PINNACLE SYSTEMS INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

[x] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended June 30, 1998 or

[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ________________ to
_______________.

Commission file number: 0-24784

PINNACLE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)

California 94-3003809
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)

280 North Bernardo, Mountain View, CA 94043
(Address of principal executive office) (zip code)

Registrant's telephone number, including area code: (650) 526-1600

Securities registered pursuant to Section 12(b) of the Act:

Name of each exchange
Title of each class On which registered
----------------------- -------------------------
None None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.[ ]

The aggregate market value of the voting stock held by non-affiliates
of the registrant, based upon the closing sale price of the Common Stock on
August 27, 1998 as reported on the Nasdaq National Market System, was
approximately $231,279,344. Shares of Common Stock held by each officer and
director and by each person who owns 5% or more of the outstanding Common Stock
have been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.

As of August 27, 1998, registrant had outstanding 10,111,952 shares of
Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

The Registrant has incorporated by reference into Part III of this Form
10-K portions of its Proxy Statement for Registrant's Annual Meeting of
Shareholders to be held October 21, 1998.

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PART I

Special Note Regarding Forward-Looking Statements

Certain statements in this Report constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995 (the "Reform Act"). Such forward-looking statements involve known and
unknown risks, uncertainties and other factors which may cause the actual
results, performance or achievements of the Company, or industry results, to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Such factors include,
among other things, the following: the uncertainty as to the continued
development of the market for desktop video systems; the uncertainty of
continued market acceptance of professional video products; significant
fluctuations in the Company's operating results; the historical absence of
backlog; the history of losses and accumulated deficit; the Company's highly
competitive industry and rapid technological change within the Company's
industry; the risks associated with dependence on resellers, contract
manufacturers and other third-party relationships; the absence of a direct sales
force; the risks associated with development and introduction of new products;
the need to manage product transitions; the risks associated with product
defects and reliability problems; the risks associated with single source
suppliers; the uncertainty of patent and proprietary technology protection and
reliance on technology licensed from third parties; the risks of third party
claims of infringement; the Company's dependence on retention and attraction of
key employees; the need to manage growth; the risks associated with future
acquisitions; the risks associated with international licensing and operations;
general economic and business conditions; and other factors referenced in this
Report.

Pinnacle Systems is a registered trademark of Pinnacle Systems, Inc.,
and Pinnacle Systems, Inc. believes that all of its product names, other than
Alladin, are trademarks of Pinnacle Systems, Inc. This Report also includes
trademarks of companies other than Pinnacle Systems, Inc.

ITEM 1. BUSINESS

Pinnacle Systems, Inc. designs, manufactures, markets and supports
computer-based video post-production products to serve the broadcast, desktop
and consumer markets. The Company's products incorporate specialized real time
video processing technologies to perform a variety of video post-production
functions such as the addition of special effects, graphics and titles to
multiple streams of live or recorded video material. To address the broadcast
market, the Company offers high performance, specialized Windows NT-based
solutions for high-end, post-production and broadcast on-air applications. For
the desktop market, the Company provides real time video manipulation tools to
support both linear, or tape-based, and non-linear, or computer-based, editing
environments. To address the consumer market, the Company offers low cost, easy
to use video editing solutions that allow consumers to edit their home videos
using a personal computer, camcorder and VCR. Used in conjunction with standard
computer platforms, these technologies provide high quality, cost effective,
computer-based video processing solutions for the post-production market. In
addition, the Company recently has expanded the scope of its products to
encompass certain COmpression/DECompression ("CODEC") technology required to
control and transfer video into and out of the computer ("video capture"). By
combining the Company's real time video processing technology, video capture
technology and application program interface ("API"), the Company intends to
provide a complete video processing platform that supports a variety of video
editing software applications.

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Industry Background

The development of a video program involves three distinct processes:
pre-production, which involves planning and preparation for the recording of the
video program; production, which involves the acquisition (shooting) of video
material; and post-production, which involves the organization of raw video
segments acquired in the production phase into a cohesive and appealing program
(editing). During the post-production phase, elements such as titles, graphics
and transitions between video segments are incorporated to enhance the overall
quality and impact of a video program.

Historically, the video production industry has focused on providing
program material for broadcast television and advertising. Recently, new and
expanding channels of video content distribution, including cable television,
direct satellite broadcast, video rentals, the Internet, CD-ROM, DVD and
video-on-demand have led to a rapid increase in demand for video content for a
wide variety of additional applications that require less expensive and easier
to use editing approaches. New commercial and industrial applications for this
market include multimedia entertainment, video games, music videos, special
event videos, education and training and corporate communications. In addition,
the popularity of camcorders, VCRs and personal computers has fueled the growth
of an emerging consumer market for low cost video production technology that
enables consumers to create and edit home videos. These expanding channels of
video content distribution and new applications are increasing the demand for
video production tools.

To create high quality video programs for broadcast television and
advertising, producers have traditionally used expensive, dedicated video
production equipment linked together in a complex interconnected system to form
a video "editing suite." Typical editing suites incorporate video recorders,
switchers, digital video effects systems, still image management systems,
character generators, electronic paint systems and other products, often
provided by multiple manufacturers. These editing suites require highly skilled
personnel to operate and maintain.

More recently, computer-based video solutions combining personal
computers with specialized video processing technology can now provide video
quality comparable to that of traditional editing suites at significantly lower
cost. As a result, these computer-based video solutions are increasingly
replacing the traditional editing suites. In addition, such solutions are often
easier to use since they utilize common graphical user interfaces. The lower
cost and ease of use of computer-based video tools enables large numbers of
creative individuals, previously untrained in video production, to produce
professional quality video programming. A complete computer-based video solution
generally includes four components: a computer, specialized audio and video
processing hardware, an associated API and specific editing applications. These
components have often been supplied by a single vendor. However, as the
computer-based video industry develops, it is shifting toward Windows NT-based
open architecture solutions.

As a result of these changes, the broadcast market is transitioning to
computer-based solutions, the desktop market is expanding rapidly and, more
recently, a consumer market has begun to emerge. These changes have created
opportunities for companies that focus on computer-based solutions for the video
production industry.

The Pinnacle Approach

The Company designs, manufactures, markets and supports computer-based
video post-production products to serve the broadcast, desktop and consumer
markets. The Company's products are based on its proprietary video manipulation
technology and offer the following benefits:

Sophisticated Video Manipulations. Pinnacle's products provide advanced
video manipulation capabilities, such as special effects, graphics and titles.
Videographers constantly seek effects to give their programs a new look and to
allow them to differentiate and enhance their end product.

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Real Time Interactivity. Pinnacle's products allow users to select an
effect and instantly see the result. This real time interactivity gives users
the flexibility to try many different effects and fine-tune the resulting
content.

Open Systems. Pinnacle's products conform to generally accepted
industry standards for video input/output and control, allowing interoperability
with a wide variety of video processing and storage equipment. Furthermore, the
Company has developed and published, and is encouraging others to adopt, open
interface specifications for video input/output products, manipulation and
control for computer-based video post-production.

Ease of Use. Pinnacle's products include menu-driven interfaces for
selecting and controlling the various video manipulation functions. This reduces
technical obstacles to the operation of the system, permitting the user to focus
on the artistic aspects of the post-production process.

Favorable Price/Performance Ratio. Pinnacle's products have a favorable
price/performance ratio, in part because the Company uses the same proprietary
components across its product lines. This enables it to reduce material costs
and take advantage of higher unit volumes. The Company intends to continue
lowering the cost of its products by further integrating its video manipulation
and video capture technologies into application specific integrated circuits
("ASICs").

The Company is organized into separate business groups to serve the
broadcast, desktop and consumer markets. The Company believes this
organizational structure enables it to address effectively different product
requirements, more rapidly implement its core technologies, more effectively
manage different distribution channels and anticipate and respond to changes in
each of these markets.

Company Strategy

Pinnacle's goal is to become the leading supplier of computer-based
video post-production products to the broadcast, desktop and consumer markets.
To pursue its goal, the Company intends to implement the following strategies:

Expand and Leverage Core Technologies. The Company intends to expand
its core software and hardware technological base through both internal
development and acquisitions. For example, the Company has developed proprietary
real time video manipulation technology and acquired video capture technology
with its August 1997 acquisition of the miroVideo product lines (the "Miro
Acquisition.") The Company uses a modular approach to product development which
allows it to leverage its investment in research and development across multiple
product designs and minimize time to market.

Establish Industry Standard Video Processing Platform. The Company
believes that as the desktop market continues to move toward an open
architecture environment, companies will either provide an open architecture
video processing platform or develop end user editing applications. The
Company's strategy is to establish an industry standard video processing
platform compatible with a broad range of applications. The platform technology
will combine real time video manipulation, video capture technology and a
unified API.

Develop and Expand Worldwide Sales and Distribution Organization. The
Company has developed a worldwide sales and distribution organization that it
believes is a strategic advantage in the rapidly changing video post-production
industry. The Company's sales organization focuses on a variety of distribution
channels, including OEMs, resellers, distributors and retail stores. In
connection with the Miro Acquisition, the Company added Miro's European consumer
sales organization and distribution relationships which complement the Company's
existing sales organization. In addition, the Company intends to continue to
develop strong strategic relationships with key OEMs and resellers.

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Acquire Complementary Businesses, Products and Technologies. The
Company has grown and intends to continue to grow both internally as well as
through the acquisition of complementary businesses, product lines or
technologies. The Company frequently evaluates strategic acquisition
opportunities that could enhance the Company's existing product offerings or
provide an avenue for developing new complementary product lines. The Company
believes that the video production industry is in a period of consolidation and
that strategic acquisition opportunities may arise.

Products

The Company offers four families of video products aimed at the
broadcast market: the DVExtreme family, the Lightning family, the Deko family,
and AlladinPRO. The Company has two general classes of desktop products: digital
video effects products, which include the Alladin and Genie families, and video
capture and editing products, which include the Reeltime, miroVIDEO DC30,
miroVIDEO DC50 and miroVIDEO DV300 families. The Company entered the consumer
market through the acquisition of the VideoDirector product line from Gold Disk,
Inc. ("Gold Disk") in June 1996 and in March 1997 commenced shipment of its
first internally developed consumer product, the VideoDirector Studio 200 which
was superseded by the Studio 400 in June 1998. In August 1997, the Company
acquired certain consumer products, specifically the miroVIDEO DC10, miroVIDEO
DC20 and miroVIDEO PCTV in connection with the Miro Acquisition. The Company
currently offers the following products to address video post-production needs
for the broadcast, desktop and consumer markets:

Broadcast Market

For the broadcast market the Company currently offers products that
provide real time digital effects, still image management and storage and real
time video character generation. These products generally include proprietary
hardware and software and specialized control panels and/or keyboards for rapid
operations, especially for on-air applications. The primary broadcast products
sold during fiscal 1997 were the Prizm and Flashfile family of products. In June
1997, the Company commenced shipment of two new product families, DVExtreme and
Lightning, which are designed to address the markets previously addressed by
Prizm and Flashfile, respectively. In April 1997, the Company completed the
acquisition of the Deko titling and character generation product line from
Digital Graphix, Inc. ("Digital Graphix.") In June 1998, the Company commenced
shipment of AlladinPRO, a new high-performance Windows NT based digital video
effects system designed for live and on-line applications. These four product
families comprise the Company's suite of high performance real time Windows
NT-based products designed for broadcast and high-end, post-production
applications.

DVExtreme Family. DVExtreme is the Company's high performance, real
time digital video effects system for broadcast and high-end, post-production
customers which seek to incorporate unique special effects into their
programming. The DVExtreme family replaced the Company's Prizm family of
products, which was first introduced in 1990. 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 with highlights and shadows, water ripples, ball effects, wave patterns
and other effects. It also includes the Company's ParticalFX and PainterlyFX
technologies which enable the creation of video textures and paint-look effects.
Because it is based on Windows NT, it can be connected to a standard computer
network to facilitate file transfers in a broadcast facility. The suggested list
price for a DVEtreme ranges from $44,990 to $63,990, depending on the
configuration.

AlladinPRO Family. AlladinPRO is the Company's newest high-performance
Windows NT based digital video effects system designed for live and on-line
applications. AlladinPRO provides users a broadcast quality single or dual
channel digital video effects system, plus a built-in still store. It performs
many of the functions of the DVEtreme family, but it is positioned in the market
as a less expensive

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alternative to the DVEtreme family of products. The suggested list price for an
AlladinPRO ranges from $19,990 to $29,990, depending on the configuration.

Lightning Family. Lightning is the Company's new high performance,
networkable image management system designed for broadcast and high-end,
post-production applications such as news and sports programs. The Lightning
family is the successor to the Company's Flashfile family of products which was
first introduced in 1992. Lightning is a Windows NT-based system that can
accommodate up to three channels of video, plus additional virtual channels for
previewing. It has internal storage capacity for over 10,000 images, and an
interface to external disks for expanded storage needs. Lightning can also
perform digital video effects on captured video images. The suggested list price
for a Lightning ranges from $25,990 to $31,780, depending on the configuration.

Deko Family. The Deko family of products is designed to provide high
performance titling and character generation for broadcast and on-air
applications. Deko is a Windows NT-based system that includes powerful text and
graphics tools such as real time text scrolling, text manipulation, font
enhancement, multiple layers for text composition and supports a wide range of
standard and international character fonts. The products support a large variety
of file formats to import backgrounds, textures and images. The suggested list
price for a Deko ranges from $26,900 to $31,900, depending on the configuration.

Desktop Market

The Company's desktop products are designed to provide high quality
video capture, compression/decompression, editing and real time video
manipulation capabilities for computer-based video post-production systems. They
are generally offered at significantly lower price points than traditional
editing suites and are integrated into the computer by a value added reseller,
an OEM, or the end user. The Company has two general classes of desktop
products: digital video effects products, which include the Alladin and Genie
families, and video capture and editing products, which include the Reeltime,
miroVIDEO DC30, miroVIDEO DC50 and miroVIDEO DV300 families.

Alladin Family. The Alladin product family is designed to provide high
quality, real time video manipulation capabilities for desktop video
post-production. It allows the user to manipulate and process up to four
simultaneous streams of live video supplied from either videotape or computer
disk. It provides a variety of video effects including dissolves, compositing of
live video with text or graphics, transparency, clipping of a live image,
sizing, rotation with perspective, 3D positioning and warping. The Alladin
connects through an external port to a standard personal computer. The suggested
list price for an Alladin ranges from $10,490 to $12,490, depending on the
configuration.

Genie Family. The Genie family of products offers a complete set of
professional quality, real time 3D digital effects, switching, character
generation, paint and still storage on a single personal computer interface
("PCI") board. While offering much of the functionality of Alladin, Genie does
so at a much lower price point and is installed in the computer rather than
connecting through an external port. GeniePlus integrates into linear desktop
editing environments and includes input/output and software allowing the user to
process up to two simultaneous streams of live video. In addition, a non-linear
version of Genie is sold to OEM vendors who integrate and sell it with their
non-linear editing products. The suggested list price for a Genie is $5,990.

ReelTime Family. ReelTime is a dual stream video and audio capture and
playback card with real time special effects. ReelTime will support the Adobe
Premiere editing software. Additionally, ReelTime's open architecture is
intended to support a wide variety of third-party video applications. ReelTime
features real time transitions, along with real time chroma, luma and linear
keying, titling, and a scalable architecture that supports the Company's Genie
RT option. The Genie RT option incorporates the Pinnacle Genie add-in

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card and enables picture-in-picture motion and real time 3D effects, including
page turns, ripples, spheres and hourglasses. The suggested list price for
Reeltime is $4,990 for an NTSC version and $5,990 for a PAL version.

MiroVIDEO DC30 Family. The miroVIDEO DC30 family was acquired as part
of the Miro Acquisition. The miroVIDEO DC30 is a non-linear video and audio
editing system offering composite video input and output connections, targeted
at the professional videographer. It is a single stream PCI-bus video product
which captures, compresses and decompresses video signals and stores and
retrieves such compressed video signals from a standard computer, and features
high bandwith audio capture and playback. It comes bundled with a software
editing package that allows videographers to edit and create high-quality video
productions. The suggested list price for a miroVIDEO DC30 is $790.

MiroVIDEO DC-50 Family. The miroVIDEO DC50 is a non-linear video and
audio editing system offering component, composite and S-Video input and output
connections, targeted at the professional videographer. It has similar
functionality as the miroVIDEO DC30 with the addition of a professional breakout
box for a variety of video input and output options including component video.
The suggested list price for a miroVIDEO DC50 is $1,950.

MiroVIDEO DV-300 Family. The miroVIDEO DV300 is an all digital
non-linear video and audio editing system offering DV (digital video) input and
output connections, targeted at the professional videographer. It has similar
functionality as the miroVIDEO DC30 except that it uses the DV video format. The
suggested list price for a miroVIDEO DV300 is $799.

Consumer Market

The Company's consumer products provide video editing and video capture
and playback solutions. Its consumer video editing solutions allow consumers to
edit their home videos using a personal computer, camcorder and VCR. The
Company's consumer products are sold at lower price points than the Company's
other products and are sold as software packages and computer add-on products.
The Company entered the consumer video editing market through the acquisition of
the VideoDirector product line from Gold Disk in June 1996. In March 1997, the
Company commenced shipment of its first internally developed consumer editing
product, the VideoDirector Studio 200. Acquired in August 1997 in connection
with the Miro Acquisition, the miroVIDEO DC10 and the miroVIDEO DC20 both
feature video capture and playback, and the miroVIDEO PCTV allows users to view
a television picture on their computer monitor. In June 1998, the Company
commenced shipment of Studio 400 which replaces the VideoDirector Studio 200.

VideoDirector Studio 200. VideoDirector Studio 200 enables basic video
editing and the addition of special effects titles and graphics to home videos.
Connecting to an external port, the product is easy to install and requires only
limited hard disk storage space. The suggested list price for VideoDirector
Studio 200 is $249.

VideoDirector Studio 400. Studio 400 is a video editing system
replacing the VideoDirector Studio 200 in North America with a more
comprehensive feature set and ease of use. Studio 400 is expected to replace the
VideoDirector Studio 200 in the rest of the world during the three months ending
September 30, 1998. It connects to an external port of a Window's 95 or Window's
98 computer, a VCR, and camcorder. It is easy to install and requires only
limited hard disk storage space. The product is aimed at the developing consumer
market and allows users to simply cut-and-paste their best video scenes
together, add music, titles, special effects and transitions. Users can create
content that has many of the same effects found in far more expensive
professional video editing systems. The suggested list price for Studio 400 is
$229.

MiroVideo DC10, DRX and DC20. The miroVIDEO DC10, miroVIDEO DRX and
miroVIDEO DC20 are non-linear editing systems offering composite video input and
output connections. The

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miroVIDEO DC10, branded the miroVIDEO DRX in North America, is targeted at the
consumer and hobbyist market while the miroVIDEO DC20 is targeted at multimedia
content developers. Both products are single stream PCI-bus video product which
capture, compress and decompress video signals using a standard computer. Both
products are bundled with a software editing packages. The miroVIDEO DC20 has
similar functionality as the miroVIDEO DC10 and miroVIDEO DRX, except that the
DC20 also includes certain audio capabilities. The suggested list price for
miroVIDEO DC10 and DRX is $249 and for miroVIDEO DC20 is $599.

MiroVideo PCTV. The miroVIDEO PCTV is targeted at the consumer market
and is a single card which allows users to view a television program on their
computer monitor. Throughout fiscal 1998 this product was primarily sold into
the European market. The suggested list price for miroVIDEO PCTV is $129.

Technology

The Company is a technological leader in video capture and real time
video manipulation. The National Academy of Television Arts and Sciences'
Outstanding Technical Achievement EMMY award has been awarded to the Company on
three occasions. In 1990, the Company received an EMMY for pioneering the
concept of the video workstation. In 1994, the Company received an EMMY for
developing technology which allows real time mapping of live video onto animated
3D surfaces and, in 1997, the Company received an EMMY for utilization of real
time video manipulation technology in non-linear editing applications. In
addition, the technology that the Company acquired from Digital Graphix was
awarded two EMMYs prior to its acquisition by the Company.

Many of the Company's products share a common internal architecture.
This design approach allows the Company to leverage its research and development
expenditures by utilizing similar hardware and software modules in multiple
products. The Company's video manipulation architecture is fundamental to the
performance and capabilities of the Company's products. As a result of the Miro
Acquisition, the Company has acquired video capture technology which allows high
quality live video and audio to be captured and played back from a standard
personal computer.

All of the Company's products use or work with a standard personal
computer for control of video manipulation functions. In all products targeting
the broadcast market, the control microprocessor is embedded within the product.
The desktop and consumer products are inserted into or connect externally to a
personal computer. The use of industry standard microprocessors offers three
main advantages over traditional video products: lower software development
costs due to the availability of powerful off-the-shelf software development
tools; lower product manufacturing costs due to the low costs of standard
microprocessors; and the ability to integrate third party software such as
networking or 3D rendering software to provide additional functionality.

Essentially all real time video manipulation must be performed on
uncompressed video data. Since uncompressed digital video rates are too high to
be processed by a microprocessor in real time, video signals are internally
distributed over a separate high-speed digital video bus ("DVB") and processed
using the Company's proprietary real time video manipulation hardware. The video
data on the DVB is processed in the standard digital component format which
fully complies with the highest digital component video standards of the
International Radio Consultation Committee, an organization which develops and
publishes standards for international telecommunication systems.

The software in the Company's video capture and video manipulation
products is divided into two layers: the user interface application and the API.
The user interface application is different and has been optimized for each
product family. The API is, for the most part, common to most of the Company's
products

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and incorporates all the proprietary low level routines which allow the
Company's products to perform high quality, real time video manipulations. This
software architecture has three main advantages: real time video manipulation
algorithms that are complex and difficult to develop can be used in multiple
products; the user interface can be tailored to meet specific user requirements;
and applications can be quickly ported to the Company's products using the API.

The Company's core technical expertise is in real time digital video
processing, video capture technology, real time software algorithms, video
input/output, advanced user interfaces and software control of commercially
available camcorders and VCRs.

Real Time Digital Video Processing. The Company has devoted significant
resources to the development of proprietary technology for real time video
processing, including high speed digital filters, image transformation buffers,
plane and perspective addressing, and non-linear image manipulation. The Company
has patented technology related to real time mapping of live video onto
multiple, complex, animated 3D shapes and surfaces. This technology includes a
proprietary data compression algorithm that compresses the address information
and allows decompression of this data in real time.

CODEC Technology. The Company has devoted significant resources to
developing and acquiring hardware and software for real time video capture. This
technology includes audio/video effects synchronization methodologies,
compression algorithms, drivers and software for real time playback from disks.

Real Time Software Algorithms. The digital video manipulation functions
of the Company's products use common core software that perform complex
computations in real time under user control. The Company has developed certain
algorithms that enable the high speed computation of multiple complex equations
which are required for real time video effects.

Video Input/Output. The Company has developed technology for video
input and output of composite analog, component analog and component digital
video data streams. All of the Company's products work with NTSC and PAL video
standards. In addition, the Company has developed interfaces to support
input/output of video streams stored on computer disks.

User Interface Design. The Company has extensive experience in the
design of graphical user interfaces for video control and manipulation. The
Company uses interactive, menu-driven user interfaces to control video
manipulation functions.

Camcorder and VCR Control. With the acquisition of the VideoDirector
product line in June 1996, the Company obtained software code which enables a
computer to control most commercially available camcorders and VCRs.

The Company has historically devoted a significant portion of its
resources to engineering and product development programs and expects to
continue to allocate significant resources to these efforts. In addition, the
Company has acquired certain products and technologies which have aided the
Company's ability to more rapidly develop and market new products, such as the
VideoDirector Studio 200 and the Studio 400. The Company's future operating
results will depend to a considerable extent on its ability to continually
develop, acquire, introduce and deliver new hardware and software products that
offer its customers additional features and enhanced performance at competitive
prices. Delays in the introduction or shipment of new or enhanced products, the
inability of the Company to timely develop and introduce such new products, the
failure of such products to gain market acceptance or problems associated with
product transitions could adversely affect the Company's business, financial
condition and results of operations, particularly on a quarterly basis.

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As of June 30, 1998, the Company had 102 people engaged in engineering
and product development. The Company's engineering and product development
expenses (excluding purchased in-process research and development) in fiscal
1998, 1997 and 1996 were $11.7 million, $7.6 million and $5.1 million,
respectively, and represented 11.1%, 20.2% and 11.1%, respectively, of net
sales.

Customers

End users of the Company's products, none of whom accounted for a
material amount of the Company's net sales during any period, range from
individual users to major corporate and government entities, video production
and broadcast facilities worldwide. The Company's broadcast customers include
domestic and international television and cable networks, local broadcasters and
program creators. The Company's desktop customers include corporations seeking
to develop internal video post-production capabilities, wedding and special
events videographers and small production houses serving cable and commercial
video markets.

Marketing, Sales and Service

Marketing

The Company's marketing efforts are targeted at users of broadcast and
desktop post-production suites, and at home video editing enthusiasts. In order
to increase awareness of its products, the Company attends a number of trade
shows, the major ones being the National Association of Broadcasters ("NAB")
show and the COMDEX exhibition, both in the United States, and the International
Broadcasters Convention ("IBC") show in Europe. The Company uses targeted direct
mail campaigns and advertisements in trade and computer publications for most of
its product lines. The Company also participates in joint marketing activities
with its OEM partners and with other desktop video companies. The Company plans
to expand its desktop joint marketing activities.

Sales

The Company maintains a sales management organization, consisting of
regional sales managers in the United States, Europe and other international
territories. The regional sales managers are primarily responsible for
supporting independent dealers and making direct sales in geographic regions
without dealer coverage or to customers that prefer to transact directly with
the Company.

The Company sells its broadcast and desktop products to end users
through an established domestic and international network of independent dealers
that specialize in selling video production equipment and through direct sales.
The independent dealers are selected for their ability to provide effective
field sales and technical support to the Company's customers. Dealers generally
carry the Company's broadcast and desktop products as demonstration units,
advise customers on system configuration and installation and perform ongoing
post-sales customer support. The Company believes that many end users depend on
the technical support offered by independent dealers in making product purchase
decisions.

The Company also sells and distributes its desktop products to OEMs
that incorporate the Company's products into their video editing products and
resell these products to other resellers and end users. These OEMs generally
purchase the Company's products and are responsible for conducting their own
marketing, sales and support activities. The Company attempts to identify and
align itself with OEMs that are market share and technology leaders in the
Company's target markets. In recent years the Company has been dependent on
sales of Alladin and Genie to Avid Technologies, Inc. ("Avid,") which is a
leading supplier of digital, non-linear video and audio editing systems for the
professional video and film editing market, but sales to Avid has a percentage
of total Company sales has declined during the last three years. Sales to Avid

-10-

accounted for approximately 10.7% of net sales in fiscal 1998, 26.4% of net
sales in fiscal 1997 and 43.3% of net sales in fiscal 1996. The concentration of
the net sales to a single OEM customer subjects the Company to a number of
risks, in particular the risk that its operating results will vary on a
quarter-to-quarter basis as a result of variations in the ordering patterns of
the OEM customer. The Company's dependence upon these resellers could have a
material adverse effect on the Company's results of operations.

The Company's consumer products are sold through different channels
than the Company's other products. The Studio 400 product which replaced the
VideoDirector Studio 200 product in North America in June, 1998, is sold
primarily through large distributors, such as Ingram Micro Inc., and large
computer and electronic retailers, such as CompUSA, ComputerCity, Circuit City,
Best Buy and The Good Guys. In addition, certain of the miroVideo products are
sold through the same retailers as the Studio 400. The Company acquired Miro's
European sales organization in connection with the Miro Acquisition, which
significantly increased the Company's desktop and consumer channel in Europe.
The Company's consumer products also sold via direct telemarketing, mail order
and over the Internet. The consumer market is characterized by longer payment
terms and higher sales returns than the Company's broadcast and desktop markets.
There can be no assurance that any particular computer retailers will continue
to stock and sell the Company's consumer products. If a significant number of
computer retailers were to discontinue selling those products or if sales
returns are higher than anticipated, the Company's results of operations would
be adversely affected. Sales to the consumer market entail a number of risks
including the limited experience of the Company in this market, inventory
obsolescence, product returns and potential price protection obligations.

Sales outside of North America represented approximately 57.6%, 39.7%
and 38.7% of the Company's net sales for fiscal 1998, 1997 and 1996,
respectively. The Company's sales outside of North American increased in fiscal
1998 due primarily to the addition of the MiroVideo sales and marketing channel
in Europe. The Company expects that sales outside of the United States will
continue to account for a significant portion of its net sales. The Company
makes foreign currency denominated sales in many countries exposing itself to
risks associated with foreign currency fluctuations. Although the dollar amount
of such foreign currency denominated sales was nominal during fiscal 1997, it
increased significantly in fiscal 1998 since most desktop and consumer sales in
Europe are now denominated in local foreign currency. International sales and
operations may also be subject to risks such as the imposition of governmental
controls, export license requirements, restrictions on the export of critical
technology, generally longer receivable collection periods, political
instability, trade restrictions, changes in tariffs, difficulties in staffing
and managing international operations, potential insolvency of international
dealers and difficulty in collecting accounts receivable. There can be no
assurance that these factors will not have an adverse effect on the Company's
future international sales and, consequently, on the Company's business,
financial condition and results of operations.

Service and Support

The Company believes that its ability to provide customer service and
support is an important element in the marketing of its products. Its customer
service and support operation also provides the Company with a means of
understanding customer requirements for future product enhancements. The Company
maintains an in-house repair facility and also provides telephone access to its
technical support staff. The Company's technical support engineers not only
provide assistance in diagnosing problems, but also work closely with customers
to address system integration issues and to assist customers in increasing the
efficiency and productivity of their systems. The Company supports its customers
in Europe and Asia primarily through its international dealers. The Company
typically warrants its products against defects in materials and workmanship for
varying periods depending on the product and the nature of the purchaser.

-11-

The Company believes its warranties are similar to those offered by other video
production equipment suppliers. To date, the Company has not encountered any
significant product maintenance problems.

Competition

The video production equipment market is highly competitive and is
characterized by rapid technological change, new product development and
obsolescence, evolving industry standards and significant price erosion over the
life of a product. Competition is fragmented with several hundred manufacturers
supplying a variety of products to this market. The Company anticipates
increased competition in the video post-production equipment market from both
existing manufacturers and new market entrants. Increased competition could
result in price reductions, reduced margins and loss of market share, any of
which could materially and adversely affect the Company's business, financial
condition and results of operations. There can be no assurance that the Company
will be able to compete successfully against current and future competitors.

Competition for the Company's broadcast products is generally based on
product performance, breadth of product line, service and support, market
presence and price. The Company's principal competitors in this market include
Chyron Corporation, Matsushita Electric Industrial Co. Ltd. ("Matsushita"),
Quantel Ltd. (a division of Carlton Communications Plc) ("Quantel"), Scitex
Video (a division of Scitex Corporation Ltd.) ("Scitex") and Sony Corporation
("Sony"), some of whom have greater financial, technical, marketing, sales and
customer support resources, greater name recognition and larger installed
customer bases than the Company. In addition, these companies have established
relationships with current and potential customers of the Company. Some of the
Company's competitors also offer a wide variety of video equipment, including
professional video tape recorders, video cameras and other related equipment. In
some cases, these competitors may have a competitive advantage based upon their
ability to bundle their equipment in certain large system sales.

The Company's competition in the desktop and consumer markets comes
from a number of groups of video companies such as traditional video equipment
suppliers, providers of desktop editing solutions, video software application
companies or others. Suppliers of traditional video equipment such as
Matsushita, Quantel, Scitex and Sony have the financial resources and technical
know-how to develop high quality, real time video manipulation products for the
desktop video market. Suppliers of desktop video editing systems or components
such as Avid, Digital Processing Systems Inc., Fast Multimedia, Iomega Corp.,
Matrox Electronics Systems, Ltd., Media100, Inc., Truevision, Inc. and Scitex,
many of which have established desktop video distribution channels, experience
in marketing video products and significant financial resources, may acquire or
develop video manipulation products for the desktop video market. The Company
believes that the consumer video editing market is an emerging market and the
sources of competition are not yet well defined. There are several established
video companies that are currently offering products or solutions that compete
directly or indirectly with the Company's consumer products by providing some or
all of the same features and video editing capabilities. In addition, the
Company expects that existing manufacturers and new market entrants will develop
new, higher performance, lower cost consumer video products that may compete
directly with the Company's consumer products. Suppliers of video manipulation
software such as Adobe Systems, Inc. ("Adobe") or SoftImage, which was acquired
by Avid Technology, may develop products which compete directly with the
Company's products. In addition, the Company may face competition from other
computer companies that lack experience in the video production industry but
that have substantial resources to acquire or develop technology and products
for the video production market. There can be no assurance that any of these
companies will not enter into the video production market or that the Company
could successfully compete against them if they did.

-12-

Manufacturing and Suppliers

The Company's manufacturing and logistics operations, located in
Mountain View, California and Braunschweig, Germany, consist primarily of
testing printed circuit assemblies, final product assembly, configuration and
testing, quality assurance and shipping for the Company's broadcast and desktop
products. Manufacturing of the Company's consumer and MiroVideo desktop products
is performed by independent subcontractors and products are often shipped
directly to the distributor or retailer. Each of the Company's products
undergoes quality inspection and testing at the board level and final assembly
stage. The Company manages its materials with a software system that integrates
purchasing, inventory control and cost accounting.

The Company relies on independent subcontractors who manufacture to the
Company's specifications its consumer and MiroVideo desktop products and major
subassemblies used in the Company's broadcast and other desktop products. This
approach allows the Company to concentrate its manufacturing resources on areas
where it believes it can add the most value, such as product testing and final
assembly, and reduces the fixed costs of owning and operating a full scale
manufacturing facility. The Company has manufacturing agreements with Quadrus, a
division of Bell Microproducts, Inc., for the manufacture of major subassemblies
used in its broadcast and desktop products, and with other subcontractors for
the manufacture of the Company's consumer products. In addition, the Company
subcontracts manufacturing related to the miroVideo products to Ihlemann GmbH
and Streiff & Helmold GmbH, both of which are located in Braunschweig, Germany.
The Company's reliance on subcontractors to manufacture products and major
subassemblies involves a number of significant risks including the loss of
control over the manufacturing process, the potential absence of adequate
capacity, the unavailability of or interruptions in access to certain process
technologies and reduced control over delivery schedules, manufacturing yields,
quality and costs. In the event that any significant subcontractor were to
become unable or unwilling to continue to manufacture these products or
subassemblies in required volumes, the Company's business, financial condition
and results of operations would be materially adversely affected.

To the extent possible, the Company and its manufacturing
subcontractors use standard parts and components available from multiple
vendors. However, the Company and its subcontractors are dependent upon single
or limited source suppliers for a number of key components and parts used in its
products, including integrated circuits manufactured by Altera Corporation,
AuraVision Corporation, LSI Logic Corp., Maxim Integrated Products, Inc.,
National Semiconductor Corporation, Philips Electronics, Inc., Raytheon
Corporation and Zoran Corporation, boards and modules manufactured by Adaptec,
Inc., Sony and Truevision, Inc., field programmable gate arrays manufactured by
Altera Corporation, serial RAM memory modules manufactured by Hitachi, Ltd. and
software applications from Adobe and Ulead Systems, Inc. The Company's
manufacturing subcontractors generally purchase these single or limited source
components pursuant to purchase orders placed from time to time in the ordinary
course of business, do not carry significant inventories of these components and
have no guaranteed supply arrangements with such suppliers. In addition, the
availability of many of these components to the Company's manufacturing
subcontractors is dependent in part on the Company's ability to provide its
manufacturers, and their ability to provide suppliers, with accurate forecasts
of its future requirements. The Company and its manufacturing subcontractors
endeavor to maintain ongoing communication with their suppliers to guard against
interruptions in supply. The Company and its subcontractors have in the past
experienced delays in receiving adequate supplies of single source components.
Also, because of the reliance on these single or limited source components, the
Company may be subject to increases in component costs which could have an
adverse effect on the Company's results of operations. Any extended interruption
or reduction in the future supply of any key components currently obtained from
a single or limited source could have a significant adverse effect on the
Company's business, financial condition and results of operations in any given
period.

-13-

The Company's broadcast and desktop customers generally order on an
as-needed basis. The Company typically ships its products within 30 to 60 days
of receipt of an order, depending on customer requirements, although certain
customers, including OEMs, may place substantial orders with the expectation
that shipments will be staged over several months. A substantial majority of
product shipments in a period relate to orders received in that period, and
accordingly, the Company generally operates with a limited backlog of orders.
The absence of a significant historical backlog means that quarterly results are
difficult to predict and delays in product delivery and in the closing of sales
near the end of a quarter can cause quarterly revenues to fall below anticipated
levels. In addition, customers may cancel or reschedule orders without
significant penalty and the prices of products may be adjusted between the time
the purchase order is booked into backlog and the time the product is shipped to
the customer. As a result of these factors, the Company believes that the
backlog of orders as of any particular date is not necessarily indicative of the
Company's actual sales for any future period.

Proprietary Rights and Licenses

The Company's ability to compete successfully and achieve future
revenue growth will depend, in part, on its ability to protect its proprietary
technology and operate without infringing the rights of others. The Company
relies on a combination of patent, copyright, trademark and trade secret laws
and other intellectual property protection methods to protect its proprietary
technology. In addition, the Company generally enters into confidentiality and
nondisclosure agreements with its employees and OEM customers and limits access
to and distribution of its proprietary technology. The Company currently holds
two United States patents covering certain aspects of its technologies for
digital video effects and has an application pending for a third patent.
Although the Company intends to pursue a policy of obtaining patents for
appropriate inventions, the Company believes that the success of its business
will depend primarily on the innovative skills, technical expertise and
marketing abilities of its personnel, rather than upon the ownership of patents.
Certain technology used in the Company's products is licensed from third parties
on a royalty-bearing basis. Such royalties to date have not been, and are not
expected to be, material. Generally, such agreements grant to the Company
nonexclusive, worldwide rights with respect to the subject technology and
terminate only upon a material breach by the Company.

In the course of its business, the Company may receive and in the past
has received communications asserting that the Company's products infringe
patents or other intellectual property rights of third parties. The Company's
policy is to investigate the factual basis of such communications and to
negotiate licenses where appropriate. While it may be necessary or desirable in
the future to obtain licenses relating to one or more of its products, or
relating to current or future technologies, there can be no assurance that the
Company will be able to do so on commercially reasonable terms or at all. There
can be no assurance that such communications can be settled on commercially
reasonable terms or that they will not result in protracted and costly
litigation.

There has been substantial industry litigation regarding patent,
trademark and other intellectual property rights involving technology companies.
In the future, litigation may be necessary to enforce any patents issued to the
Company, to protect its trade secrets, trademarks and other intellectual
property rights owned by the Company, or to defend the Company against claimed
infringement. Any such litigation could be costly and a diversion of
management's attention, either of which could have material adverse effect on
the Company's business, financial condition and results of operations. Adverse
determinations in such litigation could result in the loss of the Company's
proprietary rights, subject the Company to significant liabilities, require the
Company to seek licenses from third parties or prevent the Company from
manufacturing or selling its products, any of which could have a material
adverse effect on the Company's business, financial condition and results of
operations.

-14-

Employees

As of June 30, 1998, the Company had 323 full-time employees, including
102 engaged in engineering and product development activities, 56 in
manufacturing, 135 in marketing and sales and 30 in administration and finance.
The Company believes that its future success will depend, in part, on its
continuing ability to attract, retain and motivate qualified technical,
marketing and managerial personnel. None of the Company's employees is
represented by a collective bargaining agreement, nor has the Company
experienced work stoppages. In Germany, certain of the Company's employees are
represented by statutory worker councils, which are representative bodies to
which employees appoint representatives. In general, the employer is required to
seek the approval and/or advice of the worker council before making certain
significant decisions affecting the employees and the business. The Company
believes that its relations with its employees are good.

Executive Officers

The executive officers of the Company and their ages as of August 31, 1998 are as follows:

-------------------------------------------------------------------------------------------------------------------------------
Name Age Position
---- --- --------
-------------------------------------------------------------------------------------------------------------------------------

Mark Sanders.................... 55 President, Chief Executive Officer and Director

Ajay Chopra...................... 41 Chairman of the Board, Vice President, General Manager, Desktop Products

Arthur D. Chadwick............... 41 Vice President, Finance and Administration and Chief Financial Officer

Georg Blinn...................... 52 Vice President, General Manager, Pinnacle Systems GmbH

Pat Burns........................ 51 Vice President, Corporate Marketing

Brian R. Conner.................. 52 Vice President, Sales, Europe, Africa & Middle East

Tavy A. Hughes................... 43 Vice President, Operations

Kevin Hunt....................... 39 Vice President, Sales, North America

William Loesch................... 44 Vice President, General Manager, Consumer Products

William Ludwig................... 50 Vice President, Sales, Latin America & Asia

Robert Wilson.................... 44 Vice President, General Manager, Broadcast Products
-------------------------------------------------------------------------------------------------------------------------------

There is no family relationship between any director or executive
officer of the Company.

Mr. Sanders has served as President, Chief Executive Officer and a
director of the Company since January 1990. From 1988 to 1990, Mr. Sanders was
an independent business consultant. Prior to that time, Mr. Sanders served in a
variety of management positions, most recently as Vice President and General
Manager of the Recording Systems Division, of Ampex Incorporated, a manufacturer
of video broadcast equipment.

Mr. Chopra, a founder of the Company, has served as Chairman of the
Board of Directors since January 1990, and has served as a director of the
Company since its inception in May 1986. Mr. Chopra has served as Vice
President, General Manager, Desktop Products since April 1997. He previously
served as Chief Technology Officer from June 1996 to April 1997, Vice President
of Engineering from January 1990 to June 1996, and President and Chief Executive
Officer of the Company from its inception to January 1990.

Mr. Chadwick has served as Vice President, Finance and Administration
and Chief Financial Officer of the Company since January 1989. From February
1987 to January 1989 he served as Plant Manager for the

-15-

Philippines facility of Gould Semiconductor, a semiconductor company and as
Corporate Controller from February 1984 to February 1987.

Mr. Blinn has served as Vice President, General Manager, Pinnacle
Systems GmbH since August 1997. Prior to joining the Company, Mr. Blinn was the
Chief Financial Officer of Miro from December 1996 to August 1997 and has
remained an officer of Miro Computer Products AG since the Company's acquisition
of the Digital Video Group of Miro in August 1997. From January 1993 to December
1996, Mr. Blinn was an independent business consultant. From January 1987 to
December 1992, Mr. Blinn served as a General Manager of Hitachi Data Systems
GmbH, a mainframe computer distributor.

Mr. Burns has served as Vice President, Corporate Marketing since
February 1998. He served as Vice President of North American Sales and Corporate
Marketing of the Company since December 1996. From March 1996 to November 1996,
Mr. Burns served as a marketing and strategy consultant to software developers
in the film and video markets. From April 1995 to February 1996, he served as
Vice President and General Manager of Video and Graphics products at Radius,
Inc., a graphics company. From May 1994 to April 1995, Mr. Burns served as Vice
President and General Manager of Chyron's West Coast operations. From April 1993
to May 1994, Mr. Burns served as Director of International Marketing for
VeriFone, Inc., a financial transaction company. From November 1991 through
January 1993, Mr. Burns was Vice President of Macrovision, Inc., a video
encryption company.

Mr. Conner has served as Vice President, Sales of the Company and
General Manager of Pinnacle Systems Ltd., the Company's sales subsidiary
covering Europe, Africa and the Middle East, since February 1995. From January
1993 to February 1995, Mr. Conner was a founder and served as President of BCA
Inc., an independent European sales representative company. From January 1991 to
January 1993, Mr. Conner served as General Manager of European, African and
Middle East Sales of Videomedia, Inc., a manufacturer of video editing systems.
Prior to that, Mr. Conner was Managing Director of Videomedia Europe Ltd., a
European sales representative.

Ms. Hughes has served as Vice President, Operations since July, 1998,
as Vice President, Manufacturing of the Company since January 1995, Director of
Manufacturing from April 1994 to January 1995 and a Manager from September 1993
until April 1994. From July 1991 to September 1993, Ms. Hughes served as an
independent business consultant. From 1985 to June 1991, Ms. Hughes served as
Manufacturing Manager of Alta Group, Inc., a manufacturer of digital video
post-production equipment.

Mr. Hunt has served as Vice President, Sales, North America since
February 1998. Prior to that he served as Director, Consumer sales from May
1997. From May 1995 to May 1997 he served as Vice President, Sales for Berkeley
Systems, Inc., a consumer software company. From April 1991 to May 1995, Mr.
Hunt served in several executive sales positions with Radius, Inc., a digital
video and graphics card manufacturer, including Director, Corporate Account
Development.

Mr. Loesch has served as Vice President, General Manager, Consumer
Products since April 1997. Prior to that Mr. Loesch served as Vice President,
New Business Development of the Company from May 1994 to April 1997. From July
1993 to May 1994, Mr. Loesch served as an independent business consultant. From
June 1990 to November 1992, Mr. Loesch co-founded and served as President of
SHOgraphics Inc., a 3D graphics systems company, and from November 1992 until
July 1993 served as its Executive Vice President and Chief Technical Officer.

Mr. Ludwig has served as Vice President, Latin American and Asia Sales
of the Company since July 1996. From January 1996 to June 1996, Mr. Ludwig
served as Director of Sales for Americas/Pacific Region for FAST Electronics, a
video equipment manufacturer. From 1985 until January 1996, Mr. Ludwig served in
several executive sales positions with Abekas Video Systems, a video equipment
manufacturer, including International Sales Director for Americas/Pacific
Region.

-16-

Mr. Wilson has served as Vice President, Broadcast Products since April
1997. From May 1994 to April 1997, Mr. Wilson served as Executive Vice
President, Chief Operating Officer and Chief Financial officer of Accom, Inc., a
video company. Mr. Wilson has served on the board of directors at Accom since
April 1995. From March 1991 to April 1994, Mr. Wilson served as President and
Chief Executive Officer of The Grass Valley Group (a subsidiary of Tektronix,
Inc.), which provides video systems to the high-end production, post-production
and broadcast market.

ITEM 2. PROPERTIES

The Company's principal administrative, marketing, manufacturing and
product development facility is located in Mountain View, California. This
facility occupies approximately 106,500 square feet pursuant to a lease which
commenced August 15, 1996 and which will terminate December 31, 2003. The
Company has also entered into an agreement to sublease approximately 26,500
square feet of the Mountain View, California facility to Network Computing
Devices. That sublease agreement is currently scheduled to terminate on February
1999. The Company also leases approximately 30,000 square feet of engineering,
administrative, logistics and marketing space in Braunschweig, Germany. The
Braunschweig lease expires in August 1999.

In addition, the Company occupies sales and customer support facilities
in Uxbridge, United Kingdom; Munich, Germany: Singapore; Tokyo, Japan; Taipei,
Taiwan; Nijmegen, Netherlands; and Paris, France. The Company also has three
small engineering development facilities, in Gainesville, Florida, Paramus, New
Jersey, and Grass Valley, California.

ITEM 3. LEGAL PROCEEDINGS

Not Applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not Applicable.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

Pinnacle Systems made its initial public offering on November 8, 1994.
Its Common Stock is traded on the Nasdaq National Market under the symbol PCLE.
The following table sets forth for the fiscal periods indicated the range of
high and low sales prices per share of the Common Stock as reported on the
Nasdaq National Market.

High Low

Fiscal Year Ended June 30, 1997
First Quarter................... $21.250 $9.250
Second Quarter.................. 13.875 8.875
Third Quarter................... 15.250 9.250
Fourth Quarter.................. 19.000 12.500

-17-

Fiscal Year Ended June 30, 1998
First Quarter................... 31.750 17.125
Second Quarter.................. 33.500 20.000
Third Quarter................... 37.875 20.000
Fourth Quarter.................. 43.500 26.000

As of August 27, 1998, there were approximately 60 stockholders of
record of the common stock.

The Company has never paid cash dividends on its capital stock. The
Company currently expects that it will retain its future earnings for use in the
operation and expansion of its business and does not anticipate paying cash
dividends in the foreseeable future.

ITEM 6. SELECTED FINANCIAL DATA

The selected consolidated financial data set forth below under the
captions "Statement of Operations Data" and "Balance Sheet Data" for, and as of
the end of, each of the years in the five-year period ended June 30, 1998, are
derived from the consolidated financial statements of Pinnacle Systems, Inc. and
its subsidiaries, which financial statements have been audited by KPMG Peat
Marwick LLP, independent auditors. The results for the fiscal year ended June
30, 1998 are not necessarily indicative of the results for any future period.
The selected consolidated financial data set forth below should be read in
conjunction with the consolidated financial statements as of June 30, 1998 and
June 30, 1997 and for each of the years in the three year period ended June 30,
1998 and notes thereto set forth on Pages F-1 to F-19 and "Management's
Discussion and Analysis of Financial Condition and Results of Operation."

-18-

- -----------------------------------------------------------------------------------------------------------------------------

(In thousands, except per share data) FISCAL YEAR ENDED JUNE 30,
1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------------------------

STATEMENT OF OPERATIONS DATA:

Net sales $ 105,296 $ 37,482 $ 46,151 $ 22,193 $ 10,230
Cost of sales 48,715 23,997 23,854 11,291 5,057
-------------- ------------- ------------ ------------ ------------
Gross profit 56,581 13,485 22,297 10,902 5,173
-------------- ------------- ------------ ------------ ------------
Operating expenses:
Engineering and product development 11,652 7,579 5,140 2,405 1,806
Sales and marketing 29,301 12,667 8,907 5,340 3,274
General and administrative 5,342 3,702 2,186 1,088 567
In process research and development 16,960 4,894 3,991 - -
-------------- ------------- ------------ ------------ ------------
Total operating expenses 63,255 28,842 20,224 8,833 5,647
-------------- ------------- ------------ ------------ ------------
Operating income (loss) (6,674) (15,357) 2,073 2,069 (474)
Interest income (expense), net 3,139 2,867 3,345 738 (90)
-------------- ------------- ------------ ------------ ------------
Income (loss) before income taxes (3,535) (12,490) 5,418 2,807 (564)
Income tax expense (2,685) (2,445) (1,734) (567) (2)
-------------- ------------- ------------ ------------ ------------
Net income (loss) $ (6,220) $ (14,935) $ 3,684 $ 2,240 $ (566)
============== ============= ============ ============ ============
Net income (loss) per share:
Basic $ (0.70) $ (2.02) $ 0.51 $ 0.53 $ (0.21)
============== ============= ============ ============ ============
Diluted $ (0.70) $ (2.02) $ 0.47 $ 0.43 $ (0.21)
============== ============= ============ ============ ============
Shares used to compute net income (loss) per share:
Basic 8,907 7,402 7,158 4,266 2,745
============== ============= ============ ============ ============
Diluted 8,907 7,402 7,803 5,220 2,745
============== ============= ============ ============ ============
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------

(In thousands) JUNE 30,
1998 1997 1996 1995 1994

- -----------------------------------------------------------------------------------------------------------------------------

BALANCE SHEET DATA:

Working capital $ 100,496 $ 57,662 $ 72,337 $ 26,588 $ 2,647
Total assets 132,937 70,007 84,561 32,724 5,904
Long-term debt 163 475 - - -
Retained earnings (deficit) (18,825) (12,605) 2,330 (1,354) (3,594)
Shareholders' equity 114,392 62,711 80,198 27,743 3,125

- -----------------------------------------------------------------------------------------------------------------------------

-19-

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Certain Forward-Looking Information

Certain statements in this Management's Discussions and Analysis and
elsewhere in this 1998 Annual Report on Form 10-K are forward-looking statements
based on current expectations, and entail various risks and uncertainties that
could cause actual results to differ materially from those expressed in such
forward-looking statements. Such risks and uncertainties are set forth below
under "Factors Affecting Operating Results" These forward-looking statements
include the last sentences of the paragraphs below relating to "Engineering and
Product Development" and "Sales and Marketing," the "Expanding Product Line"
section below under "Overview," the statements regarding the Company's expected
investment in property, machinery and equipment under "Liquidity and Capital
Resources" below, among others.

Overview

The Company designs, manufactures, markets and supports video
post-production tools for high quality real time video processing. The Company's
products are used to capture, compress and store and edit video and to perform a
variety of video manipulation functions, including the addition of special
effects, graphics and titles to multiple streams of live or previously recorded
video material. Pinnacle's strategy is to leverage its existing market and
technological position to continue to provide innovative, real time, computer
based solutions for three video post production markets which the Company
characterizes as the broadcast, desktop and the consumer video markets.

Broadcast Market

The broadcast market generally requires very high technical performance
such as real time 10-bit processing, control of multiple channels of live video
and specialized filtering and interpolation. From the Company's inception in
1986 until 1994, substantially all of the Company's revenues were derived from
the sale of products into the broadcast market. The primary broadcast products
sold during fiscal 1997 were the Prizm and Flashfile family of products. In June
1997, the Company commenced shipment of DVExtreme and Lightning, two Windows NT
based products designed to address the markets previously addressed by Prizm and
Flashfile, respectively. In April 1997, the Company completed the acquisition of
the Deko titling and character generation product line from Digital Graphix
("Deko Acquisition") and has since enhanced and expanded that product line.
Substantially all of the broadcast revenue in fiscal 1998 came from the sale of
DVEtreme, Lightning and Deko products. In June 1998, the Company commenced
shipment of AlladinPRO, a new high-performance Windows NT based digital video
effects system designed for live and on-line applications. These four product
families, DVExtreme, Lightning, Deko and AlladinPRO comprise the Company's suite
of high performance real time Windows NT-based products designed for on-air,
broadcast and high-end, post-production applications. The broadcast market
accounted for approximately 24.2%, 25.4%, and 26.1% of net sales in the years
ended June 30, 1998, 1997 and 1996, respectively.

Desktop Market

The Company's desktop products are designed to provide high quality
video capture, compression/decompression, editing, and real time video
manipulation capabilities for computer based video post-production systems. They
are generally offered at significantly lower price points than traditional
editing suites and are integrated into the computer by a value added reseller,
an OEM, or the end user. The Company's first desktop product was the Alladin,
which commenced shipment in June 1994. The Company expanded its desktop product
line with the introduction of Genie in June 1996. In August 1997 the company

-20-

acquired the miroVIDEO desktop product lines and during fiscal 1998 the Company
introduced additional new desktop products. In fiscal 1998 the Company had two
general classes of desktop products: digital video effects products, which
include the Alladin and Genie families, and video capture and editing products,
which include the ReelTime, miroVIDEO DC30, miroVIDEO DC50 and miroVIDEO DV300
families. The desktop market accounted for approximately 57.5%, 59.8% and 73.5%
of net sales in the fiscal years ending June 30, 1998, 1997 and 1996,
respectively.

Consumer Market

The Company's consumer products provide complete video editing
solutions which allow consumers to edit their home videos using their home PC,
camcorder and VCR. The Company's consumer products are sold at lower price
points than the Company's other products and are sold as both software packages
and as computer peripheral products. The Company entered the consumer video
editing market by acquiring the VideoDirector product line from Gold Disk, Inc.
in June 1996, and commenced shipment of its first internally developed consumer
editing product, the VideoDirector Studio 200, in March 1997. In June 1998 the
Company commenced shipment of Studio 400, which expands the capabilities of and
replaces VideoDirector Studio 200. In August 1997 the company acquired the
miroVIDEO consumer product lines. At the end of fiscal 1998 the Company's
consumer product line included Studio 400, miroVIDEO DC10 and DRX, miroVIDEO
DC20 and miroVIDEO PCTV. The consumer market accounted for approximately 18.3%,
14.8% and 0.4% of net sales in the fiscal years ending June 30, 1998, 1997 and
1996, respectively.

Expanding Product Line

In April 1997, the Company purchased the Deko titling systems product
line and technology from Digital GraphiX, Inc. TypeDeko, in conjunction with
DVExtreme and Lightning furthers Pinnacle's strategy of offering an
interconnected family of Windows NT-based video production systems. In addition,
the Company hired 27 employees from Digital Graphix to help support the ongoing
development, marketing and sales of the Deko product line. The Company paid $5.3
million in cash, and assumed liabilities of $978,000 for the purchase of the
Deko products, technology and assets. The assets acquired primarily included
inventory and other tangible property of $593,000; intangible assets including
the Deko Brand name, work force-in-place, and source code technology totaling
$762,000; in process research and development charge of $4.9 million, and
incurred $315,000 related to the integration of the Deko product line into the
Company. The in process research and development was recorded as an expense
during the fourth quarter of fiscal 1997. The intangible assets and purchased
software are being amortized over a seven year period.

To further Pinnacle's strategy of providing an expanded line of easy to
use computer based video production products, in August 1997 the Company
acquired the miro Digital Video Products (the "Miro Acquisition") from miro
Computer Products AG ("Miro"). In the Miro Acquisition, the Company acquired the
assets of the miro Digital Video Products group, including the miroVIDEO product
line, certain technology and other assets. The Company paid $15.2 million in
cash in October 1997, issued 203,565 shares of common stock, valued at $4.4
million, assumed liabilities of $2.7 and incurred transaction costs of $1.1
million. The fair value of assets acquired included tangible assets, primarily
inventories, of $2.4 million, goodwill and other intangibles of $3.9 million,
and the Company expensed $17.0 million of in-process research and development.
In addition, the Company incurred $465,000 of other nonrecurring costs in the
year ended June 30, 1998. The terms of the Miro Acquisition also included an
earnout provision pursuant to which Miro received additional consideration based
on sales and operating profit targets. In September 1998, the Company issued
293,346 shares of Common Stock in consideration of such earnout payment, which
will be recorded as goodwill and amortized over nine years

-21-

beginning September 1, 1998.

Pinnacle distributes and sells its products to end users through the
combination of independent domestic and international dealers, retail
distributors, OEMs and, to a lesser extent, a direct sales force. Sales to
dealers, distributors and OEMs are generally at a discount to the published list
prices. Generally, products sold to OEMs are integrated into systems sold by the
OEMs to their customers. The amount of discount, and consequently the Company's
gross profit, varies depending on the product and the channel of distribution
through which it is sold, the volume of product purchased and other factors.

Results of Operations

The following table sets forth, for the periods indicated, certain
consolidated statement of operations data as a percentage of net sales:

- --------------------------------------------------------------------------------

FISCAL YEAR ENDED JUNE 30,
--------------------------
1998 1997 1996
------ ------ ------

- --------------------------------------------------------------------------------

Net sales 100.0% 100.0% 100.0%
Cost of sales 46.3 4.0 51.7
------ ------ ------
Gross profit 53.7 36.0 48.3
Operating expenses:
Engineering and product development 11.1 20.2 11.1
Sales and marketing 27.8 33.8 19.3
General and administrative 5.1 9.9 4.7
In process research and development 16.1 13.1 8.7
------ ------ -------
Total operating expenses 60.1 77.0 43.8
------ ------ ------
Operating income (loss) (6.4) (41.0) 4.5
Interest income, net 3.0 7.7 7.2
------ ------- -------
Income (loss) before income taxes (3.4) (33.3) 11.7
Income tax expense (2.5) (6.5) (3.8)
------ ------- -------
Net income (loss) (5.9)% (39.8)% 7.9%
====== ======= =======

- --------------------------------------------------------------------------------

Comparison of Years Ended June 30, 1998 and 1997

Net Sales. The Company's net sales were $105.3 million in fiscal 1998
compared to $37.5 million in fiscal 1997. The increase was attributable to an
increase in sales of all three product groups: broadcast, desktop and consumer.
The increase in consumer sales resulted from sales of products acquired in the
Miro Acquisition and sales of the VideoDirector Studio 200 and Studio 400, which
commenced shipment in March 1997 and June 1998, respectively. Broadcast sales
increased as a result of increasing sales of DVExtreme and Lightning, which were
first shipped in June 1997, Deko, which was acquired in April 1997, and
AlladinPRO which commenced shipment in June 1998, partially offset by a decline
in sales of Prizm and FlashFile. Desktop sales increased as a result of
miroVideo DC30 sales, which was acquired from Miro in August 1997, sales of
DV300 which commenced shipment in February 1998, sales of ReelTime which
commenced shipment in March 1998, and sales of miroVIDEO DC50 which commenced
shipment in June 1998. Sales outside of North America were approximately 57.6%
and 39.7% of the Company's net sales in

-22-

fiscal 1998 and 1997, respectively. The increase in sales outside of North
America in fiscal 1998 was primarily attributable to sales of miroVideo products
in Europe following the Miro Acquisition.

Cost of sales. Cost of sales consists primarily of costs related to
the acquisition of components and subassemblies, labor and overhead associated
with procurement, assembly and testing of finished products, warehousing,
shipping and warranty costs. Gross profit as a percentage of net sales was 53.7%
and 36.0% in fiscal 1998 and 1997, respectively. The increase in gross profit
percentage is due primarily to a significant charge to cost of sales in fiscal
1997 totaling $4.0 million relating to inventory write downs.

Engineering and Product Development. Engineering and product
development expenses increased by 53.9% to $11.7 million in fiscal 1998 from
$7.6 million in fiscal 1997. The increase was primarily attributable to
increased expenditures in connection with the continued expansion of the
Company's engineering design teams, in particular the engineering design group
based in Braunschweig, Germany established in connection with the Miro
Acquisition. Engineering and product development expenses as a percentage of net
sales were 11.1% and 20.2% in fiscal 1998 and 1997, respectively. The Company
expects to continue to allocate significant resources to engineering and product
development efforts, including the Deko engineering team located in Paramus, New
Jersey and the Miro engineering team located in Braunschweig, Germany.

Sales and Marketing. Sales and marketing expenses include compensation
and benefits for sales and marketing personnel, commissions paid to independent
sales representatives, trade show, cooperative marketing and advertising
expenses and professional fees for marketing services. Sales and marketing
expenses increased by 130.7% to $29.3 million in fiscal 1998 from $12.7 million
in fiscal 1997. The increase in sales and marketing expenses was primarily
attributable to promotional costs for the introduction of several new broadcast
and consumer products, as well as the hiring of sales and marketing personnel in
connection with the Miro Acquisition. Sales and marketing expenses as a
percentage of net sales were 27.8% and 33.8% in fiscal 1998 and 1997,
respectively. The Company expects to continue to allocate significant resources
to sales and marketing.

General and Administrative. General and administrative expenses
increased by 43.2% to $5.3 million in fiscal 1998 compared to $3.7 million in
fiscal 1997. General and administrative expenses as a percentage of net sales
were 5.1% and 9.9%, respectively. Included in general and administrative
expenses in fiscal 1998 were $465,000 of non-recurring spending related to the
acquisition of the Miro group. Included in general and administrative expenses
in fiscal 1997 were $315,000 of non-recurring spending related to the
acquisition of the Deko group, and approximately $500,000 relating to the
disposal of leasehold improvements and other capital equipment, moving costs and
rent overlap incurred as a result of the move to the Company's facility in
Mountain View, California.

In Process Research and Development. During the year ended June 30,
1998, the Company recorded an in process research and development charge of
approximately $17.0 million relating to the Miro Acquisition. During the year
ended June 30, 1997, the Company recorded an in process research and development
charge of approximately $4.9 million relating to the Deko Acquistion.

To determine the value of the software in the development stage for the
acquisition, the Company considered, among other factors, the stage of
development of each project, the time and resources needed to complete each
project, expected income and associated risk. Associated risks include the
inherent difficulties and uncertainties in completing the project and thereby
achieving technological feasibility and risks related to the viability of and
potential changes in future target markets. The analysis was based on past
experience of Miro, including a product lifespan of approximately three years,
continued revenue growth and profit margins ranging from 51% to 63%. In
addition, the analysis included a decrease in operating expenses as a percent of
sales resulting from increased sales and administrative efficiencies due to and
increased volume and reduced combined overhead. A discount rate of 45% was
applied to all software projects in-process. The analysis did not include any
increase in sales of non-acquired product that may result from a larger sales
force and greater market presence, particularly in Europe.

Interest Income Net. Net interest income increased 6.9% to $3.1 million
in fiscal 1998 from $2.9 million in fiscal 1997. The increase was due to an
increase in cash and marketable securities due primarily to the completion of a
public offering in November 1997.

Income Tax Expense. The Company recorded provisions for income taxes of
$2.7 million and $2.4 million for the fiscal years ended 1998 and 1997,
respectively. Income tax expense for the year ended June 30, 1997 included a
charge of $3,245,000 resulting from the establishment of a valuation allowance
against the Company's deferred tax asset due to significant operating losses and
the introduction of new products for which market acceptance was uncertain. As
of June 30, 1998, the Company has federal research and

-23-

experimentation and alternative minimum tax credit carryforwards of $1,315,000
which expire between 2009 and 2013, and state research and experimentation
credit carryforwards of $546,000 which have no expiration provision.

Comparison of Years Ended June 30, 1997 and 1996

Net Sales. The Company's net sales decreased by 18.8% to $37.5 million
in fiscal 1997 from $46.2 million in fiscal 1996. The decrease was attributable
to a decline in sales of both broadcast and desktop products, partially offset
by an increase in sales of consumer products. The most significant decline in
sales was of desktop products to OEMs, in particular Avid. Sales to Avid were
approximately 26.4% and 43.3% of the Company's net sales for the years ended
June 30, 1997 and 1996, respectively. Sales outside of North America were
approximately 39.7% and 38.7% of the Company's net sales in fiscal 1997 and
1996, respectively.

Cost of sales. Gross profit as a percentage of net sales was 36.0% and
48.3% in fiscal 1997 and 1996, respectively. The decrease in gross profit
percentage is due primarily to a significant charge to cost of sales totaling
$4.0 million relating to inventory write downs.

Engineering and Product Development. Engineering and product
development expenses increased by 47.5% to $7.6 million in fiscal 1997 from $5.1
million in fiscal 1996. The increases were primarily attributable to increased
expenditures in connection with the continued expansion of the Company's
engineering design teams and product development costs for DVExtreme, Lightning
and VideoDirector Studio 200. Engineering and product development expenses as a
percentage of net sales were 20.2% and 11.1% in fiscal 1997 and 1996,
respectively.

Sales and Marketing. Sales and marketing expenses increased by 42.2% to
$12.7 million in fiscal 1997 from $8.9 million in fiscal 1996. The increase in
sales and marketing expenses was primarily attributable to promotional costs for
the introduction of several new broadcast and consumer video products. Sales and
marketing expenses as a percentage of net sales were 33.8% and 19.3% in fiscal
1997 and 1996, respectively.

General and Administrative. General and administrative expenses
increased by 69.4% to $3.7 million in fiscal 1997 compared to $2.2 million in
fiscal 1996. General and administrative expenses as a percentage of net sales
were 9.9% and 4.7%, respectively. Included in general and administrative
expenses in fiscal 1997 were $315,000 of non-recurring spending related to the
acquisition of the Deko group, and approximately $500,000 relating to the
disposal of leasehold improvements and other capital equipment, moving costs and
rent overlap incurred as a result of the move to the Company's facility in
Mountain View, California.

In Process Research and Development. During the year ended June 30,
1997, the Company recorded an in process research and development charge of
approximately $4.9 million relating to the Deko Acquistion. In June 1996, the
Company purchased certain assets for $4.5 million from Gold Disk, Inc., a
developer and marketer of software products for video editing and assembly. The
assets acquired primarily included tangible assets of $240,000, intangible
assets including the VideoDirector Brand name, user list, and source code
technology totaling $342,000, and in process research and development of $4.0
million. The in process research and development were recorded as an expense
during the fourth quarter of 1996. The intangible assets are being amortized
over a three year period.

Interest Income Net. Net interest income decreased 14.3% to $2.9
million in fiscal 1997 from $3.3 million in fiscal 1996. The decrease was due to
a decline in cash and marketable securities as well as a decline in investment
yields. Cash was used by operations and by the repurchase of common stock.

-24-

Income Tax Benefit (Expense). The Company recorded provisions for
income taxes of $2.4 million and $1.7 million for the fiscal years ended 1997
and 1996, respectively. Income tax expense for the year ended June 30, 1997
included a charge of $3,245,000 resulting from the establishment of a valuation
allowance against the Company's deferred tax asset due to significant operating
losses and the introduction of new products for which market acceptance was
uncertain. As of June 30, 1997, the Company had federal and state net operating
loss carryforwards of $3,065,000 and $1,349,000, respectively, which expire from
2002 to 2012. The Company also had federal research and experimentation and
alternative minimum tax credit carryforwards of $886,000 which expire between
2006 and 2012, and state research and experimentation credit carryforwards of
$339,000 which had no expiration provision.

Inflationary Impact

Since the inception of operations, inflation has not significantly
affected the operations results of the Company. However, inflation and changing
interest rates have had a significant effect on the economy in general and
therefore could affect the operating results of the Company in the future.

Liquidity and Capital Resources

The Company completed its initial and follow-on public offerings in
November 1994, July 1995 raising approximately $65.5 million in cash, net of
offering expenses. In November 1997 the Company completed an additional public
offering, raising approximately $46.9 million in cash, net of offering expenses.

The Company's operating activities provided $9.7 million in fiscal
1998, used $1.6 million in fiscal 1997 and provided $900,000 in fiscal 1996,
respectively. The cash provided by operating activities during fiscal 1998 was
the result of the net loss of $6.2 million as adjusted by the acquired research
and development charge of $17.0 million, depreciation and amortization of $2.7
million and tax benefit from exercise of common stock option of $2.0 million,
partially offset by net increases in the components of working capital,
primarily account receivable. In fiscal 1997 cash used by operating activities
was the result of the net loss as adjusted by the acquired research and
development, an increase in the valuation allowance on deferred tax assets,
depreciation and amortization, and a loss on disposal of property and equipment,
partially offset by net decreases in the components of working capital,
primarily inventory.

During fiscal 1998, $2.5 million was invested in property and
equipment, compared to $3.9 million in fiscal 1997. The high level of
expenditure for the fiscal 1997 was primarily related to leasehold improvements,
furniture and equipment for the facility in Mountain View, California. The
Company expects to continue to purchase property and equipment at an increased
rate from prior year levels. Such capital expenditures will be financed from
working capital.

In January 1997, the Company's board of directors authorized a stock
repurchase program pursuant to which the Company could purchase up to 750,000
shares of its common stock on the open market. The Company had repurchased and
retired approximately 317,000 shares of its common stock in the open market at
an average purchase price of $11.43 for a total cost of $3,627,000 until the
stock repurchase program was terminated in October 1997.

In April 1997, the Company purchased the Deko product line and
technology, including the TypeDeko product from Digital GraphiX. The Company
paid $5.3 million in cash and assumed liabilities of $978,000 to consummate the
transaction. See "Overview."

In August 1997, the Company completed the Miro Acquisition. In the
purchase, the Company paid approximately $15.2 million in cash, issued 203,565
shares of common stock valued at $4.4 million, and

-25-

assumed liabilities of approximately $2.7 million. In September 1998, the
Company also paid to Miro additional consideration in the form of 293,346
additional shares of common stock based on the achievement of certain revenue
and profitability objectives during the twelve months following the Miro
Acquisition. See "Overview."

As of June 30, 1998, the Company had working capital of approximately
$100.5 million, including $47.5 million in cash and cash equivalents and $39.3
million in short-term marketable securities. The Company believes that the
existing cash and cash equivalent balances as well as marketable securities and
anticipated cash flow from operations will be sufficient to support the
Company's working capital requirements for the foreseeable future.

Factors Affecting Operating Results

Significant Fluctuations in Operating Results. The Company's quarterly
and annual operating results have in the past varied significantly and are
expected to vary significantly in the future as a result of a number of factors,
including the timing of significant orders from and shipments to major OEM
customers, in particular Avid, the timing and market acceptance of new products
or technological advances by the Company and its competitors, the Company's
success in developing, introducing and shipping new products, such as
AlladinPRO, ReelTime, DV300, DC50 and Studio 400, the mix of distribution
channels through which the Company's products are sold, changes in pricing
policies by the Company and its competitors, the accuracy of the Company's and
resellers' forecasts of end user demand, the timing and amount of any inventory
write downs, the ability of the Company to obtain sufficient supplies of the
major subassemblies used in its products from its subcontractors, the ability of
the Company and its subcontractors to obtain sufficient supplies of sole or
limited source components for the Company's products, the timing and level of
product returns, particularly from the consumer distribution channels, foreign
currency fluctuations, costs associated with the acquisition of other companies,
businesses or products, the ability of the Company to integrate acquired
companies, businesses or products, such as the product lines acquired in the
Miro Acquisition, and general economic conditions, both domestically and
internationally. The Company's operating expense levels are based, in part, on
its expectations of future revenue and, as a result, net income would be
disproportionately affected by a shortfall in net sales.

The Company also experiences significant fluctuations in orders and
sales due to seasonal fluctuations, the timing of major trade shows and the sale
of consumer products in anticipation of the holiday season. Sales usually slow
down during the summer months of July and August, especially in Europe. The
Company attends a number of annual trade shows which can influence the order
pattern of products, including the NAB convention held in April, the IBC
convention held in September and the COMDEX exhibition held in November. Due to
these factors and the potential quarterly fluctuations in operating results, the
Company believes that quarter-to-quarter comparisons of its results of
operations are not necessarily meaningful and should not be relied upon as
indicators of future performance.

Risks Associated with Potential Future Acquisitions. In August 1997,
the Company completed the Miro Acquisition. In addition, the Company purchased
the Deko product line and technology from Digital GraphiX, Inc. in April 1997
and the VideoDirector product line from Gold Disk, Inc. in June 1996. Future
acquisitions by the Company may result in the diversion of management's
attention from the day-to-day operations of the Company's business and may
include numerous other risks, including difficulties in the integration of the
operations, products and personnel of the acquired companies. Future
acquisitions by the Company have the potential to result in dilutive issuances
of equity securities, the incurrence of debt and amortization expenses related
to goodwill and other intangible assets. The Company management frequently
evaluates the strategic opportunities available to it and may in the near- or
long-term pursue acquisitions of complementary businesses, products or
technologies.

-26-

Risks Associated with the Consumer Market. The Company entered the
consumer market with the purchase of the VideoDirector product line in June
1996. The Company began shipping its first internally developed consumer
product, the VideoDirector Studio 200, in March 1997 and began shipping a
successor product, the Studio 400 in June 1998. In addition, in connection with
the Miro Acquisition in August 1997, the Company acquired certain of Miro's
consumer products, as well as Miro's European sales organization. The Company
anticipates expending considerable resources to develop, market and sell
products into the consumer market. The Company has limited experience marketing
and selling products through the consumer distribution channels. To be
successful in this market, the Company must establish and maintain effective
consumer distribution channels including distributors, electronic retail stores
and telephone and Internet orders. Because many of the Company's consumer
products must be used with a personal computer, a camcorder and a VCR, none of
which is supplied by the Company, consumer acceptance will be adversely affected
to the extent end users experience difficulties installing the Company's
products with these other electronic components. In addition, the Company faces
additional or increased risks associated with inventory obsolescence and
inventory returns as products sold into the consumer channel typically provide
stock rotation and price protection rights to the reseller. There can be no
assurance that the consumer video market will continue to develop, or that the
Company can successfully compete against current and future competitors in this
market. The failure of the Company to successfully develop, introduce and sell
products in this market could have a material adverse effect on the Company's
business, financial condition and results of operations. See "--Dependence on
Resellers; Absence of Direct Sales Force; Expansion of Distribution Channels."

Concentration of Sales to OEMs. The Company has been highly dependent
on sales of its Alladin and Genie products to OEMs, in particular Avid. Sales to
Avid accounted for approximately 10.7% of net sales in fiscal 1998, 26.4% of
sales in fiscal 1997, and 43.3% of net sales in fiscal 1996. Though this
concentration has lessened during the last two fiscal years, it still subjects
the Company to a number of risks, in particular the risk that its operating
results will vary on a quarter-to-quarter basis as a result of variations in the
ordering patterns of OEM customers, in particular Avid. The Company's results of
operations have in the past and could in the future be materially adversely
affected by the failure of anticipated orders to materialize, by deferrals or
cancellations of orders, or if overall OEM demand were to decline. For example,
since sales to Avid began in fiscal 1996, quarterly sales to Avid have
fluctuated substantially from a high of $5.6 million to a low of $1.0 million,
and the Company anticipates that such fluctuations may continue. If sales to OEM
customers, in particular Avid, were to decrease, the Company's business,
financial condition and results of operations could be materially adversely
affected.

Technological Change and Obsolescence; Risks Associated with
Development and Introduction of New Products. The video post-production
equipment industry is characterized by rapidly changing technology, evolving
industry standards and frequent new product introductions. The introduction of
products embodying new technologies or the emergence of new industry standards
can render existing products obsolete or unmarketable. The development of new,
technologically advanced products incorporating proprietary hardware and
software is a complex and uncertain process requiring high levels of innovation,
as well as accurate anticipation of technological and market trends. The Company
is critically dependent on the successful introduction, market acceptance,
manufacture and sale of new products that offer its customers additional
features and enhanced performance at competitive prices. These products include
those that the Company has recently introduced, such as DV300 and ReelTime,
which began shipping in the third fiscal quarter of 1998, as well as products
that began shipping in the fourth fiscal quarter of 1998, such as AlladinPRO,
Studio 400 and miroVIDEO DC50. Once a new product is developed, the Company must
rapidly commence volume production, a process that requires accurate forecasting
of customer requirements and the attainment of acceptable manufacturing costs.
The introduction of new or enhanced products also requires the Company to manage
the transition from older, displaced products in

-27-

order to minimize disruption in customer ordering patterns, avoid excessive
levels of older product inventories and ensure that adequate supplies of new
products can be delivered to meet customer demand. For example, the introduction
of DVExtreme and Lightning has resulted in a significant decline in sales of
Prizm and Flashfile and a write down of inventory. The Company has experienced
delays in the shipment of new products in the past, and these delays adversely
affected sales of existing products and results of operations. Delays in the
introduction or shipment of new or enhanced products, the inability of the
Company to timely develop and introduce such new products, the failure of such
products to gain significant market acceptance or problems associated with new
product transitions could adversely affect the Company's business, financial
condition and results of operations, particularly on a quarterly basis. In
addition, as is typical with any new product introduction, quality and
reliability problems may arise and any such problems could result in reduced
bookings, manufacturing rework costs, delays in collecting accounts receivable,
additional service warranty costs and a limitation on market acceptance of the
product.

Competition. The market for the Company's products is highly
competitive. The Company anticipates increased competition in each of the
broadcast, desktop and consumer video production markets, particularly since the
industry is undergoing a period of consolidation. Competition for the Company's
broadcast products is generally based on product performance, breadth of product
line, service and support, market presence and price. The Company's competitors
in the broadcast market include companies with substantially greater financial,
technical, marketing, sales and customer support resources, greater name
recognition and larger installed customer bases than the Company. In addition,
these competitors have established relationships with current and potential
customers of the Company and some offer a wide variety of video equipment which
can be bundled in certain large system sales. In the desktop market, the Company
faces competition from traditional video suppliers, providers of desktop editing
solutions, video software applications, and others. In addition, suppliers of
video manipulation software may develop products which compete directly with
those of the Company. The consumer market in which VideoDirector Studio 200,
Studio 400 and certain miroVideo products compete is an emerging market and the
sources of competition are not yet well defined. There are several established
video companies that are currently offering products or solutions that compete
directly or indirectly with the Company's consumer products by providing some or
all of the same features and video editing capabilities. In addition, the
Company expects that existing manufacturers and new market entrants will develop
new, higher performance, lower cost consumer video products that may compete
directly with the Company's consumer products. The Company expects that
potential competition in this market is likely to come from existing video
editing companies, software application companies, or new entrants into the
market, many of which have the financial resources, marketing and technical
ability to develop products for the consumer video market. Increased competition
in any of these markets could result in price reductions, reduced margins and
loss of market share, any of which could materially and adversely affect the
Company's business, financial condition and results of operations.

Dependence on Contract Manufacturers and Single or Limited Source
Suppliers. The Company relies on subcontractors to manufacture its consumer
products and the major subassemblies of its broadcast and desktop products. The
Company and its manufacturing subcontractors are dependent upon single or
limited source suppliers for a number of components and parts used in the
Company's products, including certain key integrated circuits. The Company's
strate