Stanford University Law School - Securities Class Action Clearinghouse

Complaint for Violation of the Securities Exchange Act of 1934 (Paparella, et al. v. Discreet Logic Inc., et al., Case No. C-97-1570-CW)


MILBERG WEISS BERSHAD
HYNES & LERACH LLP
WILLIAM S. LERACH (68581)
600 West Broadway, Suite 1800
San Diego, CA 92101
Telephone: 619/231-1058
- and -
REED R. KATHREIN (139304)
LISA C. ATKINSON (163320)
222 Kearny Street, 10th Floor
San Francisco, CA 94108
Telephone: 415/288-4545
 

ROSSBACHER & ASSOCIATES
HENRY H. ROSSBACHER (060260)
Union Bank Plaza, 24th Floor
445 S. Figueroa Street
Los Angeles, CA 90071
Telephone: 213/895-6500
SPECTOR & ROSEMAN, P.C.
ROBERT M. ROSEMAN
2000 Market Street
12th Floor
Philadelphia, PA 19103
Telephone: 215/864-2400
Attorneys for Plaintiffs
 

[Additional counsel appear on signature page.]
 
 

UNITED STATES DISTRICT COURT


NORTHERN DISTRICT OF CALIFORNIA





ANTON PAPARELLA, SANDRA ESNER and GEOFFREY L. SHERWOOD, On Behalf of Themselves and All Others Similarly Situated,
 

Plaintiffs,
 

vs.
 

DISCREET LOGIC INC., RICHARD J. SZALWINSKI, 9002-1585 QUEBEC INC., DAVID N. MACRAE, DOUGLAS R. JOHNSON, THOMAS CANTWELL, DAVID FOSTER, GARY G. TREGASKIS, NEARCO TRUSTEE CO. (JERSEY) LTD. RE: GARY TREGASKIS SETTLEMENT, TERRENCE HIGGINS, ROBERTSON, STEPHENS & CO., VOLPE, WELTY & CO. and PIPER JAFFRAY INC.,
 

Defendants.
_____________________________________
)))))))))))))))))))))
No.
 

CLASS ACTION

COMPLAINT FOR VIOLATION OF THE SECURITIES EXCHANGE ACT OF 1934
 
 

Plaintiffs Demand A

Trial By Jury
 


INTRODUCTION AND OVERVIEW

1. This is a class action on behalf of all purchasers of the common stock of Discreet Logic Inc. ("Discreet" or the "Company"), between September 13, 1995 and May 1, 1996 (the "Class Period"). Discreet sells digital tools which utilize computer workstations manufactured by Silicon Graphics, Inc. ("SGI") for the creation of special effects for movies, videos, etc. Discreet, its officers and directors and its underwriters artificially inflated Discreet's stock to over $30 per share by mid-November 1995, based on positive statements regarding Discreet's successful development and introduction of new products (especially for the broadcast market), its expert management team and forecasts of strong revenue and earnings growth throughout fiscal 1996 to end July 31, 1996. This permitted Discreet and its insiders to pull off a huge stock sale in November 1995 in which they unloaded 3.6 million shares of Discreet stock at $30.25 per share for $109 million. Then just two months later, Discreet's President and Chief Executive Officer resigned and Discreet reported second quarter fiscal 1996 earnings per share well below defendants' prior forecasts, causing Discreet's stock to plunge to as low as $9-3/4 per share from $25-1/4 per share in one day! However, based on defendants' reassurances that this earnings disappointment was a "short-term"/"temporary" situation, that there were no fundamental problems with Discreet's business and that Discreet's revenue and earnings growth would resume in the third and fourth quarters of fiscal 1996, defendants pushed Discreet's stock back up to $18-5/8 by late April 1996. But then, on May 1, 1996, Discreet revealed that its Chief Financial Officer had resigned, its revenues for its third quarter of fiscal 1996 had fallen sharply, that it would suffer a large third quarter loss, that it also expected to report a loss in its fourth quarter which would result in a loss for all of fiscal 1996, and that Discreet could not even state when it would return to profitability due to fundamental problems with its business, including poor sales of its most important existing product line and its failure to develop and successfully introduce new products (especially for the broadcast industry). This caused Discreet's stock to collapse to $8-3/4 per share from $17-3/8 in one day, on huge volume of over nine million shares.

2. Discreet "went public" on June 30, 1995 in a stock offering (the "June Stock Offering") underwritten by Robertson, Stephens & Co. ("Robertson Stephens") and Volpe, Welty & Co. ("Volpe Welty") in which 6.2 million shares(1)

of Discreet stock were sold to investors at $10.50 per share, with Discreet selling 3.6 million shares and certain Discreet insiders and controlling shareholders selling 2.6 million shares for $60+ million, while the underwriters got $4.5 million. At the time of the June Stock Offering, Discreet's insiders agreed not to sell any more of their Discreet shares for 180 days without the prior permission of the underwriters, i.e., Robertson Stephens and Volpe Welty. Because of the positive statements made by Discreet and the underwriters in the "Roadshow" before the June Stock Offering, Discreet's June Stock Offering was a "hot" offering and Discreet's stock jumped $6 per share on its first day of trading to close at $16-1/2. As Discreet's insiders and underwriters made more positive statements after the June Stock Offering, Discreet's stock continued to climb to over $22 per share by mid-September 1995, more than double its offering price less than three months earlier. Discreet's insiders were pleased with this strong performance by Discreet's stock as they intended to sell off large amounts of their shares as soon as they could do so, i.e., after December 30, 1995, into the trading market for Discreet's shares.

3. However, by September 1995 Discreet's insiders realized that things were not going as well with Discreet's business as publicly represented, the risks of slowing revenue and earnings growth for Discreet were much greater than publicly known and Discreet's future prospects were much less promising than it earlier appeared. This was due to, inter alia, (i) severe dissension among Discreet's top executives regarding Discreet's strategy and business plan; (ii) increasing difficulty in selling Discreet's flagship product line (FLAME/INFERNO); (iii) Discreet's difficulties in getting a sufficient supply of Indigo2 Impact workstations from SGI to sell its FLINT product in the quantities necessary to meet Discreet's internally budgeted and externally forecasted revenue and earnings levels; (iv) that SGI would shortly introduce an advanced and upgraded version of its Onyx computer workstation (Onyx InfiniteReality) which would greatly reduce the value of Discreet's non-price protected inventory of the earlier version of that product and require Discreet to offer steep discounts to sell off its products which incorporated the earlier version of the Onyx workstation; and (v) problems integrating two recent acquisitions (Brughetti/VAPOUR) and in successfully developing and introducing the new products (especially those for the broadcast industry), which were necessary to diversify Discreet's business and broaden its product line so it could achieve the revenue and earnings increases forecast by and for Discreet and which were necessary to keep its stock price trading at high levels. Discreet's insiders were concerned that since many of these difficulties with Discreet's business were worsening they would not be able to conceal them until the "lock-up," which prevented them from selling off any more of their Discreet shares without the permission of the underwriters, expired on December 30, 1995. Thus Discreet's insiders, working with Robertson Stephens, Volpe Welty and Piper Jaffray, Inc. ("Piper Jaffray") (collectively, the "Underwriter Defendants") quickly arranged a huge sale of Discreet's stock on November 14, 1995 (the "November Stock Offering"), so that Discreet could sell more of its shares to the public and raise the cash it needed to help it cope with the decline in its business its insiders knew was already underway, and so Discreet's insiders could sell off large amounts of their shares before the December 30, 1995 lock-up date and without the SEC Rule 144 volume restrictions on open market sales by corporate insiders.

4. To condition the market to accept this huge offering of Discreet stock and to push up its stock price to higher levels for the November Stock Offering, on September 13, 1995, defendants commenced a publicity campaign to make it appear that Discreet's business had never been more successful or demand for its products stronger, that its expert management team was successfully pursuing a strategy to diversify and expand Discreet's product line by developing and introducing new products, including those for the rapidly growing broadcast market, and that, as a result, Discreet would achieve strong revenue and earnings per share growth in its fiscal 1996 and 1997 years to end July 30 of each of those years.

5. Thus, on September 13, 1995, when Discreet's stock was trading at $21-5/8 per share, defendants peppered the market with very positive representations about Discreet. They said Brughetti Corp., the new acquisition by which Discreet intended to enter the broadcast market, was a "tremendous resource," while Discreet's newly acquired VAPOUR (virtual set) technology, which was also to be used to make products for the broadcast industry, was "fully integrated with Discreet Logic's digital effects and editing products" and "creates a strong and immediate presence in an exciting new market." As a result, Discreet was "favorably positioned to become a market leader" in the broadcast market, estimated to be worth $100 million in fiscal 1996. When Discreet later reported record results for fiscal 1995, ended July 31, 1995 -- revenues of $64.5 million and earnings per share of $.31 -- it assured investors these strong results showed the "continued acceptance of FLAME" (Discreet's flagship product) and that its FLAME/INFERNO, VAPOUR and Brughetti broadcast products "provid[ed] a strong base" for fiscal 1996. During the fall of 1995, defendants assured investors that "current . . . demand is robust," Discreet had "strong management," as fiscal 1995 had seen the "solidification of our management team" which could "manage chaos," that the "new management team brings . . . management expertise" and its "combined strength[ ] . . . enables [Discreet] to plan for growth with confidence." Defendants stressed Discreet's "explosive growth potential" representing that "[t]he outlook for Discreet remains shining bright," "[a]ll current signs are favorable for Discreet," and defendants "expect[ed] the momentum" of Discreet's "ferocious sales growth . . . to continue." Thus, defendants forecast that Discreet would achieve strong sequential quarterly revenue growth in fiscal 1996: Q1-$23.5 million, Q2-$26 million, Q3-$31.5 million, Q4-$37 million, with fiscal 1996 earnings per share of approximately $.50. They also forecast that Discreet would achieve fiscal 1997 revenues of $170 million and earnings per share of $.67-$.68 and have a three-year secular growth rate of 35%.

6. Just before the November Stock Offering, to increase interest among institutional investors and others in the stock offering, Discreet and certain of its top officers (Richard Szalwinski and Douglas Johnson) and the Underwriter Defendants conducted a "Roadshow" in major U.S. cities (including New York, Chicago and San Francisco) between October 15 and November 10, 1995. During the Roadshow they met with and made presentations to existing Discreet stockholders, institutional investors, securities analysts and potential purchasers of Discreet stock, the names of which are known only to defendants. During these meetings and presentations, Discreet's top officers (Szalwinski and Johnson) made positive statements. For instance, they told people during the Roadshow that Discreet's business was doing "better than planned" and that demand for its existing flagship product line, FLAME/INFERNO, was "extremely strong." They also said that Discreet was diversifying away from dependence on the FLAME/INFERNO product line by "successfully developing new products for the broadcast industry" through its newly-acquired Brughetti Corp. subsidiary and VAPOUR (virtual set) technology. They told potential investors that Discreet was making "good progress" in finalizing these products for commercial introduction and, with respect to the VAPOUR virtual set product, had received "strong indications of interest" in the product and "expected it to be a commercial success." During the Roadshow, Szalwinski and Johnson and the Underwriter Defendants also assured potential investors that there were "no significant problems" with Discreet's business, management or expansion/product diversification plan, that Discreet's top management team was cohesively pursuing a "high growth strategy," that Discreet's future had "never been brighter," and that, as a result of all of these factors, Discreet "would achieve strong sequential quarterly revenue and earnings growth throughout fiscal 1996," with fiscal 1996 revenues of over $125 million and fiscal 1996 earnings per share of approximately $.50, which would be followed by further revenue and earnings per share gains during fiscal 1997.

7. As a result of defendants' efforts, they pushed Discreet's stock price up from below $20 per share after the announcement of the November Stock Offering to artificially inflated prices as high as $32-1/4 per share by November 6, 1995, just before the November Stock Offering took place. This publicity campaign created tremendous interest in Discreet and its November Stock Offering and demand for Discreet stock, allowing defendants to sell 400,000 more shares than the 3.2 million originally planned, so that a total of 3.6 million shares were sold at $30.25 per share. 971,000 shares were sold by Discreet for $29.3 million. The Discreet insiders named as defendants sold 1,887,504 shares for $57 million. The Underwriter Defendants took over $5.4 million of the sales proceeds for helping to merchandise the stock to public investors.

8. In the last half of December 1995, Discreet stock declined sharply, falling to $17-3/4 by early January 1996, when the original "lock-up" agreement would have expired, a 41% decline in the six weeks since the huge November Stock Offering. However, defendants continued to assure the market during December 1995-January 1996 that Discreet's positive results were due to "growth in Flame and Flint shipments [and] initial shipments of Inferno . . . as well as . . . Vapour," "solid contributions from new products such as . . . Vapour and Brughetti," that "the Company has successfully navigated and begun to realize the fruits of its . . . COSS/IMP acquisition," that "Discreet will begin commercial broadcast shipments during fiscal 1996" and that "VAPOUR . . . reported favorable sales levels . . . [and] we expect Discreet's virtual set-related sales to rise to over $10 million." In late January 1996, Discreet also announced its FLAME, INFERNO and VAPOUR products would "all benefit" from the availability of a new, updated SGI computer workstation, the Onyx InfiniteReality. As a result, defendants forecast strong revenue and earnings per share growth for Discreet during the balance of fiscal 1996:

Earnings

Revenues Per Share
 

Q1A $25.0 million $.12

Q2E $27-$29 million $.12-$.13

Q3E $34-$35 million $.14-$.16

Q4E $39-$45 million $.18-$.20

FY1996 $126-$135 million $.56-$.60
 

and continued revenue and earnings per share growth in fiscal 1997 to $180-$194 million and $.75-$.85, respectively. These positive assurances and forecasts pushed Discreet's stock back up to as high as $28-1/4 per share in early February 1996. On February 12, 1996, the stock traded as high as $25-1/4 per share.

9. Then, on February 13, 1996, Discreet shocked the market by revealing that its President and Chief Executive Officer had resigned and its revenue for the quarter ended January 31, 1996 (the second quarter of fiscal 1996) would be only $25 million, an increase over the first quarter but lower than earlier expected, and achieve earnings per share of only $.02-$.04, far worse than they forecast. This was purportedly due to what Discreet claimed was an unexpected decision by Discreet's main supplier, SGI, to introduce the upgraded version of its Onyx Reality workstation just nine days before the end of Discreet's January 31, 1996 quarter, causing Discreet to lose millions of dollars in sales which it was then in the process of closing, although the director of marketing for SGI said that Discreet had known about the pending product upgrade for "months" and had all the information necessary to deal with its customers. Discreet's CFO Johnson also later admitted that President/CEO David Macrae's resignation followed "disagreements on tactics of implementation of strategies, between the CEO and the Board," that Discreet did not have any price protection on its SGI Onyx workstation inventories prior to the January 22, 1996 announcement of the upgraded Onyx InfiniteReality workstation and that, in order to sell its products, Discreet had engaged in substantial discounting. These revelations utterly crushed Discreet's stock, causing it to collapse from a high of $25-1/4 on February 12, 1996 to a low of $9-3/4 on February 13, 1996 on huge volume.

10. The collapse of Discreet's stock on February 13, 1996, caused a panic among Discreet's insiders and the Underwriter Defendants, as they realized that this collapse, coming just three months after the huge $109 million November Stock Offering, could result in them being sued. Thus, they mounted an intense effort to halt the decline of Discreet stock and push it back up to higher (inflated) levels once again, cover up their wrongdoing and avoid being sued.

11. On February 13, 1996, and in the following days and weeks, Discreet and the other defendants falsely assured the market that the primary reason for the second quarter fiscal 1996 shortfall was SGI's announcement of the new Onyx InfiniteReality workstation, which caused Discreet to lose sales then in progress or to sharply discount its products to close sales. However, this was a "temporary problem" or "short-term issue" and "demand for Discreet Logic's products remains strong." They told investors that Discreet would not have to "do as much discounting" in the third and fourth quarters and that "we'll substantially recover in this quarter . . . it's probably a two quarter full pullout of the . . . situation to where we're back on a track that we felt we were on through Q1 of this year." They also stressed "the strength of the company, the strength of the products . . . [and] the strength of the remaining management," saying they were "comfortable" with them. Discreet also announced new and/or upgraded products, including products for the broadcast industry and the FLAME/INFERNO line, while forecasting a resurgence of revenue and earnings per share growth in the last half of fiscal 1996:

Earnings

Revenues Per Share
 

Q1A $25.0 million $.12

Q2A $25.2 million $.03

Q3E $32.0 million $.07

Q4E $37.5 million $.12

FY96 $119.7 million $.34
 

while forecasting continuing fiscal 1997 revenue and earnings per share growth to $196 million and $.68 respectively. As a result of these reassurances, the decline in Discreet's stock was stopped and it was pushed higher, back to close at $11-1/4 on February 13, 1996, $13-5/8 on February 15, 1996 and as high as $18-5/8 on April 26, 1996. And, defendants were not sued.

12. Then on May 1, 1996, Discreet revealed that its chief financial officer had resigned and it expected revenues of only $17-18 million for its third quarter of fiscal 1996, ended April 30, 1996 (as compared to the $32 million forecast), a large decline from the second quarter, that it would suffer a loss in the fourth quarter which would result in a loss for all of fiscal 1996 as well, and that it could not state when it would return to profitability! Discreet admitted that these horrible results were due to poor sales of virtually all of its products, including FLAME and INFERNO, management disruptions, and its failure to even introduce a product for the broadcast market despite its acquisition of Brughetti Corp. and the VAPOUR technology months earlier. In reaction, Discreet's stock collapsed on May 1, 1996 to $8-3/4 per share from $17-3/8 on one day volume of over nine million shares, back below Discreet's $10.50 per share June Stock Offering price 10 months earlier and far below the $30.25 per share price at which defendants orchestrated the $109 million November Stock Offering just five and one-half months earlier.

13. The shocking decline in Discreet's results are set forth below:

Discreet Logic, Inc.

Quarterly Results

(in thousands, except EPS)
 

Fiscal 1995 Quarters Fiscal

10/31/94 1/31/95 4/30/95 7/31/95 1995
 

Revenues $11,016 $13,734 $17,579 $22,220 $64,549

Net Income $ 1,480 $ 1,806 $ 2,006 $ 2,493 $ 7,785

EPS $.06 $.07 $.08 $.10 $.31
 

Fiscal 1996 Quarters Fiscal

10/31/95 1/31/96 4/30/96 7/31/96 1996(2)
 

Revenues $25,044 Nov.Stk. $25,225 $14,677 $19,052 $83,997

Net Income $ 3,292 Offrng. $ 775 -$15,109 -$24,600 -$35,641

EPS $.12 $.03 -$0.55 -$0.92 -$1.32
 

Fiscal 1997 Quarters

10/31/96 12/31/96(2 months)(3)
 

Revenues $23,263 $16,833

Net Income -$ 812 $ 1,965

EPS -$0.03 $.07
 
 
 

14. This fiasco represents a flagrant abuse of the securities laws meant to protect investors and is an example of how sophisticated corporate insiders and financiers mislead the investing public and take advantage of them, here to sell over $109 million in securities to the public at grossly inflated prices when they knew the business of the issuer was in trouble, performing poorly and declining instead of growing and prospering as they represented.

15. The positive statements during the Class Period about Discreet's business, markets, products, and future prospects were materially false and misleading when made. As defendants knew, the true facts regarding Discreet and its business were:

(a) That Discreet's management team was not "strong," did not have "management expertise" and did not have the ability to "manage chaos" as, in fact, Discreet's top management team was suffering from persistent and serious disagreements over corporate strategy and operations which was leading to such fighting and disagreements among top management that important corporate decisions were being delayed or deferred which was harming Discreet's operations;

(b) That David Macrae, Discreet's President and CEO, had warned Discreet's other top officers and its Board that he was going to resign from the Company due to the serious and persistent disagreements he was having with other top officers and the Board over Discreet's corporate strategy and operations, which Macrae had warned the Board were flawed, failing and likely to lead to a poor corporate performance;

(c) That demand for Discreet's flagship product line, FLAME/INFERNO, especially the higher-end and most profitable models of these products, was softening and that Discreet was having difficulty continuing to achieve sales growth of this most important product line;

(d) That in order to make it appear that Discreet was continuing to achieve success in selling its FLAME/INFERNO product line and initial sales success of its VAPOUR "virtual set" products, Discreet was shipping units out of its "demonstration inventory" to customers, permitting them to take possession of the product without a firm agreement to accept it or pay for it, but nevertheless recording and reporting the transactions as "sales," inflating its revenues and profits;

(e) That Discreet's sales of FLINT were well below corporate plan due to an inability to obtain timely shipments of SGI's Indigo2 Impact workstations in quantities needed to meet Discreet's sales budgets;

(f) That Discreet was having serious problems in integrating the VAPOUR technology team and product into its product line, such that sales of products utilizing the VAPOUR technology were very weak and well below the levels internally budgeted or forecasted by Discreet and necessary for it to meet the forecasts of revenue and earnings growth being forecast by and for it;

(g) That Discreet's acquisition of Brughetti Corp. had not given it an "immediate presence" in a rapidly growing market, i.e., the broadcast market, as, in fact, Brughetti Corp., upon acquisition by Discreet and thereafter, did not have a functioning product capable of being sold to the broadcast market and efforts to develop such a product were plagued by serious problems, such that Discreet was unable to develop a product for sale in the important growing broadcast market and thus Discreet could not achieve the levels of revenue and earnings growth forecast by and for it;

(h) That SGI had told Discreet that it would soon be announcing an advanced version of its Onyx Reality workstation, the Onyx InfiniteReality, which would have an adverse impact on Discreet's business because:

(i) It would disrupt Discreet's sales flow and process, hurting its sales because Discreet customers would delay purchases of Discreet's existing products, pending availability of the upgraded or more advanced SGI Onyx InfiniteReality computer workstation which would hurt its revenues;

(ii) In order to continue to make sales of its existing products pending introduction of SGI's upgraded Onyx InfiniteReality computer workstation, Discreet would be forced to offer substantial discounts to its customers which would hurt its profit margins and earnings per share; and

(iii) Discreet had significant inventories of SGI's Onyx Reality computer workstations for which it had no price protection from SGI, and which would be cut significantly in value upon the announcement of the upgraded version of the Onyx Reality computer workstation.

(i) That Discreet's November Stock Offering was not undertaken to raise cash for Discreet to fund its ongoing product diversification or purported expansion plan, as Discreet had more than adequate cash resources for that purpose, but rather, was being undertaken to raise a cash cushion for Discreet to help it survive the decline in its business which its insiders knew was already under way;

(j) That as a result of the adverse factors negatively impacting Discreet's business as set forth above, defendants had no basis for and did not genuinely believe the forecasts of revenue and earnings per share growth made by and for Discreet for fiscal 1996 and fiscal 1997 and, in fact, they knew those forecasts were false when made; and

(k) That defendants had no basis for their positive forecasts and projections regarding Discreet's revenues or earnings growth during fiscal 1996 and 1997, which statements were, in fact, false as they were inconsistent with the above negative factors.

16. The charts below demonstrate the price action of Discreet's stock during the Class Period, defendants' insider selling and the collapse of Discreet's stock price as the previously concealed facts about Discreet's business emerged, and the performance of Discreet stock compared to an index of similar companies, which shows that the action of Discreet stock was due largely to company-specific events and not market forces: 
 
 

JURISDICTION AND VENUE

17. Jurisdiction exists pursuant to §27 of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. §78aa, and 28 U.S.C. §1331. The claims asserted arise under §§10(b) and 20(a) of the Exchange act, 15 U.S.C. §§78j(b), 78t(a) and Rule 10b-5.

18. Venue is proper in this District pursuant to §27 of the Exchange Act and 28 U.S.C. §1391(b). Many of the acts giving rise to the violations complained of occurred in this District.

19. Defendants used the instrumentalities of interstate commerce, the U.S. mails and the facilities of the international securities market.

CLASS ACTION ALLEGATIONS

20. Plaintiffs bring this action as a class action pursuant to Rule 23 of the Federal Rules of Civil Procedure on behalf of all persons who purchased or otherwise acquired Discreet stock from September 13, 1995 through May 1, 1996 (the "Class), excluding the defendants, members of their families and any entity in which a defendant has an interest.

21. The members of the Class are so numerous that joinder of all members is impracticable. The disposition of their claims in a class action will provide substantial benefits to the parties and the Court. During the Class Period, Discreet had more than 11 million shares of stock outstanding, owned by hundreds of shareholders.

22. There is a well-defined community of interest in the questions of law and fact involved in this case. The questions of law and fact common to the members of the Class which predominate over questions which may affect individual Class members, include the following:

(a) Whether §10(b) and Rule 10b-5 were violated by defendants;

(b) Whether §20(a) was violated by defendants;

(c) Whether defendants omitted and/or misrepresented material facts;

(d) Whether defendants' statements omitted material facts necessary to make the statements made, in light of the circumstances under which they were made, not misleading;

(e) Whether defendants knew or recklessly disregarded that their statements were false and misleading;

(f) Whether the price of Discreet stock was artificially inflated during the Class Period; and

(g) The extent of damage sustained by Class members and the appropriate measure of damages.

23. Plaintiffs' claims are typical of those of the Class because plaintiffs and the Class sustained damages from defendants' conduct.

24. Plaintiffs will adequately protect the interests of the Class. They have retained counsel who are experienced in class action securities litigation. Plaintiffs have no interests which conflict with those of the Class.

25. A class action is superior to other available methods for the fair and efficient adjudication of this controversy.

26. The prosecution of separate actions by individual Class members would create a risk of inconsistent and varying adjudications.

THE PARTIES

27. (a) Plaintiff Anton Paparella purchased 22,500 shares of Discreet stock on May 1, 1996 at $10 per share and was damaged thereby.

(b) Plaintiff Sandra Esner purchased 300 shares of Discreet stock on February 14, 1996 at $12-5/8 per share and 500 shares on May 1, 1996 at $9-5/8 per share and was damaged thereby.

(c) Plaintiff Geoffrey L. Sherwood purchased 100 shares of Discreet stock on February 15, 1996 at $13-1/2 per share and was damaged thereby.

28. (a) Defendant Discreet is a Quebec corporation which operates primarily in the United States where most of its sales took place. Discreet sold 971,000 shares of its stock in the November Stock Offering for $29.3 million. Discreet's stock was traded in an efficient market on the NASDAQ National Market System during the Class Period.

(b) Discreet sells digital image processing systems for creating, editing and composing special visual effects for film and video. The Company's systems are utilized in production and post-production to create special visual effects for various applications, including feature films, television programs, commercials, music videos and interactive game production. Discreet sells turnkey systems comprised of the Company's proprietary software utilizing workstations manufactured by SGI.

29. (a) Defendant Richard J. Szalwinski ("Szalwinski") was Chairman of the Board of Directors of Discreet and after February 13, 1996 was its acting President and Chief Executive Officer. Because of Szalwinski's position, he knew or recklessly disregarded the adverse non-public information about Discreet's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at management and Board of Directors' meetings and committees thereof and via reports and other information provided to him in connection therewith. Szalwinski sold 645,944 shares of his Discreet stock in the November Stock Offering, pocketing $18.5 million. Defendant 9002-1585 Quebec Inc. is defendant Szalwinski's personal holding company which held his Discreet shares and was his instrumentality to commit the violations of law complained of.

(b) Defendant David N. Macrae ("Macrae") was President and Chief Executive Officer of Discreet until he resigned on February 13, 1996. Because of defendant Macrae's position, he knew or recklessly disregarded the adverse non-public information about Discreet's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at management and Board of Directors' meetings and committees thereof and via reports and other information provided to him in connection therewith. Macrae sold 400,000 shares of his Discreet stock in the November Stock Offering, pocketing $11.4 million.

(c) Defendant Douglas R. Johnson ("Johnson") was Chief Financial Officer, Vice President, Treasurer and Secretary of Discreet until he resigned on May 1, 1996. Because of defendant Johnson's position, he knew or recklessly disregarded the adverse non-public information about Discreet's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at management meetings and via reports and other information provided to him in connection therewith. Johnson sold 20,000 shares of his Discreet stock in the November Stock Offering, pocketing $574,800.

(d) Defendant Thomas Cantwell ("Cantwell") is a director of Discreet. Because of defendant Cantwell's position with Discreet, he knew or recklessly disregarded the adverse non-public information about Discreet's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at management and Board of Directors' meetings and committees thereof and via reports and other information provided to him in connection therewith. Cantwell sold 383,333 shares of his Discreet stock in the November Stock Offering, pocketing $11 million.

(e) Defendant David Foster ("Foster") is an Executive Vice President-Field Operations of Discreet. Because of defendant Fosters' position with Discreet, he knew or recklessly disregarded the adverse non-public information about Discreet's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at management meetings and via reports and other information provided to him in connection therewith. Foster sold 16,667 shares of his Discreet stock in the November Stock Offering, pocketing $479,000.

(f) Defendant Terrence Higgins ("Higgins") is a Vice President-Engineering of Discreet. Because of defendant Higgins' position with Discreet, he knew or recklessly disregarded the adverse non-public information about Discreet's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at management meetings and via reports and other information provided to him in connection therewith. Higgins sold 21,560 shares of his Discreet stock in the November Stock Offering, pocketing $619,634.

(g) Defendant Gary G. Tregaskis ("Tregaskis") is a director of Discreet and was also Director of Advanced Products of Discreet. Because of defendant Tregaskis's position with Discreet, he knew or recklessly disregarded the adverse non-public information about Discreet's business, finances, products, markets and present and future business prospects via access to internal corporate documents (including the Company's operating plans, budgets and forecasts and reports of actual operations compared thereto), conversations and connections with other corporate officers and employees, attendance at management and Board of Directors' meetings and committees thereof and via reports and other information provided to him in connection therewith. Tregaskis sold 400,000 shares of his Discreet stock in the November Stock Offering, pocketing $11.4 million. Defendant Nearco Trustee Co. (Jersey) Ltd. re: Gary Tregaskis Settlement is defendant Tregaskis' personal holding company which held his Discreet shares and was his instrumentality to commit the violations of law complained of.

(h) The defendants identified in ¶29(a)-(g) are referred to herein as the Individual Defendants.

30. Individual Defendants Szalwinski, Macrae, Johnson, Cantwell and Tregaskis each reviewed and approved the false statements issued by or on behalf of Discreet during the Class Period.

31. (a) Defendants Robertson, Stephens & Co., Volpe, Welty & Co., and Piper Jaffray, Inc. are investment bankers and broker-dealers which specialize in underwriting public offerings of securities and making markets in those securities. Volpe Welty served as Discreet's financial advisor prior to the June Stock Offering. Robertson Stephens and Volpe Welty served as co-lead underwriters of the Discreet June Stock Offering. Volpe Welty, Robertson Stephens and Piper Jaffray served as co-lead underwriters of the November Stock Offering, selling 3.6 million shares of Discreet stock to the pubic. These three firms were also market-makers in Discreet stock and, as such market-makers in Discreet's stock, purchased and sold Discreet stock on a daily basis during the Class Period.

(b) In order to merchandise Discreet's stock in the November Stock Offering, Robertson Stephens, Volpe Welty and Piper Jaffray participated in Roadshow presentations in major U.S. cities prior to the November Stock Offering. Robertson Stephens, Volpe Welty and Piper Jaffray also issued false research reports on Discreet before and after the November Stock Offering which projected strong increases in revenues and earnings per share for Discreet in fiscal 1996 and 1997.

32. Robertson Stephens and Volpe Welty gave permission to Discreet and its insiders to sell stock prior to the end of the 180-day "lock-up" period and the Underwriter Defendants agreed to participate in the wrongdoing in order to please an important client and to obtain their share of the November Stock Offering sale proceeds that was allocated to them -- over $5 million. Prior to the June Stock Offering and the November Stock Offering, the Underwriter Defendants had access to confidential corporate information concerning Discreet's business, products and future business prospects. The Underwriter Defendants assisted Discreet in planning the November Stock Offering.

33. The Underwriter Defendants arranged their participation in these events in a way to try to illegally reduce the risk of any adverse financial consequences to them from their violations of law. In return for their part in the fraudulent scheme and course of business, the Underwriter Defendants required Discreet and the selling shareholders to indemnify and hold them harmless from any suits against them for violating federal securities laws, even though that agreement was illegal. Because Discreet and the selling shareholders obtained millions from the November Stock Offering, the Underwriter Defendants, by their own illegal conduct, created a substantial financial cushion to protect themselves from any adverse financial consequences of their violation of law. The end result of this scheme and course of business was that the public was victimized, while sophisticated corporate insiders and financiers lined their pockets with millions of dollars of ill-gotten gains -- all monies obtained through violations of law.

34. Each of the defendants is liable for making false and misleading statements or participating in a scheme and course of business that defrauded and damaged Class members. In committing the wrongful acts alleged, the defendants pursued a fraudulent scheme and course of business to inflate the price of Discreet stock which (i) deceived the investing public regarding the demand for and success of Discreet products, the success of its business, the quality of its management, its competitive success and its business prospects; (ii) accomplished the November Stock Offering of Discreet's stock which greatly benefited Discreet, its insiders and controlling shareholders and artificially inflated the market price of Discreet stock during the Class Period; and (iii) permitted certain Discreet insiders to sell off millions of dollars worth of their Discreet shares at inflated prices.

MOTIVE AND OPPORTUNITY

35. Each defendant had the opportunity to commit and participate in the violations of law described herein. The Individual Defendants were top officers and directors of Discreet and they controlled its press releases, corporate reports, SEC filings and its communications with analysts. Many of the Individual Defendants were on Discreet's Executive Committee and ran its business day-to-day. Thus, the Individual Defendants controlled the public dissemination of, and could falsify, the information about Discreet's business, products and finances that reached the public and impacted the price of Discreet's stock.

36. Each of the Individual Defendants also had the motive to commit and participate in the violations of law described herein. Discreet's insiders were intimately familiar with Discreet's business and the industry in which it operated and thus knew the nature and extent of the problems that were afflicting Discreet's business by the beginning of the Class Period and what they portended for the future of Discreet's business. These defendants wanted to and did make it appear that the Company would achieve sustained revenue and profit growth, so that its stock price would trade at higher levels and they could insider trade by selling off large amounts of their Discreet stock at artificially inflated prices, pocketing large sums for themselves before the truth about the decline in Discreet's business became known.

STATUTORY SAFE HARBOR

37. The statutory safe harbor provided for forward-looking statements under certain circumstances does not apply to any of the allegedly false statements pleaded in this Complaint. None of the statements pleaded in this Complaint were identified as "forward-looking statements" when made. Nor was it stated that actual results "could differ materially from those projected." Nor were the statements accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from the statements made. Alternatively, to the extent that the statutory safe harbor does apply to any statements pleaded herein, because they are "forward-looking," the defendants are liable for those statements because at the time each of those statements was made, the speaker knew the statement was false and the statement was authorized and/or approved by an executive officer of Discreet who knew that those statements were false when made.

BACKGROUND TO THE CLASS PERIOD

38. On June 30, 1995, Discreet went public in the June Stock Offering underwritten by Robertson Stephens and Volpe Welty in which 6.2 million shares of Discreet stock were sold to the public at $10.50. Discreet sold 3.6 million shares while certain Discreet insiders sold 2.6 million shares for a total of $60 million, while the underwriters took $4.5 million of the sales proceeds. At the time of the June Stock Offering, as is required by Wall Street practice when insiders sell some of their shares in a stock offering, Discreet's insiders had to agree not to sell any more of their Discreet shares for 180 days, i.e., until December 30, 1995, without the permission of the underwriters, i.e., Robertson Stephens and Volpe Welty. Because of the extremely positive statements made by Discreet, Robertson Stephens and Volpe Welty in the "Roadshow" before the June Stock Offering and by Discreet's insiders and Robertson Stephens and Volpe Welty in "Booster Shot" analyst reports after the June Stock Offering, Discreet's June Stock Offering was a "hot" deal, the stock jumped $6 per share on its first trading day to close at $16-1/2 per share and then continued to climb to over $22 per share by mid-September 1995, more than double the June Stock Offering price.

39. As part of getting the Discreet June Stock Offering business, Robertson Stephens and Volpe Welty agreed with Discreet and its insiders that they would "sponsor" and "support" Discreet by issuing favorable research reports on the Company to help support and/or boost its stock price, including issuing positive reports with strong earnings forecasts for Discreet immediately after the June Stock Offering, and that they would assist Discreet's insiders in selling off some of their shares into the open market after the expiration of the "lock-up" or in a follow on secondary public offering of stock. Piper Jaffray, which was a member of the underwriters group in the same stock offering, but not one of the co-lead underwriters, very much wanted to be one of the co-lead underwriters in any later Discreet stock offering, and was determined to position itself for being so selected by issuing extremely positive statements and reports about Discreet after the June Stock Offering.

40. On July 26, 1995, as soon as the 25 day post-stock offering "quiet period" mandated by SEC rules expired, Robertson Stephens issued a very positive "Booster Shot"(4) report on Discreet, authored by John T. Rossi ("Rossi"). Prior to issuing this report, Rossi obtained the key information contained in this report from Discreet executives, Szalwinski, Macrae and Johnson. These Discreet executives reviewed and approved this Robertson Stephens report before it was issued, knowing that the report would be publicly released and become part of the total mix of information affecting the price of Discreet stock. The report stated:

The Company Is the Leader in the High-End Special Effects Market -- Discreet Logic is the largest supplier of real-time special-effects tools used for the creation of spectacular visual effects in movies, TV shows, videos, and commercials. . . .
 

Powerful Market Transition -- Discreet Logic is at the cutting edge of a major analog-to-digital revolution that is expanding the creative range, reducing the cost, improving the production values, and speeding the pace of movie, video, and broadcast production. . . .
 

High-End Markets Gravitating toward High-Performance UNIX Systems . . . . The proof is the stunning success of companies like Discreet Logic . . . . Discreet already is the leader in high-performance visual effects tools, has the most flexible product technology, and has new products aimed at virtually every segment of the high-end digital market: special effects, editing, storage, broadcast, networking, sound. Overall, we think that Discreet Logic is the best play . . . .
 


* * *



Discreet Logic Has Racked Up a Ferocious Record of Sales Growth . . . .
 

Future Growth Enhanced by Diversification -- Further Discreet Logic's pipeline is filled with new products, and the company has just acquired Brughetti, a firm with leading technology for the emerging broadcast market. With established momentum in core markets and hot products for new markets, we forecast that the company's sales will continue to grow at muscular rates: 63% in F1996, to $100 million; and 40% in F1997, to $140 million.
 

41. On July 26, 1995, Volpe Welty also issued a "Booster Shot" research report on Discreet, authored by Charles H. Finnie ("Finnie"), who had met with, interviewed and/or obtained the key information contained in the report from Discreet's top management, i.e., Szalwinski, Macrae and Johnson. Prior to the release of this Volpe Welty report, these Discreet executives reviewed and approved it, knowing it would be publicly released and become part of the total mix of information affecting Discreet stock. The Volpe Welty report stated Discreet would likely generate 50% annual growth in revenues and income over the next few years.

42. On July 26, 1995, Piper Jaffray also issued a very positive "Booster Shot" research report on Discreet, authored by Hany M. Nada ("Nada"). Prior to issuing this report, Nada obtained the key information contained in this report from Discreet executives Szalwinski, Macrae and Johnson. These Discreet executives reviewed and approved this Piper Jaffray report before it was issued, knowing that the report would be publicly released and become part of the total mix of information affecting the price of Discreet stock. The report forecast quarterly fiscal 1996 revenues of: 1Q-$19.8 million, 2Q-$24.4 million, 3Q-$29.2 million and 4Q-$37.1 million, and fiscal 1996 revenues of $110 million. The report also stated:

The Product Pipeline -- The Company has a full product pipeline on an aggressive release schedule. The Company has approximately 13 products in its pipeline with release of its high-end INFERNO, an $800,000 ultrahigh-end film-based special effects system during the first quarter of fiscal 1996. . . . In addition, the Brughetti product line should start adding meaningful revenue during early calendar 1996.
 

. . . Discreet Logic plans to expand from its special effects products to nonlinear editing systems and broadcast solutions. Through this, we believe the Company's sales and earnings growth rate is 40%-50%.
 

43. On August 2, 1995, an article about Discreet appeared in Investor's Business Daily, which stated:

"Their management team is supreme and their marketing is superior," said Hayny [sic] Nada, an analyst with Piper, Jaffray in Minneapolis. "They just breathe this artistic, leading-edge technology."
 


* * *



Now the company is giving a face lift to its product line. "We're releasing ten new products over the next nine months," said David Macrae, 40, the company's chief executive and president.
 


* * *



"FLAME is the rave right now," Nada said.
 


* * *



But demand is high. "You have to wait about a month or two now for what they call FLAME time," Nada said.
 

44. On August 8, 1995, Reuters reported:

Discreet Logic Inc. expects to roll out 13 computer software products in the next nine months . . . .
 

"We've been investing heavily in 13 new products that are coming out over the next nine months," president and chief executive officer David Macrae told Reuters in an interview.
 


* * *



Charles Finnie, analyst at San Francisco-based Volpe, Welty & Co., . . . expects its stock to rise on higher revenues and earnings. . . . Finnie expects Discreet Logic's revenues to grow by 65 percent in fiscal 1996, with Flame accounting for more than three-quarters of revenues.
 

45. By September 1995, months before the "lock-up" was to expire, Discreet's insiders knew that things were not going as well with Discreet's business as publicly represented, that the risks of failure of Discreet's expansion and diversification plan and of slowing revenue and earnings per share growth were much greater than publicly known and Discreet's future prospects were much less promising than earlier believed. This was due to severe dissension among its top executives regarding Discreet's business, increasing difficulty in selling its flagship products (FLAME/INFERNO), problems with two recent acquisitions (Brughetti and VAPOUR technology) and difficulty in successfully developing and introducing the new products (especially for the broadcast market) necessary to meet the increased revenue and earnings forecast made by and for Discreet. Because these problems were worsening, Discreet's insiders were concerned that these difficulties could not be concealed until the "lock-up" expired on December 30, 1995 when they planned to begin to sell of some of their Discreet shares into the open or trading market. These insiders also realized that due to the volume restrictions imposed by SEC Rule 144 on open market sales of stock sold by corporate insiders, they would only be able to sell off limited amounts of their Discreet stock in open market transactions even after the "lock-up" expired at year end 1995, which further increased the risk that the adverse factors affecting Discreet's business would become public before they sold off as much of their Discreet stock as they wanted to. Thus, Discreet's insiders went to Robertson Stephens, Volpe Welty and Piper Jaffray and arranged a huge registered public offering of Discreet's stock, so that Discreet could sell new shares to the public to raise cash to help it withstand the decline in its business the insiders knew had already begun and so that the insiders themselves could sell off their shares before the December 30, 1995 "lock-up" expiration date, and in large amounts, well beyond the amounts they could have legally sold at one time under volume restrictions applicable to open market sales of unregistered stock imposed by SEC Rule 144.

46. Thus, defendants pursued a fraudulent scheme and course of business to accomplish the November Stock Offering and unload 3.6 million Discreet shares on the public at inflated prices before the impaired nature of Discreet's business became known and its stock price collapsed making such a stock sale at high prices impossible.

47. However, to pull off such a huge stock offering of Discreet stock, defendants knew that it was necessary to make it appear that Discreet would continue to grow, that Discreet was successfully developing new products, including those for the broadcast market, that would enable it to achieve strong revenue and profit growth. Thus, to condition the market to accept a huge offering of Discreet stock and to push the stock price to higher levels for the November Stock Offering, beginning in mid-September 1995, defendants commenced a campaign of false and misleading statements to make it appear that Discreet's business had never been stronger or its products more successful, that its expert management team was successfully pursuing a strategy to diversify Discreet's product line, in part via acquisitions, and that Discreet would achieve strong revenue and earnings per share growth in fiscal 1996 and 1997. This was accomplished by Discreet and its insiders making false and misleading statements in press releases, corporate communications to shareholders and to analysts, by defendants creating and circulating false and misleading research reports issued by securities analysts employed by the Underwriter Defendants and by the Underwriter Defendants and Discreet conducting a multi-city Roadshow just in advance of the offering, during which they and Discreet officers traveled around the U.S. and presented highly favorable information about Discreet to prospective investors.

FALSE AND MISLEADING STATEMENTS

DURING THE CLASS PERIOD



48. The statements set forth in ¶¶40-44 were "alive" and part of the total mix of information affecting the market price of Discreet stock on September 13, 1995, the beginning of the Class Period.

49. On September 13, 1995, Discreet issued positive announcements designed to push its stock price higher. Those announcements were:

1) Discreet had introduced VAPOUR, a software product for creating "virtual sets," computer-generated locales for television broadcasts, which provide a realistic rendering of a virtual set. Discreet had acquired the VAPOUR technology by acquiring Germany's COSS/IMP (Computer Sports Services) of Innsbruck, Austria. Discreet said:
 

"This new technology acquisition creates a strong and immediate presence in an exciting new market."
 

VAPOUR is "fully integrated with Discreet Logic's digital effects and editing products."
 

2) Discreet had acquired the Brughetti Corp. Discreet said Brughetti was a leader in the development of digital content creation, transmission and asset management systems for the broadcast market and "[t]his move will broaden and strengthen the market reach of both companies."
 

"Broadcast is the next emerging market for digital technology," said David Macrae . . . "[Brughetti] is a tremendous resource . . . ."
 

50. On September 18-19, 1995, Piper Jaffray issued reports on Discreet authored by Nada. Prior to issuing these reports, Nada met with, interviewed and/or obtained the key information contained in these reports from Discreet executives, including Szalwinski, Macrae and Johnson. These Discreet executives reviewed and approved the longer of these two Piper Jaffray reports before it was issued, knowing that it would be publicly released and become part of the total mix of information affecting Discreet stock. Both reports stated that new products utilizing VAPOUR technology would add to Discreet's earnings during calendar 1996 and also that:

Discreet Logic has acquired the COSS development team from IMP (private company). . . . We believe the virtual market is very young with many new developments coming; however, with the brand name and capital of Discreet Logic and the technology of COSS, the Company is favorably positioned to become a market leader. We believe the number of virtual set sites will increase to 50 during fiscal 1996, making it a $100 million market.
 

51. On September 20, 1995, Discreet released its results for the fiscal year ended July 31, 1995, reporting strong increases in revenue and net income for its fourth quarter and the full year of over 200%-300%. Discreet's release also stated:

David Macrae, president and chief executive officer of Discreet Logic, said, "The 1995 operating results exceeded our plan for the year and show the continued acceptance of FLAME and FLINT in the entertainment industry.
 

"The release of new products such as INFERNO and FIRE, our entry into the broadcast marketplace with our acquisition of Brughetti and the pending acquisition of the virtual sets technology . . . provide a strong base for us to meet the challenges in 1996."
 

52. After releasing Discreet's fiscal 1995 year end results on September 20, 1995, Discreet executives Szalwinski, Macrae and Johnson talked with securities analysts, institutional investors and large Discreet shareholders and told them that:

Discreet's growth was stronger than expected.
 

Discreet was enjoying strong demand for its FLAME product line.
 

Discreet was developing products using VAPOUR and Brughetti technology that would allow it to penetrate the broadcast market in the near term.
 

Discreet expected strong revenue and earnings per share growth throughout fiscal 1996 to approximately $115-$120 million and $.50, respectively.
 

Securities analysts from Robertson Stephens, Volpe Welty and Piper Jaffray as well as other firms reported this information to the marketplace where it became part of the "total mix" of information affecting Discreet's stock price.

53. On September 25, 1995, Robertson Stephens issued a report on Discreet authored by Rossi. Prior to issuing this report, Rossi obtained the key information for this report from Discreet executives, including Szalwinski, Macrae and Johnson. These Discreet executives reviewed and approved this Robertson Stephens report before it was issued, knowing that the report would be released and become part of the total mix of information affecting the price of Discreet stock. The report increased the forecasted fiscal 1996 and 1997 earnings per share for Discreet to $.50 and $.67-$.68, respectively. The report also forecast fiscal 1996 sequential revenue growth for Discreet:

Fiscal 1996 - Revenues
 

1Q - $23.5 million

2Q - $26.0 million

3Q - $31.5 million

4Q - $37.0 million

FY - $118 million
 

Fiscal 1997 Revenues
 

FY - $170 million
 

The report also stated:

The outlook for Discreet remains shining bright: the core, special-effects systems have formidable momentum, and an impressive lineup of new products will launch the company into the editing and broadcast markets in early 1996. . . . [W]e are raising our EPS estimates for F1996 from [$0.40 to $.50] and for F1997 from [$.50 to $.67-.68].
 


* * *



All current signs are favorable for Discreet: the July quarter's results were rock-solid; the current tenor of demand is robust; and the company has embarked on bold plans to expand its product line and increase its market presence.
 

Future Growth Enhanced by Diversification -- . . . the company has just announced a slew of new products aimed at nearly every high-end segment of the digital video market, including editing, broadcast, networking, sound, and storage.
 


* * *



Discreet is also mounting an assault on the broadcast market through two acquisitions. Last May, the company acquired Brughetti, a leader in the development of digital broadcast systems for content creation, transmission and asset management. Along with that, the company has just signed a letter of intent to acquire Computer Sports Services, whose Platform technology is the basis for Vapour, Discreet's new product for the creation of virtual sets. Vapour contains a full set of modeling, animation, and rendering tools that can be used to create computer-generated locales for news, sports, and entertainment programming.
 


* * *



Discreet has racked up a record of ferocious sales growth, and we expect the momentum to continue . . . we forecast that sales will grow by 83%, to $118 million, in F1996.
 

The September 25, 1995 Robertson Stephens report concluded:

Raising Estimates for F1995 and F1996 With Discreet's established momentum in core markets and hot products for new markets, we believe that the company's growth will run well above our initial estimates. As a result, we have raised our EPS Estimates from [$0.40 to $0.50] for F1996 -- with significant increases for quarter -- and from [$0.55 to $0.67-$.68] for F1997. We expect only modest sequential growth in income during the first two quarters of F1996, because the company will have to contend with dilution from the initial public offering, while also increasing its spending on marketing, research and development in preparation for its new product initiatives. On the other hand, we expect a powerful second half; many of the new products will roll out in January, and with push from NAB and then Montreaux, they should contribute mightily to the April and July quarters. Though we are making substantial increase in estimates, we believe that they are reasonably conservative, and that the company's momentum could allow it to surprise on the upside.
 

54. Between September 13, 1995 and September 29, 1995, Discreet's stock increased from $21-5/8 per share to $27-1/2 per share. Then, on October 5, 1995, Discreet publicly announced that it was going to pursue a 3.2 million share offering of its stock to be underwritten by Robertson Stephens, Volpe Welty and Piper Jaffray, in which Discreet would sell 800,000 shares and certain insiders would sell 2.4 million shares.

55. On October 14, 1995, an article about Discreet appeared in the Financial Post which stated in part:

[T]he stock is still considered a strong buy by analysts. One U.S. analyst cites its strong management, leading-edge technology and explosive growth potential.
 

The analyst quoted in this article worked for one of the Underwriter Defendants.

56. In October 1995, Discreet issued its fiscal 1995 Annual Report which included a letter from Szalwinski, which stated:

1995 also saw the solidification of our management team. The Company appointed individuals in many crucial areas. David Macrae, CEO and President, [and] Doug Johnson, Chief Financial Officer . . . are individuals who are key to ensuring our future success.
 

The report also contained a report from Macrae, which stated:

Discreet Logic embodies all the excitement and vitality of a growing company. . . . Our ability to "manage chaos" and transform this enthusiasm into creativity, further defines the Company's unique philosophy and culture.
 


* * *



During 1995, Discreet Logic achieved a number of business successes. In May, we acquired Brughetti Corporation, thereby formalizing our focus on broadcasters. Along with Brughetti's technology and assets, we gained our first dedicated broadcasting team for Sales, Marketing and Research and Development. This acquisition enables us to focus on systems for the broadcast industry. . . .
 


* * *



In October, we acquired virtual sets technologies: VAPOUR and FROST. We believe these systems offer significant market opportunities in broadcast programming.
 


* * *



Discreet Logic's new management team brings extensive industry experience and management expertise to our established structure. The combined strengths of these individuals enables us to plan for growth with confidence.
 

57. Just before the November Stock Offering, to increase interest among institutional investors and others in the stock offering, Discreet and certain of its top officers (Szalwinski and Johnson) and the Underwriter Defendants conducted a "Roadshow" in major U.S. cities (including New York, Chicago and San Francisco) between October 15 and November 10, 1995. During the Roadshow they met with and made presentations to existing Discreet stockholders, institutional investors, securities analysts and potential purchasers of Discreet stock, the names of which are known only to defendants. During these meetings and presentations, Discreet's top officers (Szalwinski and Johnson) made positive statements. For instance, they told people during the Roadshow that Discreet's business was doing "better than planned" and that demand for its existing flagship products, FLAME/INFERNO, was "extremely strong." They also said that Discreet was diversifying away from dependence on the FLAME/INFERNO product line by "successfully developing new products for the broadcast industry" through its newly-acquired Brughetti Corp. subsidiary and VAPOUR (virtual set) technology. They told potential investors that Discreet was making "good progress" in finalizing these products for commercial introduction and, with respect to the VAPOUR virtual set product, had received "strong indications of interest" in the product and "expected it to be a commercial success." During the Roadshow, Szalwinski and Johnson and the Underwriter Defendants also assured potential investors that there were "no significant problems" with Discreet's business, management or expansion/product diversification plan, that Discreet's top management team was cohesively pursuing a "high growth strategy," that Discreet's future had "never been brighter," and that, as a result of all of these factors, Discreet "would achieve strong sequential quarterly revenue and earnings growth throughout fiscal 1996," with fiscal 1996 revenues of over $125 million and fiscal 1996 earnings per share of approximately $.50, which would be followed by further revenue and earnings per share gains during fiscal 1997.

58. The positive statements particularized in ¶¶48-57 about Discreet's business, markets, products, competitive position and Discreet's future prospects, were false and misleading when made and failed to disclose and/or recklessly disregarded the following material adverse information:

(a) That Discreet's management team was not "strong," did not have "management expertise" and did not have the ability to "manage chaos" as, in fact, Discreet's top management team was wracked by persistent and serious disagreements over corporate strategy and operations which was leading to such fighting and disagreements among top management that important corporate decisions were being delayed or deferred which was harming Discreet's operations;

(b) That Macrae, Discreet's President and CEO, had warned Discreet's other top officer and its Board that he was going to resign from the Company due to the serious and persistent disagreements he was having with other top officers and the Board over Discreet's corporate strategy and operations, which Macrae had warned the Board were flawed, failing and likely to lead to an extremely poor corporate performance;

(c) That demand for Discreet's flagship product line, FLAME/INFERNO, especially the higher-end and most profitable models of these products, was softening and that Discreet was having difficulty continuing to achieve sales growth of this most important product line;

(d) That in order to make it appear that Discreet was continuing to achieve success in selling its FLAME/INFERNO product line, Discreet was shipping units out of its "demonstration inventory" to customers, permitting them to take possession of the product without a firm agreement to accept it or pay for it, but nevertheless recording and reporting the transactions as "sales," inflating its revenues and earnings;

(e) That Discreet's sales of FLINT were well below corporate plan due to an inability to obtain timely shipments of SGI's Indigo2 Impact workstations in quantities needed to meet Discreet's sales budgets;

(f) That Discreet was having serious problems in integrating the VAPOUR technology team and product into its product line, such that sales of products utilizing the VAPOUR technology were very weak and well below the levels internally budgeted or forecasted by Discreet and necessary for it to meet the forecasts of revenue and earnings growth being forecast by and for it;

(g) That Discreet's acquisition of Brughetti Corp. had not given it an "immediate presence" in a rapidly growing market, i.e., the broadcast market, as, in fact, Brughetti Corp., upon acquisition by Discreet and thereafter, did not have a functioning product capable of being sold to the broadcast market and efforts to develop such a product were plagued by serious problems, such that Discreet was unable to develop a product for sale in the important growing broadcast market and thus Discreet could not achieve the levels of revenue and earnings growth forecast by and for it;

(h) That SGI had told Discreet that it would soon be announcing an advanced version of its Onyx Reality workstation, the Onyx InfiniteReality which would have an adverse impact on Discreet's business because:

(i) It would disrupt Discreet's sales flow and process, hurting its sales because Discreet customers would delay purchases of Discreet's existing products, pending availability of the upgraded or more advanced SGI Onyx InfiniteReality computer workstation which would hurt its revenues;

(ii) In order to continue to make sales of its existing products pending introduction of SGI's upgraded Onyx InfiniteReality computer workstation, Discreet would be forced to offer substantial discounts to its customers which would hurt its profit margins and earnings per share; and

(iii) Discreet had significant inventories of SGI's Onyx Reality computer workstations for which it had no price protection from SGI, and which would be cut significantly in value upon the announcement of the upgraded version of the Onyx Reality computer workstation.

(i) That as a result of the adverse factors negatively impacting Discreet's business as set forth above, defendants knew the forecasts of revenue and earnings per share growth made by and for Discreet for fiscal 1996 and fiscal 1997 were false when made;

(j) That defendants had no basis for their positive forecasts and projections regarding Discreet's revenues or earnings growth during fiscal 1996 and 1997, which statements they knew were, in fact, false as they were inconsistent with the above negative factors;

(k) That the forecasts of increased revenues for Discreet in its third and fourth quarter of fiscal 1996 to $31.5 and $37 million, respectively, defendants knew were false, as they were contradicted by the adverse facts as set forth above and were not genuinely believed by defendants; and

(l) Defendants knew their forecasts of $.50 earnings per share for fiscal 1996 and $.67-$.68 earnings per share for fiscal 1997, respectively, or revenues of $118-125 million and $17 million respectively, were false as they were aware of adverse information which contradicted these forecasts.

59. As a result of the very positive statements made during the pre-November Stock Offering Roadshow and the positive statements and forecasts made on and after September 13, 1995 to condition the marketplace for the November Stock Offering, the November Stock Offering was a tremendous success, demand for Discreet's stock was very strong, enabling defendants to sell 400,000 more shares than originally planned, i.e., a total of 3.6 million shares for $30.25 per share, or $109 million. Discreet sold 971,000 shares for $29.3 million, while Szalwinski, Macrae, Johnson, Cantwell, Foster, Higgins and Tregaskis sold a total of 1,887,504 shares for $57 million. The underwriters got $5.4 million of the proceeds.

60. On December 7, 1995, Discreet reported its first quarter (ended October 31, 1995) fiscal 1996 results via a press release, stating:

Net income for the 1996 first quarter was $3.3 million, or 12 cents per share . . . .
 

This compares with net income of $1.5 million, or 6 cents per share, for the same quarter in fiscal-year 1995, a 122 percent increase in net income. . . .
 

Total revenues for the 1996 first quarter were $25 million, compared with total revenues of $11 million for the same quarter in fiscal-year 1995, an increase of 127 percent. The increase in revenues was due to growth in Flame and Flint shipments, initial shipments of Inferno, as previously announced, as well as an initial shipment of Vapour . . . .
 

61. After Discreet released its first quarter fiscal 1996 results, Discreet's top executives Szalwinski, Macrae and Johnson communicated with securities analysts, institutional investors and large Discreet shareholders and told them that:

Discreet's business was performing better than expected.
 

Demand for Discreet's FLAME/INFERNO product line remained strong and its FLINT sales were doing well, although shortages of the SGI Indigo2 Impact workstation had "constrained" sales of FLINT.
 

Sales of the VAPOUR virtual set product were underway and the product was meeting with success in the marketplace. Development of other products for the broadcast industry was proceeding successfully. Discreet was forecasting virtual set sales of over $10 million in fiscal 1996.
 

Discreet now forecast fiscal 1996 revenues in excess of $133 million, with earnings per share of $.55-$.57, with further increases forecast for fiscal 1997.
 

Analysts reported this information the market where it became part of the total mix of information affecting Discreet's stock price.

62. On December 11, 1995, Piper Jaffray issued a report on Discreet authored by Nada. Prior to issuing this report, Nada had discussions with Discreet executives who provided him with the information for the report. These Discreet executives reviewed and approved this Piper Jaffray report before it was issued, knowing that the report would be released and become part of the total mix of information affecting the price of Discreet stock. The report forecast fiscal 1996 and 1997 earnings per share of $.57 and $.75, respectively. The report specifically forecast the following quarterly fiscal 1996 results for Discreet:

Earnings

Revenues Per Share
 

Q1A $25.0 million $.12

Q2E $29.8 million $.13

Q3E $35.1 million $.14

Q4E $45.2 million $.18

FY96 $135 million $.57
 

The report also stated:

Conclusion -- Discreet Logic continues to emerge as a leader in the high-end digital image processing market, reporting first quarter results ahead of our expectations. For the quarter, Discreet showed particular strength in the high-end special effects editing and virtual sets market segments. We are especially pleased with the Company's results in light of the traditionally slow late-summer/early-fall sales period. Additionally, the Company has successfully navigated and begun to realize the fruits of its recent (September 1995) COSS/IMP acquisition. The acquisition has augmented the Company's product offerings, as well as aggressively launched the Company into the still infant, but rapidly growing, virtual set market.
 


* * *



New Products Boast Early Success -- During the first quarter, Discreet's two latest product offerings, INFERNO and VAPOUR, experienced better-than-expected revenue run rates.
 

INFERNO, Discreet's high-end, on-line digital image processing system, accounted for approximately 11% of the Company's total first quarter sales mix. Higher-than-anticipated INFERNO sales were due in part to 20 FLAME customers electing to upgrade to the more feature-rich INFERNO solution. We view these upgrades as particularly favorable, leading us to believe Discreet's current customers are pleased with their investment and are willing to reinvest in forthcoming upgrade opportunities. Additionally, the Company sold two new, standalone, INFERNO systems, at an estimated hardware plus software price of $700,000 per system.
 

VAPOUR, Discreet's virtual set product which was acquired through the Company's recent acquisition of COSS/IMP, also reported favorable sales levels . . . . We believe the broadcast studios currently implementing the virtual set technology on-line reaffirm the legitimacy of the virtual set market. In 1996, we expect Discreet's virtual set-related sales to rise to over $10 million.
 

Product Pipe Line/NAB Update - Discreet is preparing to release new product offerings, leveraging the April NAB Show as a product launching pad.
 


* * *



Earnings Per Share Estimates Raised. . . . [W]e have increased our forecasted revenues for fiscal 1996 to $135.1 million from $130.8 million, and have increased our earnings per share estimate to $0.56 from $0.52. We are also increasing our fiscal 1997 earnings per share estimate to $0.75 from $0.74 and our revenue from $193.5 million to $194.3 million.
 

63. On December 13, 1995, Robertson Stephens issued a report on Discreet authored by Rossi. Prior to issuing this report, Rossi had discussions with Discreet executives Szalwinski, Macrae and Johnson who provided him with the information for the report. These Discreet executives reviewed and approved this Robertson Stephens report before it was issued, knowing that the report would be released and become part of the total mix of information affecting the price of Discreet stock. The report forecast fiscal 1996 and 1997 revenues of $126.6 million and $180 million, and fiscal 1996 and 1997 earnings per share of $.60 and $.85, respectively, as well as a 35% three-year secular growth rate. In addition, the report specifically forecast the following quarterly fiscal 1996 revenues and earnings per share growth for Discreet:

Earnings

Revenue Per Share
 

Q1A $25.0 million $.12

Q2E $27.3 million $.12

Q3E $34.5 million $.16

Q4E $39.8 million $.20

FY96 $126 million $.60
 

The report also stated:

ANOTHER OVER-PERFORMANCE BY DSLGF PROMPTS US TO RAISE ESTIMATES
 

NEWS: For the October quarter, Discreet Logic reported EPS from operations of $0.12 on revenue of $25.0 million -- above our estimates once again, which were $0.10 and $23.5 million. . . . However, noting the higher baseline set by October-quarter results, and factoring in solid contributions from new products such as Fire, Vapour, and Brughetti, we raise our EPS estimates for F1996 from $0.50 to $0.60 and for F1997 from $0.67 to $0.85. We continue to recommend purchase.
 

Debut of New High-End Systems -- In the debut of Inferno, the new top-of-the-line system, Discreet shipped two complete systems and also sold about 20 Inferno software upgrades into the Flame installed base, which all together added $1-2 million in revenue. Also, in the final week of the quarter, Discreet made its first sale of a Vapour system from the acquisition, COSS, which added about $2.0 million. Even as the new products debuted, the core products continued to grow, setting new records for unit shipments. Shipments of Flame grew quarter to quarter from 38 to 47, and shipments of Flint grew from 76 to 82.
 


* * *



IMPACT ON INVESTMENT: Even though Discreet's results came in above expectations, company management sounded slightly apologetic, noting that Discreet's restructuring of its sales force into vertical market teams and Silicon Graphics' delays in shipping the new Impact system probably constrained sales. We find it encouraging that the company still keeps its internal targets above the expectations of Wall Street. Emboldened by this thought and motivated by the strong performance in the October quarter, we have increased our sale and earnings expectations for F1996 and F1997.
 

Pre-NAB Lull in the Current Quarter. In the current quarter, we expect shipments of Flame and Flint software seats to rise, but we don't think sales of hardware will pick up until Silicon Graphics gets the Impact program moving. . . . Factoring in some additional dilution from the secondary offering in November, we expect to see EPS of $0.12 in the current quarter -- flat sequentially, but up 60% year to year.
 

Reacceleration in April and July NAB will be the launching pad for Fire and the film tools package, Riot, as well as the showcase for Vapour. . . . Accordingly, we expect EPS to rise to $0.16 and then to $0.20 in the final two quarters of F1996.
 

64. On December 22, 1995, Nada, of Piper Jaffray, issued another report that reaffirmed Discreet's fiscal 1996 and 1997 earnings per share estimates of $.56 and $.75 and stated:

Discreet Logic's broadcast efforts (Brughetti Division) maintain the lead in technology over Avid, giving Discreet an upcoming opportunity to establish market presence in the digital broadcasts' growing, but still infant, market.
 

Discreet entered the digital broadcast market in May 1995 through its acquisition of Brughetti. Since the acquisition, the Company is developing the following: PURE, a digital on-air graphics system; SLICE, a nonlinear editor created for broadcast editing; AIR, a real-time, digital playback system which provides management of clips stored on disk or tape; and DIPLOMAT, a distributed facility asset database. In addition, we believe DSLGF will add significant new products into its broadcast product line. We believe Discreet will begin commercial broadcast shipments during fiscal 1996.
 

Prior to issuing this report, Nada had discussions with Discreet executives who provided him with the information for the report. These Discreet executives reviewed and approved this Piper Jaffray report before it was issued, knowing that the report would be released and become part of the total mix of information affecting the price of Discreet stock.

65. The positive statements issued between December 7, 1995 and December 22, 1995 (¶¶60-64) were materially false and misleading. As the defendants knew, the true facts regarding Discreet and its business were:

(a) That Macrae, Discreet's President and CEO, had warned Discreet's other top officers, its Board Chairman and its Board, that he was going to resign from the Company due to the serious and persistent disagreements he was having with other top officers and the Board over Discreet's corporate strategy and operations, which Macrae had warned the Board were flawed, failing and likely to lead to an extremely poor corporate performance;

(b) That demand for Discreet's flagship product line, FLAME/INFERNO, especially the higher-end and most profitable models of these products, was softening due to market saturation and other factors and that Discreet was having difficulty continuing to achieve sales growth of this most important product line without giving substantial discounts;

(c) That in order to make it appear that Discreet was continuing to achieve success in selling its FLAME/INFERNO product line and to create the appearance of initial sales success of its VAPOUR "virtual set" products, Discreet was shipping units out of its "demonstration inventory" to customers, permitting them to take possession of the product without a firm agreement to accept it or pay for it, but nevertheless recording and reporting the transaction as a "sale," inflating its revenues;

(d) That Discreet's sales of FLINT were well below corporate plan due to an inability to obtain timely shipments of SGI Indigo2 Impact workstations in quantities needed to meet Discreet's sales budgets;

(e) That Discreet's new VAPOUR virtual set product was doing very poorly, with very limited sales well below those internally budgeted or forecast and necessary for Discreet to be able to achieve the level of revenue and earnings per share growth publicly forecast by and for it;

(f) That Discreet was having serious problems in integrating the VAPOUR technology team and product into its product line, such that sales of products utilizing the VAPOUR technology were very weak and well below the levels internally budgeted or forecasted by Discreet and necessary for it to meet the forecasts of revenue and earnings growth being forecast by and for it;

(g) That Discreet's new INFERNO product was selling poorly with very limited sales well below those internally budgeted or forecast and necessary for Discreet to be able to achieve the level of revenue and earnings per share growth publicly forecast by and for it;

(h) That Discreet's acquisition of Brughetti Corp. had not given it an "immediate presence" in a rapidly growing market, i.e., the broadcast market, as, in fact, Brughetti Corp., upon acquisition by Discreet and thereafter, did not have a functioning product capable of being sold to the broadcast market and efforts to develop such a product were plagued by serious problems, such that Discreet was unable to develop a product for sale to the broadcast market and thus Discreet could not achieve the levels of revenue and earnings growth forecast by and for it;

(i) That SGI had told Discreet that it would soon be announcing an advanced version of its Onyx Reality workstation, the Onyx InfiniteReality which would have an adverse impact on Discreet's business because:

(i) It would disrupt Discreet's sales flow and process, hurting its sales because Discreet customers would delay purchases of Discreet's existing products, pending availability of the upgraded or more advanced SGI Onyx InfiniteReality computer workstation which would hurt its revenues;

(ii) In order to continue to make sales of its existing products pending introduction of SGI's upgraded Onyx InfiniteReality computer workstation, Discreet would be forced to offer substantial discounts to its customers which would hurt its profit margins and earnings per share; and

(iii) Discreet had significant inventories of SGI's Onyx Reality computer workstations for which it had no price protection from SGI, and which would be cut significantly in value upon the announcement of the upgraded version of the Onyx Reality computer workstation.

(j) That as a result of the adverse factors negatively impacting Discreet's business as set forth above, defendants knew the forecasts of revenue and earnings per share growth made by and for Discreet for fiscal 1996 and fiscal 1997 were false when made;

(k) That defendants knew their positive forecasts and projections regarding Discreet's revenues or earnings growth during fiscal 1996 to $126-$135 million and $.55-$.60, and during fiscal 1997 to $180-$194 million and $.75-$.85, respectively, were, in fact, false as they were inconsistent with the above negative factors;

(l) That the forecasts of increased revenues and earnings per share for Discreet in its third and fourth quarters of fiscal 1996 to $34-$35 million and $.14-$.16 and $39-$45 million and $.18-$.20, respectively, defendants knew were false, as they were contradicted by the adverse facts as set forth above and were not genuinely believed by defendants; and

(m) Defendants knew their forecasts for the third and fourth quarters of fiscal 1996, for fiscal 1996 and fiscal 1997, were false as they were aware of adverse information which contradicted these forecasts.

66. On January 22, 1996, Discreet issued a release headlined and stating:

DISCREET LOGIC TO SUPPORT SILICON GRAPHICS' NEW HIGH-PERFORMANCE VISUALIZATION SUPERCOMPUTER
 

FLAME, INFERNO and VAPOUR to break interactivity barriers with power of Onyx InfiniteReality
 

Discreet Logic, Inc. Monday announced future support for Silicon Graphics' new visualization supercomputer, Onyx InfiniteReality.
 


* * *



Onyx InfiniteReality will provide greatly increased performance and interactivity for FLAME and INFERNO artists in graphics-intensive modules such as ACTION. ACTION is an integrated environment with tools for 3D effects, multilayer compositing, keying, color correcting and motion tracking, plus the capability to import 3D text and models.
 


* * *



Virtual sets will also reap the benefits of Onyx InfiniteReality's tenfold increase in geometry performance and fourfold increase in texture memory.
 

The InfiniteReality subsystem's ability to process more detailed textures will allow virtual set designers to create 3D graphics and sets with significantly greater realism, and have them rendered in real-time using VAPOUR, Discreet Logic's solution for virtual set creation.
 

VAPOUR is targeted at broadcasters looking for new and innovative real-time methods of delivering interactive news, sports coverage, election updates and specialty programming such as children's shows.
 

Neray added, "This will allow broadcasters to create virtual sets that are nearly indistinguishable from physical sets -- or out-of-this-world environments that would be impossible to create in the real world."
 

67. These statements in the January 22, 1996 release were materially false and misleading. As the defendants knew, the true facts regarding Discreet and its business were:

(a) That the introduction of the advanced version of its Onyx Reality workstation, the Onyx InfiniteReality, would have an adverse impact on Discreet's business because:

(i) It would disrupt Discreet's sales flow and process, hurting its sales because Discreet customers would delay purchases of Discreet's existing products, pending availability of the upgraded or more advanced SGI Onyx InfiniteReality computer workstation which would hurt its revenues;

(ii) In order to continue to make sales of its existing products pending introduction of SGI's upgraded Onyx InfiniteReality computer workstation, Discreet would be forced to offer substantial discounts to its customers which would hurt its profit margins and earnings per share; and

(iii) Discreet had significant inventories of SGI's Onyx Reality computer workstations for which it had no price protection from SGI, and which would be cut significantly in value upon the announcement of the upgraded version of the Onyx Reality computer workstation.

68. On February 13, 1996, Discreet shocked the investment community by revealing that Macrae (its President and CEO) had resigned and that it expected to report lower revenue (approximately $25 million) and much lower earnings per share ($.02-$.04) for the quarter ended January 31, 1996, than earlier forecast by and for it. Discreet stated:

"We are very disappointed with our anticipated financial results for our second fiscal quarter. Silicon Graphics, Inc's (SGI) announcement of the Onyx InfiniteReality, with less than two weeks remaining in our second quarter, came with very aggressive pricing but with anticipated delivery scheduled for later this calendar quarter. SGI's announcement affected planned purchases of FLAME, INFERNO and VAPOUR which run on the Onyx Reality Engine(2) and negatively impacted both our revenues and margin," said Richard Szalwinski, chairman and founder of the Company. "In addition, continued availability problems with the Indigo Impact negatively affected sales of the Company's FLINT product."
 

Discreet CFO Johnson later admitted to Dow Jones that Macrae's resignation followed "disagreements on tactics of implementation of strategies, between the CEO and the board," that Discreet did not have any price protection on its SGI Onyx workstation inventories prior to the January 27, 1996 announcement of the Onyx InfiniteReality product and that, in order to sell off its products, it had engaged in substantial discounting.

69. While Discreet tried to make it appear that it was surprised by SGI's introduction of its new, enhanced Onyx InfiniteReality computer workstation, this was not true, as it had been working closely with SGI on this for months. It was publicly reported:

Silicon Graphics' director of marketing, Dan Vivoli, said Discreet Logic knew the supercomputer announcement would occur months ahead of time.
 

"They had all of the day-to-day (information) to predict what their customers were going to do," Vivoli said.
 

70. The revelations of February 13, 1996 crushed Discreet's stock causing it to collapse from a high of $25-1/4 on February 12, 1996 to a low of $9-3/4 on February 13, 1996 on huge volume. The collapse of Discreet's stock on February 13, 1996 caused a panic among the defendants as they realized that such a huge collapse of Discreet's stock just three months after the huge $109 million November Stock Offering would expose their scheme and result in them being sued for fraud. Thus, defendants mounted a strong effort to halt the collapse of Discreet stock and push it back up to higher inflated levels once again by making a series of false and misleading statements to reassure the market that Discreet's worse than expected second quarter results were due to a one time event, i.e., SGI releasing a new product near the end of the quarter, that the resignation of Macrae did not reflect any serious problems with Discreet's business, that demand for Discreet's products remained strong and that Discreet expected to achieve strong revenue and earnings growth in the last two quarters of fiscal 1996 and during fiscal 1997.

71. Thus, after releasing Discreet's disappointing second quarter fiscal 1996 results on February 13, 1996, Discreet executives Szalwinski and Johnson communicated with securities analysts, institutional investors and other large Discreet stockholders in an effort to reassure them and stem the decline in Discreet's stock. They told the analysts that:

The reason for the revenue and earnings shortfall was SGI's introduction of an enhanced workstation product just before the end of the quarter, which resulted in certain then-pending sales being deferred and this did not reflect any problem with the underlying demand for Discreet's FLAME/INFERNO, FLINT or VAPOUR products.
 

The resignation of Macrae did not reflect any fundamental or serious problem with Discreet's business.
 

The weak second quarter revenues and earnings reflected only a "temporary problem" that would be overcome in the third and/or fourth quarters of fiscal 1996.
 

Discreet expected to substantially recover its sales growth momentum in the third quarter of fiscal 1996. Discreet still forecast fiscal 1996 revenues of approximately $120 million and fiscal 1996 earnings per share of over $.30 per share.
 

Analysts from Robertson Stephens, Volpe Welty, Piper Jaffray and other firms disseminated this information to the marketplace where it became part of the total mix of information affecting Discreet's stock price. Discreet executives Szalwinski and Johnson and Piper Jaffray's Nada and Volpe Welty's Finnie also gave interviews to the financial media to try to support Discreet's stock:

(a) Dow Jones News Service reported on February 13, 1996:

Johnson says the company believes that the weak second-quarter profits reflect a "short-term issue."
 


* * *



An analyst with one of the underwriting firms from last year's offering calls today's drop in price "extremely overdone." Charles H. Finnie, of Volpe Welty & Co. in San Francisco, says the weak second-quarter earnings reflect a "temporary problem" that will be largely fixed by Silicon Graphics' shipment of its new Onyx InfiniteReality workstation this spring.
 


* * *



Finnie, of Volpe Welty, said he will be adjusting his earnings estimates downward. He had estimated that Discreet Logic would earn 55 cents a share for the fiscal year ending July 1996 and 75 cents for the year ending July 1997. Still, he said, "I think the company could do 75 cents to $1.00" in net income for calendar-year 1997. "The business is still very much intact."
 

(b) The Wall Street Journal reported on February 14, 1996:

An analyst with one of the underwriting firms from last year's offering called yesterday's plunge in Discreet Logic's share price "extremely overdone." Charles H., Finnie of Volpe Welty & Co. in San Francisco said demand for Discreet Logic's products remains strong; he said he expects the stock to return to Monday's level of around $23 a share within a year.
 

72. On February 15 or 16, 1996, Johnson of Discreet appeared at the Piper Jaffray MultiMedia Conference and made a presentation to the assembled analysts and investors in which he stated:

As most of you are aware, Silicon Graphics has announced an Infinite Reality workstation, their new Onyx version. We are, we're extremely excited about this product. We think it's gonna add a lot of performance to our, our products. It's gonna benefit our customers as well as us. Unfortunately, the timing of their announcement was about ten days before the end of our quarter and disrupted our final sales cycles on, on a number of products. That re--, resulted in some deferred revenue and some discounting in order to bring in some of the orders we are expecting. We believe that, once the Infinite Reality is shipping, that we're gonna see some excited customers and some increased demand for the Flame and Inferno systems that will be running on it, in addition to, we'll also be running Vapor on that.
 


* * *



With that . . . but, you know, we will have a breakout session afterwards.
 

73. During the breakout session, Johnson told analysts and investors that:

The reason for the revenue and earnings shortfall was SGI's introduction of an enhanced workstation product just before the end of the quarter, which resulted in certain then-pending sales being deferred and this did not reflect any problem with the underlying demand for Discreet's FLAME/INFERNO, FLINT or VAPOUR products.
 

The resignation of Macrae did not reflect any fundamental or serious problem with Discreet's business.
 

The weak second quarter revenues and earnings reflected only a "temporary problem" that Discreet would overcome in the third and/or fourth quarters of fiscal 1996.
 

Discreet expected to substantially recover its sales growth momentum in the third quarter fiscal 1996. Discreet still forecast fiscal 1996 revenues of approximately $120 million and fiscal 1996 earnings per share of approximately $.32-$.35.
 

74. During the Piper Jaffray Multimedia Conference, Johnson was also interviewed by Shelly Carabel of the Dow Jones Investors Network, during which the following was stated:

Johnson: [A]s we go into the new quarter, this, our third fiscal quarter which began on February 1st, we won't be needing to do as much discounting. There'll be some, but we've negotiated the pricing protection we need from Silicon Graphics. . . .
 

Carabel: Um will, so will you, will this, will you recover in one quarter from this bad news, or the timing problem?
 

Johnson: We, we believe that we'll substantially recover in this quarter, um, there will be some discounting as we move initial systems. Um, the big key is the shipment of the Infinite Realty. Uh, that will help dramatically. I would say it's probably a two-quarter full pullout of the, of the situation to where we're back on, on a track that we felt that we were on through Q 1 of this year.
 


* * *



Carabel: Uh, but over this past week, your shares went down about 50 percent.
 

Johnson: Correct.
 

Carabel: Are they coming back up now?
 

Johnson: Um, the last two days they have showed some strength and some recovery as, as people begin to understand um, the news. Um, news that's abrupt like that tends to create a little bit of volatility and then people begin to understand the strength of the company, the strength of the products, the fact that we have someone to step right into the CEO's position and assist us to move the company forward, the strength of the remaining management team. I think all that begins to, uh, be understood by the market, and there's begun to be a recovery over the last couple of days.
 

75. On April 18, 1996, Piper Jaffray issued a report on Discreet authored by Nada. Prior to issuing this report, Nada had discussions with Discreet executives Szalwinski and Johnson who provided him with the information for the report. The Discreet executives reviewed and approved this Piper Jaffray report before it was issued, knowing that the report would be released and become part of the total mix of information affecting the price of Discreet stock. The report forecast third quarter fiscal 1996 earnings per share of $.07 and stated:

NAB '96: As the Smoke Clears, The Winners Of This Year's NAB Show Begin To Emerge
 


* * *



-- Shows New Fire, Inferno, and Riot Products; Company To Ship New Offerings Within The Month; Positive Outlook; Strong Buy Maintained
 

Discreet showed its new products: Fire (high-end editing), Inferno (new additions, special effects), and Riot (film tools), all of which will be shipping by the end of next week. We are particularly impressed by the Company's release schedule knowing that many companies show new products at NAB, but few actually ship those products shortly after the show. Our projections for these new products are conservative . . . .
 

Discreet users appear to be happy with the products. On April 14, Discreet held a user group meeting, that had an extremely favorable reception, with users giving a standing ovation for the Flame and Inferno products running on the SGI's Infinite Reality 3 engine. While Discreet's products received very favorable review, we are still cautious that volume shipments of SGI's Infinite Reality 3 engine have not, as of yet, taken place. While SGI is currently supplying Discreet with the Infinite Realty 3 engines, we anticipate SGI will begin volume shipments of the product sometime in the first part of May.
 

On another note, Discreet announced that it has sold a Vapour system (virtual sets) to CBS. We believe this is very positive since broadcasters typically follow herd mentality when adopting new technologies. We believe CBS' name recognition will aid in the sale of future Vapour systems.
 

We are comfortable with the current quarter (May) . . . . We expect DSLGF to report in line with our $0.07 per share estimate, and reiterate our Strong Buy rating.
 

76. On April 23, 1996, Piper Jaffray issued a report on Discreet authored by Nada. Prior to issuing this report, Nada had discussions with Discreet executives Szalwinski and Johnson who provided him with the information for the report. These Discreet executives reviewed and approved this Piper Jaffray report before it was issued, knowing that the report would be released and become part of the total mix of information affecting the price of Discreet stock. The report forecast fiscal 1996 and 1997 revenues of $119 million and $196 million, respectively, and fiscal 1996 and 1997 earnings per share of $.34 and $.68, respectively. The report also specifically forecast strong third and fourth quarter fiscal 1996 revenues and earnings per share growth for Discreet:

Earnings

Fiscal 1996 Revenue Per Share
 

Q1A $25.0 million $.12

Q2A $25.2 million $.03

Q3E $32.0 million $.07

Q4E $37.5 million $.12

FY $119.7 million $.34
 

The report also repeated the statements contained in Piper Jaffray's April 18, 1996 report quoted above in ¶75.

77. As a result of the reassurances after the February 13, 1996 announcement, the decline in Discreet's stock was stopped and it was again pushed higher, back up to close at $11-1/4 on February 13, 1996, to $13-5/8 on February 15, 1996 and as high as $18-5/8 on April 26, 1996. And, as a result, defendants were not sued for fraud during this time period.

78. The positive statements issued between February 13, 1996 and April 23, 1996 (¶¶71-76) were materially false and misleading. The defendants knew that the true facts regarding Discreet and its business were:

(a) That demand for Discreet's flagship product line, FLAME/INFERNO, especially the higher-end and most profitable models of these products, was softening due to market saturation and other causes and that Discreet was having difficulty continuing to achieve sales growth of this most important product line;

(b) That in order to make it appear that Discreet was continuing to achieve success in selling its FLAME/INFERNO product line, Discreet was shipping units to customers, permitting them to take possession of the product without a firm agreement to accept it or pay for it, but nevertheless recording these transactions as "sales" for Discreet's corporate purposes;

(c) That in order to make it appear that Discreet was continuing to achieve success in selling its VAPOUR product line, Discreet was shipping units to customers, permitting them to take possession of the product without a firm agreement to accept it or pay for it, but nevertheless recording these transactions as "sales" for Discreet's corporate purposes;

(d) That Discreet's new VAPOUR product, which was supposedly a virtual set product, was doing very poorly, with very limited sales well below those internally budgeted or forecast and necessary for Discreet to be able to achieve the level of revenue and earnings per share growth publicly forecast by and for it;

(e) That Discreet's new FLAME/INFERNO product was doing very poorly, with very limited sales well below those internally budgeted or forecast and necessary for Discreet to be able to achieve the level of revenue and earnings per share growth publicly forecast by and for it;

(f) That Discreet's acquisition of Brughetti Corp. had not given it a functioning product capable of being sold and that efforts to develop such a product were plagued by serious problems, such that Discreet was unable to develop a product for sale in the foreseeable future for this important growing market and thus Discreet could not achieve the levels of revenue and earnings growth forecast by and for it;

(g) That Discreet was having serious problems in integrating the VAPOUR technology team and product into its product line, such that sales of products utilizing the VAPOUR technology were very weak and well below the levels internally budgeted or forecasted by Discreet and necessary for it to meet the forecasts of revenue and earnings growth being forecast by and for it;

(h) That as a result of the adverse factors negatively impacting Discreet's business as set forth above, defendants knew the forecasts of revenue and earnings per share growth made by and for Discreet for fiscal 1996 and fiscal 1997 were false when made;

(i) As a result of the foregoing, defendants knew Discreet's forecasts of strong revenue growth were false, as such growth was impossible to achieve in light of these undisclosed problems;

(j) That defendants had no basis for their positive forecasts and projections regarding Discreet's revenues or earnings growth during fiscal 1996 and 1997, which statements were, in fact, they knew were false as they were inconsistent with the above negative factors;

(k) That the forecasts of increased revenue and earnings per share for Discreet in its third and fourth quarters of fiscal 1996 to $32 million and $.07 and $37.5 million and $.12, respectively, were false when made, as they were contradicted by the adverse facts as set forth; and

(l) Defendants knew their forecasts of $.07 and $.12 earnings per share for the third and fourth quarters of fiscal 1996 or $.30-$.55 and $.68-$.75 earnings per share for fiscal 1996 and fiscal 1997, respectively, were false as they were aware of adverse information which contradicted these forecasts.

THE TRUE ADVERSE FACTS ABOUT DISCREET'S

BUSINESS ARE FINALLY REVEALED



79. On May 1, 1996, Discreet shocked the markets by suddenly revealing that Johnson, its Chief Financial Officer, had resigned and that it expected to report revenues of only $17-$18 million for the third quarter of fiscal 1996 -- way below the $32 million forecast by and for it, and a large decline from the $25 million in fiscal 1996 second quarter revenues. As a result, Discreet said it would suffer a "significant loss." Discreet admitted that it would also suffer a loss in its fiscal 1996 fourth quarter, for fiscal 1996 as a whole and it could not state when it would return to profitability! Discreet admitted this catastrophic situation was due to very poor sales and that its weak revenues "may indicate more fundamental problems with certain aspects of our business," that "we have not fully assimilated the acquisitions of the broadcast and virtual sets technology which the company acquired last fall . . . [and] this delay has resulted in a loss of valuable time in integrating the products," and that "FLAME sales in principal markets have slowed." On these revelations, Discreet's stock collapsed, falling from $17-3/8 on April 30, 1996 to $8-3/4 on May 1, 1996, a 50% one-day drop on 9 million shares volume -- back below its public offering price of $10.50 on June 30, 1995, and far below the $30.25 per share price at which Discreet and its insiders unloaded 3.6 million shares of Discreet stock for $109 million on the public in the November Stock Offering.

DISCREET'S FALSE FINANCIAL STATEMENTS

80. In Discreet's July 31, 1996, Form 10-K the following was disclosed in the inventory footnote:

Inventory consists of hardware purchased for resale and is valued at the lower of cost (determined on a first-in, first-out basis) or net realizable value. Demonstration inventory consists of hardware inventory used by the Company and potential customers for product demonstrations which will be subsequently sold. In 1996, the Company recorded an inventory reserve of $5,345,000 to reflect estimated net realizable value.
 

This inventory reserve was further explained in the Management Discussion and Analysis Section of Discreet's Form 10-Q and Form 10-K. The April 30, 1996 Form 10-Q stated, "The Company's third quarter financial results include certain charges that reflect the recent developments, including increased inventory reserves by $3.0 million to reflect estimated net realizable value, primarily as a result of platform changes by its key supplier . . . ." Further, Discreet's Form 10-K dated July 31, 1996 stated that "the Company recorded $5,345,000 in inventory reserves to reflect estimates of net realizable value and realized lower margins on SGI workstations in fiscal 1996, primarily as a result of platform changes by SGI." Therefore, in addition to the $3.0 million reserve in the third fiscal quarter, Discreet took an additional reserve of $2.345 million in the fourth fiscal quarter for a total reserve at fiscal year end of $5.345 million.

81. Discreet knew of these platform changes by January 1996. In fact, Discreet admitted in its January 31, 1996 Form 10-Q that "this shortfall in revenues primarily resulted from an announcement by Silicon Graphics, Inc. of a new ONYX workstation approximately two weeks prior to January 31, 1996 which caused the company to discount the selling price of its current inventory of SGI ONYX workstations and defer revenue on upgrades to the new SGI workstation." Further, Discreet admitted in that Form 10-Q that an increase in cost of revenue as a percent of revenue was due to "lower margins being recognized on SGI ONYX workstations." Based on their knowledge and the discounts already occuring on the ONYX workstation, Discreet should have taken a reserve for inventory in the second quarter ended January 31, 1996.

82. At January 31, 1996 the inventory resale account had a balance of $5.865 million and the inventory demonstration account had a balance of $4.163 million for a total inventory balance of $10.03 million. The inventory accounts contain hardware inventory, a portion of which was the SGI platform inventory. Since the new platform was just announced shortly before January 31, 1996, the SGI platform inventory contained in Discreet's inventory account at January 31, 1996 was all the "old" ONYX platform.

83. The inventory write-downs taken at April 30, 1996 and July 31, 1996 were the result of "platform changes by SGI." These changes were known to Discreet at January 31, 1996 and thus the write-down of inventory taken at July 31, 1996 should have been made at January 31, 1996. As a result of the foregoing, Discreet's financial results for the quarter ended January 31, 1996, were materially false and misleading and overstated Discreet's net income and EPS by material amounts.

CLAIM FOR RELIEF I


For Violation Of Section 10(b) Of The

Exchange Act And Rule 10b-5 Against All Defendants



84. Plaintiffs incorporate by reference ¶¶1-83.

85. Each of the defendants: (a) knew or had access to the material adverse non-public information about Discreet's financial results and then existing business conditions, which was not disclosed; and (b) participated in drafting, reviewing and/or approving the misleading statements, releases, reports and other public representations of and about Discreet.

86. During the Class Period, defendants, with knowledge of or reckless disregard for the truth, disseminated or approved the false statements specified above, which were misleading in that they contained misrepresentations and failed to disclose material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.

87. Defendants violated §10(b) of the Exchange Act and Rule 10b-5 in that they:

(a) Employed devices, schemes and artifices to defraud;

(b) Made untrue statements of material facts or omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or

(c) Engaged in acts, practices and a course of business that operated as a fraud or deceit upon plaintiffs and others similarly situated in connection with their purchases of Discreet common stock during the Class Period.

88. Plaintiffs and the Class have suffered damages in that, in reliance on the integrity of the market, they paid artificially inflated prices for Discreet stock. Plaintiffs and the Class would not have purchased Discreet stock at the prices they paid, or at all, if they had been aware that the market prices had been artificially and falsely inflated by defendants' misleading statements.

CLAIM FOR RELIEF II

For Violation Of Section 20(a) Of

The Exchange Act Against Individual

Defendants Szalwinski and Macrea And Discreet



89. Plaintiffs incorporate by reference ¶¶1-88.

90. Defendants Szalwinski and Macrea acted as controlling persons of Discreet within the meaning of §20(a) of the Exchange Act. By reason of their positions as officers and directors of Discreet, defendants Szalwinski and Macrea had the power and authority to cause Discreet to engage in the wrongful conduct complained of herein. Discreet controlled each of the Individual Defendants and all of its employees.

91. By reason of such wrongful conduct, Szalwinski and Macrae and Discreet are liable pursuant to §20(a) of the Exchange Act. As a direct and proximate result of these defendants' wrongful conduct, plaintiffs and the other members of the Class suffered damages in connection with their purchases of the Discreet securities during the Class Period.

BASIS OF ALLEGATIONS

92. Plaintiffs have alleged the foregoing based upon the investigation of their counsel, which included a review of Discreet's SEC filings, securities analysts' reports and advisories about the Company, press releases issued by the Company, media reports about the Company and discussions with consultants. Substantial evidentiary support will exist for the allegations set forth in this complaint after a reasonable opportunity for discovery.

PRAYER FOR RELIEF

WHEREFORE, plaintiffs pray for judgment as follows:

1. Declaring this action to be a proper class action pursuant to Rules 23(a) and 23(b)(3) of the Federal Rules of Civil Procedure on behalf of the Class defined herein;

2. Awarding plaintiffs and the members of the Class compensatory damages;

3. Awarding plaintiffs and the members of the Class pre-judgment and post-judgment interest, as well as reasonable attorneys' fees, expert witness fees and other costs;

4. Awarding extraordinary, equitable and/or injunctive relief as permitted by law, equity and the federal statutory provisions sued hereunder, including the imposition of a constructive trust upon the proceeds of defendants' insider trading, pursuant to Rules 64, 65 and any appropriate state law remedies; and

5. Awarding such other relief as this Court may deem just and proper.

JURY DEMAND

Plaintiffs demand a trial by jury.

DATED: April 28, 1997

MILBERG WEISS BERSHAD

HYNES & LERACH LLP

WILLIAM S. LERACH
 
 
 
 
 

______________________________

WILLIAM S. LERACH



600 West Broadway, Suite 1800

San Diego, CA 92101

Telephone: 619/231-1058
 

MILBERG WEISS BERSHAD

HYNES & LERACH LLP

REED R. KATHREIN

LISA C. ATKINSON

222 Kearny Street, 10th Floor

San Francisco, CA 94108

Telephone: 415/288-4545
 

ROSSBACHER & ASSOCIATES

HENRY H. ROSSBACHER

Union Bank Plaza, 24th Floor

445 S. Figueroa Street

Los Angeles, CA 90071

Telephone: 213/895-6500
 

SPECTOR & ROSEMAN, P.C.

ROBERT M. ROSEMAN

2000 Market Street

12th Floor

Philadelphia, PA 19103

Telephone: 215/864-2400
 

SPECTOR & ROSEMAN, P.C.

ELLEN GUSIKOFF STEWART

600 West Broadway, Suite 1800

San Diego, CA 92101

Telephone: 619/338-4514
 

Attorneys for Plaintiffs

COMPLNTS\DISLGFED.CPT

1. On October 17, 1995, Discreet announced a 2-for-1 stock split, effective in early November 1995. All per share information has been adjusted to reflect this split.

2. Excluding certain one time write-offs of purchased research and development arising from the acquisition of COSS/IMP.

3. In January 1997, Discreet announced it had changed its fiscal year to end June 30 instead of July 31.

4. A "Booster Shot" is a highly favorable research report written by one of the issuer's underwriters and issued just after the expiration of the SEC-mandated 25-day "quiet period" following a new securities issuance, which is intended to boost or support the price of the issuer's stock. 



8 July 1997