-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Mid34cpbvFeh+wYledMlK7hhtaMZ1X6w9+s7OVgIRGvbHt8wQ8gs2Y6wfTO109WW zFfdYaatsqCmdJXicJsV4w== 0000950005-01-000256.txt : 20010223 0000950005-01-000256.hdr.sgml : 20010223 ACCESSION NUMBER: 0000950005-01-000256 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010214 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PINNACLE SYSTEMS INC CENTRAL INDEX KEY: 0000774695 STANDARD INDUSTRIAL CLASSIFICATION: PHOTOGRAPHIC EQUIPMENT & SUPPLIES [3861] IRS NUMBER: 943003809 STATE OF INCORPORATION: CA FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-24784 FILM NUMBER: 1542362 BUSINESS ADDRESS: STREET 1: 280 N BERNARDO AVE CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043 BUSINESS PHONE: 6502371600 MAIL ADDRESS: STREET 1: 280 N BERNARDO AVE CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043 10-Q 1 0001.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 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 No. 0-24784 PINNACLE SYSTEMS, INC. (Exact name of Registrant as specified in its charter) California 94-3003809 - ------------------------------- ------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 280 N. Bernardo Ave. Mountain View, CA 94043 - ----------------- ---------- (Address of principal executive offices) (Zip Code) (650) 237-1600 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- The number of shares of common stock outstanding as of February 7, 2001 was approximately 51,045,167. 1 INDEX PART I - FINANCIAL INFORMATION ITEM 1 - Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets - December 31, 2000 and June 30, 2000 3 Condensed Consolidated Statements of Operations - Three Months and Six Months Ended December 31, 2000 and 1999 4 Condensed Consolidated Statements of Comprehensive Income (Loss) Three Months and Six Months Ended December 31, 2000 and 1999 5 Condensed Consolidated Statements of Cash Flows - Six Months Ended - December 31, 2000 and 1999 6 Notes to Condensed Consolidated Financial Statements 7 ITEM 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 11 ITEM 3 - Quantitative and Qualitative Disclosures About Market Risk 24 PART II - OTHER INFORMATION ITEM 4 - Submission of Matters to a Vote of Security Holders 25 ITEM 6 - Exhibits and Reports on Form 8-K 25 Signatures 26 2 PART 1 - FINANCIAL INFORMATION Item 1. Financial Statements PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands; unaudited)
December 31, June 30, 2000 2000(1) --------- --------- Assets Current assets: Cash and cash equivalents $ 48,835 $ 58,433 Marketable securities 4,464 19,366 Accounts receivable, net 58,489 55,072 Inventories 44,769 36,824 Deferred income taxes 17,103 17,103 Prepaid expenses and other assets 4,147 4,100 --------- --------- Total current assets 177,807 190,898 Marketable securities -- 4,346 Property and equipment, net 15,420 16,143 Goodwill and other intangibles, net 98,008 109,810 Other assets 2,338 1,602 --------- --------- $ 293,573 $ 322,799 ========= ========= Liabilities and Shareholders' Equity Current liabilities: Accounts payable $ 17,376 $ 22,422 Accrued expenses 24,253 30,146 --------- --------- Total current liabilities 41,629 52,568 Deferred income taxes 10,611 10,611 --------- --------- Total liabilities 52,240 63,179 Shareholders' equity: Preferred stock, no par value; authorized 5,000 shares; none issued and outstanding -- -- Common stock, no par value; authorized 120,000 shares; 51,008 and 51,293 issued and outstanding as of December 31 and June 30, 2000, respectively 272,078 257,496 Treasury shares at cost; 793 and -0- shares at December 31 and June 30, 2000, respectively (6,508) -- Retained earnings (accumulated deficit) (15,555) 7,198 Accumulated other comprehensive loss (8,682) (5,074) --------- --------- Total shareholders' equity 241,333 259,620 --------- --------- $ 293,573 $ 322,799 ========= ========= (1) Numbers are derived from the Company's audited financial statements for the fiscal year ended June 30, 2000. See accompanying notes to condensed consolidated financial statements.
3 PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data; unaudited)
Three Months Ended Six Months Ended December 31, December 31, 2000 1999 2000 1999 --------- --------- --------- --------- Net sales $ 75,033 $ 62,562 $ 137,808 $ 113,008 Cost of sales 39,668 30,415 75,910 52,714 --------- --------- --------- --------- Gross profit 35,365 32,147 61,898 60,294 --------- --------- --------- --------- Operating expenses: Engineering and product development 7,971 6,244 16,327 12,213 Sales and marketing 16,683 13,819 32,272 25,545 General and administrative 4,338 2,257 8,093 4,969 Amortization of goodwill and intangibles 7,470 4,021 15,322 7,082 Acquisition settlement 363 -- 13,613 -- In-process research and development -- -- -- 2,000 --------- --------- --------- --------- Total operating expenses 36,825 26,341 85,627 51,809 --------- --------- --------- --------- Operating income (loss) (1,460) 5,806 (23,729) 8,485 Interest income and other, net 462 804 976 1,612 --------- --------- --------- --------- Income (loss) before income taxes (998) 6,610 (22,753) 10,097 Income tax expense -- 1,221 -- 1,918 --------- --------- --------- --------- Net income (loss) $ (998) $ 5,389 $ (22,753) $ 8,179 ========= ========= ========= ========= Net income (loss) per share Basic $ (0.02) $ 0.11 $ (0.45) $ 0.17 ========= ========= ========= ========= Diluted $ (0.02) $ 0.10 $ (0.45) $ 0.15 ========= ========= ========= ========= Shares used to compute net income (loss) per share Basic 50,951 47,844 50,943 47,224 ========= ========= ========= ========= Diluted 50,951 54,454 50,943 53,710 ========= ========= ========= ========= See accompanying notes to condensed consolidated financial statements.
4 PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (In thousands; unaudited)
Three Months Ended Six Months Ended December 31, December 31, 2000 1999 2000 1999 -------- -------- -------- -------- Net income (loss) $ (998) $ 5,389 $(22,753) $ 8,179 Foreign currency translation adjustment 1,531 (2,183) (3,608) (1,066) -------- -------- -------- -------- Comprehensive income (loss) $ 533 $ 3,206 $(26,361) $ 7,113 ======== ======== ======== ======== See accompanying notes to condensed consolidated financial statements.
5 PINNACLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands; unaudited)
Six Months Ended December 31, 2000 1999 -------- -------- Cash flows from operating activities: Net income (loss) $(22,753) $ 8,179 Adjustments to reconcile net income to net cash provided by (used in) operating activities: In-process research and development -- 2,000 Acquisition settlement - equity portion 11,482 -- Depreciation and amortization 18,700 9,020 Deferred taxes 377 (1,444) Changes in operating assets and liabilities: Accounts receivable (3,524) (6,495) Inventories (8,319) (2,043) Accounts payable (5,814) 2,102 Accrued expenses (4,082) (495) Other (2,749) (845) -------- -------- Net cash provided by (used in) operating activities (16,682) 9,979 -------- -------- Cash flows from investing activities: Purchases of property and equipment (2,683) (5,103) Acquisition payments net of cash acquired (6,247) (12,597) Proceeds from maturity of marketable securities, net of purchases 19,248 11,850 -------- -------- Net cash provided by (used in) investing activities 10,318 (5,850) -------- -------- Cash flows from financing activities: Purchase of treasury stock (6,508) -- Payments on note payable -- (42) Proceeds from issuance of common stock 3,100 5,748 -------- -------- Net cash provided by (used in) financing activities (3,408) 5,706 -------- -------- Effects of exchange rate changes on cash 174 1,960 -------- -------- Net increase (decrease) in cash and cash equivalents (9,598) 11,795 Cash and cash equivalents at beginning of period 58,433 48,654 -------- -------- Cash and cash equivalents at end of period $ 48,835 $ 60,449 ======== ======== Supplemental disclosures of cash paid during the period for: Income taxes $ 1,423 $ -- ======== ======== Interest $ 2 $ -- ======== ======== Non-cash transactions: Common stock issued in business acquisitions $ -- $ 20,632 ======== ======== See accompanying notes to condensed consolidated financial statements.
6 Notes To Condensed Consolidated Financial Statements (unaudited) 1. General The accompanying unaudited condensed consolidated financial statements include the accounts of Pinnacle Systems, Inc. and its wholly owned subsidiaries ("Pinnacle" or the "Company"). Intercompany transactions and related balances have been eliminated in consolidation. These financial statements have been prepared in conformity with generally accepted accounting principles for interim financial information and in accordance with the instructions of Form 10-Q and Rule 10 of Regulation S-X. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reported periods. The most significant estimates included in these financial statements include accounts receivable and sales allowances, inventory valuation and the income tax valuation allowance. Actual results could differ from those estimates. These condensed consolidated financial statements reflect all adjustments that, in the opinion of management, are necessary for a fair statement of the consolidated financial position, results of operations and cash flows as of and for the interim periods. Such adjustments consist of items of a normal recurring nature. Certain information or footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The condensed consolidated financial statements included herein should be read in conjunction with the consolidated financial statements and notes thereto, which include information as to significant accounting policies, for the fiscal year ended June 30, 2000 included in the Company's Annual Report on Form 10-K as filed with the Securities and Exchange Commission on September 28, 2000. Results of operations for interim periods are not necessarily indicative of results for a full year. Currency Translation The Company considers the functional currency of its foreign subsidiaries to be the local currency. These functional currencies are translated into U.S. dollars using exchange rates in effect at period end for assets and liabilities and average exchange rates during each reporting period for the results of operations. Adjustments resulting from the translation of foreign subsidiary financial statements are reported within accumulated other comprehensive losses which is reflected as a separate component of shareholders' equity. Foreign currency transaction gains and losses are included in results of operations. Comprehensive Income (Loss) The Company's comprehensive income (loss) includes net income and foreign currency translation adjustments. Derivative Instruments and Hedging Activities As of July 1, 2000, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. The adoption of SFAS No. 133 did not have a material effect on the Company's financial position or results of operations. Recent Accounting Pronouncements 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 fourth quarter of fiscal 2001. The Company is in the process of assessing the impact, if any, that the adoption of SAB No. 101 will 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" ("FIN 44"). 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. The Company adopted FIN 44 on July 1, 2000. The adoption of FIN 44 did not have a material effect on the Company's financial position or results of operations. 7 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 position or results of operations. 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 position or results of operations. 2. Acquisitions (a) Minerva Networks, Inc. On December 29, 2000, the Company acquired DVD authoring technology from Minerva Networks, Inc., a leading provider of professional and consumer video networking solutions that enable the convergence of television and the Internet ("Minerva"). The technology acquired from Minerva includes the Impression family of DVD application software, DVD formatting software and associated intellectual property. Intangibles are being amortized using the straight-line method over a three-year period. In December 2000, the Company paid $2.3 million in cash for Minerva's technology. Pinnacle also incurred approximately $0.1 million in transaction costs. (b) Pro Forma Financial Information The following unaudited pro forma results of operations for the three-month and six-month periods ended December 31, 1999 are as if the acquisitions, as discussed in the Company's Form 10-K for the year ended June 30, 2000, which occurred during the period ended June 30, 2000, had occurred at the beginning of fiscal 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. Three Months Ended Six Months Ended (In thousands, except per share data) December 31, 1999 December 31, 1999 ----------------- ----------------- Net sales $ 66,217 $ 124,122 Net income $ 2,477 $ 4,083 Basic net income per share $ 0.05 $ 0.09 Diluted net income per share $ 0.05 $ 0.08 3. Per Share Information The following tables reconcile the denominator of the basic and diluted earnings per share computations shown on the Condensed Consolidated Statements of Operations:
Three Months Ended Six Months Ended December 31, December 31, (In thousands) 2000 1999 2000 1999 ------ ------ ------ ------ Basic EPS - weighted average shares of common stock outstanding 50,951 47,844 50,943 47,224 Effect of dilutive securities - stock options and warrants outstanding -- 6,610 -- 6,486 ------ ------ ------ ------ Diluted EPS - weighted average shares and dilutive securities outstanding 50,951 54,454 50,943 53,710 ====== ====== ====== ======
The Company excludes potentially dilutive securities from its diluted net income (loss) per share computation when either the Company reports a net loss or the exercise price of the securities exceeds the average fair value of the Company's common stock because the effect would be anti-dilutive. For the three-month and six-month periods ended December 31, 2000, the Company excluded options to purchase 6,254,674 and 6,302,004 shares of common stock, respectively, from the diluted earnings per share computation as their exercise prices exceeded the average fair value of the Company's common stock during the respective periods and, accordingly, their inclusion would have been anti-dilutive. 8 For the three-month and six-month periods ended December 31, 2000, the Company excluded an estimated share count for the contingent shares associated with the Avid Sports settlement and employee stock options to purchase 4,744,300 and 4,255,969 shares of common stock, respectively, from the diluted earnings per share computation, as the Company experienced a net loss in that period, and as such, their inclusion would have been anti-dilutive. 4. Segment Information Prior to July 1, 2000, the Company's organizational structure was based on three strategic business groups that sold various products into the Company's principle markets. These business groups equated to three reportable segments: Broadcast, Desktop, and Consumer. Beginning on July 1, 2000, the Company reorganized and implemented a plan to divide the operations of the Company into three distinct divisions: Broadcast Solutions, Professional .Media and Personal Web Video. The reorganization was performed to provide a structure that would meet the growing demands of the Company and to provide divisional managers the ability to focus and manage their own operations and resources. Prior to this, resources for sales, marketing, operations and logistics were managed independently outside of the business groups. The reorganization also provided the Company an opportunity to re-evaluate its product offerings and better align them within its distribution channels. The Company's chief operating decision maker evaluates the performance of these divisions based on revenues, gross profit, and operating income before income taxes, interest income, interest expenses, and other income, excluding the effects of nonrecurring charges. Nonrecurring charges include in-process research and development and amortization of goodwill and other intangibles related to the Company's acquisitions. Operating results also include allocations of certain corporate expenses. The following is a summary of the Company's operations by operating segment for the three-month and six-month periods ended December 31, 2000 and 1999. Only revenue information is being provided on a comparative basis. Due to the reorganization of the Company and the addition and realignment of operational departments and personnel, restatement of prior years segment results would be impractical. (In thousands) Three Months Ended Six Months Ended ------------------ ---------------- December 31 December 31, ----------- ------------ 2000 1999 2000 1999 -------- -------- -------- -------- Broadcast Solutions: Revenues $ 23,114 $ 19,350 $ 47,251 $ 36,359 Gross profit 12,039 23,639 Operating income (loss) $ 310 $ (861) Professional Media: Revenues $ 13,019 $ 11,295 $ 26,284 $ 22,903 Gross profit 6,987 13,021 Operating income $ 1,207 $ 280 Personal Web Video: Revenues $ 38,900 $ 31,917 $ 64,273 $ 53,746 Gross profit 16,339 25,238 Operating income $ 4,856 $ 6,167 Consolidated: Revenues $ 75,033 $ 62,562 $137,808 $113,008 Gross profit 35,365 61,898 Operating income $ 6,373 $ 5,586 9 The following table reconciles operating income (loss) to total consolidated amounts (in thousands): Three Months Six Months Ended Ended December 31, December 31, 2000 2000 -------- -------- Total operating income for reportable segments $ 6,373 $ 5,586 Unallocated expenses: Amortization of acquisition intangibles (7,470) (15,322) Reorganization expenses and other -- (380) Acquisition settlement (363) (13,613) -------- -------- Consolidated operating loss $ (1,460) $(23,729) ======== ======== 5. Customers and Credit Concentrations During the six months ended December 31, 2000 and 1999, no one customer accounted for more than 10% of net sales or accounts receivable. 6. Related Parties Bell Microproducts Inc. ("Bell") performs certain services and builds certain products for the Company. A director of the Company is also a director of Bell. During the three months ended December 31, 2000 and 1999, the Company purchased materials from Bell totaling $994,000 and $334,000, respectively. During the six months ended December 31, 2000 and 1999, the Company purchased materials from Bell totaling $3,271,000 and $1,214,000, respectively. 7. Commitments and Contingencies 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 is defending the case vigorously. On August 29, 2000, a lawsuit entitled Athle-Tech Computer Systems, Incorporated v. Montage Group, Ltd. and Digital Editing Services, Inc. No. 00-005956-C1-021 was filed in the Sixth Judicial Circuit Court for Pinellas County, Florida (the "AT Claim"). The AT Claim alleges that Montage breached a purported software development agreement between Athle-Tech Computer Systems, Incorporated ("AT") and Montage (the "AT Agreement"). The AT Claim also alleges that DES intentionally interfered with AT's claimed rights with respect to the purported AT Agreement and was unjustly enriched as a result. Finally, the AT Claim requests that the court impose a constructive trust on at least 50% of the proceeds of the purported AT Agreement and render a declaratory judgment in favor of AT. The Company has engaged counsel to defend the AT Claim. Pinnacle believes it has meritorious defenses and is vigorously defending AT's claim. 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"). On September 30, 2000, the Company entered into an agreement with the former shareholders and option holders of ASports wherein Pinnacle agrees to compensate each of them if the closing price of Pinnacle's common stock does not equal or exceed $23 per share for four consecutive trading days prior to May 31, 2001. If Pinnacle's share price does not reach this level, the value of the compensation to be paid shall be equal to the number of shares issued and options assumed in the acquisition (944,213 and 138,158, respectively) multiplied by the difference between Pinnacle's average closing stock price during the month of May, 2001 and $23 per share. Former shareholders of ASports would be compensated in shares of Pinnacle's common stock while the former option holders will be compensated in cash. On September 30, 2000, the Company recorded a charge of $13.3 million which represents the fair value of the arrangement on September 30, 2000 including $0.1 million in transaction fees. On December 31, 2000, the Company recorded an additional $0.4 million charge associated with this obligation. As of December 31, 2000, the Company had recorded a liability of $2.1 million which represents the estimated cash payout to the option holders with the remaining $11.5 million recorded as an increase in common stock. The value assigned was determined by an independent appraiser using the Black-Scholes method. 10 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 or liquidity, although there can be no assurance as to the outcome of such litigation. 8. Stock Repurchase On July 25, 2000 the Company announced that the Board of Directors had authorized the repurchase of up to 3.0 million shares of the Company's common stock. As of December 31, 2000, the Company repurchased a total of 0.8 million shares of its common stock at a cost of $6.5 million. Approximately 2.2 million shares remain authorized for repurchase. 9. Subsequent Events In January 2001, the Company and the shareholders of DES signed an amendment to the DES acquisition agreement that amended the earnout equation. The earnout period is unchanged from the original agreement, but the amended earnout formula is based on both the profitability and revenue of the DES business during the earnout period and on the profitability and revenue of the business acquired from Avid Sports in June, 2000 for the period from July 1, 2000 through the end of the original earnout period. Under the amended agreement, an earnout payment will only be made if operating margins for the total sports business (DES business plus Avid Sports business) exceeds 10% of the total sports revenue during the earnout periods. If an earnout payment is due, the amount will range between 55% and 96% of the combined DES and Avid Sports revenues for those respective periods, depending on actual operating margins of the combined businesses during the earnout period. As with the original earnout agreement, any earnout amount will be paid in shares of the Company's common stock. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Certain Forward-Looking Information Certain statements in this Report constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform Act"), including the third and sixth sentences of the fourth paragraph under "Acquisitions" relating to the cash payout to option holders, the seventh paragraph under "Acquisitions" relating to the earnout payment, the last sentence of the second paragraph under "Commitments and Contingencies" relating to the AT Claim, the fourth sentence of the third paragraph under Commitments and Contingencies" relating to the ASports Settlement, the second sentence of the fourth paragraph under "Commitments and Contingencies" relating to legal actions arising in the ordinary course of business, the last sentence in the fourth paragraph under "Results of Operations" relating to engineering and product development resources, the last sentence in each of the third and fourth paragraphs under "Recent Accounting Pronouncements" regarding the adoption of certain accounting standards, the last sentence in the first paragraph under "Liquidity and Capital Resources" relating to capital resources, the last sentence in the fourth paragraph under Liquidity and Capital Resources" relating to cash proceeds from stock option securities, the third sentence in the first paragraph under "Fixed Income Investments" regarding the Company's investment portfolio and the fifth sentence in the second paragraph under "Fixed Income Investments" regarding market and credit risk. 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. 11 Overview 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 professional 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 marketplace, 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. To focus resources to address the needs of these markets, Pinnacle has structured itself into three distinct divisions: Broadcast Solutions Division, Professional .Media Division and the Personal Web Video Division. Broadcast Solutions Division The Broadcast Solutions Division ("Broadcast") 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 MediaStream server family complements the Company's Thunder family, to provide a more 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 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. 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 September 2000, Broadcast began shipping the PDS 9000 video production switcher. The PDS 9000 was designed for broadcasters producing live video events such as news, sports and local interest programming. During the fiscal year ended June 30, 2000, the Company acquired Digital Editing Services, Inc. and Avid Sports, Inc. 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 addition, Pinnacle acquired Montage, a provider of networked non-linear editing solutions including VorteXNews(TM) which gives users the ability to process, edit, store, broadcast and stream to the Internet live news and sports content entirely in the digital domain. These products are expected to form the basis of Broadcast's Totally Networked News(TM) solutions family to create powerful and comprehensive media management, editing and streaming solutions for broadcasters and sports organizations. Broadcast accounted for approximately 30.8% and 30.9% of net sales in the three-month periods ended December 31, 2000 and 1999, respectively and 34.3% and 32.2% of net sales in the six-month periods ended December 31, 2000 and 1999, respectively. 12 Professional .Media Division The Professional .Media Division ("Media") designs, manufactures, and sells media creation and delivery solutions combining powerful media production, editing, and authoring tools with leading edge visual effects solutions. Media enables its customers to distribute rich integrated media content through traditional and new, Internet-based, delivery methods. By combining the power of the Internet with Pinnacle Systems' rich media production and editing solutions heritage, Media offers customers new ways to create value for their clients. Media includes Pinnacle's webcasting solutions which emphasize the Company's goal to be a leading provider of solutions for the Internet media-streaming marketplace. Media's product offerings include Genie, Reeltime, DVD 2000, Commotion, StreamGenie, StreamFactory, and the TARGA family of products. In March 2000, the Company acquired Puffin, a provider of content creation solutions. Puffin sells an advanced set of software tools that includes Commotion(TM), an all-in-one solution that combines the power of the paintbrush with intuitive compositing and effects tools to deliver superior performance on the desktop. Commotion 3.0 began shipping in June 2000. Also in June 2000, the Company began shipping TARGA 3000, 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 enables them to mix these formats on a single timeline. In October 2000, the Company announced the availability of CineWave, an uncompressed standard-definition (SD) video solution available for Apple's Power Mac G4. Based on the award winning TARGA architecture, CineWave is a powerful solution for the Power Mac G4. In January 2001, the Company announced the availability of the Cinewave HD (high-definition) option, an HD system for non-linear editing and post-production on the Power Mac G4. For its class of webcasting solutions, Media offers StreamGenie, a portable Webcasting solution for streaming live video programming over the Internet. The 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 Company began shipping StreamFactory in December 2000. Media accounted for approximately 17.4% and 18.1% of net sales in the three-month periods ended December 31, 2000 and 1999, respectively and 19.1% and 20.3% of net sales in the six-month periods ended December 31, 2000 and 1999, respectively. Personal Web Video Division The Personal Web Video Division ("Web") combines the Company's high-end professional video product line with its consumer retail products. Professional products, targeted to the sophisticated end-user, 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. Professional products are integrated into the computer by a value-added reseller ("VAR"), an OEM, or the end user. The Company also maintains alliances with computer manufacturers such as Dell and Compaq to provide professional workstations using Pinnacle solutions. Web's class of professional video capture and editing products includes miroVIDEO DC30, DC1000 and the DV500. Web's lower end consumer products provide complete video editing solutions that allow consumers to edit their home videos using their personal computer (PC), camcorder and VCR. Web recently announced a solution for capturing, editing and sharing video over the Internet. Web also sells products that allow consumers to watch TV, listen to FM radio and create their own videos on a PC. Web's consumer product line includes Studio DC10, Studio MP10, Studio PCTV and PCTV USB and Studio DV. Price points of consumer products are the lowest of all the Company's product lines and are marketed as computer peripherals. In September 2000, the Company announced Studio OnLine, one of the first consumer products to offer a complete integrated solution for capturing, editing and sharing video over the Internet. Studio OnLine comes with Pinnacle's powerful and easy-to-use video editing Studio software. The Company initiated shipment of Studio OnLine in January 2001. In October 2000, Web announced immediate availability of Studio Basic for RealVideo(R), an easy-to-use video editing software for creating RealNetworks(R) RealVideo content. This product is the result of an alliance between Pinnacle and RealNetworks, Inc. Web's products are mostly distributed directly to retail outlets, through retail distributors such as Ingram Micro, and to VARs, and other resellers. Web also sells directly to end-users by accepting orders via the telephone and Internet. 13 The Personal Web Video Division accounted for approximately 51.8% and 51.0% of net sales in the three-month periods ended December 31, 2000 and 1999, respectively, and 46.6% and 47.5% of net sales in the six-month periods ended December 31, 2000 and 1999, respectively. Results of Operations Net Sales. Net sales increased 19.9% to $75.0 million in the three-month period ended December 31, 2000, from $62.6 million in the same period last year. Net sales increased 21.9% to $137.8 million in the six-month period ended December 31, 2000, from $113.0 million in the same period last year. Net sales increased in all three divisions. Broadcast Solutions sales increased 19.5% and 30.0% during the three-month and six-month periods ended December 31, 2000, respectively, as compared to the same period in the prior year. The increase in Broadcast sales was primarily due to the sale of products obtained through the acquisition of ASports, DES, and Montage. Broadcast sales also benefited from increased sales of its Deko line and revenues generated from sales of its new production switcher, the PDS 9000. Media sales increased 15.3% and 14.8% during the three-month and six-month periods ended December 31, 2000, respectively, as compared to the same period in the prior year. This increase was due mostly to sales of Media's recent product releases which include the TARGA line, Stream Genie, and Stream Factory. In the Personal Web Video division, sales increased 21.9% and 19.6% during the three-month and six-month periods ended December 31, 2000, respectively, as compared to the same period in the prior year. This increase was due primarily to new product releases in the Studio line. In addition, sales of Studio DV outgrew a decline in sales of other Studio products including the Studio 400, MP10, and DC10. Following is a summary of revenues from each division:
Three-months ended December 31: 2000 % 1999 % Increase -------- ------- -------- ------- ------ Division Broadcast Solutions $23,114 30.8% $19,350 30.9% 19.5% Professional .Media 13,019 17.4% 11,295 18.1% 15.3% Personal Web Video 38,900 51.8% 31,917 51.0% 21.9% -------- ------- -------- ------- ------ $75,033 100.0% $62,562 100.0% 19.9% -------- ------- -------- ------- ------ Six-months ended December 31: 2000 % 1999 % Increase -------- ------- -------- ------- ------ Division Broadcast Solutions $ 47,251 34.3% $ 36,359 32.2% 30.0% Professional .Media 26,284 19.1% 22,903 20.3% 14.8% Personal Web Video 64,273 46.6% 53,746 47.5% 19.6% -------- ------- -------- ------- ------ $137,808 100.0% $113,008 100.0% 21.9% -------- ------- -------- ------- ------
International sales (sales outside of North America) increased 21.3% in the three-month period ended December 31, 2000 compared to the three-month period ended December 31, 1999 and accounted for approximately 57.5% and 56.9% of the Company's net sales, respectively. International sales increased 28.3% in the six-month period ended December 31, 2000 compared to the six-month period ended December 31, 1999 and accounted for approximately 56.0% and 53.2% of the Company's net sales, respectively. 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 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. In addition to direct material costs, cost of sales consists primarily of costs related to the procurement of components and subassemblies, labor and overhead associated with procurement, assembly and testing of finished products, inventory management, warehousing, shipping, warranty costs, royalties and provisions for excess and shrinkage. In the three-month period ended December 31, 2000, total blended gross profit decreased to 47.1% from 51.4% in the three-month period ended December 31, 1999. In the six-month period ended December 31, 2000, total blended gross profit 14 decreased to 44.9% from 53.4% in the six-month period ended December 31, 1999. Included in the cost of sales for the six months ended December 31, 2000 is a $2.5 million inventory charge related to discontinued products and accessories primarily in the Broadcast and Media divisions. Excluding the charge, blended gross profit would have been 46.7% in the six month-period ended December 31, 2000. The decrease in margins was primarily reflected in the Broadcast division. Broadcast margins dropped to 52.1% from 60.7% in the three-month periods ended December 31, 2000 and 1999, respectively. Excluding a $1.3 million portion of the inventory charge, Broadcast margins dropped to 50.0% from 62.3% in the six-month periods ended December 31, 2000 and 1999, respectively. The decrease in Broadcast margins was due to a decrease in service revenues, which generally provide more favorable margins. Pinnacle's margin also decreased due to changes in its overall mix of product sales. 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 27.7% to $8.0 million in the three-month period ended December 31, 2000 from $6.2 million in the same period last year. Engineering and product development expenses increased 33.7% to $16.3 million in the six-month period ended December 31, 2000 from $12.2 million in the same period last year. As a percentage of sales, engineering and product development expenses were 10.6% and 10.0% in the three-month periods ended December 31, 2000 and 1999, respectively, and were 11.8% and 10.8% in the six-month periods ended December 31, 2000 and 1999, respectively. The increase was due primarily to the acquisitions of Puffin, Montage, DES, and ASports. Pinnacle believes that investment in research and development is crucial to its future growth and position in the industry and expects to continue to allocate significant resources to all of its engineering and product development locations throughout the world. 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 20.7% to $16.7 million in the three-month period ended December 31, 2000, from $13.8 million in the same period last year. Sales and marketing expenses increased 26.3% to $32.3 million in the six-month period ended December 31, 2000, from $25.5 million in the same period last year. The increase was due to acquisitions of Puffin and ASports, expanded operations in Japan, and increased expenditures in North America and Europe. These increases reflect expenditures to achieve the Company's goal of increased sales and market share and expanded product awareness in new and existing markets throughout the world. As a percentage of sales, sales and marketing expenditures were 22.2% and 22.1% in the three-month periods ended December 31, 2000 and 1999, respectively, and were 23.4% and 22.6% in the six-month periods ended December 31, 2000 and 1999, respectively. This increase reflects a growth in sales and marketing expenditures exceeding incremental sales. General and Administrative. General and administrative expenses consist primarily of salaries and benefits for administrative, executive, finance and MIS personnel, occupancy costs and other corporate administrative expenses. General and administrative expenses increased 92.2% to $4.3 million in the three-month period ended December 31, 2000, from $2.3 million in the same period last year. General and administrative expenses increased 62.9% to $8.1 million in the six-month period ended December 31, 2000, from $5.0 million in the same period last year. As a percentage of total revenue, general and administrative expenses were 5.8% and 3.6% in the three-month periods ended December 31, 2000 and 1999, respectively, and were 5.9% and 4.4% in the six-month periods ended December 31, 2000 and 1999, respectively. The increase in general and administrative expenses was primarily due to the increased investment necessary to manage and support the Company's increased scale of operations and the infrastructure related to the Company's new business units. Other contributing factors were an increase in the bad debt reserve, due to higher overall sales activity and an increase in the reserve for a select number of customers, and higher legal fees associated with the class action lawsuit filed in July 2000. The increase also includes a reorganization charge of approximately $342,000 primarily related to severance and associated costs that were paid during the six-month period ended December 31, 2000. Amortization of Acquisition-Related Intangible Assets. Amortization of acquisition-related intangible assets consists of amortization of goodwill and identifiable intangible assets mostly including core/developed technology, customer base, trademarks, favorable contracts and assembled workforce. These assets are being amortized using the straight-line method over periods ranging from three to nine years. The amortization increased 85.8% from $4.0 million in the three-month period ended December 31, 1999 to $7.5 million in the three-month period ended December 31, 2000. The amortization increased 116.4% from $7.1 million in the six-month period ended December 31, 1999 to $15.3 million in the six-month period ended December 31, 2000. The increase is primarily related to amortization of additional goodwill and other intangibles resulting from the six acquisitions Pinnacle made during fiscal 2000. 15 Acquisition Settlement. On September 30, 2000, the Company entered into an agreement with the former shareholders and option holders of ASports wherein Pinnacle agreed to compensate each of them if the closing price of Pinnacle's common stock does not equal or exceed $23 per share for four consecutive trading days prior to May 31, 2001. If Pinnacle's share price does not reach this level, the value of the compensation to be paid shall be equal to the number of shares issued and options assumed in the acquisition (944,213 and 138,158, respectively) multiplied by the difference between Pinnacle's average closing stock price during the month of May, 2001 and $23 per share. Former shareholders of ASports would be compensated in shares of Pinnacle's common stock while the former option holders would be compensated in cash. On September 30, 2000, the Company recorded a charge of $13.3 million which represents the fair value of the arrangement on September 30, 2000 including $0.1 million in transaction fees. On December 31, 2000, the Company recorded an additional $0.4 million charge associated with this obligation. As of December 31, 2000, the Company has recorded a liability of $2.1 million which represents the estimated cash payout to the option holders with the remaining $11.5 million recorded as an increase in common stock. The value assigned was determined by an independent appraiser using the Black-Scholes method. In-Process Research and Development. During the six-month period ended December 31, 1999, the Company recorded an in-process research and development charge of $2.0 million relating to the acquisition of certain assets of the Video Communications Division of the Hewlett-Packard Company ("VID"). The acquired in-process research and development from VID relates to the development of the next generation of Media Stream products. The value assigned to purchased in-process research and development was determined by estimating the costs to develop the purchased in-process research and development into commercially viable product's; estimating the resulting net cash flows from such projects; discounting the net cash flows back to the time of acquisition and applying an attribution rate based on the estimated percent complete considering the approximate stage of completion of the in-process technology at the date of acquisition. Interest Income and Other, net. Net interest income and other consists primarily of interest income generated from the Company's investments in money market funds, government securities and commercial paper. In the three-month period ended December 31, 2000, interest income and other decreased approximately 42.5% to $462,000 from $804,000 in the same period last year. In the six-month period ended December 31, 2000, interest income and other decreased approximately 39.5% to $976,000 from $1,612,000 in the same period last year. The decrease reflects a reduction in the Company's cash and marketable securities due to cash used in operations, cash paid for acquisitions, and cash paid to repurchase common stock. In addition, cash invested by Pinnacle's foreign operations obtains lower interest yields than investments made domestically. Income Tax Expense. Income taxes are comprised of federal, state and foreign income taxes. The Company did not record a provision for income taxes for the three-month and six-month periods ended December 31, 2000. The Company recorded a provision for income taxes of $1.2 million and $1.9 million for the three-month and six-month periods ended December 31, 1999. The Company has provided a valuation allowance for a portion of its deferred tax assets as it is presently unable to conclude that all of the deferred tax assets are more likely than not to be realized. On June 30, 2000, the total valuation allowance was $9.3 million. 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. Recent Accounting Pronouncements 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 fourth quarter of fiscal 2001. The Company is in the process of assessing the impact, if any, that the adoption of SAB No. 101 will 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" ("FIN 44"). This interpretation clarifies the application of 16 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. The Company adopted FIN 44 on July 1, 2000. The adoption of FIN 44 did not have a material effect on the Company's financial position or results of operations. 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 position or results of operations. 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 position or results of operations. 17 Liquidity and Capital Resources The Company has funded its operations to date through sales of equity securities as well as through cash flows from operations. As of December 31, 2000, the Company's principal sources of liquidity included cash, cash equivalents and marketable securities totaling approximately $53.3 million. The Company believes that the existing cash and cash equivalent balances as well as marketable securities and anticipated cash flow from operations will be sufficient to support the Company's current operations and growth for the foreseeable future. The Company's operating activities consumed $16.7 million in cash during the six months ended December 31, 2000. This was primarily attributable to the increase in inventories and accounts receivable, and the paydown of accounts payable and accrued expenses from operations and assumed through acquisitions. Inventory management is 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. During the six-month period ended December 31, 2000, cash flow from investing activities increased primarily due to the maturation of the Company's investments in marketable securities, whose proceeds were used to fund operations. Cash flow used in investing activities included $2.7 million invested in property and equipment, compared to $5.1 million in the six months ended December 31, 1999. The high level of expenditures in the six-month period ended December 31, 1999 primarily reflects payments for leasehold improvements, furniture and equipment purchased for the Company's Mountain View facility expansion in August 1999 to accommodate increased headcount related to the VID acquisition and to fund the Company's SAP implementation. Such capital expenditures were financed from working capital. Cash flow from investing activities also includes payments related to acquisitions. During the six-month period ended December 31, 2000, the Company paid $3.4 million in July 2000 for the acquisition of Propel Ahead, Inc. which closed in June 2000, and $2.3 million in December 2000 for the acquisition of Minerva. During the six-month period ended December 31, 1999, the Company paid $12.6 million in August 2000 related to the VID acquisition. Cash flows used in financing activities consisted mostly of cash paid to repurchase stock on the open market. On July 25, 2000 the Company announced that the Board of Directors had authorized the repurchase of up to 3.0 million shares of the Company's common stock. As of December 31, 2000, the Company repurchased a total of 0.8 million shares of its common stock at a cost of $6.5 million. Approximately 2.2 million shares remain authorized for repurchase. Cash flows from the exercise of employee stock options decreased from $5.7 million in the six-month period ended December 31, 1999 to $3.1 million in the six-month period ended December 31, 2000. This is due mainly to the drop in the market price of the Company's common stock. The Company may continue to experience a decrease in the cash proceeds from stock option exercises, and employee stock purchases pursuant to the plan, if the stock maintains a moderately low price level. 18 Factors Affecting Operating Results |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 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 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| We must retain key employees to remain competitive. 19 If certain of our key employees leave or are no longer able to perform services for us, it could have a material adverse effect on our business. We may not be able to attract and retain a sufficient number of managerial personnel and technical employees to compete successfully. We believe that the efforts and abilities of our senior management and key technical personnel are very important to our continued success. 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 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, in the six-month period ended December 31, 2000, net sales increased 21.9% over the same period last year. 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 December 2000, we acquired Minerva Networks, Inc. In June 2000, we acquired Avid Sports, Inc. and Propel Ahead, Inc. In April 2000, we acquired Montage Group, Ltd. In March 2000, we acquired Digital Editing Services, Inc. and Puffin Designs, Inc. In January 2000, we acquired Synergy, 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: - 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. 20 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. We have publicly announced that we intend to defend the case vigorously and are in the process of doing so. 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| If our products do not keep pace with the technological developments in the rapidly changing video post-production equipment industry, then we may be adversely affected. The video post-production equipment industry is characterized by rapidly changing technology, evolving industry standards and frequent new product introductions. The introduction of products embodying new technologies or the emergence of new industry standards can render existing products obsolete or unmarketable. Delays in the introduction or shipment of new or enhanced products, our inability to timely develop and introduce such new products, the failure of such products to gain significant market acceptance or problems associated with new product transitions could materially harm our business, particularly on a quarterly basis. We are critically dependent on the successful introduction, market acceptance, manufacture and sale of new products that offer our customers additional features and enhanced performance at competitive prices. Once a new product is developed, we must rapidly commence volume production. This process requires accurate forecasting of customer requirements and attainment of acceptable manufacturing costs. The introduction of new or enhanced products also requires us to manage the transition from older, displaced products in order to minimize disruption in customer ordering patterns, avoid excessive levels of older product inventories and ensure that adequate supplies of new products can be delivered to meet customer demand. In addition, as is typical with any new product introduction, quality and reliability problems may arise. Any such problems could result in reduced bookings, manufacturing rework costs, delays in collecting accounts receivable, additional service warranty costs and a limitation on market acceptance of the product. |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, 21 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. 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. 22 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 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. 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 2001 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. 23 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. [X] We rely on a continuous power supply to conduct our operations, and California's current energy crisis could disrupt our operations and increase our expenses. California is in the midst of an energy crisis that could disrupt our operations and increase our expenses. In the event of an acute power shortage, that is, when power reserves for the State of California fall below 1.5%, California has on some occasions implemented, and may in the future continue to implement, rolling blackouts throughout California. We currently do not have backup generators or alternate sources of power in the event of a blackout, and our current insurance does not provide coverage for and any damages we or our customers may suffer as a result of any interruption in our power supply. If blackouts interrupt our power supply, we would be temporarily unable to continue operations at our facilities. Any such interruption in our ability to continue operations at our facilities could damage our reputation, harm our ability to retain existing customers and to obtain new customers, and could result in lost revenue, any of which could substantially harm our business and results of operations. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company transacts business in various foreign currencies but primarily the Euro and those of 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 offset the local currency denominated operating expenses. The Company assesses the need to utilize financial instruments to hedge foreign currency exposure on an ongoing basis. Fixed Income Investments The Company's exposure to market risk for changes in interest rates relates primarily to its investment portfolio of marketable securities. The Company does not use derivative financial instruments for speculative or trading purposes. The Company invests primarily in US Treasury Notes and high-grade commercial paper and generally holds them to maturity. Consequently, the Company does not expect to incur 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 one year. 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. 24 PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders On October 30, 2000, the Company held its Annual Meeting of Shareholders for which it solicited votes by proxy. The following is a brief description of the matters voted upon at the meeting and a statement of the number of votes cast for and against, and the number of abstentions. There were no broker non-votes with respect to item 1 below. 1. To elect seven directors to serve until the next Annual Meeting of Shareholders and until their successors are duly elected and qualified. VOTES NOMINEE VOTES WITHHELD ------- ----- -------- Mark L. Sanders 40,563,177 90,397 Ajay Chopra 40,562,763 90,811 L. Gregory Ballard 40,567,843 85,731 John Lewis 40,568,295 85,279 L. William Krause 40,559,721 93,853 Glenn E. Penisten 40,561,777 91,797 Charles J. Vaughan 40,569,181 84,393 2. To approve an amendment to the 1996 Stock Option Plan to increase the number of shares of Common Stock reserved for issuance thereunder by 800,000 shares. The vote was as follows: FOR: 28,708,540 AGAINST: 11,726,503 ABSTAIN: 218,531 BROKER NON-VOTES: 0 3. To ratify the appointment of KPMG LLP as independent auditors of the Company for the fiscal period ending June 30, 2001. FOR: 40,423,105 AGAINST: 45,998 ABSTAIN: 184,471 BROKER NON-VOTES: 0 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: None (b) Reports on Form 8-K None 25 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. PINNACLE SYSTEMS, INC. Date: February 12, 2001 By: /s/ Mark L. Sanders Mark L. Sanders President, Chief Executive Officer and Director Date: February 12, 2001 By: /s/ Arthur D. Chadwick Arthur D. Chadwick Vice President, Finance and Administration and Chief Financial Officer 26 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. PINNACLE SYSTEMS, INC. Date: February 12, 2001 By: /s/ Mark L. Sanders Mark L. Sanders President, Chief Executive Officer and Director Date: February 12, 2001 By: /s/ Arthur D. Chadwick Arthur D. Chadwick Vice President, Finance and Administration and Chief Financial Officer 27 -----END PRIVACY-ENHANCED MESSAGE-----