PINNACLE MICRO INC, 10-K, 2000-04-24

PINNACLE MICRO INC
10-K, 2000-04-24
COMPUTER STORAGE DEVICES

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FORM 10-K

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 25, 1999

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

COMMISSION FILE NO. 0-21892

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

Delaware 33-0238563
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation organization)

30191 A AVENIDA DE LAS BANDERAS
RANCHO SANTA MARGARITA, CALIFORNIA 92688
(Address of principal executive offices) (Zip Code)

(949) 635-3000
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to section 12(g) of the Act: Common Stock, par
value $0.001 per share

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 No X

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 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. [ ]

As of March 31, 2000, 14,500,089 shares of the Registrant's Common Stock were
outstanding. As of March 31, 2000, the aggregate market value of the
Registrant's Common Stock, held by non-affiliates of the Registrant was
approximately $2,755,017 based on the closing sales price of $.19 per share of
the Common Stock as of such date, as reported by the Pink Sheets published by
the National Quotation Service.

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PART I

This Report contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. Actual results and events could differ materially from those projected
as a result of many factors, including but not limited to the risk factors
stated here and through this Report.

ITEM 1. BUSINESS

GENERAL

Pinnacle Micro, Inc., (the "Company") is a supplier and reseller of removable
optical storage systems. The Company's products read from and write data to
optical media. In 1996, the Company changed its core business from reselling
products manufactured by others to research, development and manufacturing.
During 1997, the Company closed its research and development capabilities and
all personnel associated with just the research and development activities left
the Company. The Company's manufactured products range from the Vertex 2.6 GB
("GB") drive to its 4.5 terabyte multiple disk optical library systems ("optical
library"). The Company resells under its own brand name compact disc ("CD")
recording systems manufactured by others.

During 1998, the Company began selling its existing products on-line. Online
volume sales have not been significant and have had a negative impact on margins
as a result of competition from other on-line resellers.

The Company was incorporated in California in May 1987 and reincorporated in
Delaware in May 1993. The Company's headquarters and operations are located at
30191A Avenida de las Banderas Rancho Santa Margarita, California 92688, and its
telephone number is (949) 635-3000.

SIGNIFICANT RISK FACTORS

Readers of this Report should carefully consider, in addition to the other
information contained in this Report, the following:

LOSSES, LIQUIDITY AND CAPITAL RESOURCES

ON APRIL 20, 2000, THE COMPANY, FILED IN THE UNITED STATES BANKRUPTCY COURT FOR
THE CENTRAL DISTRICT OF CALIFORNIA, SANTA ANA DIVISION, A VOLUNTARY PETITION FOR
REORGANIZATION UNDER CHAPTER 11 OF TITLE 11 OF THE UNITED STATES BANKRUPTCY
CODE, CASE NUMBER SA00-13261-LR.

CHANGES IN MANAGEMENT.

The Company has experienced turnover of some members of the management team,
however, as of the end of the company's fiscal year, William F. Blum continues
to reside as President and Chief Executive Officer. There can be no assurance
that further management turnover can be prevented, the occurrence of which will
have a negative effect on the Company's operations and financial results.

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FLUCTUATIONS IN QUARTERLY OPERATING RESULTS

The Company's quarterly operating results can fluctuate significantly depending
on factors such as timing of product introductions by the Company and its
competitors, market acceptance of new products, changes in pricing policies by
the Company and its competitors, currency fluctuations and the timing of
expenditures on advertising and promotion. In addition, the Company's product
purchases, component purchases, production and spending levels are made based
upon forecasted demand for the Company's products. Any significant shortfall in
forecasted demand will have an immediate adverse impact on the Company's
quarterly results of operations and financial condition. Given the fundamental
changes in the Company's business in 1997 and 1998, there can be no assurance
that the Company will experience revenue growth and profitability in future
periods.

INTERNATIONAL TRADE, FOREIGN EXCHANGE DEPENDENT PURCHASES; CURRENCY FLUCTUATIONS

The risks of international trade include foreign government regulation, the
difficulties of finding and retaining competent management, miscommunication,
local preferences and changes in taxes and duties. The Company's optical
mechanical storage subassembly ("OMA") suppliers, media suppliers and a number
of the Company's other component suppliers are located in Japan, which subjects
the Company to risks of changes in government policies and regulatory
requirements, transportation delays and the imposition of tariffs and export
controls. In the past the Company experienced losses arising from changes in the
Japanese Yen vs. U.S. dollar exchange rates. Although the Company's purchases
and sales are now dollar denominated, there can be no assurance that the
Company's future results of operations will not be adversely affected by
currency fluctuations.

PRODUCTS

MAGNETO OPTICAL PRODUCTS

The Company's MO drive products combine proprietary firmware, electronics
design, application specific integrated circuits ("ASICs") with optical OMA's
manufactured by a third party. In the 3rd quarter of 1998, the Company
introduced the higher capacity Ultra 5.2 GB drive sold via OEM suppliers.
Despite this product's introduction, the Company's core technology and lead
product continues to be the Apex 4.6 GB 5.25" MO Drive. The Vertex 2.6 GB
product line was discontinued in early 1998. The Company's optical storage
systems are compatible with most personal computer and workstation operating
systems, including Windows NT, Windows 95, Macintosh OS, DOS, Windows and UNIX.
External systems attach to a computer system and include a power supply, OMA,
drive electronics, firmware, software, a SCSI cable and, where necessary, a SCSI
interface card. Internal systems do not include a power supply. The Company
provides a one-year warranty against defects in material and workmanship for all
of its products. The Company's 3.5" 640 MB Tahoe product was discontinued in
1997.

The Apex optical storage systems conform to certain industry standards, which
allow for disk interchangeability among 2.6 GB MO systems and compatibility with
future generations of 3.5" and 5.25" systems, respectively. The Company's Apex
4.6 GB product also reads 2.0 GB media, but not lower capacity media.

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NETWORK OPTICAL LIBRARY SYSTEMS

The Company also manufactures and sells a line of optical libraries based on its
Apex technology with storage capacities ranging from 75 GB to 4.5 terabytes. The
library mechanisms are obtained from third party suppliers and are integrated by
the Company into its library systems. These library systems are most often used
in client/server or other networked environments and are free standing, fully
enclosed units with robotic arms that move 5.25" optical disks to and from one
or more internally mounted drives.

CD RECORDER SYSTEMS

The Company distributes compact disc-recorder ("CD-R") systems under its own
brand name and has done so since 1993. The Company's CD-R systems are comprised
of drive assemblies manufactured by third-party suppliers, which the Company
differentiates from products of its competitors through added software and
packaging. The Recordable Compact Disc ("RCD") 4x12 continued to be the
Company's main CD-R line of products. CD-R products are combined with Adaptec's
"EZCD Pro" software for PC environments and Adaptec's "Toast" software for the
Macintosh environment. CD-R systems are used to create custom CDs for low volume
data reproduction and distribution. CDs created in a standardized "ISO 9660"
format can be utilized in most CD-ROM drives and players. The CD-R can be used
with Macintosh, IBM, and Unix compatible personal computers.

The Company's Apex and CD-R product lines provided the primary source of revenue
during 1999. The Company expects the CD-R product line and business to Continue
to provide important revenue and product mix contributions to the Company's
business.

"READY TO STORE" RTS PROGRAM

The Company's independent software vendors ("ISV") program is intended to assure
compatibility between the Company's products and important software products, in
order to increase market acceptance of Apex technology. The Company improved
software compatibility and certification in 1997, as optical library purchases
often depend first on software selection. Participants include Avail Systems,
Dantz, FileNet Corporation, Keyfile, KOM, Micro Design International, Inc.,
Optical Technology Group, Inc., Optika Imaging Systems, Inc., Optisys, Inc.,
Pegasus Disk Technologies, Inc., Seagate Software, Inc., Software Architects,
Tracer Technologies, Inc., and Watermark Software, Inc.

OPTICAL STORAGE MEDIA

The Company sells proprietary media for the Apex products as well as industry
standard 2.6 GB media for the Vertex and Apex. The Company also markets and
sells recordable CD media for use with its CD-R products. The Ultra media is
also sold but not proprietary to the Ultra drive.

The Company's 5.25" optical storage system conforms to standards that have been
adopted by the International Standards Organization (ISO), the American National
Standards Institute (ANSI) and the European Computer Manufacturers Association
(ECMA). These standards allow for disk interchangeability among systems and

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compatibility with future generation systems based on the same media dimensions.
Company's Apex 4.6 GB drive system and media do not conform to such standards.
The Vertex media is ANSI/ISO compliant, but it is not ECMA compliant. The
Company purchases all media from third party suppliers and resells the media
under Company trademarks.

SALES, MARKETING AND DISTRIBUTION

Market and industry trends are toward ever-increasing memory and storage
capacity. The Apex and Ultra technology is a removable, rewritable and reliable
solution, for near on-line and archival storage. Markets for Apex and Ultra
technology include archiving, desktop publishing, multi-media, graphic design,
medical imaging, network storage, near on-line storage and other data-intensive
uses.

The Company sells its products through distributors, catalogs, value-added
resellers ("VARs"), systems integrators, and direct on-line sales. The Company's
distributor channel consists both of one national and one value added
distributor. In addition, The Company sells through many catalogs and through
regional distributors.

In conformance with industry practice, the Company generally provides
distributors with stock balancing and price protection rights. This permits
distributors to return slow moving products to the Company for credit and
provides price adjustments for inventories of the Company's products held by
distributors if the Company subsequently lowers the prices of those products.

Customer service (order fulfillment) and technical support of the Company's
products are an integral part of the Company's business. The Company continues
to use an out-sourced technical support service for product support. There can
be no assurances given the Company's financial difficulties that the technical
support services will continue on terms that are reasonable for the Company. The
absence of technical and product support will have a material adverse affect on
the Company.

RESEARCH AND DEVELOPMENT

Prior to October 1997, the Company operated a research and development facility
in Colorado Springs, Colorado, which developed proprietary optical technology,
including systems, mechanical, firmware, electronics design and ASICs. During
October and November 1997, the Company closed the Colorado Springs facility
because the Company no longer had the financial resources to invest in research
and development. All personnel associated with just the research and development
activities have left the Company. Prior to closing the Colorado Springs
facility, the Company's research and development efforts were principally
directed towards completing the development of the Apex II product. The
Company's plans were to continue to engineer the Apex II, but due to capital
restrictions were unable to do so and have subsequently dropped all engineering
for that project. The Company intends to continue to source and sell products
manufactured by other companies, as it has always done.

In 1999 and 1998 the Company's research and development expenditures were $0.

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Since the closure of the Research and Development and Manufacturing facility in
Colorado Springs was closed in October of 1997, the Company has been
manufacturing it products through an outsourced company in California. This
outsource mainly manufactures and fulfills the Apex line, including the library
systems.

The absence of research and development has precluded the Company from
developing new and future product offerings. Consequently, the Company is
dependent on the continued acceptance of legacy products, principally the Apex
product. A change in demand for these legacy products will have a material
adverse impact on the Company and its results of operation.

SUPPLIERS

OMAs, Apex media and certain of the ASICs and other components used in the
Company's products are obtained from single sources. The Company also purchases
from third party suppliers circuit boards, integrated circuits and other
components used in its products. Since October 1997, the Company has outsourced
its manufacturing and fulfillment operations to unrelated companies. The
Company's dependence on third-party suppliers and service providers involves
several risks, including limited bargaining power over pricing, availability,
quality and delivery schedules for components. There is also the risk that a
large supplier may be using the Company to develop a market for later entry by
the supplier. The Company believes that second sources are available for all
components other than OMAs, Apex media and certain integrated circuits. There
can, however, be no assurance that the Company could obtain all required
components from second sources on terms as favorable as those in place, if at
all. If the Company's ability to obtain critical components from its sole source
suppliers for its products were impaired or interrupted for any reason, the
Company would not be able to establish alternative sources and integrate
replacement components into its systems without substantial disruption to the
Company's operations.

INVENTORY

Inventory values, net of reserves, for 1999 and 1998 were approximately $3,378
thousand and $3,592 thousand respectfully, a decline of over 6%. The decrease
was a result of the Company's reduced sales and the establishment of reserves
for excess and obsolescence of component and sub-assembly inventories to amounts
consistent with the Company's current sales levels and expectations for future
sales. Spare parts inventories were reserved to zero value to reflect the
relatively short product life cycles of the Company's products, which reduces
opportunities for revenue generating, out of warranty repair service revenues.

BACKLOG

As is the case with other companies in the electronics industry, the Company
does not believe that backlog amounts are meaningful indicators of future
revenues unless such backlog amounts are caused by new product introductions.
Sales of the 5.2 GB Ultra drive did not meet Company expectations, therefore no
significant backlog for that product exist at the end of 1999.

COMPETITION

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The market for data storage products is competitive and changing, characterized
by price erosion and short product life cycles. The Company's products compete
directly with other optical storage products and removable storage products.
Competition also comes from storage products based on alternative technologies
such as hard disk drives and tape drives. The Company's optical storage systems
compete directly with those manufactured by Sony Corporation, Hitachi, Ltd.,
Hewlett-Packard Company, Fujitsu Ltd., Panasonic, Iomega, Syquest, Nikon, Ricoh,
Ltd., Phillips, N.V. and others. All of these companies have larger technical
staffs, greater brand name recognition and market presence, larger marketing and
sales organizations and greater financial resources than those of the Company.
Certain of the Company's suppliers of mechanical optical storage subassemblies
also develop and market optical storage systems that compete with those of the
Company. Potential direct competitors include certain computer storage
peripheral manufacturers and business storage systems manufacturers or
developers, who may introduce optical storage products or incorporate a
competitive product in their own products. The major competitive factors in the
data storage market include product performance, capacity, price, size and
appearance, reliability, as well as the timing of new product introductions.
There can be no assurance that products based on competing technologies will not
have an adverse effect on the market for optical data storage products.

While the Company believes that its optical storage products should compete
favorably for applications that require removable, reliable, random access
storage, certain other products such as hard disk drives, tape drives or other
alternative storage technologies, separately or together in various
combinations, may compete more favorably for other applications. Hard disk
drives and tape drives may be less costly alternatives where removable storage
and data security are not required. The optical storage market is still
developing. Hard disk drives compete in cost per megabyte. In the optical media
market, the Company competes as a reseller with a number of other companies,
primarily on the basis of price/performance and purchasing convenience. Optical
media manufacturing is limited to a few companies whose future decisions may
affect the Company's media business. The Company's single source supplier of
optical media for the Apex product also competes against the Company by selling
comparable products. There can be no assurance that the Company will be able to
compete successfully with manufacturers and other resellers of optical storage
products and media or that competition will not have a material adverse effect
on the Company's results of operations.

INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS

The Company seeks to obtain the appropriate proprietary rights protection for
new technology it develops. The Company attempts to protect its trade secrets
and other proprietary information through agreements with customers and
suppliers, proprietary information agreements with employees and consultants and
other security measures. There can be no assurance that the Company will be
successful in protecting its proprietary technology. Actual protection and its
assumed benefits may differ materially from Company goals as a result of their
intellectual property rights and licensing strategies of the Company's
competitors and of other licensors.

Certain of the Company's products are subject to patents or intellectual
property rights held by third parties. The Company seeks and obtains license
rights, including indemnification against infringement of such patents or
intellectual property rights, as necessary. The high technology industry,
including the data storage industry, has seen

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a great increase in patent and related litigation in the past decade. Other
entities may hold patents or have applications on file, which, if valid or
enforced, could adversely affect the Company's use of certain of its
technologies and processes. There can be no assurance that the Company will be
successful in obtaining acceptable licenser rights and terms if in fact licenses
are necessary. The Company anticipates that it may have continuing obligations
and expenses related to licensing third party technology. There can be no
assurance that third parties will not assert infringement claims against the
Company in the future or that any such assertion may not require the Company to
enter into royalty arrangements or costly litigation.

The Company has patent applications pending in the United States and intends to
file additional patent applications relating to the designs employed within
certain of its products, both hardware and software. There can, however, be no
assurance that any patents applied for will be granted.

EMPLOYEES

As of December 25, 1999, the Company employed 14 full-time employees. The
Company's current employees are engaged in sales and administrative activities
and management of the Company's outsourced activities. The Company's employees
are not represented by any collective bargaining agreements, and the Company has
never experienced a work stoppage. There can be no assurances that further
turnover of key employees will not occur. The loss of the remaining key
employees will have a material adverse impact on the Company.

ITEM 2. PROPERTIES

The Company leases and occupies an approximately 9,000 square foot facility in
Rancho Santa Margarita, California.

ITEM 3. LEGAL PROCEEDINGS

Numerous judgments have been obtained by certain creditors demanding payment of
past due obligations. In the opinion of counsel for the Company, attempts to
collect against these judgments would not be successful because of prior lien
recorded by the Company's secured lender and by the Credit Managers Association
of California on behalf of all of the Company's unsecured creditors.

The Company is also subject to other legal proceedings and claims that arise in
the normal course of business. While the outcome of these proceedings cannot be
predicted with certainty, the Company does not believe that the outcome of these
other legal matters will have a material adverse effect on the Company's
financial statements.

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

No matters were submitted during the fourth quarter of the fiscal year covered
by this report to a vote of security holders, through the solicitation of
proxies or otherwise.

PART II

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

The Company's common stock is traded on the Pink Sheets published by the
National Quotation Service under the symbol PNCL. From July 1, 1993 until
February 4, 1998, the Company's common stock was traded on the NASDAQ National
Market System. On February 4, 1998, the company's common stock was delisted from
the NASDAQ National Market System because of non-compliance with NASDAQ's
listing criteria. The following table sets forth, for the periods indicated, the
range of high and low bid prices for the Company's common stock. These prices do
not include adjustments for retail mark-ups, markdowns or commissions.

HIGH LOW
------------------------
FISCAL YEAR 1998
First Quarter $ 0.563 $ 0.156
Second Quarter $ 0.250 $ 0.156
Third Quarter $ 0.313 $ 0.156
Fourth Quarter $ 0.391 $ 0.063

FISCAL YEAR 1999
First Quarter $ 0.266 $ 0.063
Second Quarter $ 0.203 $ 0.141
Third Quarter $ 0.188 $ 0.063
Fourth Quarter $ 0.094 $ 0.031

On March 31, 2000, the closing bid and asked quotations for the Company's common
stock were $3/16, respectively, per share.

There were approximately 984 security holders of record as of March 31, 2000.
Other than S Corporation distributions to the Company's existing stockholders in
connection with the termination of the Company's S Corporation status on July 1,
1993, the Company has not paid cash dividends and intends to retain earnings, if
any, for use in the business for the foreseeable future. Under the terms of the
Company's revolving line of credit agreement, the Company is contractually
restricted from paying cash dividends.

ITEM 6. SELECTED FINANCIAL DATA

THE COMPANY HAS BEEN UNABLE TO OBTAIN AN AUDIT OPINION ON THE FINANCIAL
STATEMENTS AND NOTES THERTO FOR THE YEARS 1997, 1998 AND 1999 FROM ITS
INDEPENDENT AUDITOR PRINCIPALLY AS A RESUULT OF THE INDEPENDENT AUDITOR'S
CONCERN OVER THE ABILITY OF THE COMPANY TO CONTINUE AS A GOING CONCERN.
CONSEQUENTLY, THE FINANCIAL STATEMENTS AND NOTES THERETO, SELECTED FINANCIAL
DATA, AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, HEREIN CONTAINED ARE PRESENTED AS UNAUDITED FOR THE YEARS
1998 AND 1999. THE READER OF THE FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL
DATA, AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS SHOULD CAREFULLY CONSIDER THE LACK OF AN INDEPENDENT

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AUDITORS ATTESTATION TO THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE
COMPANY FOR DECEMBER 26, 1998 AND DECEMBER 25, 1999 PRESENTED IN THIS FORM 10-K.

The following selected financial data should be read in conjunction with the
Financial Statements and the accompanying notes and the management's discussion
and analysis of financial condition and results of operations appearing
elsewhere herein. The statement of operations data and the balance sheet for the
years ended December 25, 1999, December 26, 1998 and December 27, 1997 are
derived from unaudited results as more fully described above. The statement of
operations data for the years ended December 28, 1996 and December 30, 1995, and
the balance sheet data at December 28, 1996, is derived from, and should be read
in conjunction with, the audited financial statements for each of those years
The statement of operations data set forth below with respect to the balance
sheet data at December 30, 1995 is derived from unaided financial statements not
included in this Form 10-K.

<TABLE>
<CAPTION>
UNAUDITED
---------------------------
Fiscal Year Ended Dec. 25 Dec. 26 Dec. 27 Dec. 28 Dec. 30
(In thousands except per share data) 1999 1998 1997 1996 1995
----------------------------------------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net Sales $6,556 $10,554 $31,124 $59,921 $81,844
Gross Profit (Loss) 925 1,073 (8,763) 11,829 21,952
Income (Loss) from Operations (2,647) (3,912) (28,579) (18,463) (3,274)
Net Income (Loss) (3,002) (4,556) (30,229) (20,833) (2,459)
Net Income (Loss) per share (1) ($0.21) ($0.31) ($2.32) ($2.52) ($0.31)

UNAUDITED
---------------------------
Dec. 25 Dec. 26 Dec. 27 Dec. 28 Dec. 30
1999 1998 1997 1996 1995
----------------------------------------------
BALANCE SHEET DATA:
Working capital (deficiency) ($23,097) ($20,215)($15,928) $12,710 $15,527
Total Assets 4,275 4,979 12,544 40,238 32,005
Notes Payable and Long-term debt 7,688 5,507 6,166 9,698 -
Shareholders' equity (deficit) (23,023) (20,025) (15,470) 8,503 16,741
</TABLE>

(1) The net income (loss) per share and the supplementary pro forma net
income per share have been retroactively restated to reflect the 1995 stock
dividend.

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

This Section contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. Actual results and events could differ materially from those projected
in the forward-looking statements as a result of many factors, including but not
limited to the risk factors stated here and throughout this Report.

THE COMPANY HAS BEEN UNABLE TO OBTAIN AN AUDIT OPINION ON THE FINANCIAL
STATEMENTS AND NOTES THERTO FROM ITS INDEPENDENT AUDITOR PRINCIPALLY AS A RESULT
OF THE INDEPENDENT AUDITOR'S CONCERN OVER THE ABILITY OF THE COMPANY TO CONTINUE
AS A GOING CONCERN. CONSEQUENTLY, THE FINANCIAL STATEMENTS AND NOTES THERETO,
SELECTED FINANCIAL DATA, AND MAMANEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, HEREIN CONTAINED ARE PRESENTED AS
UNAUDITED. THE READER OF THE FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL
DATA, AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS SHOULD CAREFULLY CONSIDER THE LACK OF AN INDEPENDENT
AUDITORS ATTESTATION TO THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE
COMPANY FOR DECEMBER 26, 1998 AND DECEMBER 25, 1999 PRESENTED IN THIS FORM 10-K.

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General

In 1999, the Company incurred a net loss of $3,002 thousand on net sales of
$6,566 thousand. During the years 1998 and 1999 the company incurred significant
and critically serious problems. The Company continues to incur significant
losses and quarterly sales remain significantly below historical levels and
those levels required for profitability. As of December 25, 1999, the Company's
liabilities exceeded its assets by $23,023 thousand. The Company's liquidity
position continues to be severely constrained. As of December 25, 1999, the
Company's working capital deficiency was $23,097 thousand. The Company was
unsuccessful in its attempt to transition from a reseller of OEM products to an
engineering and manufacturing company and it was, accordingly, forced to abandon
its research and development and manufacturing capabilities during 1997. The
Company's revised strategy is to return to its original concept as a reseller of
OEM products. The Company's future now depends upon its ability to obtain and
sell state of the art products developed and manufactured by OEMs.

RESULTS OF OPERATIONS

THE COMPANY HAS BEEN UNABLE TO OBTAIN AN AUDIT OPINION ON THE FINANCIAL
STATEMENTS AND NOTES THERTO FROM ITS INDEPENDENT AUDITOR PRINCIPALLY AS A
RESUULT OF THE INDEPENDENT AUDITOR'S CONCERN OVER THE ABILITY OF THE COMPANY TO
CONTINUE AS A GOING CONCERN. CONSEQUENTLY, THE FINANCIAL STATEMENTS AND NOTES
THERETO, SELECTED FINANCIAL DATA, AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, HEREIN CONTAINED ARE PRESENTED AS
UNAUDITED. THE READER OF THE FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL
DATA, AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS SHOULD CAREFULLY CONSIDER THE LACK OF AN INDEPENDENT
AUDITORS ATTESTATION TO THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE
COMPANY FOR DECEMBER 26, 1998 AND DECEMBER 25, 1999 PRESENTED IN THIS FORM 10-K.

COMPARISON OF 1999 TO 1998

NET SALES. Net sales of optical storage devices decreased 38% to $6,566 thousand
in 1999. The decrease was primarily attributable to the very significant
decrease in the unit sales and average sales prices of all of the Company's
products. The decreased unit sales can be attributed to increased competition,
the Company's inability to acquire products for sale because of the Company's
lack of financial resources and the discontinuance of certain of the Company's
products. Virtually all of the Company's vendors will only sell to the Company
on a prepay basis.

GROSS PROFIT. The Company realized a gross profit of $925 thousand or 14% in
1999 compared to a gross profit of $1,073 thousand for 1998.

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SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses decreased 36% to $3,572 thousand and as a percentage of net sales was
54% in 1999 and 53% in 1998. The decreased absolute dollars of Selling, General
and Administrative expenses can be attributed to the Company's need to decrease
overall expenditures due to increased cash flow restraints. The Company
continued to decrease promotional and advertising expenses along with sales and
administrative staffing. The decrease as a percentage of sales is attributed to
the significant decline in operating expenses that decreased at a faster pace
than the decrease in gross sales.

RESEARCH AND DEVELOPMENT. Research and development expenses continues to be zero
in 1999. Due to cash funding restraints and the switch to Reseller and OEM
Sales, the Company has discontinued virtually all the Research and Development
activities.

INTEREST INCOME AND INTEREST EXPENSE. Interest income was $0 and $1.1 thousand
and interest expense was $355 thousand and $654 thousand in 1999 and 1998,
respectively. The Company borrowed on its line of credit consistently during
1999 and 1998.

INCOME TAXES. Income tax expense was $0 for both 1999 and $0 for 1998.

COMPARISON OF 1998 TO 1997

NET SALES. Net Sales of optical storage devices decreased 66.0% to $10,554
thousand in 1998. The decrease was primarily attributable to the very
significant decrease in unit sales and average sales price of all of the
Company's products. The decreased unit sales can be attributed to increased
competition, the Company's inability to acquire products for sale because of the
Company's lack of financial resources and the discontinuance of certain of the
Company's products. Virtually all of the Company's vendors will only sell to the
Company on a prepay basis. Returns as a percentage of sales decreased from 19.4%
to 9.0% in 1997 and 1998 respectfully. The product returns in 1997 and 1998 were
the result of initial product quality problems with the Company's Apex and
Vertex drives, stock rotation returns by the distributor channel and general
returns.

GROSS PROFIT (LOSS). The Company realized a gross profit of $1,048 thousand or
10.2% in 1998 compared to a gross loss of $6,203 thousand for 1997. The gross
margin loss in the prior year was principally the result of increased inventory
reserves taken for component parts of the Apex and Vertex lines of inventory
which were deemed excess or obsolete based upon sales projections. In addition,
the Company incurred significant costs associated with the move of the Research
and Development and production facilities to Colorado and back all in 1997. The
gross margin realized in 1998 is principally attributable to the sale of lower
cost legacy products. Inventory reserves were taken in the 4th quarter of 1998
to reserve for excess and obsolete inventory. Obsolescence reserves amounting to
$1,100 thousand were taken for the Vertex line that was discontinued in early
1998.

SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses decreased 86.3% to $3,912 thousand and increased as a percentage of net
sales to 37.1% in 1998 from 47.4% in 1997. The decrease in absolute dollars in
selling, general and administrative expenses can be attributed to the Company's
need to decrease advertising and promotional expenditures and decreased sales
and administrative staffs

12
<PAGE>

during the latter half of 1998 in response to the Company's reduced sales and
its severe financial condition. The increase in percentage of net sales is
attributable to the significant decline in net sales that decreased at a faster
rate then the decrease in selling, general and administrative expenses.

RESEARCH AND DEVELOPMENT. Research and development expenses decreased 100.0% to
zero in 1998. Due to cash funding restraints and the switch to Reseller and OEM
ales, the Company has discontinued virtually all the Research and Development
activities in 1998.

INTEREST INCOME AND INTEREST EXPENSE. Interest income was $1 thousand and $84
thousand and interest expense was $654 thousand and $824 thousand in 1998 and
1997, respectively. The Company borrowed on its line of credit consistently
during 1998 and 1997. Additionally, the Company incurred interest expenses
relating to a guarantee made on behalf of Pinnacle Micro, Inc. by William F.
Blum. This guarantee amounted to $225 thousand and carries an interest rate of
5% per annum.

INCOME TAXES. Income tax expense/(income) was ($12 thousand) for 1998 and $57
thousand for 1997. During 1998 the company recorded a refund of $12 thousand
from the Franchise Tax Board of California.

LIQUIDITY AND CAPITAL RESOURCES

The Company has continued to incur significant losses, continues to suffer
serious liquidity constraints and has been unable to secure appropriate sources
of additional funding.

Cash and cash equivalents at December 25, 1999 increased by $167 thousand from
the December 26, 1998 balance. This increase in available cash balances at
December 25, 1999 occurred principally as a result of decreased operating
expenses. Operating activities provided/(used) cash and cash equivalents of
($1,997) thousand and $532 thousand in 1999 and 1998, respectively.

Inventories decreased by $214 thousand in 1999. The $510 thousand decrease in
accounts receivable from 1999 to 1998 was caused by the significant decline in
sales in 1999 from 1998 levels.

The Company currently has a revolving line of credit agreement with a lender,
which, is collateralized by substantially all assets of the Company. The Company
has a maximum availability of $10,000 thousand under the line of credit based on
a percentage of eligible accounts receivable and inventories. Interest is
payable monthly at the lender's reference rate (8.5% at December 25, 1999) plus
1.75%. As of December 25, 1999 through March 27, 1999, the Company was not in
compliance with the terms of this line of credit. Although the Company has the
maximum availability of $10,000 thousand under the line of credit based on a
percentage of eligible accounts receivable and

13
<PAGE>

inventories, its ability to borrow against the revolving line of credit is
largely dependent upon its level of eligible accounts receivable. Because of its
lower than expected level of shipments, the Company's eligible accounts
receivable are also lower than expected and the Company frequently has exceeded
the maximum available under the line of credit. At December 25, 1999 and March
27, 1999, the Company had borrowed in excess of its available credit under the
line.

Borrowings under the line of credit totaled $7,688 thousand at December 25, 1999
and $5,503 thousand at December 26, 1998.

INFLATION AND FOREIGN CURRENCY EXCHANGE

Inflation has not had a significant impact on the Company's operating results.
The Company has from time-to-time attempted to reduce its anticipated exposure
to currency fluctuations by negotiating price and other cost concessions from
its suppliers, and by entering hedging transactions, including the purchase of
forward contracts for foreign currencies. Currently, the Company's product and
component purchases are denominated in U. S. Dollars, as are its sales to
international customers. Accordingly, the Company does not expect to be impacted
directly by currency fluctuations. There can be no assurance, however, that the
Company's results of operations will not be adversely affected by currency
fluctuations.

RISK MANAGEMENT

The Company has not used any derivative financial instrument. Company policy
restricts the concentration of credit risk in any one institution and requires
management approval of any hedging strategies and derivative financial
instrument transactions.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See the index included on page 16, Index to Financial Statements

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

BDO Seidman, LLP

As noted in the Company's Form 8-K dated January 6, 1998, the engagement of BDO
Seidman LLP, the former independent accountants of the Company, was terminated
by the resignation of BDO Seidman LLP.

PART III

EXECUTIVE OFFICER COMPENSATION

14
<PAGE>

The following table sets forth compensation received for the fiscal years
ended December 25, 1999, December 26, 1998, and December 27, 1997 by the
Company's Chief Executive Officers and other executive officers whose salary and
bonus exceeded $100,000 for the fiscal year ended December 25, 1999
(collectively, the "Named Executive Officers"):

NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($)
- --------------------------------------------------------------------------------
Kenneth Campbell, President (1) 1999 $0 $0
1998 $0 $0
1997 $278,670 $0

William F. Blum (3) 1999 $157,200 $0
President, Chief Executive
Officer, 1998 $156,000 $0
Chief Financial Officer 1997 $141,538 $0

Roger Hay (4) 1999 $0 $0
Executive Vice President and 1998 $0 $0
Chief Financial Officer 1997 $170,697 $0

James G. Hanley (5) 1999 $0 $0
Vice President of Sales 1998 $0 $0
1997 $122,717 $32,938

Charles R. McGee 1999 $0 $0
Vice President Human Resources 1998 $100,000 $0
and Administration 1997 $128,093 $0

Jamey L. Robbins (6) 1999 $0 $0
Vice President Research and 1998 $0 $0
Development 1997 $113,059 $0

1. Effective September 30, 1997, Mr. Kenneth C. Campbell resigned from his
position as President of the Company.

2. Includes $87,500 in payments Mr. William F. Blum received prior to his
return to the Company as President, Chief Executive Officer and Chief
Financial officer.

3. Effective August 21, 1997, Mr. William F. Blum was rehired as President,
chief Executive Officer and Chief Financial Officer.

4. Effective August 28, 1997, Mr. Roger Hay resigned from his position as
executive Vice President and Chief Financial Officer

5. Effective August 25, 1997, Mr. James G. Hanley resigned from his position
as ice President of Sales of the Company.

6. Effective August 22, 1997, Mr. Bernard J. Wu resigned from his position as
ice President of Marketing of the Company.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) The following documents are filed as a part of this Report:

Financial Statements.

THE COMPANY HAS BEEN UNABLE TO OBTAIN AN AUDIT OPINION ON THE INANCIAL
STATEMENTS AND NOTES THERTO FROM ITS INDEPENDENT AUDITOR FOR HE YEARS ENDED 1998
AND 1999 PRINCIPALLY AS A RESUULT OF THE NDEPENDENT AUDITOR'S CONCERN OVER THE
ABILITY OF THE COMPANY TO ONTINUE AS A GOING CONCERN. CONSEQUENTLY, THE
FINANCIAL STATEMENTS AND NOTES THERETO, SELECTED FINANCIAL DATA, AND
MAMANEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS, HEREIN CONTAINED ARE PRESENTED AS UNAUDITED. THE READER OF THE
FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL DATA, AND MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD
CAREFULLY CONSIDER THE LACK OF AN INDEPENDENT AUDITORS ATTESTATION TO THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE COMPANY FOR DECEMBER 26,
1998 AND DECEMBER 25, 1999, PRESENTED IN THIS FORM 10-K.

15
<PAGE>

Index to Financial Statements

Comment on the Report of Independent Certified Public Accountants

Balance Sheets - December 25, 1998 and December 26, 1998

Statements of Operations - Years Ended December 25, 1999 and December 26,
1998.

Statements of Cash Flows - Years Ended December 25, 1999 and December 26,
1998.

Notes to Financial Statements

(2) Financial Statement Schedule.

None

(3) Exhibits:

EXHIBIT NO. DESCRIPTION LOCATION
----------- ----------- --------
3.1 Certificate of Incorporation of the Company (1)
3.2 Bylaws of the Company, as currently in effect (1)
4.1 Specimen Certificate of Common Stock (1)
10.1* Pinnacle Micro, Inc. Incentive Stock Option,
Non-qualified Stock Option and Restricted Stock
Purchase Plan - 1989 (the "1989 Plan") (1)
10.2* Form of Incentive Stock Option Agreement
pertaining to the 1989 Plan. (1)
10.3* Pinnacle Micro, Inc. Incentive Stock Option,
Non-qualified Stock Option and Restricted Stock
Purchase Plan -- 1993 (the "1993 Plan"). (1)
10.4* Form of Incentive Stock Option Agreement
pertaining to the 1993 Plan. (1)
10.5* Form of Non-qualified Stock Option Agreement
pertaining to the 1993 Plan. (1)
10.6* Form of Restricted Stock Purchase Agreement
pertaining to the 1993 Plan. (1)
10.7 Pinnacle Micro, Inc., Employees Stock Purchase Plan (1)
10.8 Distributor Agreement, dated June 14, 1991, by and
between the Company and Merisel Inc., together with
Amendment dated June 14, 1991 and Addendum dated
February 11, 1993. (1)
10.9 Distributor Agreement, dated July 30, 1991, by and
between the Company and Tech Data Corporation,
together with Addendum No. 1 to Distributor Agreement
dated July 30, 1991. (1)
10.10 Distributor Agreement, dated August 18, 1989, by
and between the Company and Ingram Micro D Inc.,
together with Addenda Nos. 1, 2, 3, 4 and 5. (1)
10.11 Peripherals OEM Purchase Agreement, dated May 1,
1991, by And between the Company and Hewlett-Packard
Company, together with Amendment to Peripherals OEM
Agreement No. A509M, effective May 12, 1992. (1)

16
<PAGE>

10.12 Computer Peripheral Products Company Peripheral
Systems Products Agreement, dated April 1, 1992, by
and between the Company and Computer Peripheral
Products Company, Sony Corporation of America. (1)
10.13 Basic Agreement, dated April 1, 1992, by and between
the Company and Sony Corp. in Japan. (1)
10.14 Agreement, effective October 28, 1991, by and between
the Company and Olympus Optical Co., Ltd., together with
Memorandum dated February 19, 1992, Addendum dated
August 1, 1992, Memorandum dated September 9, 1992 and
letter dated October 15, 1992. (1)
10.15+ OKI Semiconductor Standard Products Volume Purchase
Agreement, dated August 17, 1992, by and between the
Company and OKI Semiconductor. (1)
10.16+ Nippon Pinnacle Micro, Pinnacle Micro and Ricoh Company
Ltd. Purchase Agreement, dated October 1, 1992, by and
among the Company, Nippon Pinnacle Micro and Ricoh
Company Ltd. (1)
10.17 Agreement on Sale and Purchase, dated January 1, 1993,
by and between the Company and Victor Company of Japan,
Limited, together with Addenda Nos. I, II and III. (1)
10.19 Lease, dated January 6, 1993, by and between the
Company and Webb/Colorado Ventures, Ltd. (1)
10.20 Lease, dated February 5, 1991, by and between the
Company and The Irvine Company, together with
Amendment Nos. 1, 2, 3 and 4. (1)
10.21 Form of Indemnification Agreement for officers and
directors of the Company. (1)
10.22* Form of Nonqualified Stock Agreement pertaining
to the 1989 stock plan. (1)
10.23 Business Loan Agreement, dated August 4, 1994, by and
between the Company and Bank of America, together with
Amendment No. One, dated October 4, 1994 and Amendment
No. Two, dated February 2, 1995. (2)
10.24(a) Amendment No. Three, dated August 31, 1995, to Business
Loan Agreement, dated August 4, 1994, by and between the
Company and Bank of America. (3)
10.24(b) Amendment No. Four, dated October 10, 1995, to Business
Loan Agreement, dated August 4, 1994, by and between the
Company and Bank of America. (3)
10.24(c) Amendment No. Five, dated January 24, 1996, to Business
Loan Agreement, dated August 4, 1994, by and between the
Company and Bank of America. (3)
10.24(d) Amendment No. Six, dated March 28, 1996, to Business
Loan Agreement, dated August 4, 1994, by and between the
Company and Bank of America. (3)
10.25++ Development, Manufacturing and Purchasing Agreement
dated June 30, 1995, by and between the Company and
Asahi Optical Co., LTD. (3)
10.26* Employment Agreement dated December 15, 1995, by and
between the Company and James G. Hanley. (3)
10.27* First Amendment to the 1993 Equity Incentive Plan of
Pinnacle Micro Inc. (the "1993 Plan"). (3)
10.28* First Amendment to the 1989 Equity Incentive Plan of
Pinnacle Micro Inc. (the "1989 Plan"). (3)
10.29++ Development and Manufacturing Agreement dated October
6, 1994, by and between the Company and Advanced
Hardware Architectures, Inc. (3)

17
<PAGE>

10.30++ Computer 2000 Purchase Agreement dated September 13,
1995, by and between the Company and Computer 2000. (3)
10.31 Stipulation of settlement - Class action - Kurtz, et al.
vs. Blum, et al; Case No. SAC-94-1043-GLT(EEx). (3)
10.32 Form of Offshore Subscription Agreement. (4)
10.33 Form of Convertible Debentures. (4)
10.34 Form of Registration Rights Agreement. (4)
10.35 Loan and Security Agreement with Coast Business
Credit dated September 18, 1996. (5)
10.36* 1996 Long-Term Incentive Plan. (6)
10.37* 1996 Non-Employee Directors Stock Option Plan. (6)
10.38* Employment Agreement for Kenneth Campbell as of
December 1, 1996. (6)
10.39 Employment Agreement for Roger Hay as of December
1, 1996. (6)
10.40* Employment Agreement for Jonathan B. Eddison as of
December 1, 1996. (6)
10.41* Employment Agreement for Kevin Lehnert as of
December 1, 1996. (6)
10.42* Employment Agreement for David Ooley as of
December 1, 1996. (6)
10.43* Stand-still and Voting Rights Agreement dated
December 8, 1996. (6)
10.44* Scott Blum - Severance Agreement and Release of
February 13, 1997. (6)
10.45* Employment Agreement for Bernard Wu dated as of
March 26, 1997. (7)
10.46* Employment Agreement for David Nesbit dated as of
March 26, 1997. (7)
27.1 Financial Data Schedule.

(1) Incorporated by reference to the referenced exhibit number to the Company's
Registration Statement on Form S-1, Reg. No. 33-62614.
(2) Incorporated by reference to exhibit filed with the Company's Report on
Form 10-K for the fiscal year ended December 31, 1994.
(3) Incorporated by reference to exhibit filed with the Company's Report on
Form 10-K for the fiscal year ended December 30, 1995.
(4) Incorporated by reference to the exhibit filed with the Company's Report on
Form 10-Q for the period ended June 29, 1996.
(5) Incorporated by reference to the exhibit filed with the Company's Report on
Form 10-Q for the period ended September 28, 1996.
(6) Incorporated by reference to the exhibit filed with the Company's Report on
Form 10-K for the fiscal year ended December 28, 1996.
(7) Incorporated by reference to the exhibit filed with the Company's Report on
Form 10-Q for the period ended March 29, 1997.

- ------------------
* Denotes applicable executive compensation plans and arrangements of
the Company.
+ Confidential treatment has been granted by the Commission. The copy
filed
18
<PAGE>

as an exhibit omits the information subject to the confidentiality
grant.
++ Confidentiality treatment has been requested. The copy filed as an exhibit
omits the information subject to the confidentiality request.

(b) Reports on Form 8-K

January 6, 1998 Resignation of BDO Seidman, LLP as independent
auditors.
February 4, 1998 Delisting of the Company's common stock from
trading on the NASDAQ National Market.
August 22, 1998 Response to vote of unsecured creditors and
filing jof involuntary petition of Bankruptcy.

February 12, 1999 Hans Imhoff and James Roszack resignation from Board
of Directors

19
<PAGE>

Report of Independent Certified Public Accountants

THE COMPANY HAS BEEN UNABLE TO OBTAIN AN AUDIT OPINION ON THE FINANCIAL
STATEMENTS AND NOTES THERTO FROM ITS INDEPENDENT AUDITOR FOR THE YEARS ENDED
1997 AND OPINION ON THE FINANCIAL1998 PRINCIPALLY AS A RESUULT OF THE
INDEPENDENT AUDITOR'S CONCERN OVER THE ABILITY OF THE COMPANY TO CONTINUE AS A
GOING CONCERN. CONSEQUENTLY, THE FINANCIAL STATEMENTS AND NOTES THERETO,
SELECTED FINANCIAL DATA, AND MAMANEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, HEREIN CONTAINED ARE PRESENTED AS
UNAUDITED. THE READER OF THE FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL
DATA, AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS SHOULD CAREFULLY CONSIDER THE LACK OF AN INDEPENDENT
AUDITORS ATTESTATION TO THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF
THECOMPANY FOR DECEMBER 26, 1998 AND DECEMBER 25, 1999 PRESENTED IN THIS FORM
10-K.

20
<PAGE>
<TABLE>
<CAPTION>

PINNACLE MICRO, INC.
CONDENSED BALANCE SHEETS
(in thousands, except share and per share information)

(Unaudited) (Unaudited)
December 25, 1999 December 26, 1998
----------------- -----------------
<S> <C> <C>

ASSETS

Current assets
Cash and cash equivalents $ 489 $ 322
Accounts receivable, net 232 742
Inventories, net 3,378 3,592
Prepaid expenses and other current assets 102 134
--------------- ---------------

Total current assets 4,201 4,790

Furniture and equipment, net 27 46
Other Assets 47 143
--------------- ---------------
Total assets $ 4,275 $ 4,979
=============== ===============

Current liabilities
Note payable 7,688 5,503
Accounts payable 17,176 17,366
Accrued expenses 2,385 2,036
Payroll related liabilities 49 99
--------------- ---------------
Total current liabilities 27,298 25,004

Stockholders' equity
Common stock, $.001 par value: Aurthorized shares, 30,000,000
Issued and outstanding 14,500,089 at December 25, 1999 and
14,500,089 at December 26, 1998 15 15
Additional paid-in capital 34,977 34,977
Accumulated deficit (58,015) (55,017)
--------------- --------------
Total stockholders' equity (23,023) (20,025)
--------------- --------------
$ 4,275 $ 4,979
=============== ==============

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS.

</TABLE>

21
<PAGE>
<TABLE>
<CAPTION>

PINNACLE MICRO, INC.
CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except share and per share information)

(Unaudited) (Unaudited)
13 Weeks Ended 13 Weeks Ended 52 Weeks Ended 52 Weeks Ended
Dec 25, 1999 Dec 26, 1998 Dec 25, 1999 Dec 26, 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>

Net sales $ 1,255 $ 2,305 $ 6,566 $ 10,554
Cost of sales 1,062 3,136 5,641 9,481
------------ ------------ ------------ -----------
Gross profit 193 (830) 925 1,073
------------ ------------ ------------ -----------
Operating expenses:
Selling, general, and administrative expenses 883 1,097 3,572 5,610
Research and development expenses - - - -
Nonrecurring charges - - - -
------------ ------------- ------------ -----------
Total operating expenses 883 1,097 3,572 5,610
------------ ------------- ------------ -----------
Operating loss (690) (1,928) (2,647) (4,537)
------------ ------------- ------------ -----------
Other income (expense):
Interest income/expense (193) (160) (355) (19)
Non-cash interest expense related
to convertble debenturees - - - -
------------ ------------ ------------ -----------
Total other income (expense) (193) (160) (355) (19)
------------ ------------- ------------ ------------
Loss before income taxes (883) (2,088) (3,002) (4,556)

Income tax expense - - -
------------ ------------- ------------ ------------
Net loss $ (883) $ (2,088) $ (3,002) $ (4,556)
============ ============= ============ ============

Loss per common share
Basic ($0.06) ($0.14) ($0.21) ($0.31)
Diluted ($0.06) ($0.14) ($0.21) ($0.31)

Weighted average number of common and potential
common shares outstanding used in computation of
loss per share
Basic 14,500,089 14,500,089 14,500,089 14,500,089
Diluted 14,500,089 14,500,089 14,500,089 14,500,089

</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS.

22
<PAGE>

PINNACLE MICRO, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)

(Unaudited) (Unaudited)
52 Weeks Ended 52 Weeks Ended
December 25, 1999 December 26, 1998
----------------- -----------------

Cash Flows from Operating Activities
Net loss $ (3,001) $ (4,556)
Adjustments to reconcile net income
(loss) to net cash used in
operating activities:
Depreciation and amortization 44 401
Provision for doubtful accounts - -
Provision for product returns and price protection - -
Changes in operating assets and liabilities:
Accounts receivable 510 4,111
Inventories 214 2,812
Prepaid expenses and other assets 31 242
Other assets 96 (132)
Accounts payable and accrued expense 159 (2,321)
Payroll related liabilities (50) (25)
Other liabilities - -
------- -------
Net cash provided by (used in) operating
activities (1,997) 532
Cash Flows from Investing Activities
Proceeds from disposal of furniture and equipment - -
Purchase of furniture and equipment 21 -
------- -------
(21) -
Cash Flows from Financing Activities
Net cash provided by (used to) repay note
payable 2,185 (663)
------- -------
Net cash provided by (used in) financing
activities 2,185 (663)

Increase (Decrease) in cash and cash equivalents 167 (131)
Cash and cash equivalents at beginning of period 322 454
------- ------
Cash and cash equivalents at end of period 489 323

Supplement Cash Flow Information

Cash paid during the period for:
Interest 183 293
Income taxes - -

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED
FINANCIAL STATEMENTS.

23
<PAGE>

NOTES TO FINANCIAL STATEMENTS

December 25, 1999

(UNAUDITED)

THE COMPANY HAS BEEN UNABLE TO OBTAIN AN AUDIT OPINION ON THE FINANCIAL
STATEMENTS AND NOTES THERTO FROM ITS INDEPENDENT AUDITOR FOR THE YEARS ENDED
1997 AND 1998 PRINCIPALLY AS A RESUULT OF THE INDEPENDENT AUDITOR'S CONCERN OVER
THE ABILITY OF THE COMPANY TO CONTINUE AS A GOING CONCERN. CONSEQUENTLY, THE
FINANCIAL STATEMENTS AND NOTES THERETO, SELECTED FINANCIAL DATA, AND
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS, HEREIN CONTAINED ARE PRESENTED AS UNAUDITED. THE READER OF THE
FINANCIAL STATEMENTS, NOTES, SELECTED FINANCIAL DATA, AND MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD
CAREFULLY CONSIDER THE LACK OF AN INDEPENDENT AUDITORS ATTESTATION TO THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE COMPANY FOR DECEMBER 25,
1999 AND DECEMBER 26, 1998 PRESENTED IN THIS FORM 10-K.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION

Pinnacle Micro, Inc., (the "Company") acquires and markets optical storage
systems for data intensive applications for use both with stand-alone and
networked personal computers and workstations.

This summary of the Company's significant accounting policies is presented to
assist in understanding the Company's financial statements. The financial
statements and notes are representations of the Company's management, who are
responsible for their integrity and objectivity. These accounting policies
conform to generally accepted accounting principles. Management uses estimates
and assumptions in preparing financial statements in accordance with generally
accepted accounting principles. Those estimates and assumptions affect the
amounts reported in the financial statements. Actual results could vary for the
estimates that were used.

FISCAL YEARS

The Company operates and reports financial results on a fiscal year of 52 or 53
weeks ending on the Saturday closest to December 31. Accordingly, fiscal 1999
ended on December 25, 1999 and the fiscal 1998 ended on December 26, 1998.

24
<PAGE>

REVENUE RECOGNITION

The Company recognizes product sales revenue at the time of shipment and records
a reserve for estimated sales returns and price adjustments. The Company has
agreements with its resellers which, under certain circumstances, provide for
stock rotation for slow-moving items and price protection for inventories held
by the resellers at the time of published price reductions. It is reasonably
possible that the Company's estimates of sales returns and price adjustments may
change.

CASH AND CASH EQUIVALENTS

For purposes of the Statements of Cash Flows, the Company considers all highly
liquid investments with an original maturity of three months or less when
purchased to be cash equivalents. The amount of cash equivalents reported in the
financial statements approximates fair value. The Company invests its cash and
cash equivalents with high credit quality financial institutions. At times such
investments may be in excess of the FDIC insurance limit.

ACCOUNTS RECEIVABLE

Accounts receivable (less allowance for doubtful accounts) are recorded at net
realizable value. The amount of accounts receivable reported in the financial
statements approximates fair value. Company management has estimated the
allowance for doubtful accounts. It is reasonably possible that the Company's
estimate of the collectibility of accounts receivable will change.

INVENTORIES

Inventories are stated at the lower of cost (first-in, first-out method) or
market (net realizable value). It is reasonably possible that the Company's
estimate of market will change.

FURNITURE AND EQUIPMENT

Furniture and equipment is stated at cost, less accumulated depreciation and
amortization. Depreciation is determined using the straight-line method for all
assets based on the estimated useful lives of the assets, which range from one
to five years. Leasehold improvements are amortized using the straight-line
method over the shorter of their estimated useful lives or the term of the
related leases.

The Company's policy is to evaluate the remaining life and recoverability of
furniture and equipment in light of current conditions. It is reasonably
possible that the Company's estimate to recover the carrying amount of property,
plant and equipment will change.

Debt Issuance Costs

The costs related to the issuance of the convertible debentures are capitalized
and amortized over the terms of the related debt.

NOTES PAYABLE

25
<PAGE>

The amount of the notes payable reported in the financial statements
approximates fair value because of the short maturity of those instruments.

INCOME TAXES

Deferred income taxes are recorded for the temporary differences between the
Company's financial statements and tax returns in accordance with Statement of
Financial Accounting Standards No. 109 (FAS 109), Accounting for Income Taxes.
FAS 109 is an asset and liability approach that requires the recognition of
deferred tax assets and liabilities for the expected future tax consequences of
events that have been recognized in the Company's financial statements or tax
returns. In estimating future tax consequences, FAS 109 generally considers all
expected future events other than enactments of changes in the law or rates.

STOCK-BASED COMPENSATION

The Company applies APB Opinion 25, "Accounting for Stock Issued to Employees,"
and related interpretations in accounting for its stock-based compensation
plans. Accordingly, no compensation cost is recognized for its employee stock
option plans, unless the exercise price of options granted is less than fair
market value on the date of grant. The Company has adopted the disclosure
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation."

FOREIGN CURRENCY TRANSACTIONS

Exchange gains and losses arising from transactions denominated in foreign
currencies are translated at average exchange rates. There were no foreign
currency transaction gains or losses in 1999 and 1998.

SOFTWARE DEVELOPMENT COSTS

Research and development costs resulting from the design, development and
testing of new software for use in products are expensed as incurred until
technological feasibility has been established. Certain costs incurred
thereafter, such as coding and testing, are capitalized until the product is
available for general release to customers. Such amounts were not material for
the years presented.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amount of cash and cash equivalents, accounts receivable, accounts
payable and accrued expenses are reasonable estimates of their fair value
because of the short maturity of those items. The Company believes the carrying
amounts of the Company's notes payable and convertible debentures approximate
fair value because the interest rates on these instruments are subject to change
with, or approximate, market interest rates.

NET INCOME (LOSS) PER SHARE

In February 1997, The Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 128 ("FAS-128"), Earnings Per
Share. FAS-128 replaces the presentation of primary and fully diluted earnings
per share with

26
<PAGE>

the presentation of basic and diluted earnings per share. Unlike
primary earnings per share, basic earnings per share excludes any dilutive
effects of options, warrants and convertible securities. Basic income (loss) per
share is computed by dividing net income available to common shareholders by the
weighted average common shares outstanding for the period. Diluted income (loss)
per share is computed giving effect to all potentially dilutive common shares.
Potentially dilutive common shares may consist of incremental shares issuable
upon the exercise of stock options or in connection with convertible securities.
In periods in which a net loss has been incurred, all potentially dilutive
common shares are considered antidilutive and therefore excluded from the
calculation. The weighted average number of shares outstanding is adjusted to
include the number of additional common shares that would have been outstanding
if the dilutive potential common shares had been issued. All income (loss) per
share amounts for all prior periods have been restated to conform to the
requirements of FAS-128. The weighted average common shares outstanding used in
the computation of income (loss) per share have been retroactively restated to
reflect the 1995 stock dividend.

2. GOING CONCERN ISSUES

3. INVENTORIES

Inventories consist of the following:
<TABLE>
<CAPTION>

(UNAUDITED) (UNAUDITED)
1999 1998
------------- -------------
<S> <C> <C>

(IN THOUSANDS)
Components and work-in-process $10,466 $11,204
Finished Goods 875 845
Reserve for excess inventory and obsolescence (7,963) (8,457)
-------------- --------------
$3,378 $3,592
============== ==============
</TABLE>

Management has determined the reserve for excess inventory and obsolescence by
reviewing expected product life cycles, assessing current inventory levels and
analyzing projected sales levels. Inventory in excess of expected sales
requirements and inventory expected to become obsolete has been fully reserved.

4. FURNITURE AND EQUIPMENT

Furniture and equipment consists of the following:
<TABLE>
<CAPTION>

(UNAUDITED) (UNAUDITED)
1999 1998
------------- -------------
<S> <C> <C>

(IN THOUSANDS)
Furniture and equipment $1,115 $2,662
Computers 1,322 1,661
Leasehold improvements 2 -
Gross furniture and equipment 2,036 4,323
Accumulated depreciation and amortization (3,617) (7,903)
Reserve for furniture and equipment disposition - (697)
------------- -------------
Net furniture and equipment $858 $46
</TABLE>

The reserve for furniture and fixture disposition has been estimated by
management based upon the Company's current utilization of computers and
furniture and equipment. All computers or furniture and equipment which are not
being utilized have been reserved for any amounts in excess of their market
value. Assets that cannot be located have been fully reserved.

5. NOTE PAYABLE

27
<PAGE>

The Company has a $10,000 thousand revolving line of credit agreement with a
lending institution which is collateralized by substantially all assets of the
Company and which expired on September 30, 1999. Outstanding borrowings on this
line of credit were $7,688 thousand and $5,503 thousand at December 25, 1999 and
December 26, 1998, respectively. The total unused amount available at December
25, 1999 was zero and at December 26, 1998 was zero. Borrowings on this line
credit are based on a percentage of eligible accounts receivable and
inventories. As of December 25, 1999, the Company was not in compliance with the
terms of the line of credit and had borrowed in excess of its available credit
under the eligibility formulas. If it is in compliance with the terms of the
line of credit, the Company can obtain up to $3,500 thousand in letters of
credit pursuant to this agreement; there were no such obligations under standby
letters of credit at December 26, 1998 or December 27, 1997. Interest is payable
monthly at the institution's reference rate (8.50% at December 25, 1999 and
8.50% at December 26, 1998) plus 1.75%. At December 26, 1998, the Company was
not in compliance with the principal terms of the line of credit agreement.

6. STOCKHOLDERS' EQUITY

STOCK OPTIONS AND STOCK PURCHASE PLANS

Under terms of the Company's stock option plans (the "Plans"), 3,605,000 shares
of the Company's common stock are reserved for the granting of incentive stock
options and nonqualified stock options, and the sale of restricted common stock
to the Company's key employees and non-employee directors. Options may not be
granted at a price that is less than fair market value on the date of grant, as
determined by the Company's Board of Directors, while restricted common stock
may be sold at any price. Options generally vest over 36 months and must be
exercised within 10 years from the date of grant. During 1996, the Company
adopted the 1996 Non-Employee Directors Stock Option Plan under which eligible
directors will automatically receive initial option grants to purchase 25,000
shares upon joining the Company's board of directors and additional option
grants to purchase 10,000 shares after each subsequent annual meeting of the
Company's stockholders. For financial reporting purposes, compensation expense,
representing the excess of the deemed value for accounting purposes of the stock
issuable upon exercise of the options over the aggregate exercise price of such
options, amounting to $50,000, was deferred in 1992 and was amortized over the
vesting periods of the respective option grants. This compensation expense was
fully amortized at December 30, 1995. During 1997 and 1996, the Company
recognized $72 thousand and $9 thousand, respectively, of compensation expense
related to the issuance of stock options to non-employees. There was no such
expense for the year 1995.

The following is a summary of the activity under the Company's stock option
plans:
<TABLE>
<CAPTION>

Number of Shares Option Price
Under Option per Share
--------------------------------------------

<S> <C> <C>
Options outstanding at December 31, 1994 288,816 $0.33 - 12.00
Granted 737,700 6.41 - 15.17
Exercised (24,055) 0.87 - 8.83
Canceled (95,007) 6.41 - 11.17
--------------------------------------------

Options outstanding at December 30, 1995 907,454 0.33 - 15.17
Granted 1,841,175 3.69 - 15.00
Exercised (15,010) 0.33 - 6.59
Canceled (1,080,886) 0.33 - 15.17
--------------------------------------------

Options outstanding at December 28, 1996 1,652,733 0.33 - 15.17
Granted 958,450 0.75 - 4.81
Exercised (1,500) 0.88
Canceled (1,891,326) 0.88 - 15.17
--------------------------------------------

Options outstanding at December 27, 1997 718,357 0.33 - 14.25
Granted - -
Exercised - -
Canceled - -
--------------------------------------------

Options outstanding at December 26, 1998 718,357 0.33 - 14.25
Granted - -
Exercised - -
Canceled - -
--------------------------------------------

Options outstanding at December 25, 1999 718,357 0.33 - 14.25
Granted - -
Exercised - -
Canceled - -
--------------------------------------------
</TABLE>

The weighted average option price per share was $4.77, $4.77, $4.77, $6.40 and
$7.15 for options outstanding at December 25, 1999, December 26, 1998, December
28, 1997 and December 28, 1996, respectively.

Information relating to stock options at December 25, 1999 summarized by
exercise price is as follows:

28
<PAGE>
<TABLE>
<CAPTION>

Range of Options Outstanding Options Exercisable
Exercise Prices Weighted Average Weighted Average
Per Share Shares Life (Year) Exercise Price Shares Exercise Price
- ------------------------------------------------------------------------------------------------------------

<S> <C> <C> <C> <C> <C>
$0.33 to $5.50 325,691 8.54 2.63 167,524 $2.64
$6.00 to $6.00 260,166 8.73 6 234,499 6
$6.25 to $6.25 25,000 8.77 6.25 8,333 6.25
$6.41 to $6.41 9,000 7.02 6.41 6,000 6.41
$6.59 to $8.83 91,500 7.17 7.76 85,000 7.85
$11.00 to $11.00 4,250 7.61 11 4,000 11
$14.25 to $14.25 2,750 8.11 14.25 916 14.25
0 0
------------------------------------------------------------------------------------------
$0.33 to $14.25 718,357 8.42 4.77 506,272 $5.26

==========================================================================================
</TABLE>

In addition, the Company has an employee stock purchase plan which allows
employees to purchase directly from the Company shares of the Company's common
stock at a 15% discount from the market price, and to pay the purchase price in
installments by payroll deductions. The Company has reserved 150,000 shares for
granting under the employee stock purchase plan. During 1997, 83,906 shares of
common stock were purchased under this plan at an average price of $1.41. During
1996 and 1995, 19,737 and 14,938 shares of common stock were purchased under
this plan at average prices of $4.95 and $9.04, respectively, prior to
considering the impact of the stock dividend. As of December 28, 1996, the
Company's employee stock purchase plan liability (included under the caption
"Payroll Related Liabilities" in the accompanying balance sheets) totaled
$230,000. There was no such liability as of December 25, 1999 or December 26,
1998.

Statement of Financial Accounting Standards No. 123 ("FAS 123"), "Accounting for
Stock-Based Compensation," requires the Company to provide pro forma information
regarding net income and earnings per share as if such compensation cost for the
Company's stock option and purchase plans had been determined in accordance with
the fair value based method prescribed in FAS 123. The Company estimates the
fair value of each stock option at the grant date by using the Black-Scholes
option-pricing model with the following weighted-average assumptions used for
grants in 1997, 1996 and 1995, respectively: 0% dividend yield; expected
volatility of 30%, 19% and 19%; respectively, risk free interest rates of 5.45%,
6.37% and 6.92%; respectively, and expected lives of 3 years. For purpose of
calculating compensation cost in 1997, the offsetting effect of significant
cancellations of options granted in prior years would have resulted in a
decrease in the net loss and a decrease in the net loss per share on a pro forma
basis. This is because the effect of actual forfeitures are recognized as they
occur. Accordingly, the actual net loss and pro forma net loss for 1997 are the
same. There were no grants in 1999.

Under the accounting provisions of FAS 123, the Company's net loss and net loss
per share for 1997 would remain unchanged and the net loss and net loss per
share for 1996 would have been increased to the pro forma amounts indicated
below:

NET LOSS: FOR THE YEARS
1999 1998 1997
-----------------------------------------

(IN THOUSANDS EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
As Reported ($3,002) ($4,556) ($30,229)
Pro forma ($3,002) ($4,556) ($30,229)

Net Loss per share: ($0.21) ($0.31) ($2.32)
Pro forma ($0.21) ($0.31) ($2.32)

</TABLE>

7. INCOME TAXES

Income tax expense (benefit) consists of the following:

UNAUDITED UNAUDITED UNAUDITED
1999 1998 1997
--------------------------------------------
(IN THOUSANDS)
Current:
State - - $41
Foreign - - 19
--------------------------------------------
- - $57
Deferred:
State - - -
Federal - - -
--------------------------------------------
- - $57

8. COMMITMENTS AND CONTINGENCIES

Legal Proceedings

The Company is also subject to other legal proceedings and claims which arise in
the normal course of business. While the outcome of these proceedings cannot be
predicted

29
<PAGE>

with certainty, the Company does not believe that the outcome of these other
legal matters will have a material adverse effect on the Company's financial
statements.

Operating Leases

The Company leases its facilities and equipment under various noncancellable
operating leases for terms of up to four years. Future minimum lease payments
under these leases as of December 25, 1999 are as follows:

(UNAUDITED)
(in thousands)

2000 $8.2
2001 8.2
--------
$16.4
--------

9. EMPLOYEE BENEFITS

The Company maintains an elective retirement savings plan which is intended to
qualify under Section 401(k) of the Internal Revenue Code. Participating
employees are allowed to contribute up to 15% of their cash compensation. The
Company can make contributions to the plan at the discretion of management.
There were no contributions to the plan in 1999,1998 or 1997. The year 1996 was
the first year of the plan.

10. MAJOR CUSTOMERS, EXPORT SALES AND GEOGRAPHIC SEGMENT INFORMATION

In 1999 and 1998 the Company's sales were spread over various customers and no
one customer made up more than 10% of net sales. Most of the Company's sales and
assets are located in the United States.

11. SUBSEQUENT EVENTS

30
<PAGE>

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

PINNACLE MICRO, INC.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.

APRIL 20, 2000 BY: /s/ WILLIAM F. BLUM
- -------------- -----------------------

Date William F. Blum
Chairman, President, Chief Executive Officer and
Chief Financial Officer and Chief Accounting
Officer and a Director

<ARTICLE> 5
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> Dec-25-1999
<PERIOD-START> Dec-27-1998
<PERIOD-END> Dec-25-1999
<CASH> 489
<SECURITIES> 0
<RECEIVABLES> 232
<ALLOWANCES> 0
<INVENTORY> 3378
<CURRENT-ASSETS> 4201
<PP&E> 74
<DEPRECIATION> 0
<TOTAL-ASSETS> 4275
<CURRENT-LIABILITIES> 27298
<BONDS> 0
0
0
<COMMON> 15
<OTHER-SE> (23038)
<TOTAL-LIABILITY-AND-EQUITY> 4275
<SALES> 6566
<TOTAL-REVENUES> 6566
<CGS> 5641
<TOTAL-COSTS> 3572
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 355
<INCOME-PRETAX> (3002)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3002)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3002)
<EPS-BASIC> (0.21)
<EPS-DILUTED> (0.21)

</TABLE>