<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-Q/A
AMENDMENT NO. 1
(Mark One)
[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the quarterly period ended September 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 0-26100
----------------
DISCREET LOGIC INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Quebec 98-0150790
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification Number)
</TABLE>
10 Duke Street Montreal, Quebec, Canada H3C 2L7
(Address of principal executive offices) (Zip code)
(514) 393-1616
(Registrant's telephone number, including area code)
----------------
Indicate by check mark whether 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 [_]
29,882,793 shares of the registrant's Common Shares, without par value, were
outstanding as of November 9, 1998.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
FORM 10-Q
For The Quarter Ended September 30, 1998
CONTENTS
<TABLE>
<CAPTION>
Item Number Page
----------- ----
<C> <S> <C>
PART I: FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Balance Sheets............................................. 3
Statements of Operations................................... 4
Statements of Cash Flows................................... 5
Notes to Condensed Consolidated Financial Statements....... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 12
PART II: OTHER INFORMATION
Item 1. Legal Proceedings.......................................... 20
Item 6. Exhibits and Reports on Form 8-K........................... 20
SIGNATURES.............................................................. 21
</TABLE>
2
<PAGE>
PART I
DISCREET LOGIC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(All Amounts in Thousands of U.S. Dollars, Except for Share Data)
<TABLE>
<CAPTION>
June 30, September 30,
1998 1998
---------- -------------
(Unaudited)
(Restated) (Restated)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents........................... $ 46,459 $ 46,838
Accounts receivable (less reserves for doubtful
accounts).......................................... 32,102 27,346
Inventory--
Resale............................................ 7,881 10,187
Demonstration..................................... 4,776 5,287
Other current assets................................ 4,719 6,411
-------- --------
95,937 96,069
Property and equipment--less accumulated depreciation
and amortization..................................... 9,576 8,970
Deferred income taxes................................. 878 752
Other assets.......................................... 25,636 23,207
Assets held for resale................................ 4,384 4,473
-------- --------
$136,411 $133,471
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Borrowings under line of credit..................... $ 2,713 $ 2,803
Accounts payable and accrued expenses............... 36,099 33,268
Deferred revenue.................................... 6,545 6,593
Income taxes payable................................ 9,883 7,338
Customer deposits................................... 288 477
-------- --------
55,528 50,479
Government loan..................................... -- 1,834
Deferred income taxes............................... 2,229 2,843
-------- --------
57,757 55,156
-------- --------
Shareholders' Equity:
Preferred shares--no par value
Authorized--unlimited number of shares
Issued and outstanding--none
Common shares--no par value
Authorized--unlimited number of shares
Issued and outstanding--29,617,504 shares at June
30, 1998 and 29,852,253 at September 30, 1998.... 107,748 108,862
Accumulated deficit................................. (24,163) (24,914)
Deferred compensation............................... (907) (699)
Cumulative translation adjustment................... (4,024) (4,934)
-------- --------
Total shareholders' equity........................ 78,654 78,315
-------- --------
$136,411 $133,471
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(All Amounts in Thousands of U.S. Dollars, Except for Per Share Data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
-------------------------------
September 30, September 30,
1997 1998
------------- -------------
(Restated) (Restated)
<S> <C> <C> <C>
Total revenues................................. $38,405 $27,431
Cost of revenues............................... 17,280 12,759
------- -------
Gross profit................................. 21,125 14,672
------- -------
Operating expenses:
Research and development (net of tax
credits).................................... 3,512 3,750
Sales and marketing.......................... 7,433 7,914
General and administrative................... 3,605 4,442
Charge for purchased research and
development................................. 5,269 --
------- -------
Total operating expenses................... 19,819 16,106
------- -------
Operating income (loss).................... 1,306 (1,434)
Other income net............................... 377 1,547
------- -------
Income before income taxes................... 1,683 113
Provision for income taxes..................... 2,775 863
------- -------
Net loss..................................... $(1,092) $ (750)
======= =======
Loss per share:
Basic........................................ $ (0.04) $ (0.03)
======= =======
Diluted...................................... $ (0.04) $ (0.03)
======= =======
Weighted average common shares outstanding:
Basic........................................ 28,659 29,681
======= =======
Diluted...................................... 28,659 29,681
======= =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(All Amounts in Thousands of U.S. Dollars)
(Unaudited)
<TABLE>
<CAPTION>
September 30, September 30,
1997 1998
------------- -------------
(Restated) (Restated)
<S> <C> <C>
Cash flows from operating activities:
Net loss......................................... $ (1,092) $ (750)
Adjustments to reconcile net loss to cash used
in operating activities--
Depreciation and amortization.................. 3,718 4,449
Deferred income taxes.......................... 1,369 740
Write-off of in-process research and
development................................... 5,269 --
Write-off of assets related to restructuring... 109 --
Compensation expense related to stock options.. 167 183
Changes in assets and liabilities--
Restricted cash.............................. (10,800) --
Accounts receivable.......................... (1,704) 4,756
Inventory.................................... (275) (2,996)
Income taxes receivable...................... 448 --
Other current assets......................... (1,276) (1,692)
Accounts payable and accrued expenses........ (2,644) (3,059)
Insurance proceeds related to class action
litigation.................................. 3,459 --
Deferred revenue............................. 936 48
Income taxes payable......................... 211 (2,544)
Customer deposits............................ (930) 189
-------- -------
Net cash used in operating activities.......... (3,035) (676)
-------- -------
Cash flows from investing activities:
Purchase of property and equipment............... (2,323) (976)
Increase in other assets......................... -- (231)
Proceeds on disposal of assets held for resale... 818 --
Cash paid for D-Vision acquisition and related
costs........................................... (10,342) --
-------- -------
Net cash used in investing activities.......... (11,847) (1,207)
-------- -------
Cash flows from financing activities:
Proceeds from line of credit..................... -- 90
Proceeds from government loan.................... -- 2,061
Proceeds from the exercise of stock options...... 506 831
Proceeds from employee stock purchase plan....... 217 308
-------- -------
Net cash provided by financing activities...... 723 3,290
-------- -------
Foreign exchange effect on cash................... (987) (1,028)
-------- -------
(Decrease) increase in cash and cash equivalents.. (15,146) 379
Unrestricted cash and cash equivalents, beginning
of period........................................ 31,668 46,459
-------- -------
Unrestricted cash and cash equivalents, end of
period........................................... $ 16,522 $46,838
======== =======
Supplemental disclosure of cash flow information:
Interest paid during the period.................. $ 21 $ 20
-------- -------
Income taxes paid during the period.............. $ 2,110 $ 2,425
-------- -------
In connection with the acquisition of D-Vision in
July 1997, the following non-cash transaction
occurred:
Fair value of assets acquired................ $ 27,210 --
Liabilities assumed.......................... (5,811) --
Cash acquired................................ (408) --
Issuance of 555,000 shares of Common Stock... (10,649) --
-------- -------
Cash paid for acquisition, net of cash acquired... $ 10,342 --
======== =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared by Discreet Logic Inc. ("Discreet" or the "Company") pursuant to
the rules and regulations of the Securities and Exchange Commission regarding
interim financial reporting. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements and should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
Annual Report on Form 10-K for the year ended June 30, 1998. The accompanying
condensed consolidated financial statements reflect all adjustments
(consisting solely of normal, recurring adjustments) which are, in the opinion
of management, necessary for a fair presentation of results for the interim
periods presented. The results of operations for the three-month period ended
September 30, 1998 are not necessarily indicative of the results to be
expected for any other interim period or for the full fiscal year.
Restatement of Financial Statements
In connection with the proposed merger of the Company and Autodesk, Inc., a
Form S-4 (registration no. 333-65075) was filed with The Securities and
Exchange Commission ("SEC"). Subsequent to the SEC's letter to the American
Institute of Certified Public Accountants ("AICPA") dated September 9, 1998
regarding the SEC's views on in-process research and development, the Company
has increased the allocation of the purchase price to "Goodwill" and has
decreased the allocation to the "Write-off of purchased research and
development" for its acquisitions of Denim Software in fiscal 1997 and D-
Vision Systems and Lightscape Technologies, Inc. in fiscal 1998.
The revised allocation of the aggregate purchase price is as follows:
<TABLE>
<CAPTION>
As reported As restated
----------- -----------
<S> <C> <C>
In-process research and development................. $36,600,000 $ 9,178,000
Acquired technology................................. 5,553,991 5,553,991
Goodwill............................................ 1,328,753 28,750,753
Fair value of tangible assets acquired.............. 3,526,651 3,526,651
----------- -----------
$47,009,395 $47,009,395
=========== ===========
</TABLE>
The effect of these adjustments on previously reported consolidated
financial statements for the three-month periods ended September 30, 1997 and
1998 is as follows (in thousands):
<TABLE>
<CAPTION>
1997 1998
------------------ -----------------
As As As As
reported restated reported restated
-------- -------- -------- --------
<S> <C> <C> <C> <C>
General and administrative........... $ 1,884 $ 3,605 $2,157 $ 4,442
Charge for purchased research and
development......................... $ 21,000 $ 5,269 $ -- $ --
Operating income (loss).............. $(12,704) $ 1,306 $ 851 $(1,434)
Net income (loss).................... $(15,102) $(1,092) $1,535 $ (750)
Basic earnings (loss) per share...... $ (0.53) $ (0.04) $ 0.05 $ (0.03)
Diluted earnings (loss) per share.... $ (0.53) $ (0.04) $ 0.05 $ (0.03)
</TABLE>
(2) Proposed Merger with Autodesk, Inc.
On August 20, 1998, the Company announced that it had entered into a
definitive agreement providing for the acquisition of the Company by Autodesk,
Inc. ("Autodesk"). Under the terms of the agreement, Discreet
6
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
shareholders would receive 0.525 shares of Autodesk common stock for each
outstanding share of common stock of Discreet. The transaction is intended to
be accounted for as a pooling of interests. Subject to several conditions,
including approval of the shareholders of both companies, the transaction is
expected to close by December 31, 1998. Until this transaction is finalized,
both companies shall operate as separate entities.
(3) Litigation and Related Settlement Expenses
(a) Class action securities litigation
On May 29, 1996, June 13, 1996 and April 29, 1997, certain of the Company's
shareholders filed class action lawsuits alleging violations of federal
securities laws and other claims against the Company and certain of its
officers and directors among others. The three lawsuits were filed in the
Superior Court of the State of California, the United States District Court,
District of Massachusetts and the United States District Court, Northern
District of California, respectively. On or about November 25, 1997, a
settlement of all three shareholder class actions received final court
approval. Under the $10,800,000 settlement, the Company contributed
approximately $7,400,000 from its own funds, with the remainder provided by
insurance.
In the year ended July 31, 1996, the Company had provided a $2,506,000
litigation reserve for legal costs associated with defending the class action
lawsuits. During the eleven-month period ended June 30, 1997, the Company
recorded a provision of $6,500,000 to accrue the additional estimated
settlement costs to be borne by the Company.
In the twelve-month period ended June 30, 1998, the Company reversed
$405,000 of litigation and related settlement expenses in order to adjust
previously estimated legal costs to the actual amount of costs incurred.
(b) Griffith & Tekushan, Inc.
On June 2, 1998, the Company was named as a defendant in a breach of
warranty action filed in the Supreme Court of the State of New York for the
County of New York entitled Griffith & Tekushan, Inc. v. Discreet Logic, Inc.
(Index No. 602684/98) (the "Action"). The complaint alleges, among other
things, that the Company breached certain warranties arising out of a software
licensing agreement and seeks damages of $1 million. On July 10, 1998, the
Action was removed from state court to the United States District Court for
the Southern District of New York (Case No. 98 Civ. 4909 (BSJ)). On July 17,
1998, the Company filed a motion to dismiss the Action in its entirety. The
motion to dismiss is currently pending. The Company intends to contest this
case vigorously; however, the ultimate outcome of the case cannot be predicted
at this time.
(c) Class Action Litigation
On August 28, 1998, a complaint was filed in the Marin County, California,
Superior Court, entitled Jerry Krim, on Behalf of Himself and All Others
Similarly Situated, vs. Discreet Logic Inc., et al., case No. 174792. The
lawsuit relates to the proposed merger transaction with Autodesk and names as
defendants Discreet, Discreet's directors and certain unidentified "John
Does." The complaint alleges that the defendants breached their fiduciary
duties to shareholders in connection with the proposed merger transaction. The
complaint asks the court to enjoin the closing of the transaction or,
alternatively, seeks to rescind the transaction or an award of unspecified
damages from the defendants in the event the transaction is consummated.
Discreet believes the claims asserted in the complaint are without merit and
intends to vigorously contest them. On October 26, 1998, the Company filed
motions to dismiss the action, which currently are pending.
7
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On September 29, 1998, a complaint was filed in the Marin County,
California, Superior Court, entitled William Clark, et al vs. Discreet Logic
Inc., et al., case No.175037. The lawsuit relates to the proposed merger
transaction with Autodesk and names as defendants Discreet, certain of
Discreet's directors and certain unidentified "John Does." The complaint
alleges that the defendants breached their fiduciary duties to shareholders in
connection with the proposed merger transaction. The complaint asks the court
to enjoin the closing of the transaction or, alternatively, seeks to rescind
the transaction or an award of unspecified damages from the defendants in the
event the transaction is consummated. Discreet believes the claims asserted in
the complaint are without merit and intends to vigorously contest them.
(4) Earnings Per Share
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 128, Earnings per
Share. The new standard simplifies the computation of earnings per share (EPS)
and increases comparability to international standards. Under SFAS No. 128,
primary EPS is replaced by "Basic" EPS, which excludes dilution and is
computed by dividing income available to common shareholders by the weighted
average number of common shares outstanding for the period. "Diluted" EPS,
which is computed similarly to fully diluted EPS, reflects the potential
dilution that could occur if securities or other contracts to issue common
stock were exercised or converted into common stock. The Company is required
to disclose both basic and diluted EPS. All prior period EPS data have been
restated to conform to SFAS No. 128.
The following table presents, in thousands (except for EPS amounts), a
reconciliation of Basic EPS to Diluted EPS as required by SFAS No. 128:
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
September 30, 1997 September 30, 1998
---------------------- ---------------------
(Restated) (Restated)
Income Shares EPS Income Shares EPS
------- ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Income available to Common
Shareholders................... $(1,092) 28,659 $(0.04) $(750) 29,681 $(0.03)
====== ======
Effect of Dilutive Securities
Impact of exercise of stock
options under treasury stock
method......................... -- -- -- --
------- ------ ------ ----- ------
Diluted EPS
Income available to Common
Shareholders and assumed
exercises...................... $(1,092) 28,659 $(0.04) $(750) 29,681 $(0.03)
======= ====== ====== ===== ====== ======
</TABLE>
In accordance with SFAS No. 128, in periods that the Company incurs a net
loss, all outstanding options are excluded from the calculation of diluted
EPS. 2,297,000 and 760,000 options were excluded from the computation of
diluted EPS for the three-month periods ended September 30, 1997 and 1998,
respectively, because they were anti-dilutive.
(5) Related Party Purchases
During the quarter ended September 30, 1998, the Company purchased marketing
services in the amount of $244,000 from Behaviour Design Inc. As of September
30, 1998, a receivable of approximately $287,000, from previous sales to
Behaviour Entertainment, Inc. and Behaviour Studios, Inc., is outstanding in
other current assets. These related parties are companies controlled by the
Company's Chairman and Chief Executive Officer.
8
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
During the quarter ended September 30, 1998, the Company made rental
payments in the amount of $387,000 to TGR Zone Corporation ("TGR Zone"), a
company indirectly owned by Discreet Logic's Chairman and Chief Executive
Officer, for space in its new headquarters in Montreal. The Company made
payments of $204,000 for the same period last year.
In accordance with the Company's policy, the purchase of these services was
on terms no less favorable to the Company than could be obtained by the
Company from unrelated third parties.
(6) Recent Accounting Pronouncements
a) In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130, Reporting
Comprehensive Income (SFAS 130), which establishes standards for the
presentation and disclosure requirements for comprehensive income. SFAS 130
became effective or fiscal years beginning after December 15, 1997.
Effective July 1, 1998, Discreet adopted SFAS 130.
The Company's total comprehensive income was as follows for the periods
presented herein:
<TABLE>
<CAPTION>
Three-Months Three Months
Ended Ended
September 30, 1997 September 30, 1998
------------------ ------------------
(Restated) (Restated)
<S> <C> <C>
Net loss............................. $(1,092) $ (750)
Foreign currency translation
adjustment.......................... $(1,012) $ (911)
------- -------
Total comprehensive loss............. $(2,104) $(1,661)
======= =======
</TABLE>
b) In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, Disclosures about Segments of an Enterprise and Related
Information (SFAS 131), which establishes standards for the way public
business enterprises report information in annual statements and interim
financial reports regarding operating segments, products and services,
geographic areas, and major customers. SFAS 131 will first be reflected in
the Company's fiscal year 1999 Annual Report and will apply to both annual
and interim financial reporting subsequent to this date. The Company is
currently evaluating the impact of SFAS 131 on its financial disclosures.
c) In June 1998, the FASB issued SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities". This statement requires companies to
record derivatives on the balance sheet as assets or liabilities, measured
at fair value. Gains or losses resulting from changes in the values of
those derivatives would be accounted for depending on the use of the
derivative and whether it qualifies for hedge accounting. SFAS 133 will be
effective for the Company's fiscal year ending June 30, 2000. Management
believes that this statement will not have a significant impact on the
Company.
d) In March 1998, the AICPA issued Statement of Position (SOP) 98-4, which
amends certain provisions of SOP 97-2. The Company believes it is in
compliance with the provisions of SOP 97-2 as amended by SOP 98-4. However,
detailed implementation guidelines for this standard have not been issued.
Once issued, such guidance could lead to unanticipated changes in the
Company's current revenue recognition practices, and such changes could be
material to the Company's results of operations.
e) In March 1998, the Accounting Standards Executive Committee issued
Statement of Position (SOP) 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. This standard requires
companies to capitalize qualifying computer software costs which are
incurred during the
9
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
application development stage and amortize them over the software's
estimated useful life. The Company is required to adopt this standard in
fiscal year 2000 and is currently evaluating the impact that its adoption
will have on the consolidated financial position and results of operations
of the Company.
(7) Demand Line of Credit, Leasing and Tax Credit Facilities
The Company has a revolving demand line of credit and leasing facility
agreement with its bank. This agreement provides for a revolving demand line
of credit under which it can borrow up to Cdn$7,000,000 (approximately
$4,580,000 at September 30, 1998). Advances under the line accrue interest
monthly at the Canadian prime rate (7.25% at September 30, 1998) plus 0.25%.
Additionally, the agreement provides for a Cdn$600,000 (approximately $393,000
at September 30, 1998) demand leasing facility, and a Cdn$600,000
(approximately $393,000 at September 30, 1998) demand research and development
tax credit facility. Advances under these facilities accrue interest monthly
at the Canadian prime rate (7.25% at September 30, 1998) plus 1%. The line and
facilities are secured by essentially all of the Company's North American
assets. As additional security, the Company assigned to the bank its insurance
on these assets. The Company is required to maintain certain financial ratios,
including minimum levels of working capital, debt service coverage and equity
to asset ratios. As of September 30, 1998, there were no amounts outstanding
under the demand leasing and demand research and development tax credit
facilities, however, the amount available to the Company under the line of
credit was reduced by the letter of guarantee discussed below.
The Company's Japanese subsidiary has a line of credit agreement with its
bank. Under this agreement, the subsidiary can borrow up to $3,000,000.
Advances under this line accrue interest at the prevailing overnight rate for
the period (approximately 2.1% at September 30, 1998) and are secured by a
letter of guarantee, in the amount of $3,000,000, issued by the Company in
favor of the subsidiary's bank. As of September 30, 1998, the subsidiary had
borrowed (Yen)378,784,000 (approximately $2,803,000 at September 30, 1998).
(8) Government Assistance
(a) SDI loan
The Company entered into a loan agreement with the Societe de Developpement
Industriel du Quebec dated as of May 7, 1998 whereby an interest free loan was
granted to the Company by the Quebec government in the amount of Cdn$2,800,000
(approximately $1,834,000 at September 30, 1998) in relation with the
acquisition of Lightscape Technologies, Inc.. The loan is conditional to the
Company meeting certain criteria:
1. During the five year period following the disbursement of the loan by
the Quebec government, the Company is required to create 200 jobs and
maintain each of these jobs for a five year period after their creation;
2. The loan should not exceed Cdn$2,800,000 or 20% of the costs incurred by
the Company for the Lightscape acquisition. The loan is payable in four
annual installments of Cdn$600,000 (approximately $393,000 at September
30, 1998) commencing in July 2004 and a final installment of Cdn$400,000
(approximately $262,000 at September 30, 1998) in July 2008. The loan is
interest free until July 2004, after which it will bear interest at the
Canadian prime rate (approximately 7.25% at September 30, 1998) plus
1.5%. If the criteria mentioned above are not respected, a portion of
the loan may have to be repaid at an earlier date. The loan was
disbursed to the Company in July 1998 and is included as a component of
accounts payable and accrued expenses as at September 30, 1998.
10
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(b) PACST Subsidy Program
The Company entered into a financial assistance contract with the Quebec
Government dated as of March 27, 1998 under a subsidy program designed to
improve competencies in science and technology. The contract provides that the
Company is eligible to receive up to Cdn$3,012,000 (approximately $1,971,000
at September 30, 1998) in the form of reimbursement of expenses incurred by
the Company for new employee training (mainly reimbursement of salary). The
Company's job creation estimate provided to the Quebec Government at the time
of signature of the contract was 251 science and technology related jobs to be
created over a three-year period. As of June 30, 1998, an advance of
Cdn$350,000 (approximately $229,000 at September 30, 1998) was received which
covers 40% of the first year estimated subsidy. The program requires the
Company to meet certain criteria in order to earn the subsidies. Since the
criteria have not yet been met by the Company, the advance has been included
as a component of accounts payable and accrued expenses as at September 30,
1998.
(9) Restructuring
During fiscal 1996, the Company recorded a pre-tax restructuring charge of
$15,000,000 to cover the direct costs of restructuring its operations. The
following amounts were charged against the restructuring reserve:
<TABLE>
<CAPTION>
Three Months Three Months
Ended Ended
September 30, 1997 September 30, 1998
------------------ ------------------
<S> <C> <C>
Asset write down..................... $ 118,000 $ --
Lease terminations and leasehold
improvements reserve................ 88,000 --
Severance............................ 49,000 --
Professional services and other...... 124,000 21,000
---------- --------
$ 379,000 $ 21,000
========== ========
The following reflects the remaining accrued restructuring expense as of
September 30, 1997 and 1998, by major component:
<CAPTION>
September 30, September 30,
1997 1998
------------------ ------------------
<S> <C> <C>
Asset write down..................... $ 382,000 $ --
Lease terminations and leasehold
improvements reserve................ 2,575,000 350,000
Severance............................ 401,000 --
Professional services and other...... 536,000 404,000
---------- --------
$3,894,000 $754,000
========== ========
</TABLE>
During the fourth fiscal quarter of 1998, the Company accrued an additional
$829,000 charge for the closure of its U.K. research and development facility.
During the three-month period ended September 30, 1998, approximately $38,000
of professional fees was charged against this restructuring reserve. As of
September 30, 1998, the Company still has approximately $12,000 in
restructuring reserves primarily for the estimated cost of professional fees
associated with the winding down of this subsidiary.
11
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
Discreet Logic Inc. ("Discreet" or the "Company") develops, assembles,
markets and supports non-linear, on-line digital systems and software for
creating, editing and compositing imagery and special effects for film, video,
HDTV, broadcast and the Web. Discreet's systems and software are utilized by
creative professionals for a variety of applications, including feature films,
television programs, commercials, music and corporate videos, interactive game
production, live broadcasting as well as Web design. Discreet's revenues
consist of product revenues (including licensing of its software, sales of
Discreet's proprietary hardware, and resale of third party hardware) and
revenues from maintenance and other services (including consulting and
training). Effective January 1, 1998, Discreet has recognized revenue in
accordance with Statement of Position (SOP) 97-2, entitled "Software Revenue
Recognition," issued by the American Institute of Certified Public
Accountants. The adoption of SOP 97-2 has not had a material impact on revenue
recognition.
Recent Developments
Restatement of Financial Statements
In connection with the proposed merger of the Company and Autodesk, Inc., a
Form S-4 (registration no. 333-65075) was filed with The Securities and
Exchange Commission ("SEC"). Subsequent to the SEC's letter to the American
Institute of Certified Public Accountants ("AICPA") dated September 9, 1998
regarding the SEC's views on in-process research and development, the Company
has increased the allocation of the purchase price to "Goodwill" and has
decreased the allocation to the "Write-off of purchased research and
development" for its acquisitions of Denim Software in fiscal 1997 and D-
Vision Systems and Lightscape Technologies, Inc. in fiscal 1998.
The revised allocation of the aggregate purchase price is as follows:
<TABLE>
<CAPTION>
As reported As restated
----------- -----------
<S> <C> <C>
In-process research and development................. $36,600,000 $ 9,178,000
Acquired technology................................. 5,553,991 5,553,991
Goodwill............................................ 1,328,753 28,750,753
Fair value of tangible assets acquired.............. 3,526,651 3,526,651
----------- -----------
$47,009,395 $47,009,395
=========== ===========
</TABLE>
The effect of these adjustments on previously reported consolidated
financial statements for the three-month period ended September 30, 1997 and
the three month period ended September 30, 1998 is as follows:
<TABLE>
<CAPTION>
1997 1998
------------------ -----------------
As As As As
reported restated reported restated
-------- -------- -------- --------
<S> <C> <C> <C> <C>
General and adminstrative............ $ 1,884 $ 3,605 $2,157 $ 4,442
Charge for purchased research and
development......................... $ 21,000 $ 5,269 -- --
Operating income (loss).............. $(12,704) $ 1,306 $ 851 $(1,434)
Net income (loss).................... $(15,102) $(1,092) $1,535 $ (750)
Basic earnings (loss) per share...... $ (0.53) $ (0.04) $ 0.05 $ (0.03)
Diluted earnings (loss) per share.... $ (0.53) $ (0.04) $ 0.05 $ (0.03)
</TABLE>
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Proposed Transaction with Autodesk
On August 20, 1998, the Company announced that it had entered into a
definitive agreement providing for the acquisition of Discreet by Autodesk,
Inc. ("Autodesk"). Under the terms of the agreement. Discreet shareholders
would receive 0.525 shares of Autodesk common stock for each outstanding share
of common stock of Discreet. The transaction is intended to be accounted for
as a pooling of interests. Subject to several conditions, including approval
of the shareholders of both companies, the transaction is expected to close by
December 31, 1998. Until this transaction is finalized, both companies shall
operate as separate entities.
Restructurings
During the fiscal year ended July 31, 1996, excluding a restructuring charge
of $15,000,000 and its related tax effects, Discreet incurred a net loss of
approximately $31,000,000 on revenues of approximately $83,997,000. In
response to the financial results and other developments facing the business,
Discreet developed a restructuring plan during the fourth fiscal quarter of
1996. Discreet began implementation of its restructuring plan in the fourth
fiscal quarter of 1996 and had substantially completed the implementation of
the plan at the end of fiscal 1997. During the fourth fiscal quarter of 1998,
Discreet revised its estimates of remaining costs to be incurred and reversed
approximately $2,333,000 of reserves no longer considered to be necessary.
Discreet still has approximately $754,000 in restructuring reserves at the end
of September 30, 1998 primarily for the estimated cost of terminating leases,
and the legal and taxation winding down of several subsidiaries.
Discreet also recorded an unrelated restructuring charge in the fourth
fiscal quarter of 1998 in the amount of $829,000 for the estimated costs of
closing its U.K. research and development facility. As of September 30, 1998,
the closure was substantially complete and Discreet still has approximately
$12,000 in restructuring reserves primarily for the estimated cost of
professional fees associated with the winding down of this subsidiary.
Results of Operations
The following table sets forth the percentages of total revenues represented
by certain line items in the statement of operations:
<TABLE>
<CAPTION>
Three Months Ended
---------------------------
September 30, September 30,
1997 1998
------------- -------------
(Restated) (Restated)
<S> <C> <C>
Total revenues 100% 100%
Cost of revenues.................................... 45 47
--- ---
Gross profit.................................... 55 53
--- ---
Operating expenses:
Research and development.......................... 9 14
Sales and marketing............................... 20 29
General and administrative........................ 9 16
Charge for purchased research and development..... 14 --
--- ---
Total operating expenses........................ 52 59
--- ---
Operating income (loss)........................... 3 (6)
Other income net.................................... 1 6
--- ---
Income before income taxes........................ 4 --
Provision for income taxes.......................... 7 3
--- ---
Net loss........................................ (3)% (3)%
=== ===
</TABLE>
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Three Months Ended September 30, 1998 and September 30, 1997
Total Revenues. Discreet's revenues consist of product revenues (including
licensing of its software, sales of Discreet's proprietary hardware, and
resale of third party hardware) and, to a lesser extent, revenues from
maintenance and other services (including consulting and training). Effective
January 1, 1998, Discreet has recognized revenue in accordance with Statement
of Position (SOP) 97-2, entitled Software Revenue Recognition, issued by the
American Institute of Certified Public Accountants. The implementation of this
new standard did not have a material impact on the consolidated results of
operations.
Total revenues were $27,431,000 and $38,405,000 for the three-month periods
ended September 30, 1998, and September 30, 1997, respectively. Advanced
System revenues declined in all product groups while New Media revenues
increased slightly from the three-month period ended September 30, 1997. The
Company believes that the decline in Advanced System revenues is primarily due
to the following factors: (1) seasonally slower than expected sales in Europe;
(2) general market anxiety in North America causing delays in capital
spending; (3) customers deferring purchase decisions due to confusion over
HDTV timing and standards; (4) what the Company believes to be temporary
concerns in the Advanced Systems customer base regarding the acquisition of
Discreet by Autodesk which may have lead to purchasing delays; and (5) recent
changes in the Company's sales organization leadership.
Revenues from customers outside of North America were $15,796,000 (58% of
total revenues) and $18,264,000 (48% of total revenues) for the three-month
periods ended September 30, 1998, and September 30, 1997, respectively.
Although revenues in all geographical segments declined, the above factors had
a greater impact on the Company's North American revenues. As a result,
revenues from customers outside North America increased significantly as a
percentage of total revenues. The Company expects that revenues from customers
outside of North America will continue to account for a substantial portion of
its revenues and should, as a percentage of total revenues, remain
approximately the same as historical levels.
Cost of Revenues. Cost of revenues consists primarily of the cost of
hardware sold (mainly workstations manufactured by Silicon Graphics, Inc.
(SGI)), cost of hardware service contracts, cost of integration and hardware
assembly, cost of service personnel and the facilities, computing, benefits
and other administrative costs allocated to such personnel and the provision
for inventory reserves. Cost of revenues was $12,759,000 (47% of total
revenues) and $17,280,000 (45% of total revenues) for the three-month periods
ended September 30, 1998, and September 30, 1997, respectively. The increase
in cost of revenues as a percentage of total revenues was primarily due to the
presence of certain fixed expenses in cost of revenues partially offset by an
increase in the proportion of revenues from the Company's software only new
media products. Should revenues increase, the Company expects that cost of
revenues as a percentage of total revenues should decrease slightly from its
current levels. However, cost of revenues remains difficult to predict and is
subject to fluctuations due to a number of factors including product and
product configuration mix and the proportion of direct and indirect sales.
Research and Development. Research and development expenses consist
primarily of the cost of research and development personnel and the
facilities, depreciation on research and development equipment, computing,
benefits and other administrative costs allocated to such personnel, and
consulting fees. Expenditures for research and development, after deducting
Canadian federal and provincial tax credits, were $3,750,000 (13% of total
revenues) and $3,512,000 (9% of total revenues) for the three-month periods
ended September 30, 1998, and September 30, 1997, respectively. The increase
in research and development expenses was primarily due to an increase in the
number of software engineers to develop and enhance Discreet's existing and
newly acquired products and to develop new products. The increase in research
and development expenses as a percentage of total revenues is primarily due to
the decline in revenues during the three-month period ended September 30,
1998. Research and development costs are expensed as incurred. Software
development costs are considered for capitalization once technical feasibility
has been established. Discreet has not capitalized any software development
costs to date. Certain research and development expenditures are incurred
substantially in advance of related revenue and in some cases do not generate
revenues. Discreet expects that research and development
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expenses will increase from current levels, however, should revenues increase,
Discreet expects that research and development expenses as a percentage of
total revenues should decrease from current levels.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions and related benefits, facilities and administrative
costs allocated to Discreet's sales and marketing personnel, tradeshow
expenses, advertising, marketing programs and dealer commissions. Sales and
marketing expenses were $7,914,000 (29% of total revenues) and $7,433,000 (20%
of total revenues) for the three-month periods ended September 30, 1998, and
September 30, 1997, respectively. The increase in sales and marketing expenses
was primarily due to the continued expansion of the Company's direct and
indirect sales organization, including the operating costs of domestic sales
offices and foreign subsidiaries, and the introduction of marketing
initiatives designed to support the expanded dealer network. The increase in
sales and marketing expenses as a percentage of total revenues is primarily
due to the decline in revenues during the three-month period ended September
30, 1998. Discreet expects that sales and marketing expenses will increase
from current levels, however, should revenues increase, Discreet expects that
sales and marketing expenses as a percentage of total revenues should decrease
from current levels.
General and Administrative. General and administrative expenses include the
costs of finance and accounting, human resources, facilities, corporate
information systems, legal and other administrative functions of Discreet and
reserves for doubtful accounts receivable. General and administrative expenses
were $4,442,000 (16% of total revenues), as restated, and $3,605,000 (9% of
total revenues), as restated, for the three-month periods ended September 30,
1998, and September 30, 1997, respectively. The increase in general and
administrative expenses is explained by additional personnel and salary
increases and a full three months amortization, in the 1998 period, of the
goodwill associated with the D-Vision and Lightscape acquisitions which
occurred on July 15, 1997 and December 30, 1997, respectively. The increase in
general and administrative expenses as a percentage of total revenues is
primarily due to the decline in revenues during the three-month period ended
September 30, 1998 and the increased goodwill amortization charges, in the
three months ended September 30, 1998, as a result of the D-Vision and
Lightscape acquisitions. Discreet expects that general and administrative
expenses will increase from their current levels, however, should revenues
increase, Discreet expects that general and administrative expenses as a
percentage of total revenues should decrease from current levels.
Charge for Purchased Research and Development. In connection with the D-
Vision acquisition, Discreet expensed $5,269,000 as restated, based on an
appraisal, of in-process research and development that had not yet reached
technological feasibility and had no alternative use, in the three-month
period ended September 30, 1997.
Other Income. Other Income primarily consists of foreign currency gains and
losses and interest income and expense. Foreign currency translation resulted
in gains of $990,000 and of $128,000 for the three-month periods ended
September 30, 1998, and September 30, 1997, respectively. These gains are
primarily the result of Discreet and each subsidiary translating intercompany
balances denominated in a currency other than its own functional currency.
These balances are remeasured into the functional currency of each company
every reporting period. This remeasurement results in either unrealized gains
or losses depending on the exchange rate fluctuation between the functional
currency of each company and the currency in which the monetary asset or
liability is denominated. In particular during the three-month period ended
September 30, 1998, the Company recorded unrealized gains when translating
into Canadian dollars its U.S. dollar cash balance and its trade receivables
with its U.S. and German subsidiaries.
Provision for Income Taxes. Discreet's provision for income taxes was
$863,000 and $2,775,000 for the three-month periods ended September 30, 1998,
and September 30, 1997, respectively. The provision for all periods is based
upon the Canadian federal statutory rate of 38% and reflects the impact of
various tax credits and foreign taxes. The effective tax rate for the three-
month period ended September 30, 1997 differed from the statutory rate
primarily as a result of Discreet recording charges for purchased in-process
research and development for which no benefit was recorded due to the
uncertainty of realizing any future tax benefit associated with these charges,
the amortization of goodwill for which no tax benefit was recorded, offset by
the
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realization of the benefit for some prior year tax losses for which no benefit
was previously recorded. Discreet has foreign net operating loss carry
forwards which may be available to reduce future income tax liabilities.
Year 2000 Readiness Disclosure Statements
Discreet has made preliminary assessments of its products and information
systems and has determined that they are Year 2000 compliant, or that only a
limited effort will be required to achieve compliance. Discreet is currently
proceeding with detailed reviews of every application used. It is expected
that some will have to be upgraded to Year 2000 compliant applications. Some
Discreet products run on platforms, or work with peripherals that are
currently not Year 2000 compliant. Accordingly, it is expected that some
customers may experience some difficulties related to non Discreet products,
which may affect the performance of Discreet products and, therefore, lead to
an unusually high number of calls to Discreet's technical support department.
Discreet anticipates that the costs related to the detailed assessments,
application upgrades, and responding to the increased volume of support calls
will not be material to its results of operations, liquidity and capital
resources. Although management does not expect Year 2000 issues to have a
material impact on its business or future results of operations, there can be
no assurance that the potential problems described above, related to the
platforms and peripherals on and with which Discreet's products operate, will
be resolved in a timely manner, and that Discreet will not experience
significant costs or delays in developing versions of its products that are
compatible with Year 2000 compliant versions of these platforms and
peripherals.
Liquidity and Capital Resources
Discreet has funded its operations to date primarily through cash flow from
operations (including deferred revenue and customer deposits), borrowings
under its demand line of credit, capital leases, the private and public sales
of equity securities, the receipt of research and development tax credits from
the Canadian federal government and the Quebec government, and the receipt of
government grants and loans. As of September 30, 1998, Discreet had cash of
approximately $46,838,000, as restated.
Discreet's operating activities used cash of $676,000 and $3,035,000, in the
three-month periods ended September 30, 1998, and 1997, respectively. The
principal sources of cash for the three-month period ended September 30, 1998
were net income from operations, and the decrease in accounts receivable
offset by increases in inventory, and other current assets and decreases in
accounts payable and accrued expenses and income taxes payable. The decrease
in accounts receivable and the increase in inventory were primarily a result
of the shortfall in revenues during the three-month period ended September 30,
1998. The primary sources of cash during the three-month period ended
September 30, 1997, were the receipt of insurance proceeds related to the
settlement of the class action litigation, the decrease in income taxes
receivable and the increases in deferred revenue and income taxes payable,
offset by the transfer of cash to a restricted escrow account to be used to
settle the class action litigation, the increase in accounts receivable, and
the decrease in accounts payable and accrued expenses as a result of the
company paying most of the liabilities assumed in connection with the D-Vision
acquisition. Discreet's operating activities include $328,000 and $216,000 of
research and development tax credits received from the Quebec government
during the three-month periods ended September 30, 1998 and 1997,
respectively.
Discreet's investing activities used cash of $1,207,000 and $11,847,000 in
the three-month periods ended September 30, 1998, and 1997, respectively. The
principal uses of cash during the three-month period ended September 30, 1998
included the purchase of capital assets, primarily computer hardware and
software, and the acquisition of other intangible assets related to the
licensing of third-party technology. The principal uses of cash during the
three-month period ended September 30, 1997 included the acquisition of D-
Vision Systems, Inc. and the purchase of capital assets, primarily computer
hardware and software.
Financing activities provided cash of $3,290,000, as restated, and $723,000
during the three-month periods ended September 30, 1998 and 1997,
respectively. The principal sources of cash for the three-month period ended
September 30, 1998 included the receipt of a government loan from the Societe
de Developpement Industriel du Quebec, and the proceeds from the exercises of
common stock options and the issuance of shares
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under the 1995 Employee Stock Purchase Plan. The principal sources of cash for
the three-month period ended September 30, 1997 included the receipt proceeds
from the exercises of common stock options and the issuance of shares under
the 1995 Employee Stock Purchase Plan.
As of September 30, 1998, Discreet did not have any material commitments for
capital expenditures.
Discreet has never declared or paid cash dividends on its Common Shares and
does not anticipate paying any cash dividends on its Common Shares in the
forseeable future. In the event cash dividends are declared or paid, Discreet
anticipates that they would be declared and paid in U.S. dollars. Part 1A of
the Quebec Act prohibits Discreet from paying dividends that would prevent it
from discharging its liabilities when due or that would bring the book value
of its assets to an amount less than the sum of its liabilities and its issued
and paid-up share capital account.
Discreet plans to finance its long-term capital needs with cash flow from
operations and available borrowings. To the extent that such funds are
insufficient to finance Discreet's activities, Discreet may have to raise
funds to meet its operations and capital expenditure requirements through the
issuance of additional equity, or by securing additional credit facilities.
Discreet's ability to meet its future liquidity requirements is dependent upon
its ability to operate profitably or to obtain additional financing. There can
be no assurance that additional financing will be available on terms
satisfactory to Discreet or not disadvantageous to Discreet security holders.
Subject to the factors discussed in "--Certain Factors That May Affect Future
Results," Discreet believes that, with its current levels of working capital
together with funds generated from operations, it has adequate sources of cash
to meet its operations and capital expenditure requirements through fiscal
1999.
Certain Factors that may affect Future Results
Information provided by Discreet from time to time including statements in
this Form 10-Q which are not historical facts, are so-called forward-looking
statements, and are made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995 and releases of the Securities and
Exchange Commission. In particular, statements contained in the section
entitled "Management's Discussion and Analysis of Financial Condition and
Results of Operations" which are not historical facts (including, but not
limited to, statements regarding Discreet's anticipated cost of revenues,
anticipated expense levels and such expenses as a percentage of revenues, the
portion of revenues from customers outside North America and the adequacy of
cash to meet cash operations and capital expenditures, and customer concerns),
as well as statements contained in the "Legal Proceedings" section which are
not historical facts, may constitute forward-looking statements. Discreet's
actual future results may differ significantly from those stated in any
forward-looking statements. Factors that may cause such differences include,
but are not limited to, timely completion of the previously announced
transaction with Autodesk, the ability of the Company's computer systems and
products to function properly beyond 1999, the factors discussed below, other
risks discussed in this section and elsewhere in this Form 10-Q, and other
risks discussed in the Company's Annual Report on Form 10-K for the fiscal
year ended June 30, 1998, as well as from time to time in the Company's other
filings with the Securities and Exchange Commission.
Discreet's future results are subject to substantial risks and
uncertainties. Discreet's future financial performance will depend in part on
the successful development, introduction and customer acceptance of its
existing and new or enhanced products. In addition, in order for Discreet to
achieve sustained growth, the market for Discreet's systems and software must
continue to develop and Discreet must expand this market to include additional
applications within the film and video industries and develop or acquire new
products for use in related markets. There can be no assurance that Discreet
will be successful in marketing its existing or any new or enhanced products.
In addition, as Discreet enters new markets, distribution channels, technical
requirements and levels and bases of competition may be different from those
in Discreet's current markets and there can be no assurance that Discreet will
be able to develop adequate distribution channels in a timely way or compete
favorably. The markets in which Discreet competes are characterized by intense
competition and many of Discreet's current and prospective competitors have
significantly greater financial, technical, manufacturing and marketing
resources than Discreet. These companies may introduce additional products
that are competitive with
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those of Discreet, and there can be no assurance that Discreet's products
would compete effectively with such products. Furthermore, competitive
pressures or other factors, including Discreet's entry into new markets, may
result in significant price erosion that could have a material adverse effect
on Discreet's business and results of operations. Discreet has recently
completed the purchase of certain products and technology through
acquisitions. There can be no assurance that the products and technologies
acquired from these companies will be successful or will achieve market
acceptance, or that Discreet will not incur disruptions and unexpected
expenses in integrating the operations of the acquired businesses with those
of Discreet. Discreet has recently announced a proposed business combination
with Autodesk. This transaction may cause a diversion of senior management
time and attention, customer purchase decision deferrals, employee turnover,
and other unanticipated costs which may have a material adverse affect on
Discreet's results of operations.
Discreet's flame*, effect*, inferno*, fire*, smoke* and frost* systems
currently include workstations manufactured by SGI. There are significant
risks associated with this reliance on SGI and Discreet may be impacted by the
timing of the development and release of products by SGI, as was the case
during fiscal 1996. In addition, there may be unforeseen difficulties
associated with adapting Discreet's products to future SGI products. Discreet
derives a significant portion of its total revenues from foreign sales.
Foreign sales are subject to significant risks, including unexpected legal,
tax and exchange rate changes (including the recent currency volatility in
Asia) and other barriers. In addition, foreign customers may have longer
payment cycles and the protection of intellectual property in foreign
countries may be more difficult to enforce. Discreet currently relies
principally on unregistered copyrights and trade secrets to protect its
intellectual property. Any invalidation of Discreet's intellectual property
rights or lengthy and expensive defense of those rights could have a material
adverse effect on Discreet. Discreet receives letters from third parties, from
time to time, inquiring about Discreet's products and discussing intellectual
property matters, which Discreet reviews to determine the appropriate
response, if any. For example, Discreet received a letter from Avid stating
its belief that certain of Discreet's recently acquired D-Vision products
practice inventions claimed in a patent on a media editing system. Discreet
has responded to Avid's letter stating Discreet's belief that Discreet is not
infringing any valid claim of Avid's patent. To Discreet's knowledge, Avid has
not initiated any suit, action or other proceeding alleging any infringement
by Discreet of such patent. Discreet currently markets its systems through its
direct sales organization and through distributors. This marketing strategy
may result in distribution channel conflicts as Discreet's direct sales
efforts may compete with those of its indirect channels. Discreet currently
relies on SGI as the sole source for video input/output cards used in
Discreet's systems. An interruption of the supply or increase in the price of
these components could have a material adverse effect on Discreet's business
and results of operations. To date, Discreet has depended to a significant
extent upon a number of key management and technical employees and Discreet's
ability to manage its operations will require it to continue to recruit and
retain senior management personnel and to motivate and effectively manage its
employee base. The loss of the services of one or more of these key employees
could have a material adverse effect on Discreet's business and results of
operations. There can be no assurance that these factors will not have a
material adverse effect on Discreet's future international sales and
consequently, on Discreet's business and results of operations.
The market price of Discreet Common Shares could be subject to significant
fluctuations in response to quarter-to-quarter variations in Discreet's
operating results, announcements of technological innovations or new products
by Discreet, its competitors or suppliers and other events or factors. In
addition, the stock market in recent years has experienced extreme price and
volume fluctuations that have particularly affected the market prices of many
technology companies and that have often been unrelated or disproportionate to
the operational performance of these companies. These fluctuations, as well as
general economic and market conditions, may materially and adversely affect
the market price of Discreet Common Shares.
The Company believes that its operating results could vary significantly
from quarter to quarter. A limited number of systems sales may account for a
substantial percentage of the Company's quarterly revenue because of the high
average sales price of such systems and the timing of purchase orders.
Historically, the Company has generally experienced greater revenues during
the period following the completion of the annual conference of the National
Association of Broadcasters ("NAB"), which is typically held in April. The
Company's expense
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levels are based, in part, on its expectations of future revenues. Therefore,
if revenue levels are below expectations, particularly following NAB, the
Company's operating results are likely to be adversely affected as was the
case for the three-month periods ended April 30, 1996 and July 31, 1996. In
addition, the timing of revenue is influenced by a number of other factors,
including: the timing of individual orders and shipments, other industry trade
shows, competition, seasonal customer buying patterns, changes to customer
buying patterns in response to platform changes and changes in product
development and sales and marketing expenditures. Because the Company's
operating expenses are based on anticipated revenue levels and a high
percentage of the Company's expenses are relatively fixed in the short term,
variations in the timing of recognition of revenue could cause significant
fluctuations in operating results from quarter to quarter and may result in
unanticipated quarterly earnings shortfalls or losses. There can be no
assurance that the Company will be successful in maintaining or improving its
profitability or avoiding losses in any future period. The Company believes
that quarter-to-quarter comparisons of its financial results are not
necessarily meaningful and should not be relied upon as an indication of
future performance.
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PART II
Item 1. Legal Proceedings
On May 29, 1996, June 13, 1996 and April 29, 1997, certain of Discreet's
shareholders filed class action lawsuits alleging violations of federal
securities laws and other claims against Discreet and certain of its officers
and directors, among others. The three lawsuits were filed in the Superior
Court of the State of California, the United States District Court, District
of Massachusetts and the United States District Court, Northern District of
California, respectively. On or about November 25, 1997, a settlement of all
three shareholder class actions received final court approval. Under the
$10,800,000 settlement, Discreet contributed approximately $7,400,000 from its
own funds, with the remainder provided by insurance.
On June 2, 1998, the Company was named as a defendant in a breach of
warranty action filed in the Supreme Court of the State of New York for the
County of New York entitled Griffith & Tekushan, Inc. v. Discreet Logic, Inc.
(Index No. 602684/98) (the "Action"). The complaint alleges, among other
things, that the Company breached certain warranties arising out of a software
licensing agreement and seeks damages of $1 million. On July 10, 1998, the
Action was removed from state court to the United States District Court for
the Southern District of New York (Case No. 98 Civ. 4909 (BSJ)). On July 17,
1998, the Company filed a motion to dismiss the Action in its entirety. The
motion to dismiss is currently pending. The Company intends to contest this
case vigorously; however, the ultimate outcome of the case cannot be predicted
at this point.
On August 28, 1998 a complaint was filed in the Marin County, California,
Superior Court, entitled Jerry Krim, on Behalf of Himself and All Others
Similarly Situated, vs. Discreet Logic Inc., et al., case No. 174792. The
lawsuit relates to the proposed merger transaction with Autodesk and names as
defendants Discreet, Discreet's directors and certain unidentified "John
Does." The complaint alleges that the defendants breached their fiduciary
duties to shareholders in connection with the proposed merger transaction. The
complaint asks the court to enjoin the consummation of the transaction or,
alternatively, seeks to rescind the transaction or an award of unspecified
damages from the defendants in the event the transaction is consummated.
Discreet believes the claims asserted in the complaint are without merit and
intends to vigorously contest them. On October 26, 1998, the Company filed
motions to dismiss the action, which currently are pending.
On September 29, 1998, a complaint was filed in the Marin County,
California, Superior Court, entitled William Clark, et al vs. Discreet Logic
Inc., et al., case No.175037. The lawsuit relates to the proposed merger
transaction with Autodesk and names as defendants Discreet, certain of
Discreet's directors and certain unidentified "John Does." The complaint
alleges that the defendants breached their fiduciary duties to shareholders in
connection with the proposed merger transaction. The complaint asks the court
to enjoin the closing of the transaction or, alternatively, seeks to rescind
the transaction or an award of unspecified damages from the defendants in the
event the transaction is consummated. Discreet believes the claims asserted in
the complaint are without merit and intends to vigorously contest them.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
<TABLE>
<CAPTION>
Exhibit Description of Exhibit
------- ----------------------
<C> <S>
Exhibit 27.1 Financial Data Schedule.
</TABLE>
(b) Reports on Form 8-K.
A Current Report on Form 8-K dated June 8, 1998 was filed on July 13, 1998
pursuant to Item 5 of Form 8-K announcing the issuance of a press release in
which Discreet and MGI Software Corp. announced the mutual termination of
their Arrangement Agreement entered into on March 9, 1998.
20
<PAGE>
DISCREET LOGIC INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DISCREET LOGIC INC.
By: /s/ Francois Plamondon
--------------------------------
Francois Plamondon
Executive Vice President, Chief
Financial Officer, Treasurer and
Secretary
February 4, 1999
21
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
FINANCIAL STATEMENTS FOR THE THREE MONTH PERIOD ENDED SEPTEMBER 30, 1998 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-30-1998
<PERIOD-END> SEP-30-1998
<CASH> 46,838
<SECURITIES> 0
<RECEIVABLES> 31,068
<ALLOWANCES> 3,722
<INVENTORY> 15,474
<CURRENT-ASSETS> 96,069
<PP&E> 29,465
<DEPRECIATION> 16,021
<TOTAL-ASSETS> 133,471
<CURRENT-LIABILITIES> 50,479
<BONDS> 0
0
0
<COMMON> 108,862
<OTHER-SE> (30,547)
<TOTAL-LIABILITY-AND-EQUITY> 133,471
<SALES> 27,431
<TOTAL-REVENUES> 27,431
<CGS> 12,759
<TOTAL-COSTS> 12,759
<OTHER-EXPENSES> 16,106
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 19
<INCOME-PRETAX> 113
<INCOME-TAX> 863
<INCOME-CONTINUING> (750)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (750)
<EPS-PRIMARY> (0.03)
<EPS-DILUTED> (0.03)
</TABLE>
