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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 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 December 31, 1997
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 (IRS Employer
jurisdiction Identification Number)
of incorporation or
organization)
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 [_]
28,880,561 shares of the registrant's Common Shares, without par value, were
outstanding as of February 11, 1998.
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DISCREET LOGIC INC. AND SUBSIDIARIES
Form 10-Q
For the Quarter Ended December 31, 1997
CONTENTS
Item Number Page
----------- ----
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..................................... 11
Certain Factors That May Affect Future Results................ 20
PART II:OTHER INFORMATION
Item 1. Legal Proceedings............................................. 23
Item 4. Submissions of Matters to a Vote of Security Holders.......... 23
Item 6. Exhibits and Reports on Form 8-K.............................. 24
Signatures............................................................. 25
2
DISCREET LOGIC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(All amounts in thousands of U.S. dollars, except for share data)
June 30, December 31,
1997 1997
---------- ------------
(Unaudited)
(Restated) (Restated)
ASSETS
Current Assets:
Cash and cash equivalents............................ $ 31,668 $ 12,649
Accounts receivable (less reserves for doubtful
accounts)........................................... 26,893 29,559
Inventory--
Resale............................................. 10,867 9,725
Demonstration...................................... 3,054 4,073
Income taxes receivable.............................. 448 --
Other current assets................................. 3,889 4,291
--------- ---------
76,819 60,297
Property and equipment--less accumulated depreciation
and amortization...................................... 7,728 9,583
Deferred income taxes.................................. 3,490 2,467
Other assets........................................... 10,092 31,002
Assets held for resale................................. 5,248 4,241
--------- ---------
$ 103,377 $ 107,590
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued expenses................ $ 44,086 $ 36,824
Deferred revenue..................................... 8,103 5,740
Income taxes payable................................. 4,735 5,707
Customer deposits.................................... 1,359 427
--------- ---------
58,283 48,698
--------- ---------
Deferred income taxes................................ 713 2,268
--------- ---------
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--28,117,415 shares at June
30, 1997 and 28,840,493 at December 31, 1997...... 81,076 93,337
Accumulated deficit.................................. (35,207) (33,294)
Deferred compensation................................ (674) (1,209)
Cumulative translation adjustment.................... (814) (2,210)
--------- ---------
Total shareholders' equity....................... 44,381 56,624
--------- ---------
$ 103,377 $ 107,590
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
DISCREET LOGIC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(All amounts in thousands of U.S. Dollars, except for per share data)
(Unaudited)
Two Three Five Six
Months Months Months Months
Ended Ended Ended Ended
December 31, December 31, December 31, December 31,
1996 1997 1996 1997
------------ ------------ ------------ ------------
(Restated) (Restated)
Total revenues............. $16,833 $37,268 $40,096 $75,673
Cost of revenues........... 8,003 13,548 20,290 30,827
------- ------- ------- -------
Gross profit............. 8,830 23,720 19,806 44,846
------- ------- ------- -------
Operating expenses:
Research and development
(net of tax credits).... 1,575 3,901 4,253 7,413
Sales and marketing...... 4,610 8,407 10,627 15,840
General and
administrative.......... 1,189 3,951 2,705 7,556
Charge for purchased
research and
development............. -- 1,646 -- 6,915
------- ------- ------- -------
Total operating
expenses.............. 7,374 17,905 17,585 37,724
------- ------- ------- -------
Operating income ...... 1,456 5,815 2,221 7,122
Other income net........... 1,819 287 894 663
------- ------- ------- -------
Income before income
taxes................... 3,275 6,102 3,115 7,785
Provision for income
taxes..................... 1,310 3,097 1,962 5,872
------- ------- ------- -------
Net income .............. $ 1,965 $ 3,005 $ 1,153 $ 1,913
======= ======= ======= =======
Earnings Per Share:
Basic.................... $ 0.07 $ 0.10 $ 0.04 $ 0.07
======= ======= ======= =======
Diluted.................. $ 0.07 $ 0.10 $ 0.04 $ 0.06
======= ======= ======= =======
Weighted average common
shares outstanding:
Basic.................... 27,931 28,833 27,852 28,746
======= ======= ======= =======
Diluted.................. 28,444 30,597 28,412 30,608
======= ======= ======= =======
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
DISCREET LOGIC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(All amounts in thousands of U.S. Dollars)
(Unaudited)
Five Months Six Months
Ended Ended
December 31, December 31,
1996 1997
------------ ------------
(Restated)
Cash flows from operating activities:
Net income......................................... $ 1,153 $ 1,913
Adjustments to reconcile net loss to cash provided
by (used in) operating activities--
Depreciation and amortization.................... 2,597 7,656
Deferred income taxes............................ (463) 2,577
Write-off of in-process research and
development..................................... -- 6,915
Write-off of assets for restructuring............ -- 109
Compensation expense related to stock options.... -- 300
Changes in assets and liabilities--
Settlement of class action litigations......... -- (10,800)
Accounts receivable............................ 2,614 (1,783)
Inventory...................................... 9,089 935
Income taxes receivable........................ 2,907 448
Other current assets........................... (527) (255)
Insurance proceeds related to class action
litigation.................................... -- 3,459
Accounts payable and accrued expenses.......... (2,415) (13,347)
Deferred revenue............................... 3,294 (2,363)
Income taxes payable........................... -- 973
Customer deposits.............................. (934) (933)
Due to related parties......................... (25) --
-------- --------
Net cash provided by (used in) operating
activities...................................... 17,290 (4,196)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment................. (3,084) (4,350)
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............ (3,084) (13,874)
-------- --------
Cash flows from financing activities:
Proceeds from option exercises..................... 640 560
Proceeds from employee stock purchase plan......... 200 217
-------- --------
Net cash provided by financing activities........ 840 777
-------- --------
Foreign exchange effect on cash.................... (437) (1,726)
-------- --------
(Decrease) increase in cash and cash equivalents... 14,609 (19,019)
Cash and cash equivalents, beginning of period..... 21,658 31,668
-------- --------
Cash and cash equivalents, end of period........... $ 36,267 $ 12,649
======== ========
Supplemental disclosure of cash flow information:
Interest paid during the period.................... $ 14 $ 46
-------- --------
Income taxes paid during the period................ $ 622 $ 2,293
-------- --------
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
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
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 Logic" 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 for
the year ended June 30, 1997. 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, 1997 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 the six-month period ended
December 31, 1997.
The revised allocation of the aggregate purchase price is as follows:
As reported As restated
----------- -----------
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
=========== ===========
The effect of these adjustments on previously reported consolidated
financial statement for the three-month period ended December 31, 1997 is as
follows:
As reported As restated
----------- -----------
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
6
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The effect of these adjustments on previously reported consolidated
financial statements for the six-month period ended December 31, 1997 is as
follows:
As
As reported restated
------------ ----------
General and administrative......................... $ 3,896,000 $7,556,000
Charge for purchased research and development...... $ 26,800,000 $6,915,000
Operating income................................... $ (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
(2) Change of Fiscal Year
On January 9, 1997, the Board of Directors of the Company approved the
change of the Company's fiscal year end from July 31 to June 30. This change
was effective beginning with the Company's second fiscal quarter of 1997. The
condensed consolidated financial statements are presented for the three and
six month periods ended December 31, 1997 and the two and five month periods
ended December 31, 1996. The Company prepares consolidated financial
statements, re-measures accounts in foreign currencies to reflect changes in
exchange rates, and examines and adjusts certain reserve accounts at the end
of each quarter. Therefore, it is not practicable to recast prior quarterly
results to reflect the new fiscal period. Consequently, the results for the
three and six month periods ended December 31, 1997 are not directly
comparable to the results of the two and five month periods ended December 31,
1996.
(3) Litigation and Related Settlement Expenses
On May 29, 1996, a lawsuit entitled Sandra Esner and Jerry Krim, On Behalf
of Themselves and All Others Similarly Situated, vs. [........ ] Discreet Logic
Inc., et al., case No. 978584, was filed in the Superior Court of the State of
California, City and County of San Francisco. Named as defendants are the
Company, certain of the Company's former and existing directors, officers, and
affiliates, and certain underwriters and financial analysts. The plaintiffs
purport to represent a class of all persons who purchased the Company's common
stock between September 13, 1995, and May 1, 1996. The complaint alleges
violations of California law through material misrepresentations and
omissions, among other things. The Company believes that the allegations in
the complaint are without merit and has defended the lawsuit vigorously.
On June 13, 1996, a lawsuit entitled Bruce Friedberg, On Behalf of Himself
and All Others Similarly Situated, vs. Discreet Logic Inc., et al., Civ. No.
96-11232-EFH, was filed in the United States District Court, District of
Massachusetts. Named as defendants are the Company and certain of the
Company's former and existing directors and officers. The plaintiff purports
to represent a class of all persons who purchased the Company's common stock
between November 14, 1995, and February 13, 1996. On October 11, 1996, the
plaintiff filed an amended complaint which asserts substantially the same
factual allegations as the first complaint and proposes the identical class
period. The complaint alleges violations of the United States Federal
Securities law through material misrepresentations and omissions. The Company
believes that the allegations in the complaint are without merit and has
defended the lawsuit vigorously.
On April 29, 1997, a lawsuit entitled Anton Paparella, Sandra Esner and
Geoffrey L. Sherwood, On Behalf of Themselves and All Others Similarly
Situated vs. Discreet Logic Inc., et al., case No. C-97-1570, was filed in the
United States District Court, Northern District of California. Named as
defendants are the Company and certain of Company's former and existing
officers, directors and affiliates, and certain underwriters. The complaint
asserts, in all material respects, the same factual allegations and proposes
the same class period as the above-described California state court complaint
filed in May 1996, except asserts claims under federal securities
7
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
law instead of state law. The Company believes that the allegations in the
California federal complaint are without merit and has defended the lawsuit
vigorously.
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.
(4) Related Party Transactions
In the three month period ended December 31, 1997, the Company recorded
revenues from sales made to Behaviour Entertainment Inc. ("Behaviour"), a
company owned by the Company's Chairman and Chief Executive Officer, in the
amount of $309,000. The Company also purchased marketing services, in the
amount of $250,000, from Behaviour.
(5) 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 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 tables present, in thousands (except for EPS amounts) a
reconciliation of Basic EPS to Diluted EPS as required by SFAS No. 128:
Two months ended Three months ended
December 31, 1996 December 31, 1997
------------------- -------------------
(Restated)
Income Shares EPS Income Shares EPS
------ ------ --- ------ ------ ---
Basic EPS
Income available to common
shareholders......................... $1,965 27,931 $0.07 $3,005 28,833 $0.10
===== =====
Effect of Dilutive Securities
Impact of exercise of stock options
under treasury stock method.......... -- 513 -- 1,764
------ ------ ------ ------
Diluted EPS
Income available to common
shareholders and assumed exercises... $1,965 28,444 $0.07 $3,005 30,597 $0.10
====== ====== ===== ====== ====== =====
8
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Options to purchase 199,000 and 474,000 shares of common stock were
outstanding during the two month period ended December 31, 1996, and the three
month period ended December 31, 1997, respectively, but were not included in
the computation of diluted EPS because the options' exercise price was greater
than the average market price of the common shares.
Five months ended Six months ended
December 31, 1996 December 31, 1997
------------------- --------------------
(Restated)
Income Shares EPS Income Shares EPS
------ ------ --- ------ ------ ---
Basic EPS
Income available to common
shareholders........................ $1,153 27,852 $0.04 $1,913 28,746 $ 0.07
===== ======
Effect of Dilutive Securities
Impact of exercise of stock options
under treasury stock method......... -- 560 -- 1,862
------ ------ ------ ------
Diluted EPS
Income available to common
shareholders and assumed exercises.. $1,153 28,412 $0.04 $1,913 30,608 $ 0.06
====== ====== ===== ====== ====== ======
Options to purchase 297,000 and 349,000 shares of common stock were
outstanding during the five month period ended December 31, 1996, and the six
month period ended December 31, 1997, respectively, but were not included in
the computation of diluted EPS because the options' exercise price was greater
than the average market price of the common shares
(6) Revenue Recognition
In November 1997, the AICPA issued Statement of Position (SOP) 97-2,
Software Revenue Recognition. This statement is effective for all transactions
entered into in fiscal years beginning after December 15, 1997, however, early
adoption is permitted. SOP 97-2 establishes standards for recognizing revenues
related to software products and related services. The Company intends to
implement SOP 97-2 in its consolidated financial statements for the third
quarter of fiscal 1998. The Company does not anticipate that the
implementation of this statement will have a material impact on the
consolidated financial statements.
(7) Acquisition of Lightscape Technologies, Inc.
On December 2, 1997, Discreet Logic entered into an Agreement and Plan of
Merger and Reorganization (the "Merger Agreement") with Lantern Acquisition
Corp., a Delaware corporation and wholly-owned subsidiary of Discreet Logic
("Merger Sub"), and Lightscape Technologies, Inc., a Delaware corporation
("Lightscape"). On December 30, 1997, pursuant to the Merger Agreement, and
upon the satisfaction of certain closing conditions, Merger Sub merged (the
"Merger") with and into Lightscape with Lightscape as the surviving
corporation and a wholly-owned subsidiary of Discreet Logic. As a result of
the Merger, Discreet Logic acquired, among other products, the Lightscape TM
product, a software application which integrates radiosity and raytracing with
physically based lighting, including related know-how and goodwill. The
aggregate purchase price for Lightscape includes the assumption of
approximately $5,700,000 of net liabilities (of which approximately $3,400,000
was paid at the closing), not including costs associated with the transaction,
and up to $6,800,000 in contingent consideration to be paid only if certain
revenue objectives are achieved by Lightscape in calendar 1998 and 1999. The
acquisition has been accounted for as a purchase. A portion of the purchase
price and transaction costs was allocated to purchased in-process research and
development for which Discreet Logic incurred a one-time charge against
earnings in the amount of $1,646,000, ($0.05 per share on a diluted basis), as
restated based on an appraisal, in the quarter ended December 31, 1997 and
approximately $5,241,000, as restated, was allocated to intangible assets,
which include goodwill and acquired technology, and is being amortized on a
straight-line
9
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
basis over their estimated useful lives of three to five years. The terms of
the transaction were the result of arms'-length negotiations between the
representatives of Discreet Logic and Lightscape.
The following presents, on an unaudited basis, certain items on the Company's
result of operations, for the five month period ended December 31, 1996, and
six month period ended December 31, 1997, as though the acquisition and related
transactions discussed above had occurred at the beginning of those periods:
Five months Six months
ended ended
December 31, December 31,
1996 1997
------------ ------------
(Restated)
Net sales............................................. $40,457 $76,392
Operating profit (loss)............................... $(2,271) $ 4,849
Net loss.............................................. $(4,233) $(1,031)
EPS................................................... $ (0.15) $ (0.04)
10
DISCREET LOGIC INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
Discreet Logic Inc. ("Discreet Logic" or the "Company") develops, assembles,
markets and supports non-linear, digital systems and software for creating,
editing and compositing imagery and special effects for film, video, and HDTV.
The Company's systems and software are utilized by creative professionals for
a variety of applications, including feature films, television programs,
commercials, music videos, interactive game production and live broadcasting.
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:
As reported As restated
------------ -----------
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
============ ===========
The effect of these adjustments on previously reported consolidated
financial statements for the three month period ended December 31, 1997 is as
follows:
As reported As restated
------------ -----------
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
The effect of these adjustments on previously reported consolidated
financial statements for the six-month period ended December 31, 1997 is as
follows:
As reported As restated
------------ -----------
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
11
Litigation Settlement
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.
Recent Acquisitions
On December 2, 1997, Discreet Logic entered into an Agreement and Plan of
Merger and Reorganization (the "Merger Agreement") with Lantern Acquisition
Corp., a Delaware corporation and wholly-owned subsidiary of Discreet Logic
("Merger Sub"), and Lightscape Technologies, Inc., a Delaware corporation
("Lightscape"). On December 30, 1997, pursuant to the Merger Agreement, and
upon the satisfaction of certain closing conditions, Merger Sub merged (the
"Merger") with and into Lightscape with Lightscape as the surviving
corporation and a wholly-owned subsidiary of Discreet Logic. As a result of
the Merger, Discreet Logic acquired, among other products, the Lightscape TM
product, a software application which integrates radiosity and raytracing with
physically based lighting, including related know-how and goodwill. The
aggregate purchase price for Lightscape includes the assumption of
approximately $5,700,000 of net liabilities (of which approximately $3,400,000
was paid at the closing), not including costs associated with the transaction,
and up to $6,800,000 in contingent consideration to be paid only if certain
revenue objectives are achieved by Lightscape in calendar 1998 and 1999. The
acquisition has been accounted for as a purchase. A portion of the purchase
price and transaction costs was allocated to purchased in-process research and
development for which Discreet Logic incurred a one-time charge against
earnings in the amount of $1,646,000, ($0.05 per share on a diluted basis) as
restated, based on an appraisal, in the quarter ended December 31, 1997 and
approximately $5,241,000 as restated was allocated to intangible assets, which
include goodwill and acquired technology, and is being amortized on a
straight-line basis over their estimated useful lives of three to five years.
The terms of the transaction were the result of arms'-length negotiations
between the representatives of Discreet Logic and Lightscape.
On July 15, 1997, the Company acquired all of the outstanding shares of
capital stock of D-Vision Systems, Inc. ("D-Vision"), an Illinois corporation,
pursuant to a Stock Purchase Agreement dated as of July 10, 1997, among the
Company, D-Vision, the former stockholders of D-Vision (the "Selling
Stockholders") and certain other individuals (the "D-Vision Acquisition"). As
a result of the D-Vision Acquisition, the Company acquired the D-Vision OnLINE
(subsequently renamed D-VISION) and PRO software products for non-linear video
and digital media editing solutions including related know-how and goodwill.
The purchase price was paid in a combination of 555,000 newly issued Discreet
Logic common shares and approximately $10,750,000 in cash. In addition,
approximately $4,000,000 of the cash consideration is being held in escrow
until September 30, 1999, subject to (i) earlier release from escrow of up to
$1,900,000 on September 30, 1998 and (ii) the resolution of any
indemnification claims made by the Company pursuant to the Stock Purchase
Agreement. The cash used by the Company to fund the acquisition was derived
primarily from cash flow from operations. The D-Vision Acquisition was
accounted for as a purchase. A portion of the purchase price, net liabilities
of D-Vision and transaction costs was allocated to purchased in-process
research and development for which the Company incurred a one-time charge
against earnings in the amount of $5,269,000, ($0.14 per share), as restated
based on an appraisal, in the quarter ended September 30, 1997. The terms of
the transaction and the consideration received by the D-Vision stockholders
were the result of arms-length negotiations between the representatives of the
Company and D-Vision. D-Vision develops Microsoft Windows NT-based non-linear,
digital editing solutions.
12
In-process Research and Development
Overview--The Acquisition of Lightscape Technologies
The nature of the efforts required to develop the acquired in-process
technology into commercially viable products principally relates to the
completion of all planning, designing and testing activities that are
necessary to establish that the products can be produced to meet their design
requirements, including functions, features and technical performance
requirements. Generally, if the R&D project and technologies are not completed
as planned, they will neither satisfy the technical requirements of a changing
market nor be cost effective.
As of the acquisition date, Lightscape Technologies, Inc. ("Lightscape"),
had initiated the research and development effort related to the product
features and functionality that will reside in a technology and application
platform for a next-generation lighting algorithm and software system.
With respect to the acquired in-process technology, the calculations of
value were adjusted to reflect the value creation efforts of Lightscape prior
to the close of the acquisition. Following are, as of the acquisition date,
the estimated completion percentage, estimated technology life and projected
introduction date:
Percent Technology Introduction
Lightscape In-Process Technology Completed Life Date
-------------------------------- --------- ---------- ------------
Next generation Lightscape technology..... 25% 5 years April 1999
A brief description of the acquired in-process project is set forth below:
Next generation Lightscape technology
The in-process technology under development at the time of the acquisition
included improved performance and progressive refinement control, improved
accuracy and iterative design control, and improved ease of use of the
Lightscape product.
Improved Performance and Progressive Refinement Control--Using this process,
light is transferred from every surface to every other surface (not just from
the brightest surfaces), yielding correct local brightness much earlier during
the simulation as well as more accurate numerical results. The simulation can
be multi-threaded to take advantage of multi-processor computers and
distributed processing environments.
Improved Accuracy and Iterative Design Control--The accuracy of the
simulation can be refined iteratively without having to restart the simulation
from scratch. Furthermore, the user can interactively direct the refinement
process to regions of interest within the scene or change materials and
luminaires and the radiosity engine can immediately compensate for these
changes.
Improved Ease of Use--The simulation is controlled by fewer parameters than
ever possible before making the technology immediately useful to inexperienced
users. In addition, advanced model conditioning techniques are used to reduce
artifacts due to inconsistent data and non-physical models generated by CAD
systems.
Currently, the Company is also developing progressive refinement radiosity
technology, integration of radiosity effects into non-physical renderers, and
new technology to offer a much higher degree of flexibility and control than
the progressive refinement radiosity-based approach. As previously mentioned,
these efforts are an attempt to make substantial technological improvements
over the lighting software product offerings available today.
Valuation analysis
Revenue
The value of the acquired in-process technology was computed using a
discounted cash flow analysis on the anticipated income stream of the related
product sales. The value assigned to purchased in-process technology
13
was determined by estimating the costs to develop the purchased in-process
technology into commercially viable products, estimating the resulting net
cash flows from the projects and discounting the net cash flows to their
present value. The revenue projection used to value the in-process research
and development was based on estimates of relevant market sizes and growth
factors, expected trends in technology and the nature and expected timing of
new product introductions by the Company and its competitors. Future revenue
estimates were generated from the next generation Lightscape product family.
Aggregate revenue for Lightscape products was estimated to be approximately $5
million for the period from January 1, 1998 to December 31, 1998, increasing
to approximately $25 million by 2002 (representing a compound annual growth
rate of 35%) and stabilizing at a 5 percent growth rate for the remainder of
the estimation period.
The estimated revenues for the in-process technologies assumed compound
annual growth rates of 54% in the four years following introduction, assuming
the successful completion and market acceptance of the major R&D programs.
Revenues for developed technology were estimated for 1998 through 2002, and
were expected to decline gradually as new products are expected to enter the
marketplace. The estimated revenues for the in-process projects were expected
to peak within five years of acquisition and then decline sharply as other new
products and technologies are expected to enter the market.
Management's analysis also considered anticipated product release dates for
a next-generation version of the Company's Lightscape product scheduled for
release in April 1999, as well as release dates for the various acquired
products and technologies which are scheduled for release in 2001. The overall
technology life was estimated to be approximately five years for both the
Company's Lightscape product and the various products and technologies
acquired from Lightscape.
Cost to Complete
Discreet anticipated incurring costs of approximately $2.0 million over the
24 months following the acquisition to complete the R & D projects.
Operating Expenses
Operating expenses used in the valuation analysis of Lightscape included (i)
selling, general and administrative expenses and (ii) research and development
expenses. Operating expenses were estimated based on historical results and
anticipated cost savings. Due to general economies of scale, improved
infrastructure, and greater management breadth, estimated operating expense as
a percentage of revenues were expected to decrease after the acquisitions.
Cost of sales. Cost of sales, expressed as a percentage of revenue, for the
developed and in-process technologies identified in the valuation was
estimated to be 15 percent for 1998 through 2002.
Selling, General and Administrative. Selling, general and administrative
expenses, expressed as a percentage of revenue for the developed and in-
process technologies identified in the valuation, were 70.8 percent in 1998,
55.8 percent in 1999, 53.8 percent in 2000, 44.7 percent in 2001, and 37.0
percent in 2002. Thereafter, selling, general and administrative expenses,
expressed as a percentage of revenue for the developed and in-process
technologies identified in the valuation were estimated to stabilize at 37.0
percent of revenue.
Research and Development. Research and development ("R&D") expenses consist
of the costs associated with activities undertaken to develop new software and
to correct errors or to keep products updated with current information. The
R&D expense was estimated to be 20.1 percent of revenues in 1998, declining to
10.0% of revenues in 2003.
Effective income tax rate. The effective income tax rate utilized in the
analysis of the in-process technology was 35 percent throughout the valuation
period. The 35 percent reflects the Company's estimated combined federal and
state statutory income tax rate, exclusive of nonrecurring charges, and its
estimated income tax rate, as provided by management, in future years.
14
Discount rate. The discount rate selected for developed and in-process
technology was 25 and 40 percent, respectively. In the selection of the
appropriate discount rate, consideration was given to the Weighted Average
Cost of Capital ("WACC"), which was determined, in part, by using the Capital
Asset Pricing Model (CAPM) and by reviewing venture capital rates of return.
The discount rate utilized for the in-process technology was higher than
Discreet's WACC due to the risk of realizing cash flows from products that had
yet to reach technological feasibility as of the valuation date.
Allocation of value
The fair values of the assets acquired from Lightscape were allocated
between: Intellectual property--in-process research and development and
developed technology; and Other intangible assets--assembled work force and
goodwill/other intangibles. The results of the allocation of values between
the assets are as follows:
Asset Fair Market Value
----- -----------------
(Restated)
Intellectual Property:
In-Process Research and Development...................... $1,646,000
Acquired Technology...................................... $ 990,000
Other Intangible Assets:
Assembled Work Force..................................... $ 100,000
Goodwill/Other Intangibles............................... $4,151,000
Restructuring
During the fiscal year ended July 31, 1996, excluding a restructuring charge
of $15,000,000 and its related tax effects, the Company 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,
the Company developed a restructuring plan during the fourth fiscal quarter of
1996. While the Company 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, the Company still has
approximately $3,335,000 in restructuring reserves primarily for the estimated
cost of terminating leases, resolving outstanding severance issues, and the
legal and taxation winding down of several subsidiaries.
Change of Fiscal Year
On January 9, 1997, the Board of Directors of the Company approved the
change of the Company's fiscal year end from July 31 to June 30. This change
was effective beginning with the Company's second fiscal quarter of 1997. The
condensed consolidated financial statements are presented for the three and
six month periods ended December 31, 1997 and the two and five month periods
ended December 31, 1996. The Company prepares consolidated financial
statements, remeasures accounts in foreign currencies to reflect changes in
exchange rates and examines and adjusts certain reserve accounts at the end of
each quarter. Therefore, it is not practicable to recast the prior fiscal
period's results to reflect the new fiscal period. Consequently, the results
for the three and six month periods ended December 31, 1997 are not directly
comparable to the results of the two and five month periods ended December 31,
1996.
15
Results of Operations
The following table sets forth the percentages of total revenues represented
by certain line items in the statements of operations:
Two Months Three Months Five Months Six Months
Ended Ended Ended Ended
December 31, December 31, December 31, December 31,
1996 1997 1996 1997
------------ ------------ ------------ ------------
(Restated) (Restated)
Total revenues............. 100% 100% 100% 100%
Cost of revenues........... 48 36 51 41
--- --- --- ---
Gross profit............. 52 64 49 59
--- --- --- ---
Operating expenses:
Research and
development............. 9 10 10 10
Sales and marketing...... 27 23 26 21
General and
administrative.......... 7 11 7 10
Charge for purchased
research and
development............. -- 4 -- 9
--- --- --- ---
Total operating
expenses.............. 43 48 43 50
--- --- --- ---
Operating income......... 9 16 6 9
Other income net........... 11 -- 2 1
--- --- --- ---
Income before income
taxes................... 20 16 8 10
Provision for income
taxes..................... 8 8 5 8
--- --- --- ---
Net income............... 12% 8% 3% 2%
=== === === ===
Three Months Ended December 31, 1997 and Two Months Ended December 31, 1996
and Six Months Ended December 31, 1997 and Five Months Ended December 31, 1996
As discussed above, it is not practicable to recast prior quarterly results
to reflect new fiscal periodic reporting resulting from the Company's
previously announced change in fiscal year end. Therefore, the results for the
three and six month periods ended December 31, 1997 are not directly
comparable to the results of the two and five month periods ended December 31,
1996.
Total Revenues. The Company's revenues consist of product revenues
(including licensing of its software, sales of the Company's proprietary
hardware, and resale of third party hardware) and, to a lesser extent,
revenues from maintenance and other services (including consulting and
training). For all periods presented, the Company has recognized revenue in
accordance with Statement of Position 91-1, entitled "Software Revenue
Recognition," issued by the American Institute of Certified Public
Accountants. In accordance with this statement, in cases where the Company has
delivered hardware and/or software to customers and has insignificant or
noncritical vendor obligations related to these deliveries, the revenue
attributable to such obligations has been deferred until such obligations have
been fulfilled. Beginning with its third quarter of fiscal 1998, the Company
intends to implement SOP 97-2 (See Note 6 of Notes to Condensed Consolidated
Financial Statements).
Total revenues were $37,268,000 and $16,833,000 for the three month period
ended December 31, 1997, and the two month period ended December 31, 1996,
respectively, and $75,673,000 and $40,096,000 for the six month period ended
December 31, 1997, and the five month period ended December 31, 1996,
respectively. The increase in total revenues in both the three and six month
periods ended December 31, 1997, when compared to the two and five month
periods ended December 31, 1996, respectively, was primarily due to the
additional month in the fiscal 1998 periods, and an increase in worldwide
revenues generated by the Company's Special Effects and Editing (including
initial commercial shipments of SMOKE, the Company's non-linear digital
editing tool introduced in the second quarter of fiscal 1998) product lines.
These increases were partially offset by a
16
decrease in revenues, in the six month period ended December 31, 1997, from
the Company's Broadcast Production product line, as compared to the five month
period ended December 31, 1996.
Revenues from customers outside of North America were $21,702,000 (58% of
total revenues) and $10,255,000 (61% of total revenues) for the three month
period ended December 31, 1997, and the two month period ended December 31,
1996, respectively, and $39,965,000 (53% of total revenues) and $21,779,000
(54% of total revenues) for the six month period ended December 31, 1997, and
the five month period ended December 31, 1996, respectively. Revenues from
customers outside North America increased in both the three and six months
ended December 31, 1997 when compared to the two and five months ended
December 31, 1996, respectively, due to the additional month in the fiscal
1998 periods, and the increased penetration of the Company's products in the
Asian and European markets. 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 current 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 $13,548,000 (36% of total
revenues) and $8,003,000 (48% of total revenues) for the three month period
ended December 31, 1997, and the two month period ended December 31, 1996,
respectively, and $30,827,000 (41% of total revenues) and $20,290,000 (51% of
total revenues) for the six month period ended December 31, 1997, and the five
month period ended December 31, 1996, respectively. The decrease in cost of
revenues, as a percentage of total revenues, in both the three and six months
ended December 31, 1997 when compared to the two and five months ended
December 31, 1996, respectively, was primarily due to: (1) an increase in
sales to the Company's indirect channel partners, whose purchases from
Discreet Logic are predominantly software only and software and storage media
bundles since these indirect channel partners are themselves hardware
resellers; (2) porting certain of the Company's software products to recently
available, lower priced workstations, resulting in a lower cost to the Company
for the hardware component of system sales; and (3) the increased penetration
of the Company's products in the Asian market where customers typically
purchase from the Company only software or software and storage media bundles.
The decrease in cost of revenues, as a percentage of total revenues, in the
six months ended December 31, 1997 when compared to the five months ended
December 31, 1996 is also attributable to lower margins realized on systems
sold in the three month period ended October 31, 1996 under an aggressive
sales program, including product discounts, designed to reduce the inventory
on hand at the end of the fourth fiscal quarter of 1996. The Company expects
that cost of revenues, as a percentage of total revenues, should increase from
its current level. 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, amortization
of acquired technologies, 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 $3,901,000 (10% of total revenues) and $1,575,000 (9% of total revenues)
for the three month period ended December 31, 1997, and the two month period
ended December 31, 1996, respectively, and $7,413,000 (10% of total revenues)
and $4,253,000 (10% of total revenues) for the six month period ended December
31, 1997, and the five month period ended December 31, 1996, respectively. The
increase in research and development expenses in both the three and six months
ended December 31, 1997 when compared to the two and five months ended
December 31, 1996, respectively, was primarily due to: (1) the additional
month in both of the fiscal 1998 periods; (2) an increase in the number of
software engineers (including the engineers joining the Company as a result of
the Denim and D-Vision Acquisitions) to develop and enhance the Company's
existing products and to develop new products; (3) an increase in depreciation
charges on the additional research and development equipment required for the
additional personnel; and (4) an increase in the amortization of
17
acquired technologies. Research and development costs are expensed as
incurred. Software development costs are considered for capitalization once
technical feasibility has been established. The Company 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. The Company expects that research and
development expenses will increase from current levels. Should revenues
increase, the Company expects that research and development expenses, as a
percentage of total revenues, should remain approximately the same as their
current levels.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions and related benefits, facilities and administrative
costs allocated to the Company's sales and marketing personnel, tradeshow
expenses, and dealer commissions. Sales and marketing expenses were $8,407,000
(23% of total revenues) and $4,610,000 (27% of total revenues) for the three
month period ended December 31, 1997, and the two month period ended December
31, 1996, respectively, and $15,840,000 (21% of total revenues) and
$10,627,000 (26% of total revenues) for the six month period ended December
31, 1997, and the five month period ended December 31, 1996, respectively. The
increase in sales and marketing expenses, in both the three and six months
ended December 31, 1997 when compared to the two and five months ended
December 31, 1996, respectively, is explained by the additional month in the
fiscal 1998 periods, the continued expansion of the Company's direct and
indirect sales organization, including the operating costs of domestic sales
offices and foreign subsidiaries, and an increase in tradeshow activities. The
decrease in sales and marketing expenses, as a percentage of total revenues,
in both the three and six months ended December 31, 1997 when compared to the
two and five months ended December 31, 1996, respectively, is explained in
part by the growth of sales to the indirect channel partners which require a
reduced level of expenditures than direct sales to end-users. The Company
expects that sales and marketing expenses will increase from their current
levels. Should revenues increase, the Company expects that sales and marketing
expenses, as a percentage of total revenues, should remain approximately the
same as their 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 the Company
and reserves for doubtful accounts receivable. General and administrative
expenses were $3,951,000 (11% of total revenues) as restated and $1,189,000
(7% of total revenues) for the three month period ended December 31, 1997, and
the two month period ended December 31, 1996, respectively, and $7,556,000
(10% of total revenues) as restated and $2,705,000 (7% of total revenues) for
the six month period ended December 31, 1997, and the five month period ended
December 31, 1996, respectively. The increase in general and administrative
expenses in both the three and six months ended December 31, 1997 when
compared to the two and five months ended December 31, 1996, respectively, is
explained by the additional month in the later periods being compared, and by
an increase in personnel. The Company expects that general and administrative
expenses will increase from their current levels. Should revenues increase,
the Company expects that general and administrative expenses, as a percentage
of total revenues, should remain approximately the same as their current
levels.
Charge for Purchased Research and Development. In connection with the
Lightscape Acquisition, the Company expensed $1,646,000 (4% of total revenues)
as restated, of in-process research and development in the three month period
ended December 31, 1997. In connection with the D-Vision Acquisition, the
Company expensed $5,269,000, as restated, of in-process research and
development in the three month period ended September 30, 1997.
Other Income (Expense). Other Income (Expense) primarily consists of foreign
currency gains and losses and interest income and expense. Foreign currency
translation gains were $179,000 for the three month period ended December 31,
1997 compared to $1,539,000 for the two month period ended December 31, 1996.
Foreign currency translation gains were $308,000 for the six month period
ended December 31, 1997 compared to $458,000 for the five month period ended
December 31, 1996. These gains and losses are primarily the result of the
Company and each subsidiary translating intercompany balances denominated in a
currency other than its
18
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.
Provision for Income Taxes. The Company's provision for income taxes was
$3,097,000 and $1,310,000 for the three month period ended December 31, 1997,
and the two month period ended December 31, 1996, respectively, and $5,872,000
and $1,962,000 for the six month period ended December 31, 1997, and the five
month period ended December 31, 1996, 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 tax provision for the
three and six month periods ended December 31, 1997 differed from the
statutory rate primarily as a result of the Company recording charges for
acquired 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 realization of the benefit for some prior year tax
losses for which no benefit was previously recorded. The tax provision for the
five month period ended December 31, 1996 differed from the statutory rate
primarily as a result of the Company not recording a benefit related to losses
where the realization of the benefit was uncertain. The Company has foreign
net operating loss carry forwards which may be available to reduce future
income tax liabilities.
Liquidity and Capital Resources
The Company has funded its operations to date primarily through cash flow
from operations, borrowings under its demand line of credit, capital leases,
the private and public sales of equity securities, and the receipt of research
and development tax credits from the Canadian federal government and the
Province of Quebec. As of December 31, 1997, the Company had cash of
approximately $12,649,000. In August 1997, the Company amended its revolving
demand line of credit with a bank under which the Company may borrow up to
CDN$7,000,000 (or approximately $4,885,000 at December 31, 1997). Advances
under the line accrue interest monthly at the Canadian prime rate (6.0% at
December 31, 1997) plus 0.25%. Additionally, the Company has a CDN$600,000
(approximately $419,000 at December 31, 1997) demand leasing facility, and a
CDN$600,000 (approximately $419,000 at December 31, 1997) demand research and
development tax credit facility. Advances under these facilities accrue
interest monthly at the Canadian prime rate (6.0% at December 31, 1997) plus
1%. The line and facilities are secured by essentially all of the Company's
North American assets. As additional security, the Company has 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 assets ratios. As of December 31, 1997, no
amounts were outstanding under the demand line of credit, the demand leasing,
or the demand research and development tax credit facilities.
The Company's operating activities used cash of $4,196,000 and provided cash
of $17,290,000 for the six month period ended December 31, 1997 and the five
month period ended December 31, 1996, respectively. The principal uses of cash
for the six months ended December 31, 1997 were the disbursement of funds used
to settle the class action litigations and the decrease in accounts payable
and accrued expenses resulting from the Company paying many of the liabilities
assumed in connection with the D-Vision and Lightscape acquisitions. These
uses of cash were offset primarily by cash provided by net income before non-
cash charges, including the charges for purchased in-process research and
development, and the receipt of insurance proceeds related to the settlement
of the class action litigations. Net cash provided by operations in the five
month period ended December 31, 1996 was composed primarily of net income
before non-cash charges and decreases in accounts receivable and inventory.
The Company's investing activities used cash of $13,874,000 in the six month
period ended December 31, 1997 primarily for the acquisition of D-Vision
Systems, Inc. and the purchase of research and development equipment and
related software. During the six month period ended December 31, 1997, the
Company received proceeds from the sale of its Montreal land and office
building which were previously included on the balance sheet as assets held
for resale. The proceeds of sale were not materially different from the
carrying value of these
19
assets. The Company's investing activities used cash of $3,084,000 in the five
month period ended December 31, 1996, primarily for renovations to the office
building in London, England and the purchase of computer equipment and
software used in the operations of the Company's business, primarily in the
research and development area.
Financing activities provided cash of $777,000 and $840,000 in the six month
period ended December 31, 1997 and five month period ended December 31, 1996,
respectively, from proceeds from common stock option exercises and the
issuance of shares under the Employee Stock Purchase Plan.
As of December 31, 1997, the Company did not have any material commitments
for capital expenditures.
The Company's ability to meet its future liquidity requirements is dependent
upon its ability to operate profitably, or in the absence thereof, to obtain
additional financing. The Company underwent a restructuring intended to
decrease operating expenses, however, there can be no assurance that the
Company will not have to take further restructurings or be profitable in the
future. Should the Company need to secure additional financing to meet its
future liquidity requirements, there can be no assurance that the Company will
be able to secure such financing, or that such financing, if available, will
be on terms favorable to the Company. Subject to the factors discussed below
in Certain Factors That May Affect Future Results, the Company 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 1998.
Certain Factors That May Affect Future Results
Information provided by the Company 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
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" which are not historical facts (including, but not limited to,
statements regarding the Company's anticipated cost of revenues, statements
regarding the anticipated adequacy of cash to meet operations, statements
concerning anticipated expense levels and such expenses as a percentage of
revenues, statements about the anticipated portion of revenues from customers
outside North America, and the implementation of the restructuring plan) may
constitute forward-looking statements. The Company'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, the
factors discussed below, other risks discussed in this section and elsewhere
in this Form 10-Q, and the other risks discussed in the Company's Annual
Report on Form 10-K for the fiscal year ended June 30, 1997, as well as, from
time to time, in the Company's other filings with the Securities and Exchange
Commission.
The Company's future results are subject to substantial risks and
uncertainties. The Company'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 the Company
to achieve sustained growth, the market for the Company's systems and software
must continue to develop and the Company 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 the Company will be successful in marketing its existing or any new or
enhanced products. In addition, as the Company enters new markets,
distribution channels, technical requirements and levels and bases of
competition may be different from those in the Company's current markets and
there can be no assurance that the Company will be able to compete favorably.
The markets in which the Company competes are characterized by intense
competition and many of the Company's current and prospective competitors have
significantly greater financial, technical, manufacturing and marketing
resources than the Company. These companies may introduce additional products
that are competitive with those of the Company, and there can be no assurance
that the Company's products would compete effectively with such products.
Furthermore, competitive pressures or other factors, including the Company's
entry into new markets, may result in significant price erosion that could
have a material adverse effect on the
20
Company's business and results of operations. The Company 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 the Company will not incur disruptions and unexpected
expenses in integrating the operations of the acquired businesses with those
of the Company.
The Company's FLAME, FLINT, INFERNO, FIRE, VAPOUR and FROST systems
currently include workstations manufactured by SGI. There are significant
risks associated with this reliance on SGI and the Company 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 the Company's products to future SGI products. The
Company 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. The Company currently relies
principally on unregistered copyrights and trade secrets to protect its
intellectual property. Any invalidation of the Company's intellectual property
rights or lengthy and expensive defense of those rights could have a material
adverse effect on the Company. The Company received a letter from Avid
Technology, Inc. ("Avid") stating its belief that certain of the Company's
recently acquired D-Vision products practice inventions claimed in a patent on
a media editing system. The Company has responded to Avid's letter stating the
Company's belief that the Company is not infringing any valid claim of Avid's
patent. To the Company's knowledge, Avid has not initiated any suit, action or
other proceeding alleging any infringement by the Company of such patent. The
Company currently markets its systems through its direct sales organization
and through distributors. This marketing strategy may result in distribution
channel conflicts as the Company's direct sales efforts may compete with those
of its indirect channels. The Company currently relies on SGI as the sole
source for video input/output cards used in the Company's systems. The
Company's D-VISION (formerly named OnLINE) software requires a videographic
card manufactured solely by Truevision, Inc. An interruption in the supply or
increase in the price of either one of these components could have a material
adverse effect on the Company's business and results of operations. To date,
the Company has depended to a significant extent upon a number of key
management and technical employees and the Company'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 the Company's business and results of operations. There can
be no assurance that these factors will not have a material adverse effect on
the Company's future international sales and consequently, on the Company's
business and results of operations.
The market price of the Company's common shares could be subject to
significant fluctuations in response to quarter-to-quarter variations in the
Company's operating results, announcements of technological innovations or new
products by the Company, 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 the Company's 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 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,
21
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.
22
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
On May 29, 1996, a lawsuit entitled Sandra Esner and Jerry Krim, On Behalf
of Themselves and All Others Similarly Situated, vs. [... ]Discreet Logic Inc.,
et al., case No. 978584, was filed in the Superior Court of the State of
California, City and County of San Francisco. Named as defendants are the
Company, certain of the Company's former and existing directors, officers, and
affiliates, and certain underwriters and financial analysts. The plaintiffs
purport to represent a class of all persons who purchased the Company's common
stock between September 13, 1995, and May 1, 1996. The complaint alleges
violations of California law through material misrepresentations and
omissions, among other things. The Company believes that the allegations in
the complaint are without merit and has defended the lawsuit vigorously.
On June 13, 1996, a lawsuit entitled Bruce Friedberg, On Behalf of Himself
and All Others Similarly Situated, vs. Discreet Logic Inc., et al., Civ. No.
96-11232-EFH, was filed in the United States District Court, District of
Massachusetts. Named as defendants are the Company and certain of the
Company's former and existing directors and officers. The plaintiff purports
to represent a class of all persons who purchased the Company's common stock
between November 14, 1995, and February 13, 1996. On October 11, 1996, the
plaintiff filed an amended complaint which asserts substantially the same
factual allegations as the first complaint and proposes the identical class
period. The complaint alleges violations of the United States Federal
Securities law through material misrepresentations and omissions. The Company
believes that the allegations in the complaint are without merit and has
defended the lawsuit vigorously.
On April 29, 1997, a lawsuit entitled Anton Paparella, Sandra Esner and
Geoffrey L. Sherwood, On Behalf of Themselves and All Others Similarly
Situated vs. Discreet Logic Inc., et al., case No. C-97-1570, was filed in the
United States District Court, Northern District of California. Named as
defendants are the Company and certain of Company's former and existing
officers, directors and affiliates, and certain underwriters. The complaint
asserts, in all material respects, the same factual allegations and proposes
the same class period as the above-described California state court complaint
filed in May 1996, except asserts claims under federal securities law instead
of state law. The Company believes that the allegations in the California
federal complaint are without merit and has defended the lawsuit vigorously.
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.
Items 2-3. Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
At the Annual Meeting of Shareholders held on November 20, 1997 pursuant to
the Notice of Annual Meeting of Shareholders dated October 24, 1997.
1. The proposal to elect the following nominees as directors, to serve for a
two-year term or until their successors are elected and qualified, was
approved. Vote results as follows:
Class of Votes
Nominee Director Votes for Withheld Abstained
------- -------- ---------- -------- ---------
Richard Szalwinski.................... I 24,164,903 18,264 0
Thomas Cantwell....................... I 24,164,303 18,864 0
Pierre Desjardins..................... I 24,164,753 18,414 0
23
At the Annual Meeting of Shareholders held on January 9, 1997, Messrs. Brian
P. Drummond, Perry M. Simon and Gary G. Tregaskis were elected to Class II of
the Company's Board of Directors to hold office until the Annual Meeting of
Shareholders for fiscal 1998 and until their successors have been duly elected
and qualified.
2. The proposal to approve an amendment to the Company's 1994 Amended and
Restated Restricted Stock and Stock Option Plan to reserve an additional
2,000,000 shares of common stock for issuance thereunder was approved. Vote
results as follows: 14,641,810 shares in favor; 7,814,761 shares against, with
8,090 shares abstaining; and 1,718,506 counted as "non-votes'.
3. The proposal to appoint Arthur Andersen & Cie as independent accountants
for the Company for fiscal 1998 and to authorize the Board of Directors to fix
their remuneration was approved. Vote results as follows: 24,169,287 shares in
favor; 7,640 shares against, with 6,240 shares abstaining.
There were no other matters submitted to a vote of the Company's
shareholders during the second quarter of the fiscal year covered by this
report through the solicitation of proxies or otherwise.
Item 5. Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibit Description of Exhibit
------- ----------------------
Exhibit 27.1 Financial Data Schedule
(b) Reports on Form 8-K.
A Current Report on Form 8-K dated December 30, 1997 was filed on January
14, 1998. The Current Report on Form 8-K was filed pursuant to Item 2 of Form
8-K (Acquisition or Disposition of Assets) announcing the completion of the
merger of Lantern Acquisition Corp. ("Merger Sub"), a Delaware corporation and
wholly-owned subsidiary of Discreet Logic with and into Lightscape
Technologies, Inc. ("Lightscape"), a Delaware corporation, with Lightscape the
surviving corporation and a wholly-owned subsidiary of Discreet Logic,
pursuant to the Agreement and Plan of Merger and Reorganization dated as of
December 2, 1997 by and among Discreet Logic, Merger Sub and Lightscape.
24
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
25