<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended December 31, 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)
Quebec 98-0150790
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification Number)
10 Duke Street
Montreal, Quebec, Canada H3C 2L7
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (514) 393-1616
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 [_]
29,949,629 shares of the registrant's Common Shares, without par value, were
outstanding as of February 1, 1999.
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
FORM 10-Q
For The Quarter Ended December 31, 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................................... 13
PART II:OTHER INFORMATION
Item 1. Legal Proceedings........................................... 22
Item 6. Exhibits and Reports on Form 8-K............................ 22
Signatures............................................................. 24
</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, December 31,
1998 1998
---------- ------------
(Restated) (Unaudited)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents............................ $ 46,459 $ 49,767
Accounts receivable (less reserves for doubtful
accounts)........................................... 32,102 23,054
Inventory--
Resale............................................. 7,881 8,759
Demonstration...................................... 4,776 6,816
Other current assets................................. 4,719 5,530
-------- --------
95,937 93,926
Property and equipment--less accumulated depreciation
and amortization...................................... 9,576 8,988
Deferred income taxes.................................. 878 730
Other assets........................................... 25,636 21,423
Assets held for resale................................. 4,384 4,316
-------- --------
$136,411 $129,383
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Borrowings under line of credit...................... $ 2,713 $ 2,643
Accounts payable and accrued expenses................ 36,099 31,360
Deferred revenue..................................... 6,545 7,484
Income taxes payable................................. 9,883 5,646
Customer deposits.................................... 288 382
-------- --------
55,528 47,515
Government loan...................................... -- 1,828
Deferred income taxes................................ 2,229 2,955
-------- --------
Total liabilities.................................. 57,757 52,298
-------- --------
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 29,935,666 at December 31, 1998............... 107,748 109,190
Accumulated deficit.................................. (24,163) (26,801)
Deferred compensation................................ (907) (551)
Cumulative translation adjustment.................... (4,024) (4,753)
-------- --------
Total shareholders' equity......................... 78,654 77,085
-------- --------
$136,411 $129,383
======== ========
</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 Six Months Ended
------------------------- -------------------------
December 31, December 31, December 31, December 31,
1997 1998 1997 1998
------------ ------------ ------------ ------------
(Restated) (Restated)
<S> <C> <C> <C> <C>
Total revenues............. $ 37,268 $ 28,396 $ 75,673 $ 55,827
Cost of revenues........... 13,548 13,918 30,827 26,677
-------- -------- -------- --------
Gross profit............. 23,720 14,478 44,846 29,150
-------- -------- -------- --------
Operating expenses:
Research and development
(net of tax credits).... 3,901 3,600 7,413 7,350
Sales and marketing...... 8,407 8,943 15,840 16,857
General and
administrative.......... 3,951 4,161 7,556 8,603
Charge for purchased
research and
development............. 1,646 -- 6,915 --
-------- -------- -------- --------
Total operating
expenses.............. 17,905 16,704 37,724 32,810
-------- -------- -------- --------
Operating income
(loss)................ 5,815 (2,226) 7,122 (3,660)
Other income, net.......... 287 661 663 2,207
-------- -------- -------- --------
Income (loss) before
income taxes............ 6,102 (1,565) 7,785 (1,453)
Provision for income taxes. 3,097 323 5,872 1,185
-------- -------- -------- --------
Net income (loss)........ $ 3,005 $ (1,888) $ 1,913 $ (2,638)
======== ======== ======== ========
Earnings (loss) per share:
Basic.................... $ 0.10 $ (0.06) $ 0.07 $ (0.09)
======== ======== ======== ========
Diluted.................. $ 0.10 $ (0.06) $ 0.06 $ (0.09)
======== ======== ======== ========
Weighted average common
shares outstanding:
Basic.................... 28,833 29,899 28,746 29,789
======== ======== ======== ========
Diluted.................. 30,597 29,899 30,608 29,789
======== ======== ======== ========
</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>
Six Months Six Months
Ended Ended
December 31, December 31,
1997 1998
------------ ------------
(Restated)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)................................. $ 1,913 $(2,638)
Adjustments to reconcile net income (loss) to cash
used in operating activities--
Depreciation and amortization................... 7,656 8,876
Deferred income taxes........................... 2,577 874
Write-off of in-process research and
development.................................... 6,915 --
Write-off of assets related to restructuring.... 109 --
Compensation expense related to stock options... 300 331
Changes in assets and liabilities--
Settlement of class action litigations........ (10,800) --
Insurance proceeds related to class action
litigation................................... 3,459 --
Accounts receivable........................... (1,783) 9,048
Inventory..................................... 935 (3,222)
Income taxes receivable....................... 448 --
Other current assets.......................... (255) (811)
Accounts payable and accrued expenses......... (13,347) (4,740)
Deferred revenue.............................. (2,363) 939
Income taxes payable.......................... 973 (4,236)
Customer deposits............................. (933) 94
------- -------
Net cash provided by (used in) operating
activities..................................... (4,196) 4,515
------- -------
Cash flows from investing activities:
Purchase of property and equipment................ (4,350) (2,491)
Increase in other assets.......................... -- (1,346)
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........... (13,874) (3,837)
------- -------
Cash flows from financing activities:
Proceeds from government loan..................... -- 1,828
Proceeds from the exercise of stock options....... 560 1,158
Proceeds from employee stock purchase plan........ 217 308
------- -------
Net cash provided by financing activities....... 777 3,294
------- -------
Foreign exchange effect on cash..................... (1,726) (664)
------- -------
(Decrease) increase in cash and cash equivalents.... (19,019) 3,308
Cash and cash equivalents, beginning of period...... 31,668 46,459
------- -------
Cash and cash equivalents, end of period............ $12,649 $49,767
------- -------
Supplemental disclosure of cash flow information:
Interest paid during the period................... $ 46 $ 39
------- -------
Income taxes paid during the period............... $ 2,293 $ 3,391
------- -------
In connection with the acquisition of Lightscape in
December 1997, the following non-cash transaction
occurred:
Fair value of assets acquired..................... $ 7,615 $ --
Liabilities assumed............................... (7,615) --
------- -------
Cash paid for acquisition, net of cash acquired..... $ -- $ --
======= =======
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- and six-month
periods ended December 31, 1998 are not necessarily indicative of the results
to be expected for any other interim period or for the full fiscal year.
Restatement of the 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 the six-month period ended
December 31, 1997.
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 December 31, 1997, is as
follows:
<TABLE>
<CAPTION>
As
As reported restated
----------- ----------
<S> <C> <C>
General and administrative ............................. $2,012,000 $3,951,000
Charge for purchased research and development .......... $5,800,000 $1,646,000
Operating income ....................................... $3,600,000 $5,815,000
Net income ............................................. $ 790,000 $3,005,000
Basic earnings per share ............................... $ 0.03 $ 0.10
Diluted earnings per share ............................. $ 0.03 $ 0.10
</TABLE>
6
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
The effect of these adjustments on previously reported consolidated
financial statements for the six-month period ended December 31, 1997, is as
follows:
<TABLE>
<CAPTION>
As
As reported restated
------------ ----------
<S> <C> <C>
General and administrative ........................... $ 3,896,000 $7,556,000
Charge for purchased research and development ........ $ 26,800,000 $6,915,000
Operating income (loss) .............................. $ (9,103,000) $7,122,000
Net income (loss)..................................... $(14,312,000) $1,913,000
Basic earnings (loss) per share....................... $ (0.50) $ 0.07
Diluted earnings (loss) per share..................... $ (0.50) $ 0.06
</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 Discreet by Autodesk,
Inc. ("Autodesk"). Under the terms of the agreement, as amended on November
18, 1998, December 18, 1998 and January 18, 1999, Autodesk will exchange 0.33
shares of its common stock for each outstanding share 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 in March, 1999. 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
7
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
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
"Krim Complaint"). The lawsuit names as defendants Discreet, Discreet's
directors and certain unidentified "John Does." The Krim Complaint alleges
that the defendants breached their fiduciary duties to shareholders in
connection with the proposed merger transaction with Autodesk. The Krim
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 September 29, 1998, a second 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 "Clark Complaint"). The Clark Complaint is
substantially similar to the Krim Complaint and names as defendants Discreet,
certain of Discreet's directors and certain unidentified "John Does." The
Clark Complaint alleges that the defendants breached their fiduciary duties to
shareholders in connection with the proposed merger transaction with Autodesk.
The Clark 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 December 2, 1998, the Marin County, California, Superior Court (the
"Court") entered an order consolidating the Clark and Krim actions. On
December 11, 1998, the Court entered an order on Discreet's October 26, 1998
motions to dismiss. The order dismissed both the Krim and the Clark Complaints
as against Discreet for failing to state a claim against Discreet. The Court's
order granted plaintiffs 30-days leave to replead their complaints. On January
11, 1999, plaintiffs filed a consolidated amended complaint with the Court
(the "Amended Complaint") which asserts the same breach of fiduciary duty
cause of action against Discreet, certain of Discreet's directors and certain
unidentified "John Does," and seeks the same relief. Discreet believes the
claims asserted in the Amended 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.
8
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
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
December 31, 1997 December 31, 1998
------------------- ----------------------
Income Shares EPS Income Shares EPS
------ ------ ----- ------- ------ ------
(Restated)
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Income available to Common
Shareholders.................... $3,005 28,833 $0.10 $(1,888) 29,899 $(0.06)
===== ======
Effect of Dilutive Securities
Impact of exercise of stock
options under treasury stock
method.......................... -- 1,764 -- --
------ ------ ----- ------- ------ ------
Diluted EPS
Income available to Common
Shareholders and assumed
exercises....................... $3,005 30,597 $0.10 $(1,888) 29,899 $(0.06)
====== ====== ===== ======= ====== ======
</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. Had the Company not been in a loss position in the three months ended
December 31, 1998, dilutive options of 1,225,000 would have been added to
compute diluted EPS. In the three months ended December 31, 1997, 474,000
antidilutive weighted shares have been excluded from the computation of
diluted EPS.
<TABLE>
<CAPTION>
Six months ended Six months ended
December 31, 1997 December 31, 1998
------------------- ------------------------
Income Shares EPS Income Shares EPS
------ ------ ----- -------- ------ -------
(Restated)
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Income available to common
shareholders.................. $1,913 28,746 $0.07 $ (2,638) 29,789 $ (0.09)
===== =======
Effect of Dilutive Securities
Impact of exercise of stock
options under treasury stock
method........................ -- 1,862 -- --
------ ------ ----- -------- ------ -------
Diluted EPS
Income available to common
shareholders and assumed
exercises..................... $1,913 30,608 $0.06 $(2,638) 29,789 $(0.09)
====== ====== ===== ======== ====== =======
</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. Had the Company not been in a loss position in the six months ended
December 31, 1998, dilutive options of 1,188,000 would have been added to
compute diluted EPS. In the six months ended December 31, 1997, 350,000
antidilutive weighted shares have been excluded from the computation of
diluted EPS.
(5) Related Party Purchases
During the quarter ended December 31, 1998, the Company purchased marketing
services in the amount of $127,000 from Behaviour Design Inc., and purchased
consulting services in the amount of $32,000 from BHVR Communications, Inc. As
of December 31, 1998, the Company had a payable of approximately $361,000 to
these companies. These related parties are companies controlled by the
Company's Chairman and Chief Executive Officer.
9
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
During the quarter ended December 31, 1998, the Company made rental payments
in the amount of $352,000 to TGR Zone Corporation ("TGR Zone"), a company
indirectly owned by Discreet Logic's Chairman and Chief Executive Officer, for
space in its headquarters in Montreal. The Company made payments of $190,000
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 for 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 ended Six Months ended
------------------------- -------------------------
December 31, December 31, December 31, December 31,
1997 1998 1997 1998
------------ ------------ ------------ ------------
(Restated) (Restated)
<S> <C> <C> <C> <C>
Net income (loss)....... $3,005 $(1,888) $1,913 $(2,638)
Foreign currency
translation adjustment. (384) 181 (1,396) (729)
------ ------- ------ -------
Total comprehensive
income (loss).......... $2,621 $(1,707) $ 517 $(3,367)
====== ======= ====== =======
</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. In December 1998, the
AICPA issued Statement of Position 98-9, which amends certain provisions of
SOP 97-2 and extends the deferral of the application of certain passages of
SOP 97-2 provided by SOP 98-4 until the beginning of Discreet's fiscal year
2000. Discreet is currently evaluating the impact of SOP 98-9 on its
financial statements and related disclosures.
10
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
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 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
$4,569,000 at December 31, 1998). Advances under the line accrue interest
monthly at the Canadian prime rate (6.75% at December 31, 1998) plus 0.25%.
Additionally, the agreement provides for a Cdn$600,000 (approximately $392,000
at December 31, 1998) demand leasing facility, and a Cdn$600,000
(approximately $392,000 at December 31, 1998) demand research and development
tax credit facility. Advances under these facilities accrue interest monthly
at the Canadian prime rate (6.75% at December 31, 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 December 31, 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 December 31, 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 December 31, 1998, the subsidiary had
borrowed (Yen) 300,372,000 (approximately $2,643,000 at December 31, 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 $1,828,000 at December 31, 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 $392,000 at December 31,
1998) commencing in July 2004 and a final installment of Cdn$400,000
(approximately $261,000 at December 31, 1998) in July 2008. The loan is
interest free until July 2004, after which it will bear interest at the
Canadian prime rate (approximately 6.75% at December 31, 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 proceeds of the loan were
disbursed to the Company in July 1998.
11
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
(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 $1,967,000
at December 31, 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 December 31, 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 December 31,
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 Ended Three Months Ended
December 31, 1997 December 31, 1998
------------------ ------------------
<S> <C> <C>
Asset write down......................... $ 258,000 $ --
Lease terminations and leasehold
improvements reserve.................... 26,000 --
Severance................................ 124,000 --
Professional services and other.......... 151,000 43,000
---------- --------
$ 559,000 $ 43,000
========== ========
The following reflects the remaining accrued restructuring expense as of
December 31, 1997 and 1998, by major component:
<CAPTION>
December 31, 1997 December 31, 1998
------------------ ------------------
<S> <C> <C>
Asset write down......................... $ 124,000 $ --
Lease terminations and leasehold
improvements reserve.................... 2,549,000 350,000
Severance................................ 277,000 --
Professional services and other.......... 385,000 361,000
---------- --------
$3,335,000 $711,000
========== ========
</TABLE>
During the fourth fiscal quarter of 1998, the Company expensed an additional
$829,000 for the closure of its U.K. research and development facility. During
the six-month period ended December 31, 1998, approximately $38,000 of
professional fees was charged against this restructuring reserve. As of
December 31, 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.
12
<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 the six-month period ended
December 31, 1997.
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 December 31, 1997, is as
follows:
<TABLE>
<CAPTION>
As
As reported restated
----------- ----------
<S> <C> <C>
General and administrative.............................. $2,012,000 $3,951,000
Charge for purchased research and development........... $5,800,000 $1,646,000
Operating income........................................ $3,600,000 $5,815,000
Net income.............................................. $ 790,000 $3,005,000
Basic earnings per share................................ $ 0.03 $ 0.10
Diluted earnings per share.............................. $ 0.03 $ 0.10
</TABLE>
13
<PAGE>
The effect of these adjustments on previously reported consolidated
financial statements for the six-month period ended December 31, 1997, is as
follows:
<TABLE>
<CAPTION>
As
As reported restated
------------ ----------
<S> <C> <C>
General and administrative............................ $ 3,896,000 $7,556,000
Charge for purchased research and development......... $ 26,800,000 $6,915,000
Operating income (loss)............................... $ (9,103,000) $7,122,000
Net income (loss)..................................... $(14,312,000) $1,913,000
Basic earnings (loss) per share....................... $ (0.50) $ 0.07
Diluted earnings (loss) per share..................... $ (0.50) $ 0.06
</TABLE>
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, as amended on November
18, 1998, December 18, 1998 and January 18, 1999, Autodesk will exchange 0.33
shares of its common stock for each outstanding share 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 in March, 1999. 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 $711,000 in restructuring reserves at the end
of December 31, 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 December 31, 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.
14
<PAGE>
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 Six Months Ended
------------------------- -------------------------
December 31, December 31, December 31, December 31,
1997 1998 1997 19988
------------ ------------ ------------ ------------
(Restated) (Restated)
<S> <C> <C> <C> <C>
Total revenues............. 100% 100% 100% 100%
Cost of revenues........... 36 49 41 48
--- --- --- ---
Gross profit............. 64 51 59 52
--- --- --- ---
Operating expenses:
Research and development. 10 13 10 13
Sales and marketing...... 23 31 21 30
General and
administrative.......... 11 15 10 16
Charge for purchased
research and
development............. 4 -- 9 --
--- --- --- ---
Total operating
expenses.............. 48 59 50 59
--- --- --- ---
Operating income (loss).. 16 (8) 9 (7)
Other income net........... -- 2 1 4
--- --- --- ---
Income (loss) before
income taxes............ 16 (6) 10 (3)
Provision for income
taxes..................... 8 1 8 2
--- --- --- ---
Net income (loss)...... 8% (7)% 2% (5)%
=== === === ===
</TABLE>
Three Months and Six Months Ended December 31, 1998 and December 31, 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 $28,396,000 and $37,268,000 for the three-month periods
ended December 31, 1998, and 1997, respectively, and $55,827,000 and
$75,673,000 for the six-month periods ended December 31, 1998 and 1997,
respectively. The Company believes that the decline in revenues, in both the
three and six-month periods, is primarily due to the following factors: (1)
continued effects of a lack of a senior sales and marketing executive combined
with several field vacancies; (2) slower than expected sales in Europe and
Asia due in part to the personnel issues noted above as well as market
conditions in these areas causing delays in capital spending; (3) customers
deferring purchase decisions due to confusion over HDTV timing and standards;
(4) what the Company believed to be temporary concerns in the Advanced Systems
customer base regarding the acquisition of Discreet by Autodesk which may have
lead to purchasing delays, particularly in the quarter ended September 30,
1998; and (5) some product discounting and certain price reductions in the
three-month period ended December 31, 1998 that were not offset by increases
in volume.
Revenues from customers outside of North America were $12,481,000 (44% of
total revenues) and $21,702,000 (58% of total revenues) for the three-month
periods ended December 31, 1998, and 1997, respectively, and $28,277,000 (51%
of total revenues) and $39,965,000 (53% of total revenues) for the six-month
periods ended December 31, 1998 and 1997, respectively. Revenues from
customers outside North America decreased as a result of the factors noted
above, particularly, field vacancies in Asia, Europe and Latin America. 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, increase from the level experienced in the
three-month period ended December 31, 1998.
15
<PAGE>
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 $13,918,000 (49% of total
revenues) and $13,458,000 (36% of total revenues) for the three-month periods
ended December 31, 1998, and 1997, respectively, and $26,677,000 (48% of total
revenues) and $30,827,000 (41% of total revenues) for the six-month periods
ended December 31, 1998 and 1997, respectively. The increase in cost of
revenues, as a percentage of total revenues, in the three and six-month
periods ended December 31, 1998 as compared to the three month period ended
December 31, 1997 was primarily due to the following factors: (1) the decrease
in revenues in Europe, Asia , and Latin America where customers typically
purchase only software, or software and storage media bundles from the
Company; (2) product discounting and certain price reductions; (3) the
presence of certain fixed expenses in cost of revenues; (4) greater hardware-
only sales generating lower margins in the three-month period ended December
31, 1998; and (5) a greater number of systems (including the workstations and
hardware peripherals) sold through the indirect channel. Should revenues
increase, the Company expects that cost of revenues as a percentage of total
revenues should decrease 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 $3,600,000 (13% of total
revenues) and $3,901,000 (10% of total revenues) for the three-month periods
ended December 31, 1998, and 1997, respectively, and $7,350,000 (13% of total
revenues) and $7,413,000 (10% of total revenues) for the six-month periods
ended December 31, 1998 and 1997, respectively. The decrease in research and
development expenses in the three and six-month periods ended December 31,
1998 as compared to the three and six-month periods ended December 31, 1997,
respectively, was primarily due to the closure of the UK research and
development facility offset by increases 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 and six-month periods ended December 31, 1998 as compared to
the three and six-month periods ended December 31, 1997, respectively.
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 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 $8,943,000 (31% of total revenues) and $8,407,000 (23%
of total revenues) for the three-month periods ended December 31, 1998 and
1997, respectively, and $16,857,000 (30% of total revenues) and $15,840,000
(21% of total revenues) for the six-month periods ended December 31, 1998 and
1997, respectively. The increase in sales and marketing expenses, in the three
and six-month periods ended December 31, 1998 as compared to the three and
six-month periods ended December 31, 1997, respectively, 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 and six-month periods ended December 31, 1998 as
compared to the three and six-month periods ended December 31, 1997,
respectively. 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.
16
<PAGE>
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,
amortization of goodwill, and reserves for doubtful accounts receivable.
General and administrative expenses were $4,161,000 (15% of total revenues)
and $3,951,000 (11% of total revenues), as restated, for the three-month
periods ended December 31, 1998 and 1997, respectively, and $8,603,000 (16% of
total revenues) and $7,556,000 (10% of total revenues), as restated, for the
six-month periods ended December 31, 1998 and 1997, respectively. The increase
in general and administrative expenses in the three and six-month periods
ended December 31, 1998 as compared to the three and six-month periods ended
December 31, 1997, respectively, is explained by additional personnel and
salary increases as well as the amortization of goodwill associated with the
Lightscape acquisition. The increase in general and administrative expenses as
a percentage of total revenues is primarily due to the above factors and the
decline in revenues during the three and six-month periods ended December 31,
1998 as compared to the three and six-month periods ended December 31, 1997,
respectively. 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 the three-month period
ended December 31, 1997, in connection with the Lightscape acquisition, the
Company expensed $1,646,000, as restated, of in-process research and
development, based on an appraisal, that had not yet reached technological
feasibility and had no alternative use. In the three-month period ended
September 30, 1997, in connection with the D-Vision acquisition, the Company
expensed $5,269,000, as restated, of in-process research and development,
based on an appraisal, that had not yet reached technological feasibility and
had no alternative use.
Other Income. Other Income primarily consists of foreign currency gains and
losses and interest income and expense. Foreign currency translation resulted
in gains of $128,000 and $179,000 for the three-month periods ended December
31, 1998 and 1997, respectively, and $1,118,000 and $308,000 for the six-month
periods ended December 31, 1998 and 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
$323,000 and $3,097,000 for the three-month periods ended December 31, 1998
and 1997, respectively, and $1,185,000 and $5,872,000 for the six-month
periods ended December 31, 1998 and 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 and six-month periods ended December 31, 1998 differed from the
statutory rate primarily as a result of the following factors: (1) the Company
incurring losses in jurisdictions where tax loss carryforwards were not
available; and (2) the amortization of goodwill for which no tax benefit was
recorded. The effective tax rate for the three and six-month periods ended
December 31, 1997 differed from the statutory rate primarily as a result of
the following factors: (1) the Company 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;
(2) the amortization of goodwill for which no tax benefit was recorded; offset
by (3) the 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.
17
<PAGE>
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 applications 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 December 31, 1998, Discreet had cash of
approximately $49,767,000.
Discreet's operating activities provided cash of $4,515,000 and used cash of
$4,196,000, in the six-month periods ended December 31, 1998, and 1997,
respectively. The principal sources of cash for the six-month period ended
December 31, 1998 were operations, the decrease in accounts receivable, and
the increase in deferred revenue, 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 six-
month period ended December 31, 1998. The primary sources of cash during the
six-month period ended December 31, 1997, were operations, the receipt of
insurance proceeds related to the settlement of the class action litigation,
the decreases in inventory, income taxes receivable, and the increase in
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 and Lightscape acquisitions. Discreet's operating
activities include $300,000 and $229,000 of research and development tax
credits received from the Quebec government, and $375,000 and $286,000 of
research and development tax credits received from the federal government,
during the six-month periods ended December 31, 1998 and 1997, respectively.
Discreet's investing activities used cash of $3,837,000 and $13,874,000 in
the six-month periods ended December 31, 1998, and 1997, respectively. The
principal uses of cash during the six-month period ended December 31, 1998
included the purchase of capital assets, primarily computer hardware and
software, the acquisition of other intangible assets related to the licensing
of third-party technology, and certain costs related to the proposed
transaction with Autodesk. The principal uses of cash during the three-month
period ended December 31, 1997 included the of D-Vision acquisition and the
purchase of capital assets, primarily computer hardware and software.
Financing activities provided cash of $3,294,000 and $777,000 during the
six-month periods ended December 31, 1998 and 1997, respectively. The
principal sources of cash for the six-month period ended December 31, 1998
included the receipt of a government loan from the Societe de Developpement
Industriel du
18
<PAGE>
Quebec, and proceeds from the exercises of common stock options and the
issuance of shares under the 1995 Employee Stock Purchase Plan. The principal
sources of cash for the six-month period ended December 31, 1997 included the
receipt of proceeds from the exercises of common stock options and the
issuance of shares under the 1995 Employee Stock Purchase Plan.
As of December 31, 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
foreseeable 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 calendar
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
19
<PAGE>
marketing resources than Discreet. These companies may introduce additional
products that are competitive with 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
20
<PAGE>
the National Association of Broadcasters ("NAB"), which is typically held in
April. The Company's expense 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.
21
<PAGE>
PART II
Item 1. Legal Proceedings
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
"Krim Complaint"). The lawsuit names as defendants Discreet, Discreet's
directors and certain unidentified "John Does." The Krim Complaint alleges
that the defendants breached their fiduciary duties to shareholders in
connection with the proposed merger transaction with Autodesk. The Krim
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 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 "Clark Complaint"). The Clark Complaint is
substantially similar to the Krim Complaint and names as defendants Discreet,
certain of Discreet's directors and certain unidentified "John Does." The
Clark Complaint alleges that the defendants breached their fiduciary duties to
shareholders in connection with the proposed merger transaction with Autodesk.
The Clark 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 December 2, 1998, the Marin County, California, Superior Court (the
"Court") entered an order consolidating the Clark and Krim actions. On
December 11, 1998, the Court entered an order on Discreet's October 26, 1998
motions to dismiss. The order dismissed both the Krim and the Clark Complaints
as against Discreet for failing to state a claim against Discreet. The Court's
order granted plaintiffs 30-days leave to replead their complaints. On January
11, 1999, plaintiffs filed a consolidated amended complaint with the Court
(the "Amended Complaint") which asserts the same breach of fiduciary duty
cause of action against Discreet, certain of Discreet's directors and certain
unidentified "John Does," and seeks the same relief. Discreet believes the
claims asserted in the Amended 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 November 18, 1998 was filed on November
19, 1998 pursuant to Item 5 of Form 8-K (other events) announcing the issuance
of a press release in which Discreet and Autodesk announced a Second Amended
and Restated Agreement and Plan of Acquisition and Amalgamation.
22
<PAGE>
A Current Report on Form 8-K dated January 18, 1999 was filed on January 20,
1999 pursuant to Item 5 of Form 8-K (other events) announcing the Amendment of
the exchange ratio under the proposed transaction with Autodesk. It provides
for Autodesk to issue 0.33 shares of its common stock for each outstanding
common share of Discreet, which reduced the previously announced exchange
ratio of 0.48 and provides the extension of certain dates under the Amended
Agreement.
23
<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.
/s/ Francois Plamondon
By: ____________________________
Francois Plamondon
Executive Vice President,
Chief Financial Officer,
Treasurer and Secretary
February 4, 1999
24
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 10Q - Q299
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS
<FISCAL-YEAR-END> JUN-30-1999 JUN-30-1999
<PERIOD-START> OCT-01-1998 JUL-01-1998
<PERIOD-END> DEC-31-1998 DEC-31-1998
<CASH> 49,767 49,767
<SECURITIES> 0 0
<RECEIVABLES> 26,891 26,891
<ALLOWANCES> 3,837 3,837
<INVENTORY> 15,575 15,575
<CURRENT-ASSETS> 93,926 93,926
<PP&E> 25,866 25,866
<DEPRECIATION> 16,878 16,878
<TOTAL-ASSETS> 129,383 129,383
<CURRENT-LIABILITIES> 47,515 47,515
<BONDS> 0 0
0 0
0 0
<COMMON> 109,190 109,190
<OTHER-SE> (32,105) (32,105)
<TOTAL-LIABILITY-AND-EQUITY> 129,383 129,383
<SALES> 28,396 55,827
<TOTAL-REVENUES> 28,396 55,827
<CGS> 13,918 26,677
<TOTAL-COSTS> 13,918 26,677
<OTHER-EXPENSES> 16,704 32,810
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 35 55
<INCOME-PRETAX> (1,565) (1,453)
<INCOME-TAX> 323 1,185
<INCOME-CONTINUING> (1,888) (2,638)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (1,888) (2,638)
<EPS-PRIMARY> (0.06) (0.09)
<EPS-DILUTED> (0.06) (0.09)
</TABLE>
