PINNACLE SYSTEMS INC - 10-Q Quarterly Report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2002

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 (State or other jurisdiction of incorporation or organization)		94-3003809 (I.R.S. Employer Identification No.)

280 N. Bernardo Ave. Mountain View, CA (Address of principal executive offices)		94043 (Zip Code)

(650) 526-1600

(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 the registrant’s common stock outstanding as of November 8, 2002 was approximately 60,468,491.

INDEX

PART I—FINANCIAL INFORMATION

ITEM 1—Condensed Consolidated Financial Statements

Condensed Consolidated Balance Sheets—September 30, 2002 and June 30, 2002		3

Condensed Consolidated Statements of Operations—Three Months Ended September 30, 2002 and 2001		4

Condensed Consolidated Statements of Comprehensive Loss—Three Months Ended September 30, 2002 and 2001		5

Condensed Consolidated Statements of Cash Flows—Three Months Ended September 30, 2002 and 2001		6

Notes to Condensed Consolidated Financial Statements		7

ITEM 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations		13

ITEM 3—Quantitative and Qualitative Disclosures About Market Risk		32

ITEM 4—Controls and Procedures		33

PART II—OTHER INFORMATION

ITEM 1—Legal Proceedings		34

ITEM 5—Other Information		34

ITEM 6—Exhibits and Reports on Form 8-K		34

Signatures		35

Certifications		36

PART 1—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PINNACLE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands; unaudited)

	September 30, 2002			June 30, 2002
ASSETS
Current assets:
Cash and cash equivalents	$	92,115		$	80,575
Marketable securities		7,854			7,854
Accounts receivable, less allowance for doubtful accounts and returns of $4,349 and $7,583 as of September 30, 2002, and $4,065 and $6,337 as of June 30, 2002, respectively		32,841			32,462
Inventories		42,827			40,328
Deferred income taxes		3,854			3,854
Prepaid expenses and other assets		6,505			6,470

Total current assets		185,996			171,543
Property and equipment, net		11,525			12,256
Goodwill and other intangibles, net		52,516			75,136
Other assets		620			622

	$	250,657		$	259,557

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	15,741		$	12,441
Accrued expenses		27,019			25,177
Deferred revenue		14,969			11,477

Total current liabilities		57,729			49,095
Deferred income taxes		4,554			4,554

Total liabilities		62,283			53,649

Shareholders’ equity:
Preferred stock, no par value; authorized 5,000 shares; none issued and outstanding		—			—
Common stock, no par value; authorized 120,000 shares; 59,208 and 59,101 issued and outstanding as of September 30, 2002 and June 30, 2002, respectively		311,459			310,874
Treasury shares at cost; 793 shares		(6,508	)		(6,508	)
Accumulated deficit		(111,303	)		(93,433	)
Accumulated other comprehensive loss		(5,274	)		(5,025	)

Total shareholders’ equity		188,374			205,908

	$	250,657		$	259,557

See accompanying notes to unaudited condensed consolidated financial statements.

PINNACLE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data; unaudited)

	Three Months Ended September 30,
	2002			2001
Net sales	$	68,574		$	46,968
Cost of sales		30,981			26,526

Gross profit		37,593			20,442

Operating expenses:
Engineering and product development		8,263			7,323
Sales and marketing		19,668			15,540
General and administrative		4,810			4,372
Amortization of goodwill		—			4,522
Amortization of other intangible assets		3,371			4,205

Total operating expenses		36,112			35,962

Operating income (loss)		1,481			(15,520	)
Interest and other income, net		390			203

Income (loss) before income taxes and cumulative effect of change in accounting principle		1,871			(15,317	)
Income tax expense		450			175

Income (loss) before cumulative effect of change in accounting principle		1,421			(15,492	)
Cumulative effect of change in accounting principle		(19,291	)		—

Net loss	$	(17,870	)	$	(15,492	)

Net income (loss) per share before cumulative effect of change in accounting principle:
Basic and diluted	$	0.02		$	(0.28	)

Cumulative effect per share of change in accounting principle:
Basic	$	(0.32	)	$	—

Diluted	$	(0.31	)	$	—

Net loss per share:
Basic	$	(0.30	)	$	(0.28	)

Diluted	$	(0.29	)	$	(0.28	)

Shares used to compute net loss per share:
Basic		59,128			54,892

Diluted		62,018			54,892

See accompanying notes to unaudited condensed consolidated financial statements.

PINNACLE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands; unaudited)

	Three Months Ended September 30,
	2002			2001
Net loss	$	(17,870	)	$	(15,492	)
Foreign currency translation adjustment		(249	)		3,535

Comprehensive loss	$	(18,119	)	$	(11,957	)

See accompanying notes to unaudited condensed consolidated financial statements.

PINNACLE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands; unaudited)

	Three Months Ended September 30,
	2002			2001
Cash flows from operating activities:
Net loss	$	(17,870	)	$	(15,492	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		5,036			10,373
Provision for doubtful accounts		386			640
Cumulative effect of change in accounting principle		19,291			—
Changes in operating assets and liabilities:
Accounts receivable		(873	)		10,699
Inventories		(2,648	)		614
Accounts payable		3,367			(3,471	)
Accrued expenses		1,731			(2,384	)
Accrued income taxes		207			(273	)
Deferred revenue		3,502			5,688
Prepaid expenses and other assets		16			(1,247	)

Net cash provided by operating activities		12,145			5,147

Cash flows from investing activities:
Purchases of property and equipment		(1,019	)		(492	)

Net cash used in investing activities		(1,019	)		(492	)

Cash flows from financing activities:
Proceeds from issuance of common stock		585			98

Net cash provided by financing activities		585			98

Effects of exchange rate changes on cash		(171	)		1,219

Net increase in cash and cash equivalents		11,540			5,972
Cash and cash equivalents at beginning of period		80,575			47,751

Cash and cash equivalents at end of period	$	92,115		$	53,723

Supplemental disclosures of cash paid during the period for:
Interest	$	4		$	176

Income taxes	$	559		$	612

See accompanying notes to unaudited condensed consolidated financial statements.

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 accounting principles generally accepted in the United States of America 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 financial statements and notes thereto, which include information as to significant accounting policies, for the fiscal year ended June 30, 2002 included in the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission on September 27, 2002. Results of operations for interim periods are not necessarily indicative of results for a full fiscal year.

Reclassifications

Certain prior period balances have been reclassified to conform to the current period’s presentation.

Revenue Recognition

Revenue from product sales is recognized upon shipment provided title and risk of loss has passed to the customer, there is evidence of an arrangement, fees are fixed or determinable and collectibility is reasonably assured. Installation and training revenue is deferred and recognized as these services are performed. Certain products include technical support and maintenance services for a specified time period of up to one year. For products with telephone support and bug fixes bundled in as part of the original sale, revenue is recognized at the time of product shipment and the costs to provide telephone support and bug fixes are accrued, as these costs are deemed insignificant.

The Company’s systems sales frequently involve multiple elements such as hardware product, installation, training, and maintenance. For arrangements with multiple elements representing separate earnings processes, revenue is allocated to the various elements based upon the fair values of those elements. Fair value of services such as installation or training is established based upon separate sales by us of these services to other customers in accordance with Statement of Position (SOP) 97-2, “Software Revenue Recognition,” as amended, for software products or the quoted rates for such services by the Company or our competitors for non-software products. The amounts allocated to installation and training are recognized when the services are delivered. Fair values for the ongoing maintenance and support obligations are based upon separate sales of support contract renewals sold to other customers or upon renewal rates quoted in the contracts. The amounts allocated to maintenance and support are recognized ratably over the maintenance period. For systems with complex installation processes that are considered essential to the functionality of the product (for example, when the services can only be performed by us), product and installation revenue is deferred until completion of the installation. Revenue from extended support and maintenance contracts is deferred and recognized ratably over the maintenance period.

The Company recognizes revenue from sales of software in accordance with SOP 97-2. Under SOP 97-2, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed and determinable, and collectibility is probable. For systems sales that require significant customization and modification during installation to meet customer specifications, we apply the provisions of AICPA Statement of Position (SOP) 81-1, “Contract Accounting” to the entire arrangement.

During the third quarter of fiscal 2002, the Company adopted EITF Issue No. 01-09, “Accounting for Consideration Given by Vendor to a Customer or a Reseller of the Vendor’s Products,” which consisted of implementing the provisions addressing whether consideration from a vendor to a reseller of the vendor’s products is (a) an adjustment of the selling prices of the vendor’s products and, therefore, should be deducted from revenue when recognized in the vendor’s income statement or (b) a cost incurred by the vendor for assets or services received from the reseller and, therefore, should be included as a cost or an expense when recognized in the vendor’s income statement. The Company also provides marketing development funds to certain retail customers and has historically recorded these as marketing expenses. Under EITF Issue No. 01-09, these amounts should be recorded as a deduction from revenue. Accordingly, the Company reclassified approximately $0.5 million for the first quarter of the fiscal year ended June 30, 2002 from marketing expense to a reduction of revenue to conform all periods presented to the current period presentation.

Recent Accounting Pronouncements

In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which supersedes both SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” for the disposal of a segment of a business (as previously defined in that Opinion). SFAS No. 144 retains the fundamental provisions in SFAS No. 121 for recognizing and measuring impairment losses on long-lived assets held for use and long-lived assets to be disposed of by sale, while also resolving significant implementation issues associated with SFAS No. 121. For example, SFAS No. 144 provides guidance on how a long-lived asset that is used as part of a group should be evaluated for impairment, establishes criteria for when a long-lived asset is held for sale, and prescribes the accounting for a long-lived asset that will be disposed of other than by sale. SFAS No. 144 retains the basic provisions of APB Opinion No. 30 on how to present discontinued operations in the income statement but broadens that presentation to include a component of an entity (rather than a segment of a business). Unlike SFAS No. 121, an impairment assessment under SFAS No. 144 will never result in a write-down of goodwill. Rather, goodwill is evaluated for impairment under SFAS No. 142.

The Company adopted SFAS No. 144 during the quarter ended September 30, 2002. The adoption of SFAS No. 144 did not have a material effect on the Company’s financial position, results of operations, or cash flows.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146). This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” This Statement requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not expect the impact of adopting SFAS 146 to be significant to the Company’s financial position, results of operations, or cash flows.

2. Net Loss Per Share

Basic net loss per share is computed using the weighted-average number of common shares outstanding. Diluted net loss per share is computed using the weighted-average number of common shares outstanding and potential dilutive common shares from the assumed exercise of options outstanding during the period, if any, using the treasury stock method.

The following table sets forth the computation of basic and diluted net loss per common share (in thousands):

	Three Months Ended September 30,
	2002			2001
Numerator: Net loss	$	(17,870	)	$	(15,492	)

Denominator:
Basic:
Weighted-average shares outstanding		59,128			54,892
Diluted:
Employee stock options		2,890			—

Denominator for diluted net loss per share		62,018			54,892

Basic net loss per share	$	(0.30	)	$	(0.28	)

Diluted net loss per share	$	(0.29	)	$	(0.28	)

For the quarters ended September 30, 2002 and September 30, 2001, the Company excluded options to purchase 5.7 million and 13.7 million shares of common stock, respectively, from the diluted net loss per share computation as their inclusion would have been anti-dilutive.

The Company is contingently liable to issue up to 399,363 shares in connection with the acquisition of the Montage Group, Ltd. in April 2000, and the subsequent related buyout decision in April 2001 of the earnout payments under that acquisition agreement. The Company’s obligation to issue these shares is contingent upon the outcome of the Athle-Tech litigation against The Montage Group, Ltd. and

Digital Editing Services, Inc. (See Note 5). If and when such shares are issued, they would increase the number of basic and diluted weighted-average shares outstanding.

3. Segment and Geographic Information

The Company is organized into two customer-focused lines of business: (1) Broadcast and Professional, and (2) Business and Consumer. The Company believes this organizational structure enables it to effectively address varying product requirements, rapidly implement our core technologies, efficiently manage different distribution channels and anticipate and respond to changes in each of these markets. On July 1, 2002, the Company renamed the Business and Consumer division from its prior name, the Personal Web Video division, but did not change the structure or operations of this division.

The Company organizes its divisions, which equate to reportable segments, by evaluating criteria such as economic characteristics, the nature of products and services, the nature of the production process, and the type of customers. The Company currently operates its business as two reportable segments: (1) Broadcast and Professional, and (2) Business and Consumer, formerly Personal Web Video.

For the period July 1, 2001 through June 30, 2002, the Company’s organizational structure was based on two reportable segments: (1) Broadcast and Professional Solutions, and (2) Personal Web Video. For the period July 1, 2000 through June 30, 2001, the Company’s organizational structure was based on three reportable segments: (1) Broadcast Solutions, (2) Professional Media and (3) Personal Web Video.

The Company’s chief operating decision maker evaluates the performance of these divisions based on revenues, gross profit, and operating income (loss) before income taxes, interest income, interest expenses, and other income, excluding the effects of nonrecurring charges including amortization of goodwill and other intangibles related to the Company’s acquisitions and the acquisition settlement. 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 months ended September 30, 2002 and 2001 (in thousands):

	Three Months Ended September 30,
	2002			2001
Broadcast and Professional:
Revenues	$	35,007		$	26,076
Gross profit		20,186			10,308
Operating income (loss) before amortization of goodwill and other intangibles		1,851			(7,362	)
Amortization of goodwill		—			3,799
Amortization of other intangibles		2,856			3,630
Operating loss	$	(1,137	)	$	(15,478	)

Business and Consumer:
Revenues	$	33,567		$	20,892
Gross profit		17,407			10,134
Operating income before amortization of goodwill and other intangibles		3,001			570
Amortization of goodwill		—			723
Amortization of other intangibles		515			575
Operating income (loss)	$	2,618		$	(42	)

Combined:
Revenues	$	68,574		$	46,968
Gross profit		37,593			20,442
Operating income (loss) before amortization of goodwill and other intangibles, acquisition settlement and other unallocated		4,852			(6,792	)
Amortization of goodwill		—			4,522
Amortization of other intangibles		3,371			4,205
Operating income (loss)	$	1,481		$	(15,520	)

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. Foreign sales are reported based on the sale destination. The following table presents a summary of net sales by geographic region for quarters ended September 30, 2002 and 2001 (in thousands):

	Three Months Ended September 30,
	2002		2001
Net Sales by Geographic Region
United States	$	34,216	$	23,316
United Kingdom, Ireland		3,686		2,446
Germany		7,065		2,855
France		3,466		2,743
Spain, Italy, Benelux		4,495		3,364
Japan, China, Hong Kong, Singapore, Korea, Australia		6,493		3,801
Other foreign countries		9,153		8,443

Total	$	68,574	$	46,968

4. Goodwill and Other Intangible Assets

In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” which the Company adopted on July 1, 2002. As a result of the adoption of SFAS No. 142, the Company no longer amortizes goodwill and identifiable intangible assets with indefinite lives. Intangible assets with definite lives will continue to be amortized.

The Company performed the goodwill impairment analysis required by SFAS No. 142 as of July 1, 2002 and concluded that goodwill was impaired, as the carrying value of two of the Company’s reporting units in the Broadcast and Professional division exceeded their fair value. As a result, the Company recorded a charge of $19.3 million to reduce the carrying amount of its goodwill. This charge is a non-operating and non-cash charge. This charge is reflected as a cumulative effect of change in accounting principle in the accompanying condensed consolidated statements of operations. As of September 30, 2002, the Company had approximately $52.5 million of net goodwill and other intangible assets, after recording the $19.3 million goodwill impairment charge.

The Company has evaluated the remaining useful lives of its other intangible assets to determine if any adjustments to the useful lives were necessary or if any of these assets had indefinite lives and were, therefore, not subject to amortization. The Company determined that no adjustments to the useful lives of its other intangible assets were necessary.

The goodwill impairment test consisted of the two-step process as follows:

In both Step 1 and Step 2, below, the fair value of each reporting unit was determined by estimating the present value of future cash flows for each reporting unit.

Step 1. The Company compared the fair value of its reporting units to its carrying amount, including the existing goodwill and other intangible assets. Since the carrying amount of two of the Company’s reporting units exceeded its fair value, the comparison indicated that the reporting units’ goodwill was impaired.

Step 2. The Company then compared the implied fair value of the impaired reporting units’ goodwill, which was determined using a purchase price allocation, to its carrying amount. The Company used a purchase price allocation to assign the fair value of each reporting unit to the reporting units’ goodwill. The assigned fair value of goodwill was then compared to the carrying amount of goodwill. Since the carrying amount of the impaired reporting units’ goodwill exceeded its fair value, the Company recorded a transitional impairment charge of $19.3 million, which was the amount equal to that excess.

In accordance with SFAS No. 142, the Company will evaluate, on an annual basis or whenever significant events or changes occur in its business, whether its goodwill has been impaired. If the Company determines that its goodwill has been impaired, it will recognize an impairment charge.

A summary of changes in the Company’s goodwill during the quarter ended September 30, 2002 by business segment is as follows (in thousands):

Goodwill	Professional and Broadcast Division			Business and Consumer Division		Total
Net carrying amount as of June 30, 2002	$	48,731		$	7,061	$	55,792
Goodwill previously classified as other intangibles		—			2,117		2,117
Goodwill impairment charge		(19,291	)		—		(19,291	)
Other goodwill adjustments		42			—		42

Net carrying amount as of September 30, 2002	$	29,482		$	9,178	$	38,660

The following tables set forth the carrying amount of other intangible assets that will continue to be amortized (in thousands):

	As of September 30, 2002
Other Intangible Assets	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Core/developed technology	$	39,691	$	(30,307	)	$	9,384
Trademarks and trade names		8,798		(6,597	)		2,201
Customer-related intangibles		8,336		(6,474	)		1,862
Assembled workforce		2,750		(2,424	)		326
Other identifiable intangibles		3,858		(3,775	)		83

Total	$	63,433	$	(49,577	)	$	13,856


	As of June 30, 2002
Other Intangible Assets	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Core/developed technology	$	39,691	$	(27,927	)	$	11,764
Trademarks and trade names		8,798		(6,344	)		2,454
Customer-related intangibles		8,336		(5,963	)		2,373
Assembled workforce		2,750		(2,264	)		486
Other identifiable intangibles		7,545		(5,278	)		2,267

Total	$	67,120	$	(47,776	)	$	19,344

The total amortization expense related to goodwill and other intangible assets is set forth in the table below (in thousands):

	Three Months Ended September 30,
Amortization Expense	2002		2001
Goodwill	$	—	$	4,522
Core/developed technology		2,380		2,664
Trademarks and trade names		252		480
Customer-related intangibles		511		559
Assembled workforce		160		221
Other identifiable intangibles		68		281

Total amortization	$	3,371	$	8,727

The total estimated future annual amortization related to other intangible assets is set forth in the table below (in thousands):

	Future Amortization Expense
For the Nine-Month Period October 1, 2002 through June 30, 2003:
2003	$	8,643

For the Fiscal Years Ending June 30,
2004		3,104
2005		1,687
2006		422

Total estimated future amortization expense for other intangible assets	$	13,856

The following table summarizes the effect on net loss that would have resulted if the provisions of SFAS No. 142 had been in effect for all periods presented (in thousands):

	Three Months Ended September 30,
	2002			2001
Net loss:
Net loss as reported	$	(17,870	)	$	(15,492	)
Add back: amortization of goodwill		—			4,522

Adjusted net loss	$	(17,870	)	$	(10,970	)


Net loss per share:
Basic as reported	$	(0.30	)	$	(0.28	)
Diluted as reported	$	(0.29	)	$	(0.28	)

Add back: amortization of goodwill	$	—		$	0.08

Adjusted basic net loss per share	$	(0.30	)	$	(0.20	)
Adjusted diluted net loss per share	$	(0.29	)	$	(0.20	)

Shares used to compute net loss per share:
Basic		59,128			54,892

Diluted		62,018			54,892

5. Commitments and Contingencies

Legal Actions

In July 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 of its officers and directors. Additional actions based on the same allegations were filed in the same Court. In October 2000, all of the actions were consolidated under the name In re Pinnacle Systems, Inc. Securities Litigation, Master File No. C-00-2596-MMC, and lead plaintiffs and lead counsel were appointed. The consolidated action is a putative class action alleging that defendants violated the federal securities laws by making false and misleading statements concerning the Company’s business during a putative class period of April 18, 2000 through July 10, 2000. Plaintiffs seek unspecified damages. Plaintiffs filed a consolidated amended complaint in December 2000, and defendants thereafter moved to dismiss that complaint. In a written order dated May 7, 2001, the Court dismissed the consolidated amended complaint and permitted plaintiffs to file an amended complaint. Plaintiffs filed a second amended complaint in June 2001. Defendants thereafter moved to dismiss that complaint. In a written order dated January 25, 2002, the Court dismissed the second amended complaint and granted plaintiffs leave to amend. On March 22, 2002, plaintiffs filed a third consolidated amended complaint. Defendants’ motions to dismiss plaintiffs’ third consolidated amended complaint is currently scheduled to be heard on November 15, 2002. The Company is defending the case vigorously. The Company has not accrued any liability related to this contingency since a liability cannot be reasonably estimated.

County, Florida (referred to as “Athle-Tech Claim”). The Athle-Tech Claim alleges that Montage breached a purported software development agreement between Athle-Tech Computer Systems, Incorporated, or Athle-Tech, and Montage. The Athle-Tech Claim also alleges that DES intentionally interfered with Athle-Tech’s claimed rights with respect to the purported Athle-Tech Agreement and was unjustly enriched as a result. Finally, Athle-Tech seeks a declaratory judgment against DES and Montage. The Company denies any liability relating to the Athle-Tech Claim and is vigorously defending the case. The parties are currently engaged in the discovery process. In July 2002, the Court held a hearing on the Company’s motion for summary judgment and the plaintiff’s motion for partial summary judgment. The court denied both motions. A trial date is currently set for February 2003. The Company has not accrued any liability related to this contingency since a liability cannot be reasonably estimated.

In March 2000, the Company acquired DES. Pursuant to the Agreement and Plan of Merger dated as of March 29, 2000 between DES, 1117 Acquisition Corporation, the former DES shareholders and the Company, the former DES shareholders were entitled to an earnout payable in shares of the Company’s common stock if the DES operating profits exceeded at least 10% of the DES revenues during the period from March 30, 2000 until March 30, 2001. In October 2000, the Company entered into an amendment to the DES Agreement and Plan of Merger with the former DES shareholders to provide for an earnout based on the combined revenues, expenses and operating profits of DES and Avid Sports, Inc. due to the combination of the DES and Avid Sports, Inc. divisions in July 2000. In April 2001, the Company determined that no earnout payment was payable. In May 2001, the former DES shareholders asserted that an earnout payment was payable. In accordance with the DES Agreement and Plan of Merger, in October 2001 the parties submitted this matter to an independent arbitrator. Currently, the DES earnout arbitration is ongoing. The Company has not accrued any liability related to this contingency since a liability cannot be reasonably estimated.

The Company is engaged in certain additional legal actions arising in the ordinary course of business. The Company believes it has adequate legal defenses and that the ultimate outcome of these actions will not have a material effect on the Company’s consolidated financial position, results of operations or liquidity, although there can be no assurance as to the outcome of such litigation.

6. Subsequent Event

In October 2002, the Company acquired VOB Computersysteme GmbH, or VOB, a privately held company based in Dortmund, Germany that specializes in writable CD and DVD products and technology. The Company plans to combine VOB’s writable CD and DVD technology with the Company’s DVD and consumer video authoring solutions to enable the recording of data, music and video to both CDs and DVDs. VOB will be merged into the Company’s Business and Consumer division. The Company acquired VOB for a total purchase price of approximately $7.0 million consisting of approximately $4.0 million in cash and the issuance of approximately $3.0 million of the Company’s common stock. The Company acquired all intellectual property, products and software rights, along with all other assets and liabilities of VOB.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Certain Forward-Looking Information

Certain statements in this Quarterly Report on Form 10-Q are “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by the forward-looking statements. These risks and other factors include those listed under “Factors That Could Affect Future Operating Results” and elsewhere in this Quarterly Report on Form 10-Q. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue” or the negative of these terms or other comparable terminology. Forward-looking statements include, but are not limited to, those statements regarding the following: our organizational structure; the combination of certain of VOB’s technology with certain of our technology; the merger of VOB into our Business and Consumer division; the reasonableness of the estimates, judgments and assumptions we make with respect to our critical accounting policies; our evaluation of whether our goodwill and other intangible assets have been impaired; the timing of our recognition of revenue for large system sales; the portion of our total net sales represented by our international sales; our disclosure of any material impact of the subsequent disposition of our written-down inventory on our gross margins; the importance of our investment in research and development; the sufficiency of our existing cash and cash equivalent balances and anticipated cash flow from operations; the impact of our adoption of SFAS 146 on our financial position, results of operations and cash flows; our fixed income investment portfolio; our potential exposure to market and credit risk; and the adequacy of our legal defenses with respect to certain legal actions arising in the ordinary course of business.

Overview

We are a supplier of video authoring, storage, distribution and streaming solutions for broadcasters, professionals, and consumers. Our products are used in the home, in the studio and on the air to create, store, and distribute video content for television programs, television commercials, pay-per-view, sports videos, corporate communications and personal home movies. The dramatic increase in distribution channels including cable television, direct satellite broadcast, video-on-demand, digital video disks, or DVD, and the Internet have led to a

rapid increase in demand for video content. This is driving a market need for affordable, easy-to-use video creation, storage, distribution and streaming tools.

Our 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, we offer networked systems solutions and high performance, specialized computer-based solutions for high-end, production, post-production, team sports analysis, broadcast on-air and streaming applications. For the professional market, we provide computer-based content creation solutions, and solutions used to stream live and recorded video over the Internet. To address the consumer market, we offer 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, outputting their productions to tape, CD, DVD or the Internet.

We are organized into two customer-focused lines of business: (1) Broadcast and Professional and (2) Business and Consumer. We believe this organizational structure enables us to effectively address varying product requirements, rapidly implement our core technologies, efficiently manage different distribution channels and anticipate and respond to changes in each of these markets. On July 1, 2002, we renamed the Business and Consumer division from its prior name, the Personal Web Video division, but did not change the structure or operations of this division.

In October 2002, we acquired VOB Computersysteme GmbH, or VOB, a privately held company based in Dortmund, Germany that specializes in writable CD and DVD products and technology. We plan to combine VOB’s writable CD and DVD technology with our DVD and consumer video authoring solutions to enable the recording of data, music and video to both CDs and DVDs. VOB will be merged into the our Business and Consumer division. We acquired VOB for a total purchase price of approximately $7.0 million consisting of approximately $4.0 million in cash and the issuance of approximately $3.0 million of our common stock. We acquired all intellectual property, products and software rights, along with all other assets and liabilities of VOB.

Broadcast and Professional Division

Our Broadcast and Professional division serves a wide range of customers with products that provide both point solutions and systems solutions. Our products are designed to meet the end-to-end production and distribution needs of live and recorded television broadcasting. We pioneered the blending of capabilities from formerly segmented broadcast functions to provide broadcasters with greater creative flexibility and enhanced value from their equipment investment. Today, many local, national and international broadcasters use our broadcast equipment for digital effects, character generation, and management of video and graphic assets, storage and on-air playout. Major global broadcast, satellite and cable networks utilize our broadcast servers to reliably deliver contents to their viewers. Our networked news solutions have been chosen as the backbone for some of the world’s most sophisticated news and information providers. The Broadcast and Professional division also develops and manufactures computer based non-linear editing and special effects systems for post-production facilities, broadcasters and independent producers working on advertising commercials and broadcast program promotions, documentaries and nature programming, and Hollywood feature films. This division also develops and manufactures proprietary hardware and software for professional and collegiate sports teams in baseball, football, basketball, and hockey, that allow better play analysis and more effective coaching of players, both individually and as a team overall.

Live-to-Air Production Products

We sell a range of products designed to meet the creative challenges confronted by broadcasters. Each of these turnkey systems addresses a specific area of responsibility within the broadcast operation: digital effects, character generation, asset management, and image processing. We design each of our point products with some overlap to the others to increase the value of each product within the broadcast workflow. Furthermore, most of our products are designed to work on a network, enabling them to become part of complete solution packages with enhanced features and capabilities. Our products differ from the proprietary nature of traditional production equipment by using the same simplified file structures, high speed networking technologies, and interoperability found in the desktop PC industry. Material created on any of our live production products can be played back on any other.

Our live-to-air production products include Deko character generators (FXDeko II, Deko2200, Deko1000, Deko500, HD Deko500, PostDeko, DekoCast, DekoRocket, ClipDeko, and StillDeko), Digital Video Effects (DVE) systems (DVEXCEL, DVEXtremePlus, and AlladinPro), clip and still servers (Lightning1000, Thunder LT, and Thunder XL), and PDS digital video switchers (PDS 6000, PDS 6000i, PDS 9000, PDS 9000i). These products compete with offerings from companies that include Chyron, Panasonic, Sony, Thomson Multimedia and others.

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, and multiple layers for text composition. The Deko product family supports a wide range of standard and international character fonts. The suggested list price for a Deko ranges from approximately $3,000 to $75,000, depending on the configuration.

DVExtreme Family. DVExtreme is our high performance, real time three-dimensional (3D) digital video effects system for broadcast and high-end post-production customers who 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 sophisticated visual effects. The suggested list price for a DVExtreme ranges from approximately $30,000 to $64,000, depending on the configuration.

Content Creation Products

We offer a complete range of non-linear editing (NLE) products for both the Apple ^®Power Mac ^™G4 or the Windows PC. Each product is a combination of hardware and software and can be used for a wide range of applications including broadcast graphics and design, corporate video, webcasting, post-production, visual effects, and DVD authoring. These products enable users to ingest material, edit it, create graphics and ultimately send their completed project to their chosen distribution medium.

We offer three content creation product families. Our Pinnacle Liquid family (Liquid blue, silver, purple and purple field) provides customers with a range of video format support and capability using a common application. CinéWave is an extensible Apple Macintosh-based solution that combines our TARGA Ciné video processing hardware with a package of software tools including Commotion Pro and CinéAcquire from Pinnacle and Final Cut Pro from Apple. CinéWave is unique in the industry in its easy upgrade ability from standard definition to high definition, simply by adding optional hardware attachments. Our TARGA 3000, available for retail and as part of OEM solutions, is high bandwidth video processing hardware designed to power third-party professional video and audio editing solutions Retail list price is approximately $6,595. These products primarily compete with offerings from Avid, Media 100, Sony, Quantel, Matrox and Leitch.

Pinnacle Liquid Family. The Pinnacle Liquid brand is comprised of non-linear editing and post-production solutions based on proprietary Pinnacle hardware and software running on Windows/Intel (so-called Wintel) platforms. Liquid blue delivers complete native support for every standard definition video format—that means no more transcoding and no more degradation by recompression. Liquid blue products are sold as turnkey systems designed for seamless integration within existing broadcast and post production facilities. Liquid blue supports a variety of networked editing topologies from simple file transfer networks to large storage area networks (SAN). Liquid silver, sold as a bundle of Pinnacle proprietary hardware and software, is designed for long-form or corporate editing needs using compressed as well as even higher quality uncompressed formats. Liquid silver also offers direct MPEG-2 and integrated export and DVD burning, making this the ideal solution for DVD authoring. Liquid purple is a complete DV editing solution for the Wintel platform. Based on the Pinnacle Liquid editing software, it has powerful logging tools, color correction, 2D and 3D effects and is network ready. Liquid purple supports DV, Panasonic DVCPRO and Sony DVCAM and can be accelerated with the addition of Pinnacle’s optional In-Time hardware. Prices start at approximately $2,995 for Liquid purple, $19,995 for Liquid silver, and $49,995 for Liquid blue as a full turnkey system including computer and a modest amount of storage.

Ciné Wave Family is designed for the Apple Macintosh platform and includes Pinnacle hardware and our own Commotion Pro and CinéAcquire software, as well as Apple’s award-winning FinalCut Pro non-linear editing application. CinéWave 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 CinéWave product family offers professional audio/video tools at an affordable price. The CinéWave hardware and software bundle has an entry level suggested list price of approximately $6,495 for standard definition. Complete CinéWave high-definition TV production systems, including the computer and a modest amount of storage, start as low as approximately $30,000, substantially less than previously available post-production systems used for these advanced digital video formats.

TARGA Family. The TARGA products are designed to power non-linear video and audio editing solutions targeted at professional videographers and digital content creation applications. TARGA products are based on the memory-centric HUB3 architecture, a Pinnacle-designed technology for very high bandwidth video processing. The TARGA products can support uncompressed video processing, multiple codec formats such as DV and MPEG2, variable picture resolutions and aspect ratios for standard definition and high definition television, variable frame rates, and very high precision color processing in both YUV and RGB. The suggested list price is approximately $6,595 for an entry-level TARGA hardware and software bundle, while a ready-to-edit TARGA system with computer and a modest amount of storage starts at approximately $12,000.

Content Delivery Products

We develop and sell products and systems solutions used by broadcasters, corporations and other video professionals to cost-effectively deliver their video content. Using computer based networking, storage and encoding technologies these products enable customers to create a program once, at any location, and distribute it to many outlets in a variety of formats. We supply content delivery solutions that meet the needs of customers ranging in size from small web operations through massive international broadcast operations.

MediaStream digital video servers record, store, retrieve and process digital video content for broadcast over conventional mediums or the Internet. The suggested list prices start at approximately $10,000 but can run as high as a few million dollars for large networked systems. StreamFactory is a real-time web stream encoder that accepts professional video and audio inputs. Suggested list prices range from approximately $9,995 to $18,995. Pinnacle Edge Servers (ES100, ER100 and DekoCast) are combined with Pinnacle VBase central site software to provide customized large-scale interconnected solutions addressing Content Distribution, Network Localization, and remote ad insertion applications for major networks.

StreamGenie Family. The StreamGenie product is designed to broadcast live events over the Internet. It is a portable Internet broadcast station in a single box and supports multiple camera switching, titling, DVE’s and realtime encoding of professional quality audio and video into a variety of Webcasting formats such as Microsoft’s Windows Media and Real Network’s SureStream for live output to the Internet and/or video archives. The StreamGenie Presenter option enables integration of PowerPoint(tm) graphics that can be viewed simultaneously with the associated video. List prices for StreamGenie range from approximately $19,995 to $24,995 depending on system configuration.

StreamFactory Family. The StreamFactory product is a real-time web stream encoder that accepts professional video and audio inputs. StreamFactory enables output at a variety of data rates in Microsoft Windows Media, Real Networks SureStream and QuickTime formats. Designed to be a rack-mounted infrastructure appliance, StreamFactory can be configured and managed remotely, either across a LAN, or across the Internet. Simply connect a video tape recorder, video router, satellite downlink, or other audiovisual source directly to StreamFactory to convert professional quality programming contents to popular streaming formats in real-time. Suggested list prices for StreamFactory range from approximately $9,995 to $18,995 depending on system configuration.

Media Stream Server Family. The Media Stream digital video server is designed to record, store, retrieve, process and playout digital video content for broadcasters. The Media Stream servers can handle up to 16 channels of MPEG-2 I/O. It includes a redundant array of independent disks, or RAID, and optional disk expansion chassis can be used to expand capability to over 1000 hours of online video storage. Media Stream Servers are engineered for extreme reliability and have been successfully installed in numerous facilities worldwide operating 24 hours per day, 7 days per week. The suggested list prices start at less than approximately $30,000 but can run as high as a few million dollars for large systems.

News Production Products

Pinnacle Vortex is an integrated digital networked news solution specifically designed to enable the conversion of television news production from traditional tape-based editing and segmented production functions performed by specialists to non-linear server based editing and finishing. It combines many of our key strengths in video processing, storage, management, editing and delivery, into an integrated and efficient solution for meeting the end-to-end requirements of broadcast news operations. Vortex is designed to support scaleable operations, sophisticated programming, and the productivity needed to control costs. Vortex makes it possible for multiple editors, graphics designers, directors, producers and journalists to access shared video assets simultaneously over both high-speed production networks and common LAN or Internet connections. Vortex systems include proprietary Pinnacle software, hardware and storage sub-systems combined with high performance IT components using standard networking interfaces. This makes Vortex a superior solution for broadcast news originators—both local and national—that require solutions to help them be the first to air with breaking news while still delivering sophisticated on-air looks that differentiate their channel from competitors. Vortex is highly scalable and is configurable to address the modest needs of local broadcasters as well as the constant demands of 24-hour global broadcast news operations. Vortex system prices can range from approximately $200,000 to millions of dollars, depending on configuration.

Sports Analysis Products

Pinnacle’s Team Sports products are designed for use by professional and collegiate sports teams to capture, edit and view video from team sports events including football, basketball, baseball and hockey. Team Sports products can be used as stand alone products or networked together to give the coaching staff access to current and historic video footage of games and practice events and training. Networked Sports products allow users to access and view videos from anywhere on the net. The suggested list prices range from approximately $25,000 to one million dollars for a large networked system.

Business and Consumer Division

On July 1, 2002, we renamed the Business and Consumer division from its prior name, the Personal Web Video division, but did not change the structure or operations of this division.

Our Business and Consumer division develops and markets products which are aimed at the consumer and prosumer markets, and allow users to edit video to create professional-looking home movies, corporate presentations, wedding videos and other productions using a standard personal computer and camcorder. Products targeted at the prosumer market fall into two categories: those based on Adobe’s Premiere video editing software, and those based on Pinnacle’s Edition video editing software.

Premiere-Based Products. The Business and Consumer division sells a variety of products based on Adobe’s Premiere video editing software. All of these products are hardware/software combinations and all are targeted for use with Microsoft Windows-based personal computers. We add both hardware and software to Adobe’s Premiere software to create a complete solution for end users. Our added hardware supports video input/output and real-time video effects capabilities in conjunction with Premiere software. Our added software includes Impression (for DVD authoring) and TitleDeko (for video character generation). Premiere-based products include DV500, DVD500, Pro-ONE and Pro-ONE RTDV. These products compete primarily with products from Matrox and Canopus. Suggested list price in the U.S. for these products range from approximately $649 to $999.

Edition-Based Products. Edition is a video editing software program for prosumers which runs on standard Microsoft Windows-based personal computers. The Business and Consumer division sells Edition software as a software-only product bundled with its Impression and TitleDeko software. We also sell Edition bundled with video input/output cards developed by Pinnacle (e.g. Edition DV500). Edition software

competes with products such as Adobe’s Premiere, Avid Technology’s Xpress and Apple’s Final Cut. The suggested retail price for Edition in the U.S. is approximately $699.

Products targeted at the consumer market allow home users to edit their personal video to create professional-looking “home movies” using an industry-standard Microsoft Windows-based personal computer and camcorder. We have developed an easy-to-use software interface called the Studio application, which serves as the primary interface for all of its Studio consumer video editing products. We currently offer either a stand-alone software solution, or software bundled with video capture hardware. In addition to Studio products, the Business and Consumer division sells Express, a program designed for consumers who want to archive their home movies on VideoCD or DVD.

Studio Products. Studio is a non-linear video editing software program that runs on Microsoft Windows and works with standard video capture hardware installed on the end-user’s personal computer. Studio is specifically designed to allow consumers to edit their “home movies.” 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 current version of Studio software, version 8, first shipped to end users in August 2002, and incorporates many significant new features such as integrated DVD authoring, which were not included in the earlier version (version 7). A significant part of our strategy is to sell users of earlier versions of Studio software, upgrades to the current version. Studio software competes with programs such as Ulead’s VideoStudio and Roxio’s VideoWave. The suggested list price for Studio Version 8 software in the U.S. is approximately $99.

In addition to selling Studio as a stand-alone software product, we sell Studio software bundled with a variety of video input/output hardware. These products include Studio DV, Studio AV, Studio DC10plus, Studio DVplus and Studio Deluxe. The suggested list price for these products in the U.S. ranges from approximately $129 to $299.

Expression Products. Expression (previously named Pinnacle Express) is a software program which allows end-users to copy their home movies to VideoCD or DVD for playback on standard set-top DVD players. Expression requires a standard Microsoft Windows-based personal computer which is equipped with a writable CD or DVD optical drive. Expression also allows users to add menus to their home movies to index their videos and more quickly find scenes of interest. The suggested list price for Expression software in the U.S. is approximately $49.

TV Receiver Products. 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 for PCTV in the U.S. ranges from approximately $69 to $199.

CRITICAL ACCOUNTING POLICIES

Management’s discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. We review the accounting policies we use in reporting our financial results on a regular basis. The preparation of these financial statements requires management to make estimates and judgments 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.

The methods, estimates and judgments we use in applying our accounting policies have a significant impact on the results we report in our financial statements. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. We also have other key accounting policies that may not require us to make estimates and judgments that are as difficult or subjective, such as our policies for revenue recognition and the deferral of revenues for large system sales and sales to distributors. On an ongoing basis, we evaluate our estimates, including but not limited to those related to revenue recognition, product returns, accounts receivable and bad debts, inventories, investments, intangible assets, income taxes, warranty obligations, restructuring, contingencies and litigation. We base our estimates on historical experience and on various other assumptions we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. The financial impact of these estimates and judgments is reviewed by management on an ongoing basis at the end of each quarter prior to public release of our financial results. Management believes that these estimates are reasonable; however, actual results could differ from these estimates.

We have identified the accounting policies below as the policies most critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations are discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 in the Notes to the Consolidated Financial Statements. Our critical accounting policies are as follows:

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Revenue recognition

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Sales returns and allowance for doubtful accounts

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Valuation of goodwill and other intangible assets

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Valuation of inventory

Revenue Recognition

We derive our revenue primarily from the sale of products, including both hardware and software licenses and, to a lesser extent, from services and support revenue including software and hardware maintenance and training.

For many of our transactions, we apply the provisions of SEC Staff Accounting Bulletin 101 “Revenue Recognition.” However, revenues from sales of software are recognized in accordance with AICPA Statement of Position (SOP) 97-2, “Software Revenue Recognition,” as amended and interpreted. For systems sales that require significant customization and modification during installation to meet customer specifications, we apply the provisions of AICPA Statement of Position (SOP) 81-1, “Contract Accounting.”

We define revenue recognition criteria as follows:

(1) Persuasive evidence of an arrangement exists. For all sales, we use either a binding purchase order or another form of documented agreement as evidence of an arrangement. Sales to most of our distributors are evidenced by a master agreement governing the relationship together with binding purchase orders on a transaction-by-transaction basis.

(2) Delivery has occurred or services have been rendered. We consider delivery to occur upon shipment provided title and risk of loss have passed to the customer. Shipping terms generally are FOB shipping point.

(3) The fee is fixed or determinable and (4) collectibility is reasonably assured. At the time of a transaction, we assess whether the sale amount is fixed or determinable and whether collection is reasonably assured. We assess collection based on a number of factors, including past transaction history with the customer and its creditworthiness. If we determine that collection of a fee is not probable, we defer the fee and recognize revenue at the time collection becomes probable, which is generally upon receipt of cash.

Except for large systems sales, our arrangements do not generally include acceptance clauses. However, if an arrangement includes an acceptance provision, revenue is recognized upon acceptance, which occurs upon the earlier of receipt of a written customer acceptance or a certain event, such as “on-air” that contractually constitutes acceptance. For sales to distributors who have only limited return rights, revenue is generally recognized at the time of shipment and a sales return reserve is recorded to provide for estimated product returns. For sales to distributors who have unlimited return rights, revenue is recognized when the product is sold through to their customer.

For products with telephone support and bug fixes bundled in as part of the original sale, revenue is recognized at the time of product shipment and the costs to provide telephone support and bug fixes are accrued as these costs are deemed insignificant.

Our systems sales frequently involve multiple elements such as hardware product, installation, training, and maintenance. For arrangements with multiple elements representing separate earnings processes, revenue is allocated to the various elements based upon the residual value method. Fair value of services such as installation or training is established based upon separate sales by us of these services to other customers, in accordance with SOP 97-2, for software products or the quoted rates for such services by us or our competitors for non-software products. The amounts allocated to installation and training are recognized when the services are delivered. Fair values for the ongoing maintenance and support obligations are based upon separate sales of support contract renewals sold to other customers or upon renewal rates quoted in the contracts. The amounts allocated to maintenance and support are recognized ratably over the maintenance period. For systems with complex installation processes that are considered essential to the functionality of the product (for example, when the services can only be performed by us), product and installation revenue is deferred until completion of the installation. Revenue from extended support and maintenance contracts is deferred and recognized ratably over the maintenance period.

Management is required to make and apply significant judgments and estimates in connection with the recognition of revenue. Material differences may result in the amount and timing of our revenue for any period if our management were to make different judgments or apply different estimates.

Sales Returns and Allowance for Doubtful Accounts

We analyze historical returns, current economic trends, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales return allowance. We record an increase in the allowance for doubtful accounts when the prospect of collecting a specific account receivable becomes doubtful. We specifically analyze accounts receivable and historical bad debts, customer creditworthiness, current economic trends, international situations (such as currency devaluations), and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts.

We must make significant judgments and estimates in connection with establishing the sales returns in any accounting period and the uncollectability of our accounts receivables. Material differences may result in the amount and timing of our revenue or bad debt expense for any period if we were to make different judgments or utilized different estimates.

Valuation of Goodwill and Other Intangible Assets

We review our long-lived assets, including goodwill and identifiable intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In addition, we review goodwill annually for impairment. Factors we consider important and which could trigger an impairment review include the following:

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significant underperformance relative to expected historical or projected future operating results

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significant changes in the manner of our use of the acquired assets or the strategy for our overall business

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significant negative industry or economic trends

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significant decline in our stock price for a sustained period

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Our market capitalization relative to net book value

In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” which we adopted on July 1, 2002. As a result of our adoption of SFAS No. 142, we no longer amortize goodwill and identifiable intangible assets with indefinite lives. Intangible assets with definite lives will continue to be amortized.

We performed the goodwill impairment analysis required by SFAS No. 142 as of July 1, 2002 and concluded that goodwill was impaired, as the carrying value of two of our reporting units in the Broadcast and Professional division exceeded their fair value. As a result, we recorded a charge of $19.3 million to reduce the carrying amount of our goodwill. This charge is a non-operating and non-cash charge. This charge is reflected as a cumulative effect of change in accounting principle in the accompanying condensed consolidated statements of operations. As of September 30, 2002, we had approximately $52.5 million of net goodwill and other intangible assets, after recording the $19.3 million goodwill impairment charge.

We have evaluated the remaining useful lives of our other intangible assets to determine if any adjustments to the useful lives were necessary or if any of these assets had indefinite lives and were, therefore, not subject to amortization. We determined that no adjustments to the useful lives of our other intangible assets were necessary.

The goodwill impairment test consisted of the two-step process as follows:

In both Step 1 and Step 2, below, the fair value of each reporting unit was determined by estimating the present value of future cash flows for each reporting unit.

Step 1. We compared the fair value of our reporting units to their carrying amount, including the existing goodwill and other intangible assets. Since the carrying amount of two of our reporting units exceeded its fair value, the comparison indicated that our reporting units’ goodwill was impaired.

Step 2. We then compared the implied fair value of our impaired reporting units’ goodwill, which was determined using a purchase price allocation, to its carrying amount. We used a purchase price allocation to assign the fair value of each reporting unit to the reporting units’ goodwill. The assigned fair value of goodwill was then compared to the carrying amount of goodwill. Since the carrying amount of our impaired reporting units’ goodwill exceeded its fair value, we recorded a transitional impairment loss of $19.3 million, which was the amount equal to that excess.

In accordance with SFAS No. 142, we will evaluate, on an annual basis or whenever significant events or changes occur in our business, whether our goodwill has been impaired. If we determine that our goodwill has been impaired, we will recognize an impairment charge.

We must make significant judgments and estimates in connection with the valuation of our goodwill and other intangible assets. Material differences may result in the amount and timing of an impairment charge or amortization expense for any period if we were to make different judgments or utilized different estimates.

Valuation of Inventory

Inventory is valued at the lower of cost or market value. Inventory is purchased as a result of the monthly internal demand forecast that we produce, which drives the issuance of purchase orders with our suppliers. We capitalize all labor and overhead costs associated with the manufacture of our products.

Inventory is reviewed quarterly and written down to adjust for excess or obsolete material. We identify excess material by comparing the internal demand forecasts, based on product sales forecasts, to current inventory levels. Inventory that is deemed to be excess is written down to its estimated resale value in the secondary material resale market or to zero if there is no resale value. Inventory is identified as obsolete if we discontinue the use of a specific inventory item. Inventory that is deemed to be obsolete is written down to its estimated resale value or to zero if it has no resale value. Active inventory is written down to its net realizable value if the sales price falls below our carrying value.

We must make significant judgments and estimates in connection with the valuation of our inventory. Material differences may result in the amount of our cost of sales for any period if we were to make different judgments or utilized different estimates.

RESULTS OF OPERATIONS

Net Sales

Overall net sales increased 46.0% to $68.6 million in the quarter ended September 30, 2002 from $47.0 million in the quarter ended September 30, 2001. This overall net sales increase was primarily due to new product introductions in our Business and Consumer division, and increased sales of our team sports and Vortex News systems in our Broadcast and Professional division. Net sales increased in the quarter ended September 30, 2002, compared to the quarter ended September 30, 2001, in both the Broadcast and Professional and the Business and Consumer divisions.

The following is a summary of net sales by division (in thousands):

Three Months Ended September 30:
	2002		% of net sales		2001		% of net sales		% Change
Net Sales by Division
Broadcast and Professional	$	35,007	51.0	%	$	26,076	55.5	%	34.3	%
Business and Consumer		33,567	49.0	%		20,892	44.5	%	60.7	%

Total	$	68,574	100.0	%	$	46,968	100.0	%	46.0	%

In the quarter ended September 30, 2002, the Broadcast and Professional division represented 51.0% of our total sales, while the Business and Consumer division represented 49.0% of our total sales in the same period. In the quarter ended September 30, 2001, the Broadcast and Professional division represented 55.5% of our total sales, while the Business and Consumer division represented 44.5% of our total sales in the same period.

Broadcast and Professional sales increased 34.3% to $35.0 million in the quarter ended September 30, 2002 from $26.1 million in the quarter ended September 30, 2001. Broadcast and Professional sales increased primarily due to increased sales of our team sports systems and the successful installation during the quarter of one of our Vortex News systems. The increase was also attributable to the addition of products from product lines acquired from FAST Multimedia in October 2001.

Business and Consumer sales increased 60.7% to $33.6 million in the quarter ended September 30, 2002 from $20.9 million in the quarter ended September 30, 2001. The Business and Consumer sales increase was primarily due to the introduction of new products, which include our Studio Version 8 and Edition software. We also generated higher sales in our existing PCTV product during the quarter ended September 30, 2002. These sales increases were slightly offset by decreased sales of our DV500 business product.

Deferred revenue increased to $15.0 million as of September 30, 2002 from $11.5 million as of June 30, 2002. This increase in deferred revenue was primarily due to an increase in large system sales in our Broadcast and Professional Solutions division. As of September 30, 2002, we billed certain customers for several installments but did not recognize any of the revenue associated with these large system sales. We will recognize the revenue for these large system sales upon the completion of installation and customer acceptance. The increase in deferred revenue was also due to increased extended support and maintenance contracts from our team sports systems that were billed during the quarter ended September 30, 2002 but will be recognized ratably over the support period, generally one year.

The following is a summary of net sales by region (in thousands):

Three Months Ended September 30:
	2002		% of net sales		2001		% of net sales		% Change
Net Sales by Region
North America	$	35,081	51.2	%	$	26,263	55.9	%	33.6	%
International		33,493	48.8	%		20,705	44.1	%	61.8	%

Total	$	68,574	100.0	%	$	46,968	100.0	%	46.0	%

For the quarters ended September 30, 2002 and September 30, 2001, international sales (sales outside of North America) represented 48.8% and 44.1% of our net sales, respectively, while North America sales represented 51.2% and 55.9% of our net sales, respectively. We expect that international sales will continue to represent a significant portion of our total net sales.

International sales increased 61.8% to $33.5 million in the quarter ended September 30, 2002 from $20.7 million in the quarter ended September 30, 2001. International sales increased primarily due to new product introductions, as well as increased sales from some of our existing products, in our Business and Consumer division. The sales increase in the quarter ended September 30, 2002 was augmented by lower than usual retail sales during the quarter ended September 30, 2001.

North America sales increased 33.6% to $35.1 million in the quarter ended September 30, 2002 from $26.3 million in the quarter ended September 30, 2001. North America sales increased primarily due to our new product introductions in our Business and Consumer division, as well as increased sales from some of our existing products, including our team sports and Vortex News systems.

Gross Margins

We distribute and sell our 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, our gross margins, vary depending on the product, the channel of distribution, the volume of product purchased, and other factors. Cost of sales consists primarily of costs related to the procurement of components and subassemblies, labor and overhead associated with procurement, assembly and testing of finished products, inventory management, warehousing, shipping, warranty costs, royalties, and provisions for obsolescence and shrinkage.

The following is a summary of gross margins by division (in thousands):

	Three Months Ended September 30,
	2002		2001
Gross Margins by Division
Broadcast and Professional	57.7	%	39.5	%
Business and Consumer	51.9	%	48.5	%
Total blended gross margins	54.8	%	43.5	%

Our total gross margins as a percentage of net sales increased to 54.8% in the quarter ended September 30, 2002 from 43.5% in the quarter ended September 30, 2001. Excluding a $2.3 million inventory charge, which was recorded in the quarter ended September 30, 2001, gross margins would have been 48.4% in the quarter ended September 30, 2001. As discussed in the Restructuring section, below, we completed our reorganization in the first quarter of fiscal 2002.

The increase in our overall gross margins for the quarter ended September 30, 2002 compared to the quarter ended September 30, 2001 was due to increased gross margins in both the Business and Consumer division and the Broadcast and Professional division.

Business and Consumer gross margins increased to 51.9% from 48.5% in the quarters ended September 30, 2002 and September 30, 2001, respectively. The increase in Business and Consumer gross margins was primarily due to a more favorable mix of higher margins from the sale of our new products, including our Studio Version 8 and Edition software products.

Broadcast and Professional gross margins increased to 57.7% from 39.5% in the quarters ended September 30, 2002 and September 30, 2001, respectively. Excluding the $2.3 million inventory charge, which was recorded in the quarter ended September 30, 2001, Broadcast and Professional gross margins would have been 48.3% in the quarter ended September 30, 2001. The increase in Broadcast and Professional gross margins was primarily due to lower material costs and a decrease in manufacturing overhead costs, as a percentage of sales, because of more efficient operations. The increase was also attributable to reduced manufacturing spending and higher support sales, which generated higher margins.

Restructuring

During the quarter ended September 30, 2001, we reorganized and merged operations of the Broadcast division and the Professional Media division into one division named the Broadcast and Professional division. The new divisions equate to two reportable segments:

Broadcast and Professional, and Business and Consumer. The reorganization was performed to provide a structure that would allow better focus on our business and reduction of costs. As part of this reorganization, we consolidated our worldwide accounting function and eliminated certain redundant positions, resulting in involuntary termination expenses of approximately $0.7 million related to severance and associated costs related to employees that were terminated during the quarter ended September 30, 2001.

Included in the cost of sales for the quarter ended September 30, 2001 was a $2.3 million inventory charge related to the write-down of products used in our Vortex News systems, which are included in our Broadcast and Professional division. This $2.3 million inventory charge was recorded in the quarter ended September 30, 2001, and resulted from upgrading our TARGA 2000 product with our TARGA 3000 product (a component of our Vortex News systems), which is included in our Broadcast and Professional division. As a result, we recorded a $2.3 million inventory charge to write down inventory related to the TARGA 2000. As of September 30, 2002, this $2.3 million of written-down inventory was not yet scrapped or sold. We intend to disclose any material impact of the subsequent disposition of this written-down inventory on our gross margins.

Operating Expenses

Operating expenses include engineering and product development expenses, sales and marketing expenses, general and administrative expenses, amortization of goodwill prior to July 1, 2002, and amortization of other intangible assets.

Operating expenses, including amortization of goodwill and other intangible assets, increased 0.4% to $36.1 million in the quarter ended September 30, 2002 from $36.0 million in the quarter ended September 30, 2001. Operating expenses, excluding amortization of goodwill and other intangible assets, increased 20.2% to $32.7 million in the quarter ended September 30, 2002 from $27.2 million in the quarter ended September 30, 2001. Net sales in the quarter ended September 30, 2002 increased 46.0% to $68.6 million in the quarter ended September 30, 2002 from $47.0 million in the quarter ended September 30, 2001.

As a percentage of net sales, operating expenses, including amortization of goodwill and other intangible assets, decreased to 52.7% in the quarter ended September 30, 2002 from 76.6% in the quarter ended September 30, 2001. As a percentage of net sales, operating expenses, excluding amortization of goodwill and other intangible assets, decreased to 47.8% in the quarter ended September 30, 2002 from 58.0% in the quarter ended September 30, 2001. For further detail, see the sections below entitled Engineering and Product Development, Sales and Marketing, General and Administrative, Amortization of Goodwill, and Amortization of Other Intangible Assets.

The following table presents certain information regarding our operating expenses during the periods indicated (in thousands):

	Three Months Ended September 30,
	2002			2001			% Change
Engineering and product development	$	8,263		$	7,323		12.8	%
Percentage of net sales		12.0	%		15.6	%	—

Sales and marketing	$	19,668		$	15,540		26.6	%
Percentage of net sales		28.7	%		33.1	%	—

General and administrative	$	4,810		$	4,372		10.0	%
Percentage of net sales		7.0	%		9.3	%	—

Amortization of goodwill	$	—		$	4,522		(100.0	)%
Percentage of net sales		—	%		9.6	%

Amortization of other intangibles assets	$	3,371		$	4,205		(19.8	)%
Percentage of net sales		4.9	%		9.0	%

Operating expenses including amortization of goodwill and other intangible assets	$	36,112		$	35,962		0.4	%
Percentage of net sales		52.7	%		76.6	%

Operating expenses excluding amortization of goodwill and other intangible assets	$	32,741		$	27,235		20.2	%
Percentage of net sales		47.8	%		58.0	%

Net sales	$	68,574		$	46,968		46.0	%

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 12.8% to $8.3 million in the quarter ended September 30, 2002 from $7.3 million in the quarter ended September 30, 2001. This increase was primarily due to higher engineering and product development expenses in connection with the technology and products that we acquired from FAST in October 2001. As a percentage of net sales, engineering and product development expenses decreased to 12.0% in the quarter ended September 30, 2002 from 15.6% in the quarter ended September 30, 2001. The decrease in engineering and product development expenses, as a percentage of net sales, was primarily due to a growth in net sales without a corresponding increase in engineering and product development expenses as a result of tight expense controls. We believe that investment in research and development is crucial to our future growth and position in the industry and expect to continue to allocate significant resources to all of our 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 26.6% to $19.7 million in the quarter ended September 30, 2002 from $15.4 million in the quarter ended September 30, 2001. The increase was primarily due to higher sales commissions and bonuses, which resulted from higher overall net sales, the expansion of our sales operations into broader markets, and higher marketing costs associated with the launch of our new products. As a percentage of net sales, sales and marketing expenditures decreased to 28.7% in the quarter ended September 30, 2002 from 33.1% in the quarter ended September 30, 2001. The decrease in sales and marketing expenses, as a percentage of net sales, was primarily due to an increase in sales without a corresponding increase in sales and marketing expenses, since some portion of our sales and marketing expenses are relatively fixed and not variable with changes in sales.

General and Administrative

General and administrative expenses consist primarily of salaries and benefits for administrative, executive, finance and management information systems personnel, legal and accounting fees, IT infrastructure costs, bad debt expense, and other corporate administrative expenses.

General and administrative expenses increased 10.0% to $4.8 million in the quarter ended September 30, 2002 from $4.4 million in the quarter ended September 30, 2001. This increase in general and administrative expenses was primarily due to higher legal fees during the quarter ended September 30, 2002 compared to the quarter ended September 30, 2001. As a percentage of net sales, general and administrative expenses were 7.0% and 9.3% in the quarters ended September 30, 2002 and 2001, respectively. This decrease in general and administrative expenses as a percentage of net sales was due to an increase in sales without a corresponding increase in general and administrative expenses, due to improved efficiencies in managing our general and administrative expenses. As discussed in the Restructuring section, above, we completed our reorganization in the first quarter of fiscal 2002.

Amortization of Goodwill

Goodwill is the amount by which the cost of acquired identifiable net assets exceeded the fair values of those identifiable net assets on the date of purchase.

The amortization of goodwill decreased from $4.5 million in the quarter ended September 30, 2001 to zero in the quarter ended September 30, 2002. This decrease was the result of our adoption of SFAS No. 142 on July 1, 2002, which required the discontinuance of goodwill amortization.

The goodwill impairment test consisted of the two-step process as follows:

In both Step 1 and Step 2, below, the fair value of each reporting unit was determined by estimating the present value of future cash flows for each reporting unit.

Amortization of Other Intangible Assets

Acquisition-related intangible assets result from our acquisition of businesses accounted for under the purchase method of accounting and consist of the values of identifiable intangible assets, including core/developed technology, assembled work force, trade names, customer-related intangibles, trademarks, and favorable contracts. Acquisition-related intangibles are being amortized using the straight-line method over periods ranging from three to six years.

The amortization of our intangible assets decreased 19.8% to $3.4 million in the quarter ended September 30, 2002 from $4.2 million in the quarter ended September 30, 2001. This decrease in amortization was due to several intangible assets that became fully amortized during the quarter ended September 30, 2002, partially offset by an increase in intangible amortization resulting from the technology and products that we acquired from FAST in October 2001.

Interest and Other Income, net

Interest and other income, net consists primarily of interest income generated from our investments in money market funds, government securities and high-grade commercial paper. Interest income increased approximately 92.1% to $0.4 million in the quarter ended September 30, 2002 from $0.2 million in the quarter ended September 30, 2001. The increase in interest and other income reflects a significant increase in our cash balance as of September 30, 2002 compared to September 30, 2001, despite a lower interest rate environment. Our increased cash balance was generated primarily from the net cash provided by our operating activities.

Income Tax Expense

Income taxes are comprised of federal, state and foreign income taxes. We recorded a provision for income taxes of $0.5 million and $0.2 million for the quarters ended September 30, 2002 and 2001, respectively, primarily relating to income from our international subsidiaries. As of June 30, 2002, we have provided a valuation allowance for our net U.S. deferred tax assets, as we are presently unable to conclude that all of the deferred tax assets are more likely than not to be realized.

Cumulative Effect of Change in Accounting Principle

We performed the goodwill impairment analysis required by SFAS No. 142 as of July 1, 2002 and concluded that goodwill was impaired, as the carrying value of two of our reporting units in the Broadcast and Professional division exceeded their fair value. As a result, we recorded a charge of $19.3 million to reduce the carrying amount of goodwill. This charge is a non-operating and non-cash charge. This charge is reflected as a cumulative effect of change in accounting principle in the accompanying condensed consolidated statements of operations. See Note 4 to the condensed consolidated financial statements.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents increased $11.5 million during the quarter ended September 30, 2002, compared to an increase of $6.0 million during the quarter ended September 30, 2001. Cash and cash equivalents were $92.1 million as of September 30, 2002 compared to $80.6 million as of June 30, 2002. We have funded our operations to date through sales of equity securities as well as through cash flows from operations. We believe that existing cash and cash equivalent balances, as well as anticipated cash flow from operations, will be sufficient to support our current operations and growth for the foreseeable future.

Operating Activities

Our operating activities generated cash of $12.1 million during the quarter ended September 30, 2002, compared to generating cash of $5.1 million during the quarter ended September 30, 2001.

Cash generated from operations of $12.1 million during the quarter ended September 30, 2002 was attributable to increases in deferred revenues, accounts payable and accrued expenses, which were partially offset by increases in inventories and accounts receivable. As a result, we maintained positive cash flows from operations, despite incurring a net loss of $17.9 million for the quarter ended September 30, 2002 and after adjusting for depreciation, amortization, and the cumulative effect of change in accounting principle related to the goodwill impairment that resulted from our adoption of SFAS 142 on July 1, 2002. The increase in our deferred revenues was the result of receiving some advance payments on several large system sales, which we recorded as deferred revenue.

Cash generated from operations of $5.1 million during the quarter ended September 30, 2001 was attributable to a significant decrease in accounts receivable and an increase in deferred revenues, which were partially offset by a decrease in our accounts payable and accrued expenses. As a result, we maintained positive cash flows from operations, despite incurring a net loss of $15.5 million during the quarter ended September 30, 2001 and after adjusting for depreciation and amortization.

Investing Activities

Our investing activities consumed cash of $1.0 million during the quarter ended September 30, 2002 compared to consuming cash of $0.5 million during the quarter ended September 30, 2001.

Cash consumed by investing activities of $1.0 million during the quarter ended September 30, 2002 was due to the purchase of property and equipment. Cash consumed by investing activities of $0.5 million during the quarter ended September 30, 2001 was due to the purchase of property and equipment.

Financing Activities

Our financing activities generated cash of $0.6 million during the quarter ended September 30, 2002 compared to generating cash of $0.1 million during the quarter ended September 30, 2001.

Cash generated from financing activities of $0.6 million during the quarter ended September 30, 2002 was due to the proceeds from the exercise of employee stock options. Cash generated from financing activities of $0.1 million during the quarter ended September 30, 2001 was due the proceeds from the exercise of employee stock options.

Lease Obligations

We lease facilities and vehicles under non-cancelable operating leases. Future minimum lease payments are as follows (in thousands):

For the Nine-Month Period October 1, 2002 through June 30, 2003:
2003	$	3,461

For the Fiscal Years Ending June 30,
2004		3,804
2005		2,253
2006		1,784
2007		1,138
Thereafter		1,496

Total Operating Lease Obligations	$	13,936

The lease obligation remaining for the current fiscal year 2003 represents only a nine-month period from October 1, 2002 through June 30, 2003. The lease obligation disclosure, above, represents a four-year and nine-month period from October 1, 2002 through June 30, 2007 and any lease obligations thereafter.

Other Contractual Obligations

Our contractual obligations, other than operating leases, include purchase orders related to the procurement of materials that are required to produce our products for sale. Currently, we do not have any capital leases, long-term debt, other long-term obligations, or contractual cash obligations.

The most significant contractual financial obligations we have, other than specific balance sheet liabilities and facility leases, are the purchase order (PO’s) commitments we place with vendors and subcontractors to procure and guarantee a supply of the electronic components required to manufacture our products for sale. We place PO’s with our vendors on an ongoing basis based on our internal sales forecasts. The amount of outstanding PO’s can range from the value of material required to supply one half of the sales in a quarter to as much as the full amount needed for a quarter. As of September 30, 2002, the amount of outstanding PO’s was approximately $20.9 million. The total amount of these commitments can vary from quarter to quarter based on a variety of factors, including but not limited to, the total amount of expected future sales, lead times in the electronic components markets, the mix of projected sales and the mix of components required for those sales. Most of these PO’s are firm commitments that cannot be canceled, though some PO’s can be rescheduled without penalty and some can be completely canceled with little or no penalty.

Recent Accounting Pronouncements

The provisions of SFAS No. 144 will be effective for fiscal years beginning after December 15, 2001, which will be our fiscal year 2003. The Company adopted SFAS No. 144 during the quarter ended September 30, 2002. The adoption of SFAS No. 144 did not have a material effect on our financial position, results of operations, or cash flows.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146). This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” This Statement requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002. We do not expect the impact of adopting SFAS 146 to be significant to the Company’s financial position, results of operations, or cash flows.

FACTORS THAT COULD AFFECT FUTURE RESULTS

There are various factors that may cause our future net revenues and operating results to fluctuate. As a result, quarter-to-quarter variations could result in a substantial decrease in our stock price if our net revenues and operating results are below analysts’ expectations.

Our net revenues and 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:

•

Adverse changes in general economic conditions in any of the countries in which we do business, including the recent slow-down affecting North America, Europe, Asia Pacific and potentially other geographic areas

•

The continuing adverse economic impact of the recent national tragedy on September 11, 2001

•

Increased competition and pricing pressure

•

The timing of significant orders from and shipments to major customers, including OEM’s and our large broadcast accounts

•

The timing and market acceptance of new products and upgrades

•

The timing of customer acceptance on large system sales

•

Our success in developing, marketing and shipping new products

•

Our dependence on the distribution channels through which our products are sold

•

The accuracy of our and our resellers’ forecasts of end-user demand

•

The accuracy of inventory forecasts

•

Our ability to obtain sufficient supplies from our subcontractors on a timely basis

•

The timing and level of consumer product returns

•

Foreign currency fluctuations

•

Delays and costs associated with the integration of acquired operations

•

The introduction of new products by major competitors

•

Intellectual property infringement claims (by or against us)

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 in April and the IBC convention in September.

Our operating expense levels are based, in part, on our expectations of future revenue. Such future revenue levels are difficult to forecast. Any shortfall in our quarterly net sales would have a disproportionate, negative impact on our quarterly net income. The resulting quarter-to-quarter variations in our revenues and operating results could create uncertainty about the direction or progress of our business, which could cause our stock price to decline.

Due to these factors, our future net revenues and operating results are not predictable with any significant degree of accuracy. As a result, 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.

Deteriorating market conditions and continued economic uncertainty could materially adversely impact our revenues and growth rate.

As a result of recent unfavorable economic conditions and reduced capital spending, individuals and companies have delayed or reduced expenditures, as we experienced during the fourth quarter of fiscal 2001 and the first quarter of fiscal 2002. Although our sales increased in the first quarter of fiscal 2003 from the first, second, third and fourth quarters of fiscal 2002, our revenue growth and profitability depend primarily on the overall demand for our products. If demand for these products decreases due to ongoing economic uncertainty, this may result in decreased revenues, earnings levels or growth rates. If United States or international economic conditions worsen, demand for our products may weaken, and our business, operating results, financial condition and stock price may be materially adversely affected as a result.

Our revenues, particularly in the Broadcast and Professional Division, are becoming increasingly dependent on large broadcast system sales to a few significant customers. Our business and financial condition may be materially adversely affected if sales are delayed or not completed within a given quarter or if any of our significant broadcast customers terminate their relationship or contracts with us, modify their requirements, which may delay installation and revenue recognition, or significantly reduce the amount of business they do with us.

We expect sales of large broadcast systems to a few significant customers to continue to constitute a material portion of our net revenues. Our quarterly and annual revenues could fluctuate significantly if:

•

Sales to one or more of our significant customers are delayed or are not completed within a given quarter

•

The contract terms preclude us from recognizing revenue during that quarter

•

We are unable to provide any of our major customers with products in a timely manner and on competitive pricing terms

•

Any of our major customers experience competitive, operational or financial difficulties

•

Any of our major customers terminate their relationship with us or significantly reduce the amount of business they do with us

•

Any of our major customers reduce their capital investments in our products in response to slowing economic growth

If we are unable to complete anticipated transactions within a given quarter, our revenues may fall below the expectations of market analysts, and our stock price could decline.

We incurred losses in fiscal 2001, fiscal 2002 and the first quarter of fiscal 2003, and may generate losses in the remainder fiscal 2003.

In fiscal 2001 and fiscal 2002, we recorded net losses of approximately $60.5 million and $40.1 million, respectively. In the first quarter of fiscal 2003, we recorded net losses of approximately $17.9 million, including acquisition-related amortization charges and the cumulative effect of a change in accounting principles related to goodwill. If current economic conditions remain unfavorable or decline further, if our revenues grow at a slower rate than in the past or decline, or if our expenses increase without a commensurate increase in our revenues, we may incur net losses, and our results of operations and the price of our common stock may decline as a result.

If we experience difficulty in the ongoing development and installation of our Vortex News systems, our financial position and results of operations could be harmed.

In April 2000, we acquired all of the outstanding stock of Montage. The Montage product line includes Vortex News, a networked news solution for broadcasters. Since the Montage acquisition, we have invested significant resources and capital to further develop the Vortex News products, and to integrate those products into our existing products. We have received orders for our Vortex News products from key customers and have proceeded with the initial installations. We have successfully completed installation of the first few of those systems, but the systems are complex and are configured for each customer’s needs. If we experience difficulty in installing future Vortex News systems or in adapting these systems to our customers’ needs, or if our customers are dissatisfied with the functionality or performance of our Vortex News systems once they are installed, these systems may not obtain broad market acceptance or contribute meaningfully to our revenues or profitability. In addition, if we do not successfully install, market and sell these systems, we will consume significant resources without obtaining commensurate revenues, and our financial position and results of operations will be harmed.

Our goodwill and other intangible assets may become impaired, rendering their carrying amounts unrecoverable, and, as a result, we may be required to record a substantial impairment charge that would adversely affect our financial position.

In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” which we adopted on July 1, 2002. In connection with our adoption of SFAS No. 142, we recorded a goodwill impairment charge of $19.3 million in the first quarter of fiscal 2003. As of September 30, 2002, we had approximately $52.5 million of net goodwill and other intangible assets, after recording the $19.3 million goodwill impairment charge.

In accordance with SFAS No. 142, we will evaluate, on an annual basis or whenever significant events or changes occur in our business, whether our goodwill has been impaired. The recent general economic slowdown has adversely affected demand for our products, increasing the likelihood that our goodwill and other intangible assets will become impaired. If we determine that our goodwill has been impaired, we will recognize an impairment charge that could be significant and could have a material adverse effect on our financial position and results of operations.

Our stock price may be volatile.

The trading price of our common stock has in the past, and could in the future, fluctuate significantly. These fluctuations have been, or could be, in response to numerous factors, including:

•

Quarterly variations in our results of operations

•

Announcements of technological innovations or new products by us, our customers or our competitors

•

Changes in securities analysts’ recommendations

•

Announcements of acquisitions

•

Changes in earnings estimates made by independent analysts

•

General stock market fluctuations

Our revenues and results of operations for any given quarter or year 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 our quarterly results. In the day following this announcement, our share price lost more than 59% of its value. 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. We do not have 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 our best interest or in the interest of our 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. In July 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 us and certain of its officers and directors. Additional actions based on the same allegations were filed in the same Court. In October 2000, all of the actions were consolidated under the name In re Pinnacle Systems, Inc. Securities Litigation, Master File No. C-00-2596-MMC, and lead plaintiffs and lead counsel were appointed. The consolidated action is a putative class action alleging that defendants violated the federal securities laws by making false and misleading statements concerning our business during a putative class period of April 18, 2000 through July 10, 2000. Plaintiffs seek unspecified damages. Plaintiffs filed a consolidated amended complaint in December 2000, and defendants thereafter moved to dismiss that complaint. In a written order dated May 7, 2001, the Court dismissed the consolidated amended complaint and permitted plaintiffs to file an amended complaint. Plaintiffs filed a second amended complaint in June 2001. Defendants thereafter moved to dismiss that complaint. In a written order dated January 25, 2002, the Court dismissed the second amended complaint and granted plaintiffs leave to amend. On March 22, 2002, plaintiffs filed a third consolidated amended complaint. Defendants’ motion to dismiss plaintiffs’ third consolidated amended complaint is currently scheduled to be heard on November 15, 2002. We are defending 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 that may be brought against us could result in substantial costs and would likely divert management’s attention and resources from the day-to-day operations of our business. Any adverse determination in such litigation could also subject us to significant liabilities.

If we do not compete effectively against other companies in our target markets, our business and results of operations will be harmed.

We compete in the broadcast, professional, business, and consumer video production markets. Each of these markets is highly competitive and diverse, and the technologies for our products can change rapidly. The competitive nature of these markets results in pricing pressure and drives the need to incorporate product upgrades and accelerate the release of new products. New products are introduced frequently and existing products are continually enhanced. We anticipate increased competition in each of the broadcast, professional, business, and consumer video production markets, particularly since the industry continues to undergo a period of rapid technological change and consolidation. Competition for our broadcast, professional, business, and consumer video products is generally based on:

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Product performance

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Breadth of product line

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Quality of service and support

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Market presence and brand awareness

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Price

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Ability of competitors to develop new, higher performance, lower cost consumer video products

Certain competitors in the broadcast, professional, business, 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.

Our principal competitors in the broadcast and professional markets include:

Accom, Inc.

Avid Technology

Chyron Corporation

Leitch Technology Corporation

Matsushita Electric Industrial Co. Ltd.

Quantel Ltd. (a division of Carlton Communications Plc)

SeaChange Corporation

Sony Corporation

Thomson Multimedia

Our principal competitors in the business and consumer markets are:

Adobe Systems, Inc.

Apple Computer

Avid Technology, Inc.

Dazzle Multimedia (a division of SCM Microsystems, Inc.)

Hauppauge Digital, Inc.

Matrox Electronics Systems, Ltd.

Media 100, Inc.

Roxio, Inc.

Sony Corporation

These lists are not all-inclusive.

Increased competition in the broadcast, professional, business, or consumer markets could result in price reductions, reduced margins and loss of market share. If we cannot compete effectively in these markets by offering products that are comparable in functionality, ease of use and price to those of our competitors, our revenues will decrease and our operating results will be adversely affected.

Because we sell products internationally, we are subject to additional risks.

Sales of our products outside of North America represented approximately 48.8% of net sales in the quarter ended September 30, 2002 and approximately 44.1% of net sales in the quarter ended September 30, 2001. Sales of our products outside of North America represented approximately 51.0% of net sales in the year ended June 30, 2002 and approximately 57.9% of net sales in the year ended June 30, 2001. 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. We expect that in fiscal 2003 and beyond, a majority of our European sales will continue to be denominated in local foreign currency, including the Euro. We have developed natural hedges for some of this risk since most of the European operating expenses are also denominated in local currency. However, where we sell our products in local currencies, we may be competitively unable to change our prices to reflect exchange rate fluctuations.

As of September 30, 2002, our cash and cash equivalents balance was approximately $92.1 million, with approximately $47.4 million located in the U.S. and approximately $44.7 million located at international locations. Our cash balance from international operations included various foreign currencies, primarily the Euro, but also included the British Pound and Japanese Yen. Our operational structure is such that fluctuations in foreign exchange rates can impact and cause fluctuations in our cash balances.

In addition to foreign currency risks, our international sales and operations may also be subject to the following risks:

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Unexpected changes in regulatory requirements

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Export license requirements

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Restrictions on the export of critical technology

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Political instability

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Trade restrictions

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Changes in tariffs

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Difficulties in staffing and managing international operations

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Potential insolvency of international dealers and difficulty in collecting accounts

We are also subject to the risks of changing economic conditions in other countries around the world. These risks may harm our future international sales and, consequently, our business.

If our products do not keep pace with the technological developments in the rapidly changing video production industry, our business may be materially adversely affected.

The video production 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. Our future growth will depend, in part, upon our ability to introduce new features and increased functionality for our existing products, improve the performance of existing products, respond to our competitors’ new product offerings and adapt to new industry standards and requirements. 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 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 limited market acceptance of the product.

Quarter-end discounting, resulting from customers delaying negotiations until quarter-end in an effort to improve their ability to obtain more favorable pricing terms, may delay sales transactions and cause our quarterly revenues to fall below analysts’ expectations.

Our sales were relatively linear throughout fiscal 2002 and the first quarter of fiscal 2003. However, an increase in large systems sales or an expansion of our distribution channels could require us to recognize a substantial portion of our revenues in the last month or weeks of a given quarter. If certain sales cannot be closed during those last weeks, sales may be deferred until the following quarter. This may cause our quarterly revenues to fall below analysts’ expectations.

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, our business and financial condition could be materially harmed.

We rely on subcontractors to manufacture our professional 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:

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Loss of control over the manufacturing process

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Potential absence of adequate manufacturing capacity

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Potential delays in lead times

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Unavailability of certain process technologies

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Reduced control over delivery schedules, manufacturing yields, quality and cost

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Unexpected increases in component costs

As a result of these risks, the financial stability of, and our continuing relationships with, our subcontractors and single or limited source suppliers are important to our success. 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.

We must retain key employees to remain competitive.

If certain of our key employees leave or are no longer able to perform services for us, this could materially and adversely affect our business. We believe that the efforts and abilities of our senior management and key technical personnel are very important to our continued success. As a result, our success is dependent upon our ability to attract and retain qualified technical and managerial personnel. 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.

Any failure to successfully integrate the businesses we have acquired or which we acquire in the future could have an adverse effect on our business or results of operations.

Over the past three years, we have acquired a number of businesses and technologies and expect to continue to make acquisitions as part of our growth strategy. In October 2002, we acquired all of the outstanding stock of VOB Computersysteme GmbH, based in Dortmund, Germany. In October 2001, we acquired the business and substantially all of the assets, and assumed certain liabilities, of FAST Multimedia Holdings Inc. and FAST Multimedia AG, based in Munich, Germany. In December 2000, we acquired DVD authoring technology from Minerva. In June 2000, we acquired Avid Sports, Inc. and Propel. In April 2000, we acquired Montage. In March 2000, we acquired DES and Puffin. In August 1999, we acquired the Video Communications Division of HP. In March 1999, we acquired Truevision, 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

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Costs, delays and inefficiencies associated with integrating acquired operations, products and personnel

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Difficulty in realizing the potential financial or strategic benefits of the transaction

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Difficulty in maintaining uniform standards, controls, procedures and policies

•

Possible impairment of relationships with employees and customers as a result of the integration of new businesses and management personnel

•

Potentially dilutive issuances of our equity securities

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Incurring debt and amortization expenses related to goodwill and other intangible assets

We may be adversely affected if we are subject to, or initiate, intellectual property litigation.

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:

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Divert management’s attention away from the operation of our business

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Result in the loss of our proprietary rights

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Subject us to significant liabilities

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Force us to seek licenses from third parties

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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.

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 adequately 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. Additionally, policing the unauthorized use of our proprietary technology is costly and time-consuming, and software piracy can be expected to be a persistent problem. If we are unable to protect our intellectual property, our business could be materially harmed.

We rely on dealers, VARs and OEMs to market, sell and distribute many of our products. In turn, we depend heavily on the success of these resellers. If these resellers are not successful in selling our products or if we are not successful in opening up new distribution channels, our financial performance will be negatively affected.

A significant portion of our sales are sourced, developed and closed through dealers, VARs and OEMs. We believe that these resellers have a substantial influence on customer purchase decisions, especially purchase decisions by large enterprise customers. These resellers may not effectively promote or market our products or may experience financial difficulties or even close operations. In addition, our dealers and retailers are not contractually obligated to sell our products. Therefore, they may, at any time, refuse to promote or distribute our products. Also, since many of our distribution arrangements are non-exclusive, our resellers may carry our competitors’ products and could discontinue our products in favor of our competitors’ products.

Also, since these distribution channels exist 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 based on their forecasted demand which may or may not materialize.

With respect 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. Our consumer product distribution network exposes us to the following risks, some of which are out of our control:

•

We are obligated to provide price protection to our 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

•

These distributors or retailers may not continue to stock and sell our consumer products

•

Retailers and distributors often carry competing products

As a result of these risks, we could experience unforeseen variability in our revenues and operating results.

Excess or obsolete inventory, and overdue or uncollectible accounts receivables, could weaken our cash flow, harm our financial condition and results of operations and cause our stock price to fall.

The downturn in the global economy contributed to a reduced demand for some of our products earlier in fiscal 2002. If the economy experiences a “double dip” recession or if our industry experiences a decline during fiscal 2003 or beyond, we may experience increased exposure to excess and obsolete inventories and higher overdue and uncollectible accounts receivables. If we fail to properly manage these inventory and accounts receivables risks, our cash flow may be weakened, and our financial position and results of operations could be harmed as a result. This, in turn, may cause our stock price to fall.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currencies

We transact business in various foreign currencies, primarily the Euro, but also the British Pound and Japanese Yen. Accordingly, we are subject to exposure from adverse fluctuations in foreign currency exchange rates. We use a natural hedge approach, since local currency revenues substantially offset the local currency denominated operating expenses. We continually assess the need to use financial instruments to hedge foreign currency exposure.

Fixed Income Investments

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio of marketable securities. We generally do not use derivative financial instruments for speculative or trading purposes. We invest primarily in United States Treasury Notes and high-grade commercial paper and generally hold them to maturity. Consequently, we do not expect any material loss with respect to our investment portfolio.

We do not use derivative financial instruments in our investment portfolio to manage interest rate risk. We do, however, limit our exposure to interest rate and credit risk by establishing and strictly monitoring clear policies and guidelines for our fixed income portfolios. At the present time, the maximum duration of all portfolios is one year. Our 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 our guidelines, we do not expect that our exposure to market and credit risk will be material.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures.

Within the 90 days prior to the filing of this Quarterly Report on Form 10-Q (the “Evaluation Date”), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Exchange Act). Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that material information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms. It should be noted, however, that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

(b) Changes in internal controls.

Subsequent to the Evaluation Date, there have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their last evaluation.

PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In July 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 of its officers and directors. Additional actions based on the same allegations were filed in the same Court. In October 2000, all of the actions were consolidated under the name In re Pinnacle Systems, Inc. Securities Litigation, Master File No. C-00-2596-MMC, and lead plaintiffs and lead counsel were appointed. The consolidated action is a putative class action alleging that defendants violated the federal securities laws by making false and misleading statements concerning our business during a putative class period of April 18, 2000 through July 10, 2000. Plaintiffs seek unspecified damages. Plaintiffs filed a consolidated amended complaint in December 2000, and defendants thereafter moved to dismiss that complaint. In May 2001, the Court dismissed the consolidated amended complaint and permitted plaintiffs to file an amended complaint. Plaintiffs filed a second amended complaint in June 2001. Defendants thereafter moved to dismiss that complaint. In a written order dated January 25, 2002, the Court dismissed the second amended complaint and granted plaintiffs leave to amend. On March 22, 2002, plaintiffs filed a third consolidated amended complaint. Defendants’ motions to dismiss. plaintiffs’ third consolidated amended complaint is currently scheduled to be heard on November 15, 2002. We are defending the case vigorously. We have not accrued any liability related to this contingency since a liability cannot be reasonably estimated.

In August 2000, a lawsuit entitled Athle-Tech Computer Systems, Incorporated v. Montage Group, Ltd. and Digital Editing Services, Inc. (DES), wholly owned subsidiaries of Pinnacle Systems, No. 00-005956-C1-021 was filed in the Sixth Judicial Circuit Court for Pinellas County, Florida (referred to as “Athle-Tech Claim”). The Athle-Tech Claim alleges that Montage breached a purported software development agreement between Athle-Tech Computer Systems, Incorporated, or Athle-Tech, and Montage. The Athle-Tech Claim also alleges that DES intentionally interfered with Athle-Tech’s claimed rights with respect to the purported Athle-Tech Agreement and was unjustly enriched as a result. Finally, Athle-Tech seeks a declaratory judgment against DES and Montage. We deny any liability relating to the Athle-Tech Claim and are vigorously defending the case. The parties are currently engaged in the discovery process. In July 2002, the Court held a hearing on our motion for summary judgment and the plaintiff’s motion for partial summary judgment. The court denied both motions. A trial date is currently set for February 2003. We have not accrued any liability related to this contingency since a liability cannot be reasonably estimated.

In March 2000, we acquired DES. Pursuant to the Agreement and Plan of Merger dated as of March 29, 2000 between DES, 1117 Acquisition Corporation, the former DES shareholders and the Company, the former DES shareholders were entitled to an earnout payable in shares of our common stock if the DES operating profits exceeded at least 10% of the DES revenues during the period from March 30, 2000 until March 30, 2001. In October 2000, we entered into an amendment to the DES Agreement and Plan of Merger with the former DES shareholders to provide for an earnout based on the combined revenues, expenses and operating profits of DES and Avid Sports, Inc. due to the combination of the DES and Avid Sports, Inc. divisions in July 2000. In April 2001, we determined that no earnout payment was payable. In May 2001, the former DES shareholders asserted that an earnout payment was payable. In accordance with the DES Agreement and Plan of Merger, in October 2001 the parties submitted this matter to an independent arbitrator. Currently, the DES earnout arbitration is ongoing. We have not accrued any liability related to this contingency since a liability cannot be reasonably estimated.

We are engaged in certain additional legal actions arising in the ordinary course of business. We believe that we have adequate legal defenses and that the ultimate outcome of these actions will not have a material effect on our consolidated financial position, results of operations or liquidity, although there can be no assurance as to the outcome of such litigation.

ITEM 5. OTHER INFORMATION.

In accordance with Section 10A of the Securities Exchange Act of 1934, as promulgated by Section 202 of the Sarbanes Oxley Act of 2002, the Audit Committee of our Board of Directors approved on October 31, 2002 the following non-audit services to be performed by KPMG LLP, our independent auditors: (1) accounting advisory services with respect to SEC filings; (2) accounting advisory services related to acquisitions; (3) litigation support, arbitration assistance and related services; (4) tax-related services; and (5) other accounting consultation and assistance.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

Number		Description
2.2		Share Purchase and Transfer Agreement by and among Volkmar Breitfeld, Maik Langenberg, Pinnacle Systems GmbH and Pinnacle Systems, Inc. entered into on September 30, 2002.

99.1		Certification of Chief Executive Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b) Reports on Form 8-K

Pinnacle Systems, Inc. did not file any Reports on Form 8-K during the quarter ended September 30, 2002.

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.

Date: November 14, 2002 PINNACLE SYSTEMS, INC.

By:		/s/ J. KIM FENNELL
		J. Kim Fennell President and Chief Executive Officer

Date: November 14, 2002

By:		/s/ ARTHUR D. CHADWICK
		Arthur D. Chadwick Vice President, Finance and Administration and Chief Financial Officer

CERTIFICATIONS

I, J. Kim Fennell, certify that:

I have reviewed this quarterly report on Form 10-Q of Pinnacle Systems, Inc.;

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly represent in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.


Date: November 14, 2002	By:	/s/ J. KIM FENNELL
		J. Kim Fennell President and Chief Executive Officer

CERTIFICATIONS

I, Arthur D. Chadwick, certify that:

I have reviewed this quarterly report on Form 10-Q of Pinnacle Systems, Inc.;

evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and


Date: November 14, 2002	By:	/s/ ARTHUR D. CHADWICK
		Arthur D. Chadwick Vice President, Finance and Administration, Chief Financial Officer and Secretary

INDEX TO EXHIBITS

Exhibit Number		Description
2.2		Share Purchase and Transfer Agreement by and among Volkmar Breitfeld, Maik Langenberg, Pinnacle Systems GmbH and Pinnacle Systems, Inc. entered into on September 30, 2002.

99.1		Certification of Chief Executive Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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