inc. accounted for approximately 5.9% of the Company's net sales for the year ended June 30, 2000 and 10.5% for in each of the years ended June 30, 1999 and 1998. Sales to Ingram are included in both the Company's desktop and consumer business segments. In addition, Ingram Micro Inc. accounted for 9.6% and 23.2% of net accounts receivable at June 30, 2000 and 1999, respectively. No other customer accounted for greater than 10% of accounts receivable. Note 11 Related Party During the fiscal years ended June 30, 2000, 1999, and 1998, the Company purchased materials totaling $5.0 million, $11.3 million, and $4.0 million respectively, from Bell Microproducts, Inc. ("Bell"). Bell provides value-added turnkey services on behalf of the Company to build certain products in accordance with the Company's specifications. A director of the Company is also a director of Bell. F-25 Note 12 Supplemental Cash Flow Information The following table reflects supplemental cash flow from investing activities related to acquisitions for the fiscal years ended June 30:
---------------------------------------------------------------------------------------- Fair value of: 2000 1999 1998 -------------- -------------------------------------------------------------- -------------------------- Assets acquired and goodwill $ 124,654 $ 25,735 $ 23,350 -------------------------------------------------------------- -------------------------- Liabilities assumed (42,558) (13,312) (3,800) -------------------------------------------------------------- -------------------------- Common stock, stock options -------------------------------------------------------------- -------------------------- and warrants issued (69,771) (12,856) (4,400) --------- --------- --------- -------------------------------------------------------------- -------------------------- Net cash (received) paid on acquisitions $ 12,325 $ (433) $ 15,150 ========= ========= ========= ----------------------------------------------------------------------------------------
F-26 Note 13 Quarterly Financial Data (Unaudited) Summarized quarterly financial information for fiscal 2000 and 1999 is as follows (in thousands except for per share data amounts):
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter ---------------------------------------------------------------------------------- Fiscal 2000: ------------ Net sales $ 50,447 $ 62,562 $ 61,246 $ 63,712 Gross profit 28,147 32,147 33,286 30,814 In process research and development 2,000 -- 1,100 400 Income (loss) from operations 2,680 5,806 1,071 (3,593) Net income (loss) 2,790 5,389 1,669 (2,261) Net income (loss) per share - basic 0.06 0.11 0.03 (0.05) - diluted 0.05 0.10 0.03 (0.05) Shares used to compute net income per share - basic 46,600 47,844 48,655 50,129 - diluted 52,984 54,454 56,424 50,129 Fiscal 1999: ------------ Net sales $ 32,273 $ 39,172 $ 40,147 $ 47,506 Gross profit 17,260 20,975 21,705 25,135 In process research and development -- -- 6,579 -- Income (loss) from operations 3,863 5,176 (1,127) 6,447 Net income 4,008 5,040 8 9,378 Net income per share - basic 0.10 0.12 0.00 0.21 - diluted 0.09 0.11 0.00 0.19 Shares used to compute net income per share - basic 40,808 42,096 43,084 45,160 - diluted 44,452 46,004 47,708 50,654
F-27 Schedule II - Valuation and Qualifying Accounts (in thousands) Balance at Balance at beginning of end of period period --------------- --------------- Year ended June 30, 2000 ------------------------ Allowance for bad debt 1,899 2,528 (a) Sales return allowances 3,158 3,255 (b) Year ended June 30, 1999 ------------------------ Allowance for bad debt 1,469 1,899 (a) Sales return allowances 2,954 3,158 (b) Year ended June 30, 1998 ------------------------ Allowance for bad debt 800 1,469 Sales return allowances 954 2,954 (a) Ending amount includes acquisition-related allowances of $0.9 million and $0.3 million for the fiscal years ended June 30, 2000 and 1999, respectively. (b) Ending amount includes acquisition-related allowances of $0.9 million for the fiscal years ended June 30, 2000 and 1999, respectively. Acquisition related allowances are recorded on the date of acquisition and are used solely as a valuation on acquired assets of each separate acquisition. F-28