<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): March 9, 1998
Discreet Logic Inc.
-------------------
(Exact name of Registrant as specified in its charter)
Quebec 0-26100 98-0150790
- ---------------------------- ------------- ------------------
(State or other jurisdiction (Commission (IRS Employer
of Incorporation) File Number) Identification No.)
10 Duke Street
Montreal, Quebec, Canada H3C 2L7
- ------------------------ -----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (514) 393-1616
<PAGE>
ITEM 5. OTHER EVENTS.
EXECUTION OF DEFINITIVE AGREEMENT TO ACQUIRE MGI SOFTWARE CORP.
On March 9, 1998, Discreet Logic Inc. (the "Company") entered into a
definitive agreement to acquire MGI Software Corp. ("MGI") in a proposed
arrangement transaction (the "Arrangement") and issued a press release
announcing the agreement. A copy of the definitive agreement is attached as
Exhibit 2.1 to this Current Report on Form 8-K.
On or about April 20, 1998 MGI commenced a mailing to its stockholders of a
Notice of Special Meeting of Shareholders, Notice of Application and Management
Information Circular dated April 15, 1998 (the "Circular") relating to the
Arrangement. A copy of the Circular is attached as Exhibit 99.1 to this Current
Report on Form 8-K.
The following unaudited pro forma combined condensed financial statements
relating to the Arrangement (presented according to generally accepted
accounting principles in effect in the United States) are attached as
Exhibit 99.2 to this Current Report on Form 8-K:
1. Unaudited Pro Forma Combined Condensed Balance Sheet as at December
31, 1997 for Discreet and January 31, 1998 for MGI; and
2. Unaudited Pro Forma Combined Condensed Statements of Operations for
the Six-Month Period Ended December 31, 1997 for Discreet and the Six-Month
Period ended January 31, 1998 for MGI.
Certain financial statements of MGI, presented according to generally
accepted accounting principles in effect in the United States, are attached as
Exhibit 99.3 to this Current Report on Form 8-K.
<PAGE>
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
<TABLE>
<CAPTION>
Exhibit No. Exhibit
- ----------- -------
<C> <S>
2.1 Arrangement Agreement by and among
Discreet Logic Inc., MGI Software Corp.,
and 1284517 Ontario Inc. Dated as of
March 9, 1998.
99.1 Notice of Special Meeting of
Shareholders of MGI Software Corp.,
Notice of Application and Management
Information Circular Concerning an
Arrangement Involving MGI Software
Corp. and Discreet Logic Inc.
99.2 Unaudited Pro Forma Combined Condensed
Financial Statements As At December 31,
1997.
99.3 Audited MGI Software Corp. Financial Statements
as at January 31, 1998.
</TABLE>
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
DISCREET LOGIC INC.
April 28, 1998
By: /s/ Francois Plamondon
-------------------------------
Francois Plamondon
Senior Vice President,
Chief Financial Officer, Treasurer
and Secretary
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Exhibit
- ----------- -------
<C> <S>
2.1 Arrangement Agreement by and among
Discreet Logic Inc., MGI Software Corp.,
and 1284517 Ontario Inc. Dated as of
March 9, 1998.
99.1 Notice of Special Meeting of
Shareholders of MGI Software Corp.,
Notice of Application and Management
Information Circular Concerning an
Arrangement Involving MGI Software
Corp. and Discreet Logic Inc.
99.2 Unaudited Pro Forma Combined Condensed
Financial Statements As At December 31,
1997.
99.3 Audited MGI Software Corp. Financial Statements
as at January 31, 1998.
</TABLE>
<PAGE>
EXHIBIT 2.1
-----------
ARRANGEMENT AGREEMENT
BY AND AMONG
DISCREET LOGIC INC.,
MGI SOFTWARE CORP.,
AND
1284517 ONTARIO INC.
DATED AS OF
MARCH 9, 1998
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE NO.
<S> <C>
ARTICLE 1 INTERPRETATION
1.1 DEFINITIONS. . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.2 SUBSIDIARIES . . . . . . . . . . . . . . . . . . . . . . . . . 7
1.3 KNOWLEDGE . . . . . . . . . . . . . . . . . . . . . . . . . . 8
1.4 NUMBER, GENDER AND PERSONS . . . . . . . . . . . . . . . . . . 8
1.5 INTERPRETATIONS NOT AFFECTED BY HEADINGS, ETC. . . . . . . . . 8
1.6 DATE FOR ANY ACTION. . . . . . . . . . . . . . . . . . . . . . 8
1.7 CURRENCY . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
1.8 TIME . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
1.9 STATUTORY REFERENCES . . . . . . . . . . . . . . . . . . . . . 9
1.10 DISCLOSURE SCHEDULES . . . . . . . . . . . . . . . . . . . . . 9
1.11 INCLUDE, AVAILABLE AND DATE. . . . . . . . . . . . . . . . . . 9
ARTICLE 2 THE ARRANGEMENT
2.1 THE ARRANGEMENT. . . . . . . . . . . . . . . . . . . . . . . . 9
2.2 ADJUSTMENTS FOR CAPITAL CHANGES. . . . . . . . . . . . . . . . 10
2.3 DISSENTING SHAREHOLDERS. . . . . . . . . . . . . . . . . . . . 10
2.4 OTHER EFFECTS OF THE ARRANGEMENT . . . . . . . . . . . . . . . 10
ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF MGI
3.1 ORGANIZATION AND QUALIFICATION OF MGI. . . . . . . . . . . . . 11
3.2 CAPITAL STRUCTURE OF MGI . . . . . . . . . . . . . . . . . . . 11
3.3 AUTHORITY; NO CONFLICT; REQUIRED FILINGS AND CONSENTS. . . . . 12
3.4 SECURITIES LAW FILINGS . . . . . . . . . . . . . . . . . . . . 13
3.5 FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . 13
3.6 NO UNDISCLOSED LIABILITIES . . . . . . . . . . . . . . . . . . 13
3.7 ABSENCE OF CERTAIN CHANGES OR EVENTS . . . . . . . . . . . . . 13
3.8 RESTRICTIONS ON BUSINESS ACTIVITIES. . . . . . . . . . . . . . 14
3.9 TAX MATTERS. . . . . . . . . . . . . . . . . . . . . . . . . . 14
3.10 PROPERTIES . . . . . . . . . . . . . . . . . . . . . . . . . . 15
3.11 INTELLECTUAL PROPERTY. . . . . . . . . . . . . . . . . . . . . 15
3.12 AGREEMENTS, CONTRACTS AND COMMITMENTS. . . . . . . . . . . . . 17
3.13 LITIGATION . . . . . . . . . . . . . . . . . . . . . . . . . . 17
3.14 ENVIRONMENTAL MATTERS. . . . . . . . . . . . . . . . . . . . . 18
3.15 EMPLOYEE BENEFIT PLANS . . . . . . . . . . . . . . . . . . . . 18
3.16 LABOUR MATTERS . . . . . . . . . . . . . . . . . . . . . . . . 18
3.17 COMPLIANCE WITH LAWS . . . . . . . . . . . . . . . . . . . . . 19
3.18 INSURANCE . . . . . . . . . . . . . . . . . . . . . . . . . . 19
3.19 POOLING OF INTERESTS . . . . . . . . . . . . . . . . . . . . . 19
3.20 CIRCULAR . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
3.21 NO EXISTING DISCUSSIONS. . . . . . . . . . . . . . . . . . . . 20
3.22 OPINION OF FINANCIAL ADVISOR . . . . . . . . . . . . . . . . . 20
3.23 VOTE REQUIRED. . . . . . . . . . . . . . . . . . . . . . . . . 20
3.24 BOARD APPROVAL . . . . . . . . . . . . . . . . . . . . . . . . 20
3.25 BROKERAGE . . . . . . . . . . . . . . . . . . . . . . . . . . 20
<PAGE>
3.26 REPRESENTATIONS COMPLETE . . . . . . . . . . . . . . . . . . . 20
ARTICLE 4 REPRESENTATIONS AND WARRANTIES OF DISCREET
4.1 ORGANIZATION AND QUALIFICATION OF DISCREET . . . . . . . . . . 21
4.2 CAPITAL STRUCTURE OF DISCREET. . . . . . . . . . . . . . . . . 21
4.4 SEC FILINGS. . . . . . . . . . . . . . . . . . . . . . . . . . 23
4.5 FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . 23
4.6 NO UNDISCLOSED LIABILITIES . . . . . . . . . . . . . . . . . . 23
4.7 ABSENCE OF CERTAIN CHANGES OR EVENTS . . . . . . . . . . . . . 24
4.8 TAX MATTERS. . . . . . . . . . . . . . . . . . . . . . . . . . 24
4.9 INTELLECTUAL PROPERTY. . . . . . . . . . . . . . . . . . . . . 24
4.10 LITIGATION . . . . . . . . . . . . . . . . . . . . . . . . . . 25
4.11 ENVIRONMENTAL MATTERS. . . . . . . . . . . . . . . . . . . . . 25
4.12 EMPLOYEE BENEFIT PLANS . . . . . . . . . . . . . . . . . . . . 25
4.13 COMPLIANCE WITH LAWS . . . . . . . . . . . . . . . . . . . . . 25
4.14 POOLING OF INTERESTS . . . . . . . . . . . . . . . . . . . . . 26
4.15 CIRCULAR . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
4.16 INTERIM OPERATIONS OF SUBCO. . . . . . . . . . . . . . . . . . 26
4.17 BOARD APPROVAL . . . . . . . . . . . . . . . . . . . . . . . . 26
4.18 REPRESENTATIONS COMPLETE . . . . . . . . . . . . . . . . . . . 26
ARTICLE 5 REPRESENTATIONS AND WARRANTIES OF SUBCO
5.1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
ARTICLE 6 COVENANTS
6.1 COVENANTS OF MGI . . . . . . . . . . . . . . . . . . . . . . . 28
6.2 NO SOLICITATION. . . . . . . . . . . . . . . . . . . . . . . . 30
6.3 COVENANTS OF DISCREET. . . . . . . . . . . . . . . . . . . . . 31
ARTICLE 7ADDITIONAL AGREEMENTS
7.1 PREPARATION OF CIRCULAR AND OTHER FILINGS AND SUBMISSIONS. . . 32
7.2 THE ARRANGEMENT. . . . . . . . . . . . . . . . . . . . . . . . 33
7.3 NOTIFICATION OF CERTAIN MATTERS. . . . . . . . . . . . . . . . 34
7.4 SUPPORT OF RESOLUTION TO APPROVE ARRANGEMENT . . . . . . . . . 34
7.5 MGI STOCK OPTIONS. . . . . . . . . . . . . . . . . . . . . . . 34
7.6 BROKER SPECIAL WARRANTS. . . . . . . . . . . . . . . . . . . . 35
7.7 INTEL WARRANT. . . . . . . . . . . . . . . . . . . . . . . . . 36
7.8 AFFILIATES AGREEMENT . . . . . . . . . . . . . . . . . . . . . 36
7.9 ACCESS TO INFORMATION. . . . . . . . . . . . . . . . . . . . . 37
7.10 LETTER OF MGI'S AUDITORS . . . . . . . . . . . . . . . . . . . 37
7.11 LETTER OF DISCREET'S AUDITORS. . . . . . . . . . . . . . . . . 38
7.12 SPECIAL MEETING. . . . . . . . . . . . . . . . . . . . . . . . 38
7.13 CONFIDENTIALITY. . . . . . . . . . . . . . . . . . . . . . . . 38
7.14 LEGAL CONDITIONS TO ARRANGEMENT. . . . . . . . . . . . . . . . 38
7.15 PUBLIC ANNOUNCEMENTS . . . . . . . . . . . . . . . . . . . . . 39
7.16 POOLING ACCOUNTING . . . . . . . . . . . . . . . . . . . . . . 39
7.17 NASDAQ QUOTATION . . . . . . . . . . . . . . . . . . . . . . . 39
7.18 CONSENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
7.19 FORM S-8 . . . . . . . . . . . . . . . . . . . . . . . . . . 39
7.20 ADDITIONAL AGREEMENTS; REASONABLE EFFORTS. . . . . . . . . . . 40
<PAGE>
7.21 MERGER OF COVENANTS . . . . . . . . . . . . . . . . . . . . . 40
7.22 BOARD REPRESENTATION . . . . . . . . . . . . . . . . . . . . . 40
ARTICLE 8 CONDITIONS TO ARRANGEMENT
8.1 CONDITIONS FOR THE BENEFIT OF DISCREET . . . . . . . . . . . . 40
8.2 CONDITIONS FOR THE BENEFIT OF MGI. . . . . . . . . . . . . . . 42
8.3 NOTICE AND CURE PROVISIONS . . . . . . . . . . . . . . . . . . 44
8.4 MERGER OF CONDITIONS . . . . . . . . . . . . . . . . . . . . . 44
ARTICLE 9 OPTION
9.1 GRANT OF OPTION. . . . . . . . . . . . . . . . . . . . . . . . 45
9.2 COVENANTS OF MGI . . . . . . . . . . . . . . . . . . . . . . . 45
9.3 SECURITIES QUALIFICATION REQUIREMENTS. . . . . . . . . . . . . 46
9.4 ADJUSTMENT . . . . . . . . . . . . . . . . . . . . . . . . . . 46
9.5 PROCEEDINGS PRIOR TO ANY ACTION REQUIRING ADJUSTMENT . . . . . 49
9.6 CERTIFICATE OF ADJUSTMENT. . . . . . . . . . . . . . . . . . . 50
9.7 ADJUSTMENT RULES . . . . . . . . . . . . . . . . . . . . . . . 50
9.8 NOTICE OF SPECIAL MATTERS. . . . . . . . . . . . . . . . . . . 50
9.9 EXERCISE OF OPTION . . . . . . . . . . . . . . . . . . . . . . 50
9.10 EFFECT OF EXERCISE OF OPTION . . . . . . . . . . . . . . . . . 51
9.11 OPTION VOID AFTER EXPIRE TIME. . . . . . . . . . . . . . . . . 52
9.12 COMPANY MAY CONSOLIDATE, ETC. ON CERTAIN TERMS . . . . . . . . 52
9.13 SUCCESSOR BODY CORPORATE SUBSTITUTED . . . . . . . . . . . . . 52
ARTICLE 10 COMPETING TRANSACTION
10.1 DISCREET'S RIGHT TO INCREASE CONSIDERATION . . . . . . . . . . 52
10.2 CASH EQUIVALENT VALUE OF NON-CASH CONSIDERATION. . . . . . . . 53
10.3 POSTPONEMENT OF SPECIAL MEETING AND TERMINATION. . . . . . . . 53
ARTICLE 11 TERMINATION
11.1 TERMINATION. . . . . . . . . . . . . . . . . . . . . . . . . . 54
11.2 EFFECT OF TERMINATION. . . . . . . . . . . . . . . . . . . . . 55
11.3 EXPENSES AND TERMINATION FEES. . . . . . . . . . . . . . . . . 55
ARTICLE 12 MISCELLANEOUS
12.1 NONSURVIVAL OF REPRESENTATIONS AND WARRANTIES. . . . . . . . . 57
12.2 NOTICE . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
12.3 COUNTERPARTS . . . . . . . . . . . . . . . . . . . . . . . . . 58
12.4 AMENDMENT . . . . . . . . . . . . . . . . . . . . . . . . . . 58
12.5 EXTENSION; WAIVER. . . . . . . . . . . . . . . . . . . . . . . 58
12.6 ENTIRE AGREEMENT; NO THIRD PARTY BENEFICIARIES . . . . . . . . 58
12.7 GOVERNING LAW. . . . . . . . . . . . . . . . . . . . . . . . . 59
12.8 OTHER REMEDIES; SPECIFIC PERFORMANCE . . . . . . . . . . . . . 59
12.9 SEVERABILITY . . . . . . . . . . . . . . . . . . . . . . . . . 59
12.10 ASSIGNMENT . . . . . . . . . . . . . . . . . . . . . . . . . . 59
12.11 AUTHORITY OF DISCREET . . . . . . . . . . . . . . . . . . . . 60
EXHIBIT 1 - PLAN OF ARRANGEMENT
ARTICLE 1 INTERPRETATION
<PAGE>
1.1 DEFINITIONS. . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.2 NUMBER, GENDER AND PERSONS . . . . . . . . . . . . . . . . . . . 3
1.3 INTERPRETATION NOT AFFECTED BY HEADINGS, ETC.. . . . . . . . . . 3
1.4 DATE FOR ANY ACTION. . . . . . . . . . . . . . . . . . . . . . . 3
1.5 TIME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.6 CURRENCY . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.7 STATUTORY REFERENCES . . . . . . . . . . . . . . . . . . . . . . 3
1.8 APPENDICES . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
ARTICLE 2 ARRANGEMENT
2.1 BINDING EFFECT . . . . . . . . . . . . . . . . . . . . . . . . . 4
2.2 EVENTS SEQUENTIAL. . . . . . . . . . . . . . . . . . . . . . . . 4
2.3 THE ARRANGEMENT. . . . . . . . . . . . . . . . . . . . . . . . . 4
ARTICLE 3 RIGHTS OF DISSENT
3.1 RIGHTS OF DISSENT. . . . . . . . . . . . . . . . . . . . . . . . 6
ARTICLE 4 CERTIFICATES AND FRACTIONAL SHARES
4.1 DELIVERY OF CERTIFICATES . . . . . . . . . . . . . . . . . . . . 7
4.2 DISTRIBUTIONS. . . . . . . . . . . . . . . . . . . . . . . . . . 7
4.3 NO FRACTIONAL SHARES . . . . . . . . . . . . . . . . . . . . . . 8
4.4 LOST CERTIFICATES. . . . . . . . . . . . . . . . . . . . . . . . 8
4.5 UNCLAIMED CERTIFICATES . . . . . . . . . . . . . . . . . . . . . 9
ARTICLE 5AMENDMENT
5.1 PLAN OF ARRANGEMENT AMENDMENT. . . . . . . . . . . . . . . . . . 9
EXHIBIT 2.1 - MGI AFFILIATE AGREEMENT
EXHIBIT 2.2 - DISCREET AFFILIATE AGREEMENT
</TABLE>
<PAGE>
ARRANGEMENT AGREEMENT
ARRANGEMENT AGREEMENT, dated as of March 9, 1998, by and among Discreet
Logic Inc., a company incorporated under the laws of the province of Quebec
("DISCREET"), MGI Software Corp., a corporation amalgamated under the laws of
the province of Ontario ("MGI"), and 1284517 Ontario Inc. ("Subco").
WHEREAS the respective Boards of Directors of Discreet and MGI deem it
advisable and in the best interests of each corporation and their respective
shareholders that Discreet and MGI engage in a strategic combination in order
to advance the long-term business interests of Discreet and MGI;
WHEREAS the strategic combination of Discreet and MGI shall be effected
by the terms of this Agreement through an arrangement in which Subco will
amalgamate with MGI, Amalco will become a wholly-owned subsidiary of Discreet
and the shareholders of MGI will become shareholders of Discreet;
WHEREAS the Board of Directors of Discreet has authorized Discreet to
enter this Agreement;
WHEREAS Mr. Oren Asher has entered into an agreement with MGI and
Discreet dated the date hereof pursuant to which he has agreed to vote all of
his MGI Common Shares in favour of the transaction (subject to the terms and
condition thereof) (the "Lock-up Agreement");
WHEREAS the Board of Directors of MGI has authorised MGI to enter this
Agreement and has determined to recommend that the MGI Shareholders vote in
favour of the Arrangement;
WHEREAS for accounting purposes, it is intended that the Arrangement
shall be accounted for as a pooling of interests under U.S. GAAP.
NOW, THEREFORE, in consideration of the foregoing and the respective
representations, warranties, covenants and agreements set forth below, the
parties agree as follows:
ARTICLE 1
INTERPRETATION
1.1 DEFINITIONS
In this Agreement, unless there is something in the subject matter or
context inconsistent therewith, the following terms shall have the following
meanings, respectively:
"AFFILIATES" has the meaning ascribed thereto in Section 7.8.
"AFFILIATE" shall have the meaning ascribed thereto in the OBCA.
"AGREEMENT", "HEREOF", "HEREUNDER" and similar expressions mean this
Agreement, including the recitals, Schedules and Exhibits hereto, and not any
particular Article, Section or other part hereof and includes any written
agreement or instrument supplementary or ancillary hereto.
"ALTERNATIVE PROPOSAL" means any offer or proposal for, or any indication
of interest in (i) an
<PAGE>
amalgamation, consolidation, arrangement or other business combination
involving MGI or any of its subsidiaries, (ii) the acquisition of 20% or more
of the outstanding shares in the share capital of MGI (including without
limitation by way of a tender offer or an exchange offer), (iii) the
acquisition of beneficial ownership or a right to acquire beneficial
ownership of, directly or indirectly, together with persons acting in
concert, 20% or more of the then outstanding shares in the share capital of
MGI, (iv) the acquisition of any material assets (excluding the sale or
distribution of assets in the ordinary course of business) of MGI or any of
its subsidiaries, or (v) any public announcement of a proposal, plan or
intention to do any of the foregoing or any agreement to engage in any of the
foregoing, in each case other than the transactions contemplated by this
Agreement.
"AMALCO" means the corporation resulting from the Amalgamation.
"AMALGAMATION" means the amalgamation of MGI and Subco pursuant to
Section 2.3(a) of the Plan of Arrangement.
"ARRANGEMENT" means an arrangement under the provisions of Section 182
of the OBCA, on the terms and conditions set forth in the Plan of Arrangement.
"BROKER SPECIAL WARRANTS" means the 175,000 broker special warrants
issued as additional compensation to Gordon Capital Corporation, Cannaccord
Capital Corporation and Griffiths McBurney Inc. pursuant to an agency
agreement by and among the aforementioned dealers and MGI and which entitles
the holders thereof, in the aggregate, to 175,000 compensation options
without additional payment to MGI; each compensation option entitles the
holder thereof to purchase, on or before December 29, 1998, one MGI Common
Share (subject to adjustment) at a price of $5.25 per share.
"BUSINESS DAy" means a day which is not a Saturday, Sunday or a day when
banks are not open for business in Montreal, Quebec and in Toronto, Ontario.
"CA" means the COMPETITION ACT (Canada).
"CANADIAN GAAP" means generally accepted accounting principles in effect
in Canada as of the date of the subject financial statements.
"CIRCULAR" means the management proxy circular to be prepared and sent
to the MGI Shareholders in connection with the Special Meeting.
"COMPETING TRANSACTION" means an offer made (i) to purchase or otherwise
acquire all of the outstanding MGI Common Shares held by Canadian
shareholders (other than an issuer bid), (ii) for a consideration per MGI
Common Share having a combined cash and cash equivalent value greater than
the cash equivalent value offered by Discreet for each MGI Common Share
pursuant to the Arrangement, (iii) by means of an Alternative Proposal which
is available to all Canadian holders of MGI Common Shares, (iv) with
conditions no more beneficial, taken as a whole, to the person making the
offer than those contained in this Agreement for the benefit of Discreet, and
(v) in respect of which the Board of Directors of MGI does not make any
recommendation or which the Board of Directors of MGI determines to be more
favourable to the MGI Shareholders than the Arrangement.
"COURT" means the Ontario Court (General Division) Commercial List or,
if the Commercial List is unavailable, the Ontario Court (General Division).
"CURRENT MARKET PRICE", in respect of a MGI Common Share at any date,
means the price per
<PAGE>
share equal to the weighted average closing price of the MGI Common Shares on
The Toronto Stock Exchange for the 5 consecutive trading days ending on the
fifth trading day before such date or, if the MGI Common Shares are not then
listed thereon, on such stock exchange on which the MGI Common Shares are
then listed as may be selected for such purpose by the directors of MGI or if
the MGI Common Shares are not then listed on any stock exchange then on the
over-the-counter market; the weighted average closing price shall be
determined by dividing the aggregate of the sale prices of all the MGI Common
Shares sold on the said exchange or market, as the case may be, during the
said 5 consecutive trading days by the total number of MGI Common Shares so
sold.
"DIRECTOR" means the Director appointed under Section 278 of the OBCA.
"DISCLOSURE DOCUMENTS" means (i) in respect of MGI, its:
(a) Annual Report to shareholders for the fiscal year ended January 31,
1997;
(b) Management Proxy Circular for its 1997 annual and special meeting
of shareholders;
(c) Interim Financial Statements for the periods ended April 30, 1997,
July 31, 1997, and October 31, 1997;
(d) Annual Information Form for the fiscal year ended January 31, 1997;
and
(e) Material change reports and press releases filed or issued by it since
January 31, 1997; and
(ii) in respect of Discreet, its:
(a) Annual Report to shareholders for the fiscal year ended June 30, 1997;
(b) Annual Report on Form 10-K for its fiscal year ended June 30, 1997;
(c) Proxy Statement with respect to its 1997 annual meeting of
shareholders;
(d) Quarterly Reports on Form 10-Q for each quarter since the end of its
most recent fiscal year; and
(e) Reports on Form 8-K since the end of its latest fiscal year;
which Disclosure Documents have been or will have been filed under the
applicable Securities Legislation or issued prior to the Effective Date and
have been or will have been provided to the other parties prior to the
Effective Date.
"DISCREET" means Discreet Logic Inc.
"DISCREET BALANCE SHEET" has the meaning ascribed thereto in Section 4.5.
"DISCREET COMMON SHAREHOLDERS" at any time means the holders of outstanding
Discreet Common Shares at such time.
"DISCREET COMMON SHARES" means the common shares in the share capital of
Discreet.
<PAGE>
"DISCREET DIRECTOR OPTION PLANS" means, collectively, Discreet's 1995
Non-Employee Director Stock Option Plan and the 1997 Special Limited
Non-Employee Director Stock Option Plan.
"DISCREET DISCLOSURE SCHEDULE" means the disclosure schedule delivered
by Discreet to the other parties hereto on or before the date of this
Agreement.
"DISCREET ESPP" means Discreet's 1995 Employee Stock Purchase Plan.
"DISCREET PREFERRED SHARES" means the preferred shares in the share
capital of Discreet.
"DISCREET SEC REPORTS" means all forms, reports and documents filed or
required to be filed by Discreet with the SEC since June 30, 1997.
"DISCREET STOCK OPTION PLAN" means the Discreet Amended and Restated
1994 Restricted Share and Option Plan.
"DISCREET STOCK OPTIONS" means the rights (vested or not) to purchase
Discreet Common Shares which are from time to time outstanding under the
Discreet Stock Option Plan and the Discreet Director Option Plans.
"DISSENTING SHAREHOLDERS" has the meaning ascribed thereto in Section 2.3.
"EFFECTIVE DATE" means the date shown in the certificate of arrangement to
be issued by the Director and giving effect to the Arrangement.
"EFFECTIVE TIMe" means 12:00 a.m. on the Effective Date.
"EXCHANGE RATIO" has the meaning ascribed thereto in Section 2.1.
"FINAL ORDER" means the final order of the Court made in connection with
the approval of the Arrangement, following the application therefor contemplated
in Section 2.1.
"FINANCIAL STATEMENTS" means (i) with respect to Discreet the audited
financial statements of Discreet prepared on a consolidated basis, for and as
at the end of its 1997 fiscal year, together with the interim unaudited
financial statements of Discreet for the six month period ended December 31,
1997, and (ii) with respect to MGI, the audited financial statements of MGI
prepared on a consolidated basis, for and as of the end of its 1997 fiscal
year, together with the interim unaudited financial statements of MGI for the
nine month period ended October 31, 1997, all of which financial statements
have been filed pursuant to applicable Securities Legislation.
"GOVERNMENTAL ENTITY" means any domestic or foreign court or tribunal or
governmental agency or other regulatory authority or administrative agency or
commission or any elected or appointed public official.
"HSR ACT" means the HART-SCOTT-RODINO ANTITRUST IMPROVEMENTS ACT OF 1976
(United States of America) and the rules and regulations promulgated
thereunder.
"INTEL WARRANT AGREEMENT" means the Warrant Agreement providing for the
issuance of the Intel Warrants dated as of September 30, 1997 between MGI and
Intel Corporation.
"INTEL WARRANTS" means the 1,022,757 common share purchase warrants
entitling the holder
<PAGE>
thereof until September 30, 2000 to purchase 1,022,757 MGI Common Shares,
subject to adjustment, at the lower of (i) $3.95 per MGI Common Share and
(ii) the higher of the then current market price of the MGI Common Shares and
$3.20 per MGI Common Share.
"INTERIM ORDER" means the interim order of the Court made in connection
with the approval of the Arrangement, following the application therefor
contemplated by Section 2.1.
"IRC" means the United States Internal Revenue Code of 1986, as amended.
"ITA" means the INCOME TAX ACT (Canada).
"LIEN" means any mortgage, hypothec, lien, security interest, lease,
option, right of third parties or other charge or encumbrance, including the
lien or retained title of a conditional vendor and any easement, right of way
or other encumbrance on title to real property.
"MGI" means MGI Software Corp.
"MGI AUTHORIZATIONS" has the meaning ascribed to it in Section 4.9.
"MGI COMMON SHARES" means the common shares in the share capital of MGI.
"MGI CONTRACTS" has the meaning ascribed thereto in Section 4.13.
"MGI DISCLOSURE SCHEDULE" means the disclosure schedule delivered by MGI to
the other parties hereto on or before the date of this Agreement.
"MGI INTELLECTUAL PROPERTY RIGHTS" has the meaning ascribed thereto in
Section 4.12(a).
"MGI SHAREHOLDERS" at any time means the holders of outstanding MGI Common
Shares at such time.
"MGI STOCK OPTION PLAN" means MGI's stock option plan for the benefit of
its officers, directors and key employees.
"MGI STOCK OPTIONS" means the rights (whether or not vested) to purchase
MGI Common Shares which are from time to time outstanding under the MGI Stock
Option Plan.
"MGI THIRD PARTY INTELLECTUAL PROPERTY RIGHTS" has the meaning ascribed
thereto in Section 4.12(a).
"MATERIAL ADVERSE EFFECT" means when used in connection with Discreet or
MGI, any change, effect, event, occurrence or state of facts arising within
or specifically affecting such party that is, or would reasonably be expected
to be, material and adverse to the business, operations or condition,
financial or otherwise, of such party and its subsidiaries taken as a whole,
and for greater certainty, does not include any change, effect, event or
occurrence (i) affecting the Canadian, United States or any other economy or
securities markets in general (including any decline in the party's stock
price), (ii) reasonably attributable to the announcement of this Agreement
and the transactions contemplated hereby, or (iii) relating to the computer
software or technology industry in general.
"OBCA" means the BUSINESS CORPORATIONS ACT (Ontario).
<PAGE>
"OPTION" means the right granted to Discreet to acquire MGI Common
Shares in accordance with Article 9 of this Agreement.
"OPTION EVENT" has the meaning ascribed thereto in Section 9.9.
"OPTION EXERCISE NUMBER" means 4,795,442, being the number of MGI Common
Shares which may be received on exercise of the Option.
"OPTION EXERCISE PRICE" means the amount of $5.32 per MGI Common Share.
"OPTION EXPIRY DATE" means the earlier of (i) the Effective Date, (ii)
the date which is 12 months from the date of this Agreement, and (iii)
termination of this Agreement prior to the occurrence of an Option Event.
"OPTION EXPIRY TIME" means 5:00 p.m. (Montreal time) on the Option
Expiry Date.
"PERMITTED LIEN" means any Lien which is expressly permitted by the
terms of any financing instrument or security agreement to which Discreet or
any of its subsidiaries is a party or to which MGI or any of its subsidiaries
is a party, as the case may be, including the security granted under any such
financing instrument or security agreement other than Liens arising as a
result of defaults under such instruments or agreements.
"PLAN" has the meaning ascribed thereto in Section 4.16(a).
"PLAN OF ARRANGEMENT" means the plan of arrangement set out as Exhibit 1
hereto and any amendment or variation thereto.
"SEC" means the United States Securities and Exchange Commission.
"SECURITIES LEGISLATION" means the OBCA, the SECURITIES ACT (Quebec),
the SECURITIES ACT (Ontario) and the equivalent legislation in the other
provinces of Canada, the U.S. Securities Act, the U.S. Exchange Act and the
securities laws of the states of the United States, all as now enacted or as
the same may from time to time be amended, reenacted or replaced, and the
applicable rules, regulations, rulings, orders and forms made or promulgated
under such statutes and the published policies of the regulatory authorities
administering such statutes, as well as the rules, regulations, bylaws and
policies of The Toronto Stock Exchange, and the Nasdaq National Market and
the NASD.
"SECURITIES REPORT" has the meaning ascribed thereto in Section 3.4.
"SHAREHOLDER SECURITIES" means all MGI Common Shares held beneficially
or of record by the Principal Shareholders.
"SPECIAL MEETING" means the special meeting of MGI Shareholders to be
held to consider and, if deemed advisable, to approve the Arrangement by way
of special resolution (as defined under the OBCA) of the MGI Shareholders.
"SUBCO" means 1284517 Ontario Inc., a wholly-owned subsidiary of
Discreet incorporated under the OBCA for the purpose of carrying out the
Arrangement.
"TAXES OR TAX" means all taxes (including, income, capital, sales, payroll,
value added, goods
<PAGE>
and services, customs duties, excise, property, transfer and water taxes),
imposts, duties, levies, withholdings, charges, assessments, reassessments or
fees of any nature (including interest and penalties) that are imposed under
any laws or by any relevant taxing authority.
"TERMINATION DATE" means August 31, 1998 or such later date as may be
agreed upon in writing between the parties hereto.
"U.S. EXCHANGE ACT" means the UNITED STATES SECURITIES EXCHANGE ACT OF
1934, as amended.
"U.S. GAAP" means generally accepted accounting principles as in effect
in the United States of America as of the date of the subject financial
statements.
"U.S. SECURITIES ACT" means the UNITED STATES SECURITIES ACT OF 1933, as
amended.
1.2 SUBSIDIARIES
When a reference is made in this Agreement to subsidiaries of Discreet
or MGI or any other entity, the word "SUBSIDIARY" means, with respect to any
party, any corporation or other organization, whether incorporated or
unincorporated, of which (i) such entity or any other subsidiary of such
entity is a general partner (excluding partnerships, the general partnership
interests of which held by such entity or any subsidiary of such entity do
not constitute a majority of the voting interest in such partnership), or
(ii) at least a majority of the securities or other interests having by their
terms ordinary voting power to elect a majority of the Board of Directors or
others performing similar functions with respect to such corporation or other
organization is directly or indirectly owned or controlled by such entity or
by any one or more of its subsidiaries, or by such entity and one or more of
its subsidiaries.
1.3 KNOWLEDGE
In this Agreement, any reference to a party's "KNOWLEDGE" means such
party's actual knowledge after reasonable inquiry of officers, directors and
other employees of such party charged with senior administrative or
operational responsibility of such matters.
1.4 NUMBER, GENDER AND PERSONS
In this Agreement, unless the context requires otherwise, words imposing
the singular number include the plural and VICE VERSA, words importing any
gender include all genders and words importing persons shall include
individuals, corporations, partnerships, associations, trusts, unincorporated
organisations, governmental bodies and other legal or business entities of
any kind.
1.5 INTERPRETATIONS NOT AFFECTED BY HEADINGS, ETC.
The division of this Agreement into Articles, Sections and other parts
and the insertion of headings are for convenience of reference only and shall
not affect the construction or interpretation of this Agreement. When a
reference is made in this Agreement to Sections, such reference shall be to a
Section of this Agreement unless otherwise indicated. The table of contents
and headings contained in this Agreement are for reference purposes only and
shall not affect in any way the meaning or interpretation of this Agreement.
1.6 DATE FOR ANY ACTION
<PAGE>
In the event that any date on which any action is required or permitted
to be taken hereunder is not a Business Day, such action shall be required or
permitted to be taken on or by the next succeeding day which is a Business
Day.
1.7 CURRENCY
Except as otherwise specified, all references to currency in this
Agreement are to Canadian dollars, being lawful money of Canada, and the sign
''$'' without more shall mean Canadian dollars.
1.8 TIME
All times expressed herein are local time (Montreal, Quebec) unless
otherwise stipulated herein.
1.9 STATUTORY REFERENCES
Any reference in this Agreement to a statute includes all regulations
made thereunder, all amendments to such statute or regulations in force from
time to time, and any statute or regulation that supplements or supersedes
such statute or regulations.
1.10 DISCLOSURE SCHEDULES
Each of the Discreet Disclosure Schedule and MGI Disclosure Schedule
shall be arranged in paragraphs corresponding to the applicable numbered and
lettered sections or paragraphs of this Agreement.
1.11 INCLUDE, AVAILABLE AND DATE
Whenever the words "include," "includes" or "including" are used in this
Agreement they shall be deemed to be followed by the words "without
limitation." The phrase "made available" in this Agreement shall mean that
the information referred to has been made available if requested by the party
to whom such information is to be made available. The phrases "the date of
this Agreement," "the date hereof," and terms of similar import, unless the
context otherwise requires, shall be deemed to refer to March 9, 1998.
ARTICLE 2
THE ARRANGEMENT2THE ARRANGEMENT
2.1 THE ARRANGEMENT
As soon as reasonably practicable after the execution of this Agreement,
Subco and MGI agree that they shall apply to the Court pursuant to Section 182
of the OBCA for an Interim Order (in form and substance satisfactory to Discreet
and MGI, such approval not to be unreasonably withheld or delayed) providing
for, among other things, the calling and holding of the Special Meeting for the
purpose of considering and, if deemed advisable, approving the Arrangement. If
the approval by the MGI Shareholders of the Arrangement at the Special Meeting
as set out in the Interim Order is obtained, as soon as reasonably practicable
thereafter, Subco and MGI shall take the necessary steps to submit the
Arrangement to the Court and apply for the Final Order in such fashion as the
Court may direct. If such Final Order is obtained, as soon as reasonably
practicable thereafter, and subject to the fulfilment or
<PAGE>
waiver of each of the conditions set forth in Article 8 hereof, Subco and MGI
shall file, pursuant to Section 182 of the OBCA, articles of arrangement as
necessary with respect to the Arrangement. As part of its applications for
the Interim Order and the Final Order, MGI will inform the Court that, if the
Court approves the Arrangement, the Discreet Common Shares issued pursuant to
the transactions covered by the Arrangement will not require registration
under the U.S. Securities Act by virtue of the Court's approval. At the
Effective Time, the following transactions shall occur and shall be deemed to
occur in the following order without any further act or formality: (a) each
MGI Common Share (other than the MGI Common Shares held by holders who have
exercised their rights of dissent in accordance with the Plan of Arrangement
and who are ultimately entitled to be paid fair value for such shares) shall
be exchanged for 0.162 Discreet Common Shares (the "EXCHANGE RATIO") and the
MGI Stock Options, the Intel Warrants and the Broker Special Warrants will be
dealt with in accordance with Sections 7.5, 7.6 and 7.7. No fractional
Discreet Common Shares will be delivered. In lieu thereof, each holder of a
MGI Common Share who otherwise would be entitled to receive a fraction of a
Discreet Common Share shall be paid by Discreet an amount determined in
accordance with the Plan of Arrangement; (b) upon the exchange referred to in
(a) above, each holder of MGI Common Shares whose shares shall have been so
exchanged shall cease to be a holder of MGI Common Shares, shall have its
name removed from the register of holders of MGI Common Shares, shall become
a holder of a number of fully paid Discreet Common Shares to which he is
entitled as above described, and such holder's name shall be added to the
register of holders of Discreet Common Shares; and (c) MGI and Subco shall
amalgamate.
2.2 ADJUSTMENTS FOR CAPITAL CHANGES
If, prior to the Effective Time, Discreet or MGI recapitalizes through a
subdivision of its outstanding shares into a greater number of shares or a
combination of its outstanding shares into a lesser number of shares, or
reorganizes, reclassifies or otherwise changes its outstanding shares into
the same or a different number of shares of other classes, or declares a
dividend on its outstanding shares payable in shares of its capital stock or
securities convertible into shares of its share capital, then the Exchange
Ratio will be adjusted appropriately as shall be agreed between MGI and
Discreet.
2.3 DISSENTING SHAREHOLDERS
MGI Shareholders may exercise rights of dissent with respect to such
shares in connection with the Arrangement pursuant to and in the manner set
forth in Section 3.1 of the Plan of Arrangement (such holders referred to as
"DISSENTING SHAREHOLDERS"). MGI shall give Discreet (i) prompt notice of any
written demands of a right of dissent, withdrawals of such demands, and any
other instruments served pursuant to the OBCA and received by MGI and (ii)
the opportunity to participate in all negotiations and proceedings with
respect to such rights. MGI shall not, except with the prior written consent
of Discreet, voluntarily make any payment with respect to any such rights or
offer to settle or settle any such rights.
2.4 OTHER EFFECTS OF THE ARRANGEMENT
At the Effective Time: (a) the by-laws of Subco immediately prior to the
Effective Time will continue as the by-laws of Amalco, subject to later
amendment; (b) the directors of Amalco will be the directors of Subco prior
to the Effective Time; (c) the officers of Amalco will be the officers of
Subco prior to the Effective Time; (d) each MGI Common Share, MGI Stock
Options, Broker Special Warrants and the Intel Warrants outstanding
immediately prior to the Effective Time will be dealt with as provided for in
Sections 2.1, 7.5, 7.6 and 7.7, respectively; and (e) the Arrangement will,
from and after the Effective Time, have all of the effects provided by
applicable law, including, without limitation, the OBCA.
<PAGE>
ARTICLE 3
REPRESENTATIONS AND WARRANTIES OF MGI
MGI represents and warrants to Discreet and Subco as follows:
3.1 ORGANIZATION AND QUALIFICATION OF MGI
MGI is a corporation duly amalgamated, organized, validly existing and
in good standing under the laws of the jurisdiction of its amalgamation, has
all requisite corporate power and authority to own, lease and operate its
property and to carry on its business as now being conducted and is duly
qualified to carry on business and is in good standing as a foreign
corporation in each jurisdiction in which the failure to be so qualified
would have a Material Adverse Effect. MGI has delivered (or otherwise made
available) a true and correct copy of the Articles of Amalgamation as
amended, and by-laws, as amended, or other charter documents, as applicable,
of MGI to Discreet. MGI is not in violation of any of the provisions of its
Articles of Amalgamation or by-laws. MGI does not directly or indirectly own
any equity or similar interest in, or any interest convertible into or
exchangeable or exercisable for, any corporation, partnership, joint venture
or other business association or entity.
3.2 CAPITAL STRUCTURE OF MGI.
(a) The authorized share capital of MGI consists of an unlimited number
of MGI Common Shares. As of March 3, 1998, (i) 23,977,212 MGI Common Shares
were validly issued and were outstanding as fully paid and non-assessable,
(ii) 3,084,175 MGI Common Shares were reserved for future issuance pursuant
to options granted and outstanding under the MGI Stock Option Plan, (iii)
175,000 MGI Common Shares were reserved for future issuance pursuant to the
exercise of the compensation options to be issued upon the exercise of the
Broker Special Warrants, and (iv) 1,022,757 MGI Common Shares were reserved
for future issuance upon the exercise of the Intel Warrants. True and
complete copies of all agreements and instruments presently in effect
relating to or issued under the MGI Stock Option Plan, the Intel Warrant
Agreement and the Broker Special Warrants have been delivered or made
available to Discreet and such agreements and instruments have not been
amended, modified or supplemented, and there are no agreements to amend,
modify or supplement such agreements or instruments in any case from the form
delivered to Discreet. All MGI Common Shares subject to issuance as
specified above, upon issuance on the terms and conditions specified in the
instruments pursuant to which they are issuable, shall be duly authorized and
validly issued as fully paid and non-assessable. Except as disclosed in the
MGI Disclosure Schedule, there are no obligations, contingent or otherwise,
of MGI to repurchase, redeem or otherwise acquire any MGI Common Shares or to
provide funds to or make any investment (in the form of a loan, capital
contribution or otherwise) in any other entity. No person or entity has
demand or other rights to cause MGI or any successor company to file any
prospectus, registration statement or like document under applicable
Securities Legislation relating to any MGI Common Shares or any right to
participate in any such prospectus, registration statement or like document.
(b) Except as set forth in this Section 3.2 or as reserved for future
grants of options or rights under the MGI Stock Option Plan, there are no
equity securities of any class of MGI, or any security exchangeable into or
exercisable for such equity securities, issued, reserved for issuance or
outstanding. Except as set forth in this Section 3.2, there are no options,
warrants, equity securities, calls, rights, commitments or agreements of any
nature to which MGI is a party or by which it is bound, obligating MGI to
issue, deliver or sell, or cause to be issued, delivered or sold, additional
shares in the share capital of MGI or obligating MGI to grant, extend,
accelerate the vesting of or enter into any such option,
<PAGE>
warrant, equity security, call, right, commitment or agreement. To the
knowledge of MGI, there are no voting trusts, proxies or other agreements or
understandings with respect to the shares in the share capital of MGI. Other
than as set out in the MGI Disclosure Schedule, none of the MGI Stock Options
shall become vested nor will they have to be exercised within a limited time,
failing which they would terminate, as a result of the consummation of the
transactions contemplated herein or the execution of this Agreement.
3.3 AUTHORITY; NO CONFLICT; REQUIRED FILINGS AND CONSENTS.
(a) MGI has all requisite corporate power and authority to enter into
this Agreement and, subject to the receipt of its shareholders' approval, to
consummate the transactions contemplated by this Agreement. The execution
and delivery of this Agreement and the consummation of the transactions
contemplated by this Agreement have been duly authorized by all necessary
corporate action on the part of MGI, subject only to the approval of the
Arrangement by MGI's Shareholders. This Agreement has been duly authorized,
executed and delivered by MGI and constitutes a valid and binding obligation
of MGI, enforceable against it in accordance with its terms, subject,
however, to limitations with respect to enforcement imposed by law in
connection with bankruptcy or similar proceedings, the equitable power of the
courts to stay proceedings before them and the execution of judgements and to
the extent that equitable remedies such as specific performance and
injunction are in the discretion of the court from which they are sought.
(b) Except as disclosed in the MGI Disclosure Schedule, the execution
and delivery of this Agreement by MGI does not, and the performance and the
consummation of the transactions contemplated by this Agreement will not, (i)
conflict with, or result in any violation or breach of, any provision of the
Articles of Amalgamation or by-laws of MGI, (ii) result in any violation or
breach of, or constitute (with or without notice or lapse of time, or both) a
default (or give rise to a right of termination, cancellation or acceleration
of any obligation or loss of any material benefit) under any of the terms,
conditions or provisions of any note, bond, mortgage, indenture, lease,
contract or other agreement, instrument or obligation to which MGI or any of
its subsidiaries is a party or by which any of them or any of their
properties or assets may be bound, or (iii) conflict or violate any permit,
concession, franchise, license, judgement, order, decree, statute, law,
ordinance, rule or regulation applicable to MGI or any of its or their
properties or assets, except in the case of Subsections 3.3(b)(ii) and
3.3(b)(iii) for any such conflicts, violations, defaults, terminations,
cancellations or accelerations which would not have, in the aggregate, a
Material Adverse Effect on MGI.
(c) No consent, approval, order or authorization of, or registration,
declaration or filing with any Governmental Entity is required by or with
respect to MGI in connection with the execution and delivery of this
Agreement or the consummation of the transactions contemplated hereby (other
than the grant of the Option), except for (i) the filing of the Articles of
Arrangement with the Ministry of Consumer and Commercial Relations (Ontario),
(ii) appropriate notices with the relevant stock exchanges, material change
reports and press releases, (iii) such consents, approvals, orders,
authorizations, registrations, declarations and filings as may be required
under applicable Securities Legislation, including the Interim Order and the
Final Order, (iv) such filings as may be required under the CA, the HSR and
other legislation of similar nature, and (v) such other consents,
authorizations, filings, approvals and registrations which, if not obtained
or made, would not have a Material Adverse Effect on MGI or, to the knowledge
of MGI, would prevent the completion of the Arrangement.
<PAGE>
3.4 SECURITIES LAW FILINGS
MGI is and has been a reporting issuer in the province of Ontario since
at least September, 1996. Except as disclosed in the MGI Disclosure
Schedule, MGI has filed all proxy circulars, reports and other documents
required to be filed by it pursuant to the Securities Legislation. MGI has
provided to Discreet copies of the Disclosure Documents relating to MGI and
all MGI's final proxy circulars, reports and other documents filed by MGI
since January 31, 1997 pursuant to the Securities Legislation (collectively,
the "SECURITIES REPORTS"). Each Securities Report was, as of the date of
filing such report (or if amended or superseded by a filing prior to the date
of this Agreement, then on the date of such filing), in compliance in all
material respects with all applicable requirements of its respective form and
none of the Securities Reports, as of their respective filing dates,
contained any misrepresentation or any untrue statement of a material fact or
omitted to state a material fact required to be stated therein or necessary
to make the statements therein, in light of the circumstances under which
they were made, not misleading.
3.5 FINANCIAL STATEMENTS.
MGI has previously delivered to Discreet true and complete copies of
the Financial Statements of MGI. These Financial Statements present fairly,
in all material respects, the consolidated financial position of MGI and the
results of its operations and its cash flows as of the respective dates and
for the periods presented therein in conformity with Canadian GAAP as in
effect on the applicable dates of such financial statements and applied on a
consistent basis, except as noted therein and except that in the case of the
unaudited financial statements, no notes are included and such unaudited
financial statements may be subject to normal, recurring adjustments that
would be made in the course of an audit and that would not be material in
amount.
3.6 NO UNDISCLOSED LIABILITIES
Except as disclosed in the Securities Reports and in the MGI Disclosure
Schedule, MGI does not have any liabilities, either accrued or contingent
(whether or not required to be reflected in financial statements in accordance
with Canadian GAAP), and whether due or to become due, other than (i)
liabilities reflected in the balance sheet forming part of the Financial
Statements of MGI, (ii) liabilities specifically described in this Agreement and
(iii) normal or recurring liabilities incurred since October 31, 1997 in the
ordinary course of business consistent with past practices; except for any
liabilities which would not have, in the aggregate, a Material Adverse Effect on
MGI.
3.7 ABSENCE OF CERTAIN CHANGES OR EVENTS.
Except as disclosed in the Securities Reports, since the date of the
balance sheet forming part of the Financial Statements of MGI, MGI has
conducted its business only in the ordinary course and in a manner consistent
with past practice and, since such date, there has not been (i) any change in
the affairs or financial condition of MGI which would have a Material Adverse
Effect; (ii) any damage, destruction or loss (whether or not covered by
insurance) with respect to MGI which has had a Material Adverse Effect; (iii)
any change by MGI in its accounting methods, principles or practices (except
as required by any changes to Canadian GAAP); (iv) any revaluation by MGI of
any of its assets, including, without limitation, writing down the value of
capitalized software or inventory or writing off notes or accounts receivable
other than in the ordinary course of business; or (v) any other action or
event that would have required the consent of Discreet pursuant to Section
6.1 of this Agreement had such action or event occurred after the date of
this Agreement.
3.8 RESTRICTIONS ON BUSINESS ACTIVITIES.
<PAGE>
There is no agreement, judgement, injunction, order or decree binding on
MGI or its assets which has or could reasonably be expected to have a Material
Adverse Effect on MGI.
3.9 TAX MATTERS
Except as disclosed in the MGI Disclosure Schedule, MGI has correctly
prepared and duly and timely filed all tax returns required to be filed by it
(except if not yet due), has paid all Taxes which are due and payable, and
MGI has made adequate provision in the Financial Statements of MGI for the
payment of all Taxes not then due and payable. MGI has made adequate and
timely instalments of Taxes for the taxation period ending on or immediately
before the Effective Date and all Tax returns filed by each of them have been
duly and accurately completed as required by law. With respect to any
taxation period up to and including the Effective Date for which tax returns
have not yet been filed or for which Taxes are not yet due and payable, each
of them has only incurred liabilities for Taxes in the ordinary course of its
business. Other than as disclosed in the MGI Disclosure Schedule, all Taxes
owed by MGI (whether or not shown on any Tax return) have been timely
withheld, remitted and paid. MGI has withheld from payments made to its past
or present employees, officers and directors, and to non-residents of Canada,
the required amount in respect of Taxes and other deductions to be withheld
therefrom, and has remitted such withheld amounts to the applicable
Governmental Entity within the required time periods under the applicable
legislation.
MGI has collected all Taxes that it was required to collect and, as of
the date hereof, all such Taxes (of the nature of payroll or sales taxes)
have been remitted to the applicable Governmental Entity.
MGI has not received any refund of Taxes or any credit against Taxes
from any relevant taxing authority to which it was not entitled and which has
not been returned to any such relevant Governmental Entity.
All Tax returns have been filed through and including the financial year
ended January 31, 1997 and there are no outstanding waivers of any limitation
periods or agreements providing for an extension of time for the filing of
any Tax return or the payment of any Taxes.
There is no dispute or claim concerning any Tax liability of MGI either
(i) claimed or raised by any Governmental Entity or (ii) as to which MGI has
knowledge based upon personal contact with any agent of such Governmental
Entity.
MGI is not a party to any Tax allocation, Tax indemnification or Tax
sharing agreement. MGI does not have any liability for the Taxes of any
person (other than itself) under any applicable Canadian or United States
federal, provincial, state, local or foreign Tax law, as a transferee or
successor, by contract, or otherwise.
MGI is not a party to any agreement, contract, arrangement or plan that
has resulted or would result, separately or in the aggregate, in the payment
of any "excess parachute payments" within the meaning of Section 280G of the
United States Internal Revenue Code, as amended (the "Code"), or any amounts
which would be nondeductible under Sections 162 or 404 of the Code. MGI has
not had, and does not have, any permanent establishment or other fixed place
of business in another country, as defined in any applicable Tax treaty or
convention between Canada and such country. The transactions contemplated by
this Agreement will not result in the recognition by MGI of any Taxable
income or gain under the ITA. MGI does not have any agreements, plans or
arrangements governed by or subject to Section 482 of the Code or the
transfer pricing provisions of any Tax law.
<PAGE>
3.10 PROPERTIES
MGI owns no real property. Set forth in the MGI Disclosure Schedule is a
true and complete list of all real property leased by MGI and the name of the
lessor, the date of the lease and each amendment to the lease and the
aggregate annual rental or other fee payable under any such lease. All
properties used in the operations of MGI and its subsidiaries are reflected
in the balance sheet forming part of the Financial Statements to the extent
Canadian GAAP require the same to be reflected.
3.11 INTELLECTUAL PROPERTY
(a) MGI owns, or has the right to use all patents, trade-marks, trade
secrets, trade-names, copyrights and any applications therefor TECHNOLOGY,
KNOWHOW, COMPUTER SOFTWARE PROGRAMS (IN BOTH SOURCE CODE AND OBJECT CODE
FORM), integrated circuit topographies and other intangible property that are
used in the business of MGI as currently conducted by MGI (the "MGI
INTELLECTUAL PROPERTY RIGHTS"). The MGI Disclosure Schedule sets forth MGI
Intellectual Property Rights consisting of a list of registrations and
applications for trade-marks, trade-names, copyrights and patents specifying
as to each, as applicable: (i) the nature of such rights; (ii) the owner of
such rights; and (iii) the jurisdictions by or in which such right has been
issued or registered or in which an application for such issuance or
registration has been filed, including the respective registration or
application numbers. MGI has received valid executed assignments for each of
the inventions disclosed in the patent and patent applications owned by MGI
listed in the MGI Disclosure Schedule from the inventors of the inventions
claimed in such patents and has properly recorded the assignments for each of
MGI's patents and patent applications in the appropriate patents office.
(b) The MGI Disclosure Schedule lists: (i) all licenses, sublicenses
and other agreements as to which MGI is a party and pursuant to which any
other person is authorised to use any MGI Intellectual Property Right; and
(ii) all licenses, sublicenses and other agreements as to which MGI is a
party and pursuant to which MGI is authorised to use any patent, trade-mark
or copyright (including copyright in software) owned by a third party which
are incorporated in, are, or form a part of or are bundled with any MGI
product (the "MGI THIRD PARTY INTELLECTUAL PROPERTY RIGHTS") or any trade
secret of a third party in or as to any MGI product, including the identity
of all parties to such licenses, sublicenses and other agreements.
(c) MGI is not, nor will it be as a result of the execution and
delivery of this Agreement or the performance of its obligations hereunder,
in breach or violation of any MATERIAL terms of any license, sublicense or
agreement disclosed in the MGI Disclosure Schedule. No claims with respect
to MGI Intellectual Property Rights, or MGI Third Party Intellectual Property
Rights (to the extent arising out of any use, reproduction or distribution of
such MGI Third Party Intellectual Rights by or through MGI), have been
asserted or threatened in writing by any person against MGI. To the
knowledge of MGI, there are no valid grounds for any BONA FIDE claims (i) to
the effect that the manufacture, sale, licensing or use of any product as now
used, sold or licensed or proposed for use, sale or license by MGI infringes
on any copyright, patent, trade-mark or trade secret owned by a third party;
(ii) that the use by MGI of any MGI Intellectual Property Rights infringes,
violates or misappropriates any intellectual property right of any other
party; (iii) challenging the ownership or validity of any MGI Intellectual
Property Right listed in the MGI Disclosure Schedule; or (iv) challenging
MGI's license or right to use, or the validity of MGI Third Party
Intellectual Rights.
MGI (i) has not been sued or charged in writing as a defendant in any claim,
suit, action or proceeding
<PAGE>
which involves a claim of infringement of any patents, trade-marks or
copyrights or violation of any trade secret or other proprietary right of any
third party and MGI has no knowledge of any basis for any such suit or
charge; and (ii) has not been threatened or charged in writing with
infringement or violation of any patents, trade-marks, copyrights or trade
secrets or other proprietary right of any third party and MGI has no
knowledge of any basis for any such threat or claim.
(d) All patent applications held by MGI are pending in their respective
patent office, and to the knowledge of MGI, there are no defects in the
prosecution of any such application resulting from the negligent acts or
omissions of MGI's patent agents that would irrevocably foreclose the grant
of patent rights under such application. To the knowledge of MGI, there is
no unauthorized use, disclosure, infringement or misappropriation of any of
the MGI Intellectual Property Rights or any MGI Third Party Intellectual
Property Right by any third party including any employee or consultant
outside the course of their respective employment or consultant duties or
former employee or consultant of MGI.
(e) No MGI Intellectual Property Right or MGI Third Party Intellectual
Property Right is subject to any outstanding order, judgment, lien decree or
governmental or judicial stipulation restricting in any manner the licensing
thereof by MGI. MGI has not entered into any agreement other than the
licenses, sublicenses and agreements disclosed in the MGI Disclosure Schedule
to indemnify any other person against any charge of infringement of any MGI
Third Party Intellectual Property Right.
(f) As a matter of corporate policy, MGI HAS TAKEN REASONABLE MEASURES
CONSISTENT WITH INDUSTRY PRACTICE to protect and preserve (i) the validity
and enforceability of trade-marks included in the MGI Intellectual property
Rights, (ii) the validity and enforceability of copyrights included in the
MGI Intellectual Property Rights, (iii) the validity and enforceability of
patents included in the MGI Intellectual Property Rights, and (iv) the
confidentiality and validity and enforceability of its trade secrets and
other confidential information. All current and former employees and
consultants of MGI have executed nondisclosure and assignment of inventions
agreements to protect the confidentiality and to vest in MGI exclusive
ownership of such MGI Intellectual Property Rights. A list of all current
and former employees and consultants of MGI (including such individuals'
employment title), who have signed such agreement(s), is included in the MGI
Disclosure Schedule. To the knowledge of MGI, (i) no trade secret or
confidential information of MGI has been used, divulged or appropriated for
the benefit of any person other than MGI or its permitted licensees or
otherwise to the detriment of MGI, and (ii) no employee or consultant of MGI
has used any trade secrets or other confidential information of any other
person in the course of their work for MGI without such person's consent.
MGI has no written or oral agreements with employees or consultants with
respect to the ownership of inventions, trade secrets or other works created
by them as a result of which any such employee or consultant may have
non-exclusive rights to the portions of MGI's Intellectual Property Rights so
created by such individual.
(g) EXCEPT AS SET FORTH IN THE MGI DISCLOSURE SCHEDULE, NO OFFICER, OR
TO the knowledge of MGI, no employee or consultant of MGI is in violation of
any term of any employment contract, patent disclosure agreement, proprietary
information agreement, noncompetition agreement, nonsolicitation agreement,
confidentiality agreement, or any other similar contract or agreement or any
restrictive covenant relating to the right of any such officer, employee or
consultant to be employed or engaged by MGI because of the nature of the
business conducted or to be conducted by MGI or relating to the use of trade
secrets or proprietary information of others and the continued employment or
retention of its officers, employees or consultants does not subject MGI to
any liability with respect to any of the foregoing matters.
3.12 AGREEMENTS, CONTRACTS AND COMMITMENTS
<PAGE>
MGI has not breached, or received in writing any claim or threat that it
has breached, any of the terms or conditions of any agreement, contract or
commitment (the "MGI CONTRACTS") in such a manner as would permit any other
parties to cancel or terminate the same or would permit any other party to
seek damages which would have, in the aggregate, a Material Adverse Effect on
MGI. Each MGI Contract that has not expired or been terminated is in full
force and effect and to the knowledge of MGI is not subject to any default by
any party obligated to MGI pursuant to the MGI Contracts. Except as set
forth in the MGI Disclosure Schedule, neither the execution and delivery of
this Agreement nor the consummation of the transactions contemplated hereby
will (i) result in any payment (including, without limitation, severance,
unemployment compensation, golden parachute, bonus or otherwise) becoming due
to any director or employee of MGI or any of its subsidiaries, (ii) increase
any benefits otherwise payable by MGI, or (iii) result in the acceleration of
the time of payment or vesting of any such benefits.
3.13 LITIGATION
Except as set forth in the MGI Disclosure Schedule, there is no action,
suit or proceeding, claim, arbitration or investigation against MGI or any of
its properties or officers or directors pending or threatened which would
have a Material Adverse Effect on MGI or the consummation of this Agreement.
There is no judgement, decree or order against MGI or any of its directors or
officers, that could be expected to prevent, enjoin, alter or delay any of
the transactions contemplated by this Agreement. The foregoing sentences
include, without limiting their generality, actions pending or threatened (or
any basis therefor) involving the prior employment or engagement of any of
MGI's officers or employees or their use in connection with MGI's business of
any information or techniques proprietary to any of their former employers or
to any other person.
3.14 ENVIRONMENTAL MATTERS
As of the date hereof, MGI has not received notice of any event,
condition, circumstance, activity, practice, incident, action or plan which
is likely to interfere with or prevent continued compliance with or which
would give rise to any common law or statutory liability, or otherwise form
the basis of any claim, action, suit or proceeding, based on or resulting
from MGI's (or any of its agent's) manufacture, processing, distribution,
use, treatment, storage, disposal, spill, leakage, burial, spray, transport
or handling, or the emission, discharge or release into the environment, of
any pollutant, contaminant or hazardous or toxic material or waste.
3.15 EMPLOYEE BENEFIT PLANS
Except as set forth in the MGI Disclosure Schedule, (i) there are no
pension, retirement, supplemental pensions, profit sharing, incentive
compensation, bonus, savings, deferred compensation, stock option, purchase,
or appreciation, health, life insurance, disability, sick pay, severance pay,
group insurance or other material employee benefit plans, programs or
arrangements maintained or contributed to by MGI (each such plan, program or
arrangement, a "PLAN"), (ii) there are no outstanding violations or defaults
thereunder nor to the knowledge of MGI, any actions, claims, or other
proceedings pending or threatened with respect to the Plans, (iii) no Plan is
currently under a governmental investigation or audit and no such
investigation or audit is contemplated or under consideration, (iv) each Plan
covers only current or former employees of MGI and their dependents or
beneficiaries, (v) no promise or commitment to increase benefits under any
Plan or to adopt any additional Plan has been made except as required by law,
(vi) no event has occurred which could subject any person or fund to any tax,
penalty or fiduciary liability in connection with any Plan, (vii) there have
been no withdrawals of surplus or contributions holidays, except as permitted
by law and the terms of the Plans and (viii) each such Plan
<PAGE>
has been operated and administered in all material respects in compliance
with all applicable laws. None of the Plans are subject to the United States
EMPLOYEE RETIREMENT INCOME SECURITY ACT OF 1974, as amended ("ERISA"). Each
Plan is fully funded on a going concern basis and has no unfunded liabilities
or experience deficiencies, except as would not have a Material Adverse
Effect.
3.16 LABOUR MATTERS
Except as disclosed in the MGI Disclosure Schedule, MGI is in compliance
in all respects with all currently applicable laws and regulations respecting
employment, discrimination in employment, terms and conditions of employment,
wages, hours and occupational safety and health and employment practices, and
are not engaged in any unfair labour practice. There are no pending claims
against MGI under any workers compensation plan or policy or for long term
disability. There are no controversies, claims or investigations pending or
threatened, between MGI and any of its employees; MGI is not a party to any
collective bargaining agreement or other labour union contract applicable to
persons employed by MGI nor does MGI know of any activities or proceedings of
any labour union to organize any such employees; and there are no strikes,
slowdowns, work stoppages, lockouts, or threats thereof, by or with respect
to any employees of MGI. MGI is not a party to any written or oral
agreement providing for severance or termination payments to any director or
officer or member of senior management as a result of the transactions
contemplated by this Agreement or any employment agreement with any of its
directors or officers or member of senior management. To the knowledge of
MGI as of the date hereof, no officer, member of senior management, key
employee, or significant group of employees plans to terminate employment
with MGI during the next 12 months.
3.17 COMPLIANCE WITH LAWS
MGI has not received any written notices of violation with respect to
and, to its knowledge, has complied with, and is not knowingly in violation
of, any federal, provincial or local statute, law or regulation with respect
to the conduct of its business, or the ownership or operation of its
business, where any such violations could have, in the aggregate, a Material
Adverse Effect on MGI.
3.18 INSURANCE
MGI has policies of insurance and bonds of the type and in amounts
customarily carried by persons conducting businesses or owning assets similar
to those of MGI. There is no claim pending under any of such policies or
bonds as to which coverage has been questioned, denied or disputed by the
underwriters of such policies or bonds. All premiums due and payable under
all such policies and bonds have been paid and MGI is otherwise in compliance
in all respects with the terms of such policies and bonds. There is no
threatened termination of, or premium increase with respect to, any of such
policies.
3.19 POOLING OF INTERESTS
Neither MGI nor, to the knowledge of MGI, any of its Affiliates has,
through the date of this Agreement, taken or agreed to take any action which
would prevent Discreet from accounting for the business combination to be
effected by the Arrangement upon the terms and conditions of the Arrangement
as a pooling of interests under U.S. GAAP.
<PAGE>
3.20 CIRCULAR
The information supplied by MGI for inclusion in the Circular to be sent
to the MGI Shareholders in connection with the Special Meeting to consider
the Arrangement shall not, on the date the Circular is first mailed to MGI
Shareholders, at the time of the Special Meeting and at the Effective Time,
contain any statement concerning MGI which, at such time and in light of the
circumstances under which it shall be made, is false or misleading with
respect to any material fact concerning MGI, or omit to state any material
fact concerning MGI necessary in order to make the statements made in the
Circular not false or misleading; or omit to state any material fact
necessary to correct any statement in any earlier communication with respect
to the solicitation of proxies for the Special Meeting which has become false
or misleading. If at any time prior to the Effective Time any event relating
to MGI or any of its Affiliates, officers or directors should be discovered
by MGI which should be set forth in a supplement to the Circular, MGI shall
promptly inform Discreet. Notwithstanding the foregoing, MGI makes no
representation, warranty or covenant with respect to any information supplied
by Discreet or Subco which is contained in any of the foregoing documents.
3.21 NO EXISTING DISCUSSIONS
Except as disclosed in the MGI Disclosure Schedule, as of the date
hereof, MGI is not engaged, directly or indirectly, in any discussions or
negotiations with any other party with respect to an Alternative Proposal nor
has it any knowledge of any Alternative Proposal forthcoming.
3.22 OPINION OF FINANCIAL ADVISOR
The financial advisor of MGI, First Marathon Securities Limited, has
delivered an opinion to MGI to the effect that the Exchange Ratio is fair
from a financial point of view to the MGI Shareholders.
3.23 VOTE REQUIRED
There is no requirement contained in MGI's constating documents or other
agreements binding on MGI which would require any approval of any holders of
MGI securities to approve the Arrangement other than the affirmative vote of
the holders of not less than two-thirds of the votes cast by holders of MGI
Common Shares entitled to vote at the Special Meeting.
3.24 BOARD APPROVAL
The Board of Directors of MGI has, prior to the execution hereof, (i)
approved this Agreement and the Arrangement, (ii) determined that the
Arrangement is in the best interests of the MGI Shareholders and is on terms
that are fair to the MGI Shareholders and (iii) determined to recommend that
the MGI Shareholders approve this Agreement and consummation of the
Arrangement, subject to the terms of Sections 6.2 and 7.4, and no member of
the Board of Directors has opposed this Agreement or the Arrangement.
3.25 BROKERAGE
There are no claims for brokerage commissions, finders' fees or similar
compensation in connection with the transactions contemplated herein based on
any arrangement or agreement made by or on behalf of MGI.
<PAGE>
3.26 REPRESENTATIONS COMPLETE
None of the representations or warranties made by MGI herein or in any
Schedule hereto, including the MGI Disclosure Schedule, or certificate
furnished by MGI pursuant to this Agreement, or the Securities Reports, when
all such documents are read together in their entirety, contains any untrue
statement of a material fact relating to MGI, or omits to state any material
fact relating to MGI necessary in order to make the statements relating to
MGI contained herein or therein, in the light of the circumstances under
which made, not misleading.
ARTICLE 4
REPRESENTATIONS AND WARRANTIES OF DISCREET
Discreet represents and warrants as follows:
4.1 ORGANIZATION AND QUALIFICATION OF DISCREET
Each of Discreet and its subsidiaries is a corporation duly
incorporated, organized, validly existing and in good standing under the laws
of the jurisdiction of its incorporation, has all requisite corporate power
and authority to own, lease and operate its property and to carry on its
business as now being conducted and is duly qualified to do business and is
in good standing as a foreign corporation in each jurisdiction in which the
failure to be so qualified would have a Material Adverse Effect. Discreet
has delivered a true and correct copy of the Articles of Incorporation, as
amended, and by-laws, as amended, or other charter documents, as applicable
of Discreet, to MGI. Neither Discreet nor, to the knowledge of Discreet ,
any of its subsidiaries is in violation of any of the provisions of its
Articles of Incorporation, by-laws or equivalent organisational documents.
Except as set forth in the Discreet SEC Reports or the Discreet Disclosure
Schedule, neither Discreet nor any of its subsidiaries directly or indirectly
owns any equity or similar interest in, or any interest convertible into or
exchangeable or exercisable for, any corporation, partnership, joint venture
or other business association or entity, excluding securities in any publicly
traded company held for investment by Discreet and comprising less than five
percent (5%) of the outstanding shares of such company.
4.2 CAPITAL STRUCTURE OF DISCREET
(a) The authorized share capital of Discreet consists of an unlimited
number of Discreet Common Shares and an unlimited number of Discreet
Preferred Shares. As of March 4, 1998, (i) 29,544,261 Discreet Common Shares
were issued and outstanding, all of which were issued as fully paid and
non-assessable, (ii) 5,086,303 Discreet Common Shares were reserved for
future issuance pursuant to options granted and outstanding under the
Discreet Stock Option Plan, and (iii) 80,000 Discreet Common Shares were
reserved for future issuance pursuant to options granted and outstanding
under the Discreet Director Option Plans. As of the date of this Agreement,
no Discreet Preferred Shares were issued and outstanding. Except as disclosed
in the Discreet Disclosure Schedule, all Discreet Common Shares subject to
issuance as specified above, upon issuance on the terms and conditions
specified in the instruments pursuant to which they are issuable, shall be
validly issued as fully paid and non-assessable. Except as disclosed in the
Discreet Disclosure Schedule, there are no obligations, contingent or
otherwise, of Discreet or any of its subsidiaries to repurchase, redeem or
otherwise acquire any shares or the capital stock of any subsidiary or to
provide funds to or make any investment (in the form of a loan, capital
contribution or otherwise) in any such subsidiary or any other entity other
than guarantees of bank obligations or office leases of subsidiaries entered
into in the ordinary course of business. All of the
<PAGE>
outstanding shares in the share capital of each of Discreet's subsidiaries
have been validly issued as fully paid and non-assessable and all such shares
(other than directors' qualifying shares) are owned by Discreet or another
subsidiary free and clear of all Liens or limitations in Discreet's voting
rights, charges or other encumbrances of any nature.
(b) Except as set forth in this Section 4.2 or as reserved for future
grants of options under the Discreet Stock Option Plan or Discreet Director
Option Plans, there are no equity securities of any class of Discreet or any
of its subsidiaries, or any security exchangeable into or exercisable for
such equity securities, issued, reserved for issuance or outstanding. Except
as set forth in this Section 4.2 or in the Discreet Disclosure Schedule,
there are no options, warrants, equity securities, calls, rights, commitments
or agreements of any nature to which Discreet or any of its subsidiaries is a
party or by which it is bound, obligating Discreet or any of its subsidiaries
to issue, or sell, or cause to be issued, or sold, additional shares in the
share capital of Discreet or any of its subsidiaries or obligating Discreet
or any of its subsidiaries to grant, extend, accelerate the vesting of or
enter into any such option, warrant, equity security, call, right, commitment
or agreement. To the knowledge of Discreet, there are no voting trusts,
proxies or, except as set forth in the Discreet Disclosure Schedule, other
agreements or understandings with respect to the shares of the share capital
of Discreet.
(c) All the Discreet Common Shares to be issued in connection with the
Arrangement have been duly authorized by all necessary corporate action and
will be, when issued in accordance with this Agreement, duly authorized and
validly issued as fully paid and non-assessable.
4.3 AUTHORITY; NO CONFLICT; REQUIRED FILINGS AND CONSENTS
(a) Discreet has all requisite corporate power and authority to enter
into this Agreement and to consummate the transactions contemplated by this
Agreement. The execution and delivery of this Agreement and the consummation
of the transactions contemplated by this Agreement have been duly authorized
by all necessary corporate action on the part of Discreet. This Agreement
has been duly authorized, executed and delivered by Discreet and constitutes
a valid and binding obligation of Discreet, enforceable against it in
accordance with its terms, subject, however, to limitations with respect to
enforcement imposed by law in connection with bankruptcy or similar
proceedings, the equitable power of the courts to stay proceedings before
them and the execution of judgements and to the extent that equitable
remedies such as specific performance and injunction are in the discretion of
the court from which they are sought.
(b) The execution and delivery of this Agreement by Discreet does not,
and the consummation of the transactions contemplated by this Agreement will
not, (i) conflict with, or result in any violation or breach of, any
provision of the Articles of incorporation, as amended, or by-laws of
Discreet, (ii) except as set forth in the Discreet Disclosure Schedule,
result in any violation or breach of, or constitute (with or without notice
or lapse of time, or both) a default (or give rise to a right of termination,
cancellation or acceleration of any obligation or loss of any material
benefit) under any of the terms, conditions or provisions of any note, bond,
mortgage, indenture, lease, contract or other agreement, instrument or
obligation to which Discreet or any of its subsidiaries is a party or by
which any of them or any of their properties or assets may be bound, or (iii)
conflict or violate any permit, concession, franchise, license, judgement,
order, decree, statute, law, ordinance, rule or regulation applicable to
Discreet or any of its subsidiaries or any of its or their properties or
assets, except in the case of Subsections 4.3(b)(ii) and 4.3(b)(iii) for any
such conflicts, violations, defaults, terminations, cancellations or
accelerations which, the aggregate, would not have a Material Adverse Effect
on Discreet.
<PAGE>
(c) No consent, approval, order or authorization of, or registration,
declaration or filing with, any Governmental Entity, is required by or with
respect to Discreet or any of its subsidiaries in connection with the
execution and delivery of this Agreement or the consummation of the
transactions contemplated hereby, except for (i) the filing of Articles of
Arrangement with the Ministry of Consumer and Commercial Relations (Ontario),
(ii) such consents, approvals, orders, authorizations, registrations,
declarations and filings as may be required under applicable Securities
Legislation, including the Interim Order and the Final Order, (iii) such
filings as may be required under the CA, the HSR and other legislation of a
similar nature, (iv) such filings as may be required under the INVESTMENT
CANADA ACT, and (v) such other consents, authorizations, filings, approvals
and registrations which, if not obtained or made, would not have a Material
Adverse Effect on Discreet.
4.4 SEC FILINGS
Discreet has filed and made available to MGI all Discreet SEC Reports.
The Discreet SEC Reports (i) at the time filed, complied in all material
respects with the applicable requirements of the U.S Securities Act and the
U.S. Exchange Act, as the case may be, and (ii) did not at the time they were
filed (or if amended or superseded by a filing prior to the date of this
Agreement, then on the date of such filing) contain any untrue statement of a
material fact or omit to state a material fact required to be stated in such
Discreet SEC Reports or necessary in order to make the statements in such
Discreet SEC Reports, in the light of the circumstances under which they were
made, not misleading. Except as set forth in the Discreet Disclosure
Schedule, all documents required to be filed as exhibits to the Discreet SEC
Reports have been so filed, except those which have expired or been
terminated in accordance with their terms. None of Discreet's subsidiaries is
required to file any forms, reports or other documents with the SEC.
4.5 FINANCIAL STATEMENTS
Each of the consolidated financial statements (including, in each case,
any related notes) contained in the Discreet SEC Reports, including SEC
Reports filed after the date of this Agreement until the Effective Time,
complied as to form in all material respects with the applicable published
rules and regulations of the SEC with respect thereto, was prepared in
accordance with U.S. GAAP as in effect on the applicable dates of such
financial statements applied on a consistent basis throughout the periods
involved (except as noted therein and except the case of unaudited financial
statements, as permitted by Form 10-Q of the SEC) and fairly presented the
consolidated results of its operations and cash flows for the periods
indicated, except that the unaudited interim financial statements were or are
subject to normal and recurring year-end adjustments which were not or are
not expected to be material in amount. The unaudited balance sheet of
Discreet as of December 31, 1997 is referred to herein as the "DISCREET
BALANCE SHEET".
4.6 NO UNDISCLOSED LIABILITIES
Except as disclosed in the Discreet SEC Reports, to the knowledge of
Discreet, Discreet does not have any liabilities, either accrued or
contingent (whether or not required to be reflected in financial statements
in accordance with U.S. GAAP), and whether due or to become due, other than
(i) liabilities reflected in the balance sheet forming part of the Financial
Statements of Discreet, (ii) liabilities specifically described in this
Agreement and (iii) normal or recurring liabilities incurred since June 30,
1997 in the ordinary course of business consistent with past practices;
except in each case for any such liability which would not have a Material
Adverse Effect on Discreet.
4.7 ABSENCE OF CERTAIN CHANGES OR EVENTS
<PAGE>
Except as disclosed in the Discreet SEC Reports, since the date of the
balance sheet forming part of the Financial Statements of Discreet, Discreet
has conducted its business only in the ordinary course and in a manner
consistent with past practice and, since such date, there has not been (i)
any change in the affairs or financial condition of Discreet which has had a
Material Adverse Effect; (ii) any change by Discreet in its accounting
methods, principles or practices; or (iii) any revaluation by Discreet of any
of its assets, including, without limitation, writing down the value of
capitalized software or inventory or writing off notes or accounts receivable
other than in the ordinary course of business.
4.8 TAX MATTERS
Discreet and each of its subsidiaries have filed all material tax
returns required to be filed with respect to any Taxes, which returns are
true and correct in all material respects, and neither Discreet nor any of
its subsidiaries is in default in the payment of any material amount of
Taxes, including penalties and interest, assessments, fees and other charges,
shown thereon due or otherwise assessed, other than those being contested in
good faith and for which adequate reserves have been provided or those
currently payable without interest which were payable pursuant to said
returns or any assessments with respect thereto. The provisions for Taxes in
the audited and unaudited financial statements included in the Discreet SEC
Reports have been determined in accordance with U.S. GAAP.
4.9 INTELLECTUAL PROPERTY
(a) To the knowledge of Discreet, Discreet has the right to use all
patents, trade-marks, trade secrets, trade-names, copyrights and any
applications therefor, integrated circuit topographies and other intangible
property ("INTELLECTUAL PROPERTY") that are used in the business as currently
conducted by Discreet (the "Discreet Intellectual Property Rights"), except
where any deficiency therein would not have, in the aggregate, a Material
Adverse Effect.
(b) Discreet is not currently subject to any exclusive licenses (whether
such exclusivity is temporary or permanent) to any material portion of the
Discreet Intellectual Property Rights. To the knowledge of Discreet, there are
no outstanding licenses or agreements of any kind relating to any Discreet
Intellectual Property Rights except for agreements with OEM's and other
customers of Discreet entered into in the ordinary course of its business.
Discreet is not obligated to pay any royalties or other payments to third
parties with respect to the marketing, sale, distribution, manufacture, license
or use of any Discreet Intellectual Property Rights, except as Discreet may be
so obligated in the ordinary course of its business or as disclosed in the
Discreet SEC Reports or where the failure to make such payments would not have,
in the aggregate, a Material Adverse Effect.
(c) To the knowledge of Discreet, Discreet has not violated or infringed
and is not currently violating or infringing, and has not received any
communications alleging that Discreet (or any of its subsidiaries, employees or
consultants) has violated or infringed, any Intellectual Property of any other
person or entity, to the extent that any such violation or infringement, either
individually or together with all other such violations and infringements, would
have a Material Adverse Effect.
(d) To the knowledge of Discreet, no employee of or consultant to Discreet
is in default under any term of any employment contract, agreement or
arrangement relating to the Discreet Intellectual Property Rights or any
non-competition arrangement, other contract, or any restrictive covenant
relating to the Discreet Intellectual Property Rights, which default would have
a Material Adverse Effect.
<PAGE>
4.10 LITIGATION
Except as set forth in the Discreet SEC Reports, there is no action,
suit or proceeding, claim, arbitration or investigation against Discreet or
any of its subsidiaries or any of their respective properties or officers or
directors pending or threatened which would have a Material Adverse Effect on
Discreet. There is no judgement, decree or order against Discreet or any of
its directors or officers, that could be expected to prevent, enjoin, alter
or delay any of the transactions contemplated by this Agreement. The
foregoing sentences include, without limiting their generality, actions
pending or threatened (or any basis therefor) involving the prior employment
or engagement of any of Discreet's officers or employees or their use in
connection with Discreet's business of any information or techniques
proprietary to any of their former employers or to any other person.
4.11 ENVIRONMENTAL MATTERS
As of the date hereof, Discreet has not received notice of any event,
condition, circumstance, activity, practice, incident, action or plan which
is likely to interfere with or prevent continued compliance with or which
would give rise to any common law or statutory liability, or otherwise form
the basis of any claim, action, suit or proceeding, based on or resulting
from Discreet's or any of its subsidiary's (or any of their respective
agent's) manufacture, processing, distribution, use, treatment, storage,
disposal, spill, leakage, burial, spray, transport or handling, or the
emission, discharge or release into the environment, of any pollutant,
contaminant or hazardous or toxic material or waste.
4.12 EMPLOYEE BENEFIT PLANS
Discreet does not have any pension, retirement or supplemental pension
plans.
4.13 COMPLIANCE WITH LAWS
Discreet has not received any written notices of violation with respect
to and, to its knowledge, has complied with, and is not knowingly in
violation of, any federal, provincial or local statute, law or regulation
with respect to the conduct of its business, or the ownership or operation of
its business, where any such violations could have, in the aggregate, a
Material Adverse Effect on Discreet.
4.14 CIRCULAR
The information supplied by Discreet for inclusion in the Circular to be
sent to the MGI Shareholders in connection with the Special Meeting to
consider the Arrangement shall not, on the date the Circular is first mailed
to MGI Shareholders, at the time of the Special Meeting and at the Effective
Time, contain any statement concerning Discreet which, at such time and in
light of the circumstances
<PAGE>
under which it shall be made, is false or misleading with respect to any
material fact concerning Discreet, or omit to state any material fact
concerning Discreet necessary in order to make the statements made in the
Circular not false or misleading; or omit to state any material fact
concerning Discreet necessary to correct any statement in any earlier
communication with respect to the solicitation of proxies for the Special
Meeting which has become false or misleading. If at any time prior to the
Effective Time any event relating to Discreet or any of its Affiliates,
officers or directors should be discovered by Discreet which should be set
forth in a supplement to the Circular, Discreet shall promptly inform MGI.
Notwithstanding the foregoing, Discreet makes no representation, warranty or
covenant with respect to any information supplied by MGI which is contained
in any of the foregoing documents.
4.15 INTERIM OPERATIONS OF SUBCO
Subco was formed solely for the purpose of engaging in the transactions
contemplated by this Agreement, has engaged in no other business activities
and has conducted its operations only as contemplated by this Agreement.
4.16 BOARD APPROVAL
The Boards of Directors of Discreet and Subco have unanimously, and the
sole shareholder of Subco has, approved this Agreement and the Arrangement.
No vote of the Shareholders of Discreet is necessary to approve this
Agreement or the Arrangement.
4.17 REPRESENTATIONS COMPLETE
None of the representations or warranties made by Discreet or Subco
herein or in any Schedule hereto, including the Discreet Disclosure Schedule,
or certificate furnished by Discreet or Subco pursuant to this Agreement, or
the Discreet SEC Reports, when all such documents are read together in their
entirety, contains or will contain at the Effective Time any untrue statement
of a material fact concerning Discreet, or omits or will omit at the
Effective Time to state any material fact concerning Discreet necessary in
order to make the statements concerning Discreet contained herein or therein,
in the light of the circumstances under which made, not misleading.
ARTICLE 5
REPRESENTATIONS AND WARRANTIES OF SUBCO
Subco represents and warrants to and in favour of MGI as follows:
5.1 Subco is a corporation duly incorporated and validly existing under the
OBCA;
(a) Subco has the corporate power and authority to enter into this
Agreement and, subject to obtaining the requisite approvals
contemplated hereby, to perform its obligations hereunder;
(b) the execution and delivery of this Agreement by Subco and the
completion of the transactions contemplated herein:
(i) do not and will not result in the breach of, or violate any term
or provision of, the articles or by-laws of Subco; and
<PAGE>
(ii) do not and will not as of the Effective Date violate any
provision of law or administrative regulation or any judicial or
administrative award, judgment or decree applicable and known to
Subco, after due inquiry;
(c) the execution and delivery of this Agreement and the completion of the
transactions contemplated herein have been duly approved by the board
of directors of Subco and this Agreement has been duly executed and
delivered by Subco and constitutes a valid and binding obligation of
Subco enforceable against it in accordance with its terms, subject,
however, to limitations with respect to enforcement imposed by law in
connection with bankruptcy or similar proceedings, the equitable power
of the courts to stay proceedings before them and the execution of
judgements and to the extent that equitable remedies such as specific
performance and injunction are in the discretion of the court from
which they are sought;
(d) Subco has not engaged in any business nor is it a party to or bound by
any contract, agreement, arrangement, instrument, licence, permit or
authority, other than this Agreement and any transaction or agreement
necessary or incidental to the fulfilment of its obligations under
this Agreement, nor does it have any liabilities, contingent or
otherwise, except as provided in or permitted by the foregoing;
(e) the authorized capital of Subco consists of an unlimited number of
Subco common shares, of which 100 Subco common shares are currently
issued and outstanding (all of which are held by Discreet); and
(f) no individual, firm, corporation or other person holds any securities
convertible or exchangeable into any shares of Subco or has any
agreement, warrant or option or any right capable of becoming an
agreement, warrant or option for the purchase of any unissued shares
of Subco except as contemplated by this Agreement.
ARTICLE 6
COVENANTS
6.1 COVENANTS OF MGI
During the period from the date of this Agreement and continuing until
the earlier of the termination of this Agreement or the Effective Time, MGI
agrees (except to the extent that Discreet shall otherwise consent in
writing), to carry on its business in the ordinary course in substantially
the same manner as previously conducted, to pay its debts and Taxes when due
subject to good faith disputes over such debts or Taxes, to pay or perform
other obligations when due and, to use all commercially reasonable efforts
consistent with past practices and policies to preserve intact its present
business organization, keep available the service of its present officers and
key employees and preserve its relationships with customers, suppliers,
distributors, licensors, licensees, and others having business dealings with
it to the end that its goodwill and ongoing business shall be unimpaired at
the Effective Time. MGI agrees to promptly notify Discreet of any event or
occurrence not in the ordinary course of its business and of any event which
could have a Material Adverse Effect on MGI. Without limiting the foregoing,
except as expressly contemplated by this Agreement, MGI shall not, without
the prior written consent of Discreet, not to be unreasonably withheld:
(a) Accelerate, amend or change the period of exercisability or vesting
of options or other
<PAGE>
rights granted under any employee stock plan or authorize cash payments
in exchange for any options granted under any of such plans;
(b) Transfer or license to any person or entity or otherwise extend,
amend or modify any rights to the MGI Intellectual Property Rights, other
than in the ordinary course of business consistent with past practices;
(c) Declare or pay any dividends on or make any other distributions
(whether in cash, share or property) in respect of any of its share capital,
or split, combine or reclassify any of its share capital or issue or
authorize the issuance of any other securities in respect of, in lieu of, or
in substitution for shares of its share capital, or purchase or otherwise
acquire, directly or indirectly, any shares of its share capital except for
the repurchase of shares from terminated employees in accordance with
agreements providing for the repurchase of shares in connection with any
termination of services to it;
(d) Except as set forth in the MGI Disclosure Schedule, issue, deliver
or sell or authorize or propose the issuance, delivery or sale of, or
purchase or propose the purchase of, any shares of its share capital or
securities convertible into shares of its share capital, or subscriptions,
rights, warrants or options to acquire, or other agreements or commitments of
any character obligating it to issue any such shares or other convertible
securities, other than issuances of MGI Common Shares pursuant to the
exercise of stock options, warrants or other rights therefor outstanding as
of the date of this Agreement and other than issuances under the MGI Stock
Option Plan in the ordinary course of business consistent with past practice;
(e) Acquire or agree to acquire by amalgamating or consolidating with,
or by purchasing a substantial portion of the assets of, or by any other
manner, any business or any corporation, partnership, association or other
business organization or division, or otherwise acquire or agree to acquire
any assets which are material, individually or in the aggregate, to its
business, taken as a whole, or acquire or agree to acquire any equity
securities of any corporation, partnership, association or business
organization;
(f) Sell, lease, license or otherwise dispose or encumber of any of its
properties or assets which are material, individually or in the aggregate, to
its business, except in the ordinary course of business consistent with past
practice;
(g) (i) Increase or agree to increase the compensation payable or to
become payable to its officers or employees, except for increases in salary
or wages of employees other than officers of MGI in the ordinary course of
business consistent with past practice, (ii) increase or agree to increase
the compensation payable or to become payable to officers of MGI or grant any
additional severance or termination pay to, or enter into any employment or
severance agreements with, such officers, (iii) grant any severance or
termination pay to, or enter into any employment or severance agreement, with
any employee, except in accordance with past practice, (iv) hire any new
officer level employee, (v) enter into any collective bargaining agreement,
or (vi) establish, adopt, enter into or amend any bonus, profit sharing,
thrift, compensation, stock option, restricted share, pension, retirement,
deferred compensation, employment, termination, severance insurance
(including any self-insured or post-retirement arrangements), disability,
vacation, profit sharing or other plan, trust, fund, policy or arrangement
for the benefit of any directors, officers or employees, other than proposed
plans described in the MGI Disclosure Schedule and except as may be required
by applicable law. For the purposes of this Section 6.1(g), the term officer
shall mean only those persons identified as officers of MGI in MGI's
prospectus dated December 8, 1997 and filed with the Ontario Securities
Commission;
(h) Revalue any of its assets, including writing down the value of
capitalized software or
<PAGE>
inventory or writing off notes or accounts receivable other than in the
ordinary course of business consistent with past practice;
(i) Incur any indebtedness for borrowed money or guarantee any such
indebtedness or issue or sell any debt securities or warrants or rights to
acquire any debt securities of it or guarantee any debt securities of others,
other than indebtedness incurred in the ordinary course of business
consistent with past practice;
(j) Amend or propose to amend its Articles of Amalgamation or by-laws;
(k) Enter into any contract or commitment, or amend or otherwise modify
or waive any of the terms of any of its contracts, other than in the ordinary
course of business consistent with past practice and in excess of $100,000;
(l) Enter into or amend any agreements pursuant to which any other
party is granted exclusive marketing or other exclusive rights of any type or
scope with respect to any of its products or technology;
(m) Enter into any operating lease other than in the ordinary course of
business consistent with past practice;
(n) Pay, discharge or satisfy in an amount in excess of $25,000 in any
one case or $100,000 in the aggregate, any claim, liability or obligation
(absolute, accrued, asserted or unasserted, contingent or otherwise) arising
other than (i) in the ordinary course of business consistent with past
practice, other than the payment, discharge or satisfaction of liabilities
reflected or reserved against in the balance sheet forming part of the
Financial Statements and (ii) the payment of the transaction expenses
associated with the transactions contemplated by this Agreement;
(o) Make any capital expenditures, capital additions or capital
improvements except in the ordinary course of business and consistent with
past practice;
(p) Reduce the amount of any insurance coverage provided by existing
insurance policies;
(q) Commence a lawsuit other than (i) for the routine collection of
bills, (ii) in such cases where it in good faith determines that failure to
commence suit would result in the material impairment of a valuable aspect of
its business, provided that it consults with Discreet prior to the filing of
such a suit, or (iii) for a breach of this Agreement or the confidentiality
agreement referred to in Section 7.15;
(r) Make, revoke or change any election in respect of Taxes, adopt or
change any accounting method in respect of Taxes, file any amendment to a Tax
return, settle any claim or assessment in respect of Taxes, or consent to any
extension or waiver of the limitation period applicable to any claim or
assessment in respect of Taxes;
(s) Adopt or change any accounting policies, except for any changes
required by Canadian GAAP; or
(t) Take, or agree in writing or otherwise to take, any action which is
likely to make any of such party's representations or warranties contained in
this Agreement untrue or incorrect in any material respect on the date made
(to the extent so limited) or as of the Effective Time.
<PAGE>
6.2 NO SOLICITATION
From and after the date hereof until the earlier of the Effective Time
or the termination of this Agreement in accordance with Article 11, MGI and
its officers, directors, employees, representatives and agents will not,
directly or indirectly, (i) take any action to solicit, initiate or encourage
any Alternative Proposal, (ii) subject to the terms of the immediately
following sentence, engage in any discussion or negotiations with, or
disclose any non-public information relating to MGI to, or otherwise assist
or facilitate, or enter into any agreement or understanding with, or afford
access to the properties, books or records of MGI to, any person, entity or
group (other than Discreet and its affiliates, agents, and representatives)
that has advised MGI that it may be considering making, or that has made, an
Alternative Proposal or (iii) subject to the terms of the immediately
following sentence, agree to, approve or recommend any Alternative Proposal.
Notwithstanding the immediately preceding sentence, if an unsolicited
Alternative Proposal, or an unsolicited expression of interest to make an
Alternative Proposal, shall be received by the Board of Directors of MGI
prior to the approval of this Agreement by the MGI Shareholders at the
Special Meeting, then, to the extent the Board of Directors of MGI believes
in good faith (after consultation with its financial advisor) that such
Alternative Proposal would constitute a Competing Transaction then MGI and
its officers, directors, employees, investment bankers, financial advisors,
attorneys, accountants and other representatives retained by it may, subject
to Discreet's rights under Article 10, furnish information in connection
therewith and the Board of Directors of MGI shall be entitled to consider,
negotiate, approve, recommend to its shareholders and enter into an agreement
in respect of such Competing Transaction and such actions shall not be
considered a breach of this Section 6.2 or any other provisions of this
Agreement and Discreet shall not be permitted to terminate this Agreement
pursuant to Section 11.1(b) as a result of such actions; provided, that, in
each such event MGI notifies Discreet of such determination by the Board of
Directors of MGI and provides Discreet with a true and complete copy of the
Alternative Proposal document with such deletions as are necessary to protect
confidential information relating to the business of the third party,
provided that material terms or the identity of the person making the
Alternative Proposal may not be deleted, if the Alternative Proposal is in
writing, or a complete written summary on the same basis, if it is not in
writing, and provides Discreet with all documents containing or referring to
non-public information of MGI that are supplied to such third party; provided
further, that (A) the Board of Directors of MGI has determined, with the
advice of MGI's investment bankers, that such third party has demonstrated
that there is reasonable assurance that any required financing will be
obtained and there are no other apparent impediments to such third party
commencing and completing such transaction, (B) MGI may not provide any
non-public information to any such third party if it has not prior to the
date thereof provided (or does not simultaneously with providing such
information to such third party provide) such information to Discreet or
Discreet's representatives, and (C) MGI provides such non-public information
pursuant to a non-disclosure agreement substantially the same as or otherwise
at least as restrictive on such third party as the confidentiality agreement
referred to in Section 7.13 is on Discreet. MGI will notify Discreet
immediately (and no later than 24 hours) after receipt of any Alternative
Proposal or any notice that any person is considering making an Alternative
Proposal or any request for non-public information relating to MGI or for
access to the properties, books or records of MGI by any person that has
advised MGI that it may be considering making, or that has made, an
Alternative Proposal and will keep Discreet fully informed of the status and
non-confidential details of any such Alternative Proposal notice, request or
any correspondence or communications related thereto and shall provide
Discreet with a true and complete copy of such Alternative Proposal notice or
request or correspondence or communications related thereto with such
deletions as are necessary to protect confidential information relating to
the business of the third party, if it is in writing, or a complete written
summary on the same basis, if it is not in writing. MGI shall ensure that
its officers, directors and employees and any investment banker or other
advisor or representative retained by MGI are aware of the restrictions
described in this Section, and MGI shall be responsible for any breach of
this Section
<PAGE>
6.2 by its bankers, advisors and representatives.
6.3 COVENANTS OF DISCREET
During the period from the date of this Agreement and continuing until
the earlier of the termination of this Agreement or the Effective Time,
Discreet agrees as to itself and its subsidiaries (except to the extent that
MGI shall otherwise consent in writing, such consent not to be unreasonably
withheld), to carry on its and its subsidiaries business, taken as a whole,
in the ordinary course in substantially the same manner as previously
conducted and to use commercially reasonable efforts consistent with past
practices and policies to preserve its present business organization except
where the failure to do so would not have a Material Adverse Effect.
Discreet agrees to promptly notify MGI of any event or occurrence not in the
ordinary course of business of its or its subsidiaries business and of any
event which could have a Material Adverse Effect on Discreet. MGI
acknowledges that, in the normal course of their businesses, Discreet and its
subsidiaries, from time to time, acquire and dispose of subsidiaries,
businesses and assets. MGI agrees that unless such acquisition or
disposition would or could result in a Material Adverse Effect on Discreet,
Discreet has no disclosure obligations in this respect or obligation to
obtain the prior consent of MGI.
ARTICLE 7
ADDITIONAL AGREEMENTS
7.1 PREPARATION OF CIRCULAR AND OTHER FILINGS AND SUBMISSIONS
MGI and Discreet shall cooperate and use their reasonable efforts in:
(i) the preparation of the Circular; (ii) the obtention of all licences,
consents, approvals, authorizations and orders of governmental, regulatory
and stock exchange authorities and third parties as are necessary for the
consummation of the transactions contemplated hereby; (iii) taking all such
actions as may reasonably be deemed necessary by Discreet and MGI to
discharge their obligations under the U.S. Securities Act in connection with
the Arrangement and the issuance and resale of Discreet Common Shares under
the U.S. Securities Act to the MGI Shareholders; (iv) the preparation of all
documents and the obtention of all required or necessary exemption orders for
the qualification for distribution and resale in all provinces of Canada
where MGI Shareholders reside of Discreet Common Shares issuable upon the
Arrangement; and (v) the taking of all such actions as may be required under
or pursuant to the OBCA in connection with the Arrangement. MGI and Discreet
shall each furnish to one another, on a timely basis, all such information as
may be required to effectuate the foregoing actions, and each covenants that
no information so furnished by it in writing in connection with such actions
or otherwise in connection with the consummation of the transactions provided
for in the Arrangement will contain any untrue statement of a material fact
or omit to state a material fact required to be stated in order to make any
information so furnished, in light of the circumstances in which they were
made, not misleading. Each of Discreet and MGI will ensure that the
information relating to it which is provided in the Circular will not contain
any "misrepresentation" as such expression is construed under the SECURITIES
ACT (Ontario). Discreet and MGI shall each promptly notify the other if at
any time before or after the Effective Time it becomes aware that the
Circular contains a "misrepresentation" or any untrue statement of a material
fact or omits to state a material fact required to be stated therein or
necessary to make the statements contained therein not misleading in light of
the circumstances under which they were made. In any such event, Discreet and
MGI shall cooperate in the preparation of a supplement or amendment to the
Circular that corrects such misstatement or omission, and shall cause the
same to be distributed to the MGI Common Shareholders and, if required by the
Securities Legislation, filed with the appropriate regulatory
<PAGE>
authority.
7.2 THE ARRANGEMENT
Each of the parties hereto shall, and Discreet shall cause its
subsidiaries to, use all reasonable efforts to satisfy each of the conditions
precedent to be satisfied by it and to take, or cause to be taken, all other
actions and to do, or cause to be done, all other things necessary, proper or
advisable under applicable laws, including the Securities Legislation, to
permit the completion of the Arrangement in accordance with the provisions of
this Agreement and to consummate and make effective all other transactions
contemplated in this Agreement and to cooperate with each other in connection
with the foregoing, including:
(a) without limiting Section 12.5, agreeing to such changes,
modifications or amendments to the Arrangement as any party hereto may
reasonably request, provided any such change, modification or amendment would
not adversely affect any party hereto in the sole opinion of such party
acting reasonably;
(b) using all reasonable efforts to provide notice to, and obtain all
necessary waivers, consents and approvals from other parties to loan
agreements, leases and other contracts to which it or any of its subsidiaries
is a party, and releases of all pledges, guarantees and security interests
made or granted by it, the failure of which to obtain would prevent the
parties hereto from effecting the Arrangement or the other transactions
contemplated hereby or may have a Material Adverse Effect on Discreet and its
subsidiaries taken as a whole or on MGI;
(c) using all reasonable efforts to obtain all necessary consents,
approvals and authorisations as are required to be obtained by it under any
Canadian, United States, provincial, state, municipal, local or foreign law
or regulations, the failure to obtain which would prevent the parties hereto
from effecting the Arrangement and the other transactions contemplated hereby
or may have a Material Adverse Effect on Discreet and its subsidiaries taken
as a whole or on MGI;
(d) using all reasonable efforts to lift or rescind any injunction or
restraining order or other order which may be entered against it, which
injunction or order would prevent the parties hereto from completing the
transactions contemplated hereby;
(e) using all reasonable efforts to effect or cause to be effected all
necessary registrations and filings (including any filings required by the
CA, the HSR Act or equivalent legislation of other foreign jurisdictions or
required to maintain any of MGI's, Discreet's or its subsidiaries' permits in
full force and effect upon completion of the Arrangement) and submissions of
information requested of it by governmental authorities, the failure of which
to obtain would prevent the parties hereto from effecting the transactions
contemplated hereby or would have a Material Adverse Effect on Discreet and
its subsidiaries taken as a whole or on MGI; and
(f) co-operating with each other in connection with any lawsuits or
legal proceedings brought against any party or any affiliate thereof
challenging this Agreement, or the completion of the transactions
contemplated hereby, and keeping each other informed of any material
information that becomes known to them in connection therewith.
Without limiting the generality of the foregoing, each party shall keep
the other party apprised of the steps it has taken or will take in order to
effect the foregoing matters and, where appropriate, provide the other party
with the opportunity to comment on documents, in draft form, which are
necessary in
<PAGE>
connection with such matters.
7.3 NOTIFICATION OF CERTAIN MATTERS
Between the date hereof and the Effective Time, each party shall give
prompt notice in writing to the other parties hereto of (i) any information
that indicates that any of its representations or warranties contained herein
was not true and correct as of the date hereof or will not be true and
correct at and as of the Effective Time with the same force and effect as if
made at and as of the Effective Time (except for changes permitted or
contemplated by this Agreement), (ii) the occurrence of any event that will
result, or has a reasonable prospect of resulting, in the failure of any
condition specified in Article 8 hereof to be satisfied and (iii) any notice
or other communication from any third party alleging that the consent of such
third party is or may be required in connection with the Arrangement and the
other transactions contemplated in this Agreement, or that the Arrangement
and the other transactions contemplated in this Agreement may otherwise
violate the rights of or confer remedies upon such third party.
7.4 SUPPORT OF RESOLUTION TO APPROVE ARRANGEMENT
MGI shall through its Board of Directors recommend that the MGI
Shareholders approve the Arrangement and shall use all reasonable efforts to
secure all such approvals subject in each case to the directors' fiduciary
obligations and Section 6.2.
MGI covenants that it will not withdraw or modify in a manner adverse to
Discreet its approval or recommendation of the Arrangement and shall not
cancel or not call and hold the Special Meeting prior to termination of this
Agreement in any circumstances other than if there shall have occurred or
arisen one or more events or changes that has or would be reasonably likely
to have a Material Adverse Effect on Discreet and its subsidiaries, taken as
a whole, or if any person (other than Discreet or an affiliate of Discreet)
shall have publicly announced an Alternative Proposal or publicly disclosed
an intention to make an Alternative Proposal.
7.5 MGI STOCK OPTIONS
(a) On the Effective Date, MGI's obligations with respect to each
outstanding MGI Stock Option, whether vested or unvested, will be assumed by
Discreet and, on such assumption, the rights to acquire MGI Common Shares
under the MGI Stock Option Plan shall become rights to acquire Discreet
Common Shares. Each MGI Stock Option so assumed by Discreet under this
Agreement shall continue to have, and be subject to, the same terms and
conditions set forth in the MGI Stock Option Plan and agreement pursuant to
which such MGI Stock Option was issued as in effect immediately prior to the
Effective Date, except that (i) such MGI Stock Option will be deemed to
constitute an option to purchase that number of Discreet Common Shares equal
to the product of the number of MGI Common Shares that the holder of such
option would have been entitled to receive had such holder exercised such
option immediately prior to the Effective Date (not taking into account
whether such option was in fact exercisable) multiplied by the Exchange
Ratio, rounded down to the nearest whole number of Discreet Common Shares,
and (ii) the per share exercise price for the Discreet Common Shares issuable
upon exercise of such assumed MGI Stock Option will be equal to the quotient
determined by dividing the exercise price per MGI Common Share at which such
MGI Stock Option was exercisable immediately prior to the Effective Date by
the Exchange Ratio, and rounding the resulting exercise price up to the
nearest whole cent.
(b) As soon as practicable after the Effective Date, Discreet shall
deliver to each holder of
<PAGE>
an outstanding MGI Stock Option, an appropriate notice setting forth such
holder's rights pursuant thereto and such MGI Stock Option shall continue in
effect on terms and conditions substantially the same (subject to the
adjustment required by this Section 7.5 after giving effect to the
Arrangement). Discreet shall comply with the terms of all such MGI Stock
Options. Discreet shall take all corporate action necessary to reserve for
issuance a sufficient number of Discreet Common Shares for delivery pursuant
to the terms set forth in this Section 7.5.
7.6 BROKER SPECIAL WARRANTS
(a) On the Effective Date, MGI's obligations with respect to each
outstanding Broker Special Warrant entitling the holder thereof to receive on
the exercise of such Broker Special Warrant compensation options, will be
assumed by Discreet and, on such assumption, the right to obtain compensation
options without additional payment to MGI under such Broker Special Warrant
shall be exchanged for the right to obtain compensation options of Discreet
without additional payment to Discreet. Each Broker Special Warrant so
assumed by Discreet under this Agreement shall continue to have, and be
subject to, the same terms and conditions set forth in the agreement pursuant
to which such Broker Special Warrants were issued as in effect immediately
prior to the Effective Date, except that (i) such Broker Special Warrants
will be deemed to constitute a right to obtain, in the aggregate, 175,000
compensation options without additional payment to Discreet, (ii) such
compensation options will be deemed to constitute options to purchase that
number of Discreet Common Shares equal to the product of the number of MGI
Common Shares that the holders of such options would have been entitled to
receive had such holder exercised such compensation options immediately prior
to the Effective Date (not taking into account whether such compensation
option was in fact exercisable) multiplied by the Exchange Ratio, rounded
down to the nearest whole number of Discreet Common Shares, and (iii) the per
share exercise price for the Discreet Common Shares issuable upon exercise of
such compensation options will be equal to the quotient determined by
dividing the exercise price per MGI Common Share at which such compensation
options were exercisable immediately prior to the Effective Date by the
Exchange Ratio, and rounding the resulting exercise price up to the nearest
whole cent.
(b) As soon as practicable after the Effective Date, Discreet shall
deliver to each holder of an outstanding Broker Special Warrant, an appropriate
notice setting forth such holder's rights pursuant thereto and such Broker
Special Warrant shall continue in effect on the same terms and conditions
(including anti-dilution provisions, and subject to the adjustments required by
this Section 7.6 after giving effect to the Arrangement). Discreet shall comply
with the terms of all such Broker Special Warrants. Discreet shall take all
corporate action necessary to reserve for issuance a sufficient number of
Discreet Common Shares for delivery pursuant to the terms set forth in this
Section 7.6.
7.7 INTEL WARRANT
(a) On the Effective Date, MGI's obligations with respect to the
outstanding Intel Warrant will be assuemd by Discreet and, on such
assumption, the rights to acquire MGI Common Shares under the Intel Warrant
shall become rights to acquire Discreet Common Shares under the Intel
Warrant. The Intel Warrant so assumed by Discreet under this Agreement shall
continue to have, and be subject to, the same terms and conditions as set
forth in the Intel Warrant Agreement as in effect immediately prior to the
Effective Date, except that (i) the Intel Warrant will be deemed to
constitute a warrant to purchase that number of Discreet Common Shares equal
to the product of the number of MGI Common Shares that the holder of the
Intel Warrant would have been entitled to receive had such holder exercised
such warrant immediately prior to the Effective Date (not taking into account
whether the Intel Warrant was in fact exercisable) multiplied by the Exchange
Ratio, rounded down to the nearest whole number of Discreet Common Shares,
and (ii) the per share exercise price for the Discreet Common Shares issuable
<PAGE>
upon exercise of the Intel Warrant will be equal to the quotient determined
by dividing the exercise price per MGI Common Shares at which the Intel
Warrant was exercisable immediately prior to the Effective Date by the
Exchange Ratio, and rounding the resulting in exercise price up to the
nearest whole cent.
(b) As soon as practicable after the Effective Date, Discreet shall
deliver to the holder of the Intel Warrant, an appropriate notice setting
forth such holder's rights pursuant thereto and the Intel Warrant shall
continue in effect on the same terms and conditions (including further
anti-dilution provisions, and subject to the adjustments required by this
Section 7.7 after giving effect to the Arrangement). Discreet shall comply
with the terms of the Intel Warrant. Discreet shall take all corporate action
necessary to reserve for issuance a sufficient number of Discreet Common
Shares for delivery pursuant to the terms set forth in this Section 7.7.
7.8 AFFILIATES AGREEMENT
As promptly as reasonably practicable and in no event later than ten
(10) days after the date of this Agreement, MGI shall deliver to Discreet an
executed MGI Affiliate Agreement in the form annexed hereto as Exhibit 2.1
from each of its directors and executive officers who may, in the reasonable
judgment of MGI and Discreet, be deemed to be an "Affiliate" of MGI, and
Discreet shall deliver to MGI an executed Discreet Affiliate Agreement in the
form annexed hereto as Exhibit 2.2 from each of its directors and executive
officers who may, in the reasonable judgment of Discreet and MGI, be deemed
to be an "Affiliate" of Discreet. For the purposes hereof, the term
"Affiliate" shall have the same meaning as in paragraphs (c) and (d) of Rule
145 (each such person who is an "Affiliate" of MGI or Discreet, as the case
may be, within the meaning of Rule 145 is referred to as an "Affiliate")
promulgated under the U.S. Securities Act ("Rule 145") and/or as used in and
for purposes of Accounting Series Releases 130 and 135, as amended, and Staff
Accounting Bulletins 65 and 76 of the SEC. Between the date of this Agreement
and the Effective Time, Discreet and MGI shall, if requested, promptly
provide each other such information and documents as MGI or Discreet shall
reasonably request for purposes of reviewing a list of such Affiliates.
Discreet shall be entitled to place appropriate legends on the certificates
evidencing any Discreet Common Stock to be received by such Affiliates of MGI
pursuant to the transactions contemplated by this Agreement and to issue
appropriate stop transfer instructions to the transfer agent for the Discreet
Common Stock, consistent with the terms of the MGI Affiliate Agreement or the
Discreet Affiliate Agreement, as the case may be.
7.9 ACCESS TO INFORMATION
The parties will cooperate to provide each other the appropriate
information required to complete the documentation necessary to give effect
to the transactions contemplated in this Agreement.
Subject to applicable law and to the foregoing sentence, upon reasonable
notice, Discreet shall afford MGI's officers, employees, counsel, accountants
and other authorized representatives and advisors ("Representatives") access
arranged through designated individuals, during normal business hours from
the date hereof until the earlier of the Effective Date or the termination of
this Agreement, to its properties, books, contracts and records as well as to
its management personnel, and, during such period, Discreet shall (and shall
cause each of its subsidiaries to) furnish promptly to MGI all information
concerning its business, properties and personnel as MGI may reasonably
request. MGI shall provide the same access to Discreet and its
Representatives on the same terms and conditions. Nothing in the foregoing
shall require MGI or Discreet to disclose information subject to a written
confidentiality agreement with third parties, customer specific or
competitively sensitive information relating to areas or projects where MGI
and Discreet are competitors. For greater certainty, until the earlier of
the Effective Date and the termination of this Agreement, access to and
exchange of competitively sensitive confidential information ("Confidential
Data") as between the parties shall be limited to that which is
<PAGE>
reasonably necessary for the purposes of securing all necessary regulatory
approvals, the preparation and settlement of definitive documents and the
advancement of the Arrangement as contemplated herein and shall be further
limited such that the dissemination of such Confidential Data shall be
confined to those representatives of the parties and their advisors who have
a need to know such information for these purposes and who agree to respect
such confidentiality in their dealings with such Confidential Data. In
particular, with reference to access to and the sharing of Confidential Data
of one party with representatives of the other party for the purposes of
preparing any filings or submissions under the CA in respect of the
Arrangement, the general principle which shall be applied is that such
information shall be made available to, exchanged or shared with counsel to
the parties rather than the parties or their representatives.
7.10 LETTER OF MGI'S AUDITORS
MGI shall use all reasonable efforts to cause to be delivered to
Discreet (a) a letter of Price Waterhouse, MGI's auditors, dated a date
within five Business Days before the date on which the Circular shall become
effective and addressed to Discreet, in form reasonably satisfactory to
Discreet and customary in scope and substance for letters delivered by
auditors in connection with financial disclosure similar to the Circular and
(b) the letter of Price Waterhouse referred to in Section 8.1(m).
7.11 LETTER OF DISCREET'S AUDITORS
Discreet shall use all reasonable efforts to cause to be delivered to
MGI (a) a letter of Arthur Andersen & Cie., Discreet's auditors, dated a date
within five Business Days before the date on which the Circular shall become
effective and addressed to MGI, in form reasonably satisfactory to MGI and
customary in scope and substance for letters delivered by auditors in
connection with financial disclosure similar to the Circular and (b) the
letter of Arthur Andersen & Cie. referred to in Section 8.2(n).
7.12 SPECIAL MEETING
As promptly as practicable after the date hereof, MGI shall prepare, in
consultation with Discreet, the Circular for mailing to the MGI Shareholders.
MGI shall convene the Special Meeting on a date to be agreed upon between
Discreet and MGI but in any event no later than May 26, 1998, or if the
termination right in section 11.1(g) is waived by Discreet, such later date
as shall be agreed to by MGI and Discreet. Discreet and MGI shall file the
Circular in all jurisdictions where the same is required and mail the same in
accordance with applicable law. Prior to mailing the Circular or the
Effective Time, as the case may be, Discreet shall take such steps as are
necessary under the securities laws of the states of the United States and
the provinces of Canada where MGI Shareholders reside for the offer and sale
of Discreet Common Shares to the MGI Shareholders in such states and
provinces. Each of the parties hereto shall provide each other, on a timely
basis, with all such information as may be required to be included in the
Circular and which relates to each of them, respectively.
The parties hereto shall cooperate with each other in connection with
the preparation of documentation for submission to regulatory authorities and
holders of their respective securities and shall keep each other informed of
any requests or comments made by regulatory authorities in connection with
such documentation.
7.13 CONFIDENTIALITY
The parties acknowledge that each of Discreet and MGI have previously
executed a mutual nondisclosure and confidentiality agreement dated December
23, 1997 which confidentiality agreement
<PAGE>
shall continue in full force and effect in accordance with its terms.
7.14 LEGAL CONDITIONS TO ARRANGEMENT
Subject to Article 8, each of Discreet and MGI will take all reasonable
actions necessary to comply promptly with all legal requirements which may be
imposed on itself with respect to the Arrangement (which actions shall
include, without limitation, furnishing all information required in
connection with approvals of or filings with any Governmental Entity) and
will promptly cooperate with and furnish information to each other in
connection with any such requirements imposed upon any of them or any of
their subsidiaries in connection with the Arrangement. Each of Discreet and
MGI will, and will cause its subsidiaries to, take all reasonable actions
necessary to obtain (and will cooperate with each other in obtaining) any
consent, authorization, order or approval of, or any exemption by, a
Governmental Entity including those required under the CA or the HSR,
required to be obtained or made by Discreet, MGI or any of their subsidiaries
in connection with the Arrangement or the taking of any action contemplated
thereby or by this Agreement.
7.15 PUBLIC ANNOUNCEMENTS
Discreet and MGI shall not, nor shall Discreet permit any of its
subsidiaries to (and each such party shall use all reasonable efforts to
cause its affiliates, shareholders, directors, officers, employees, agents
and representatives not to), issue any press release, make any public
announcement or public filing or furnish any written statement to its
employees or shareholders generally concerning the Arrangement without the
consent of the other parties hereto (which consent shall not be unreasonably
withheld), except to the extent required by applicable law or the applicable
Securities Legislation (and in any such case, such party shall, to the extent
consistent with timely compliance with such requirement, consult with the
other party prior to making the required release, announcement, filing or
statement). MGI shall make no analysts' presentation without the consent of
Discreet (which consent shall not be unreasonably withheld).
7.16 POOLING ACCOUNTING
MGI shall use its reasonable best efforts to cause the business
combination to be effected by the Arrangement to be accounted for as a
pooling of interests in accordance with U.S. GAAP. Each of Discreet and MGI
shall use its best efforts to cause its respective Affiliates not to take any
action that would adversely affect the ability of Discreet to account for the
business combination to be effected by the Arrangement as a pooling of
interests in accordance with U.S. GAAP.
7.17 NASDAQ QUOTATION
Discreet shall use its best efforts to cause the shares of Discreet
Common Shares to be issued in connection with the Arrangement (a) to be
approved for quotation on the Nasdaq National Market, subject to official
notice of issuance, prior to the Effective Time, and (b) to generally not be
subject to resale restructions in the United States, other as set forth in
Section 7.8 and pursuant to Sections 144 and 145 of the U.S. SECURITIES ACT,
and to generally not be subject to resale restrictions in those provinces of
Canada where MGI Shareholders reside, from and after the Effective Time.
7.18 CONSENTS
Each of Discreet and MGI shall use all reasonable efforts to obtain all
necessary consents, waivers and approvals under any of Discreet's or MGI's
material agreements, contracts, licenses or
<PAGE>
leases in connection with the Arrangement.
7.19 FORM S-8
Discreet shall file, no later than 20 Business Days after the Effective
Time, a registration statement on Form S-8 covering the shares of Discreet
Common Shares issuable pursuant to outstanding options under the MGI Stock
Option Plan assumed by Discreet/Subco. MGI shall cooperate with and assist
Discreet in the preparation of such registration statement.
7.20 ADDITIONAL AGREEMENTS; REASONABLE EFFORTS
Subject to the terms and conditions of this Agreement, each of the
parties agrees to use all reasonable efforts to take, or cause to be taken,
all action and to do, or cause to be done, all things necessary, proper or
advisable under applicable laws and regulations to consummate and make
effective the transactions contemplated by this Agreement, subject to the
appropriate vote of Shareholders of MGI described in Section 4.24, including
co-operating fully with the other party, including by provision of
information.
7.21 MERGER OF COVENANTS
The covenants set out in this Agreement, except for Sections 7.22 and
11.3(a) shall not survive the completion of the Arrangement, and shall expire
and be terminated without recourse to the parties upon such completion.
7.22 BOARD REPRESENTATION
Discreet shall use its best efforts to appoint or recommend to its Board of
Directors a current director of MGI acceptable to Discreet not later than at the
next annual meeting of shareholders of Discreet; Discreet shall be under no
obligation to recommend for election any such person after the next annual
meeting of shareholders of Discreet.
ARTICLE 8
CONDITIONS TO ARRANGEMENT
8.1 CONDITIONS FOR THE BENEFIT OF DISCREET
The obligations of Discreet and Subco to complete the Arrangement shall
be subject to the fulfilment, or the waiver by Discreet and Subco, of the
following conditions, each of which is for the exclusive benefit of Discreet
and Subco and may be waived by Discreet and Subco at any time, in whole or in
part, in its sole discretion without prejudice to any other rights that it
may have:
(a) all necessary corporate or similar action shall have been taken by
MGI to authorize the execution and delivery of this Agreement and the
consummation of the Arrangement;
(b) the Arrangement, as proposed or with any amendment acceptable to
Discreet, acting reasonably, shall have been approved by the MGI Shareholders
at the Special Meeting in compliance with applicable Securities Legislation
and the OBCA;
<PAGE>
(c) the Interim Order and the Final Order shall each have been obtained
in form and substance satisfactory to Discreet, acting reasonably, and shall
not have been set aside or modified in a manner unacceptable to Discreet,
acting reasonably, on appeal or otherwise;
(d) all material approvals or consents that are necessary in connection
with the Arrangement shall have been obtained on terms that do not have a
Material Adverse Effect on Discreet and its subsidiaries taken as a whole or
on MGI;
(e) MGI shall have performed each covenant or obligation to be
performed by it hereunder in favour of Discreet on or prior to the Effective
Time, if the failure, in the reasonable judgement of Discreet, to comply with
such covenants would individually or in the aggregate have a Material Adverse
Effect on Discreet and its subsidiaries taken as a whole or on MGI or
materially impede the completion of the Arrangement or the other transactions
contemplated in this Agreement;
(f) the representations and warranties of MGI set forth in this
Agreement shall be true and correct in all respects on and as of the
Effective Time (as if made on and as of that date) except as affected by the
transactions contemplated or permitted by this Agreement, except to the
extent that any such representation or warranty is made as of a specified
date, in which case such representation or warranty shall have been true and
correct as of such date, and except where any failure to be true and correct
would not have a Material Adverse Effect on MGI;
(g) no judgement or order shall have been issued by any Governmental
Entity, no action, suit or proceeding shall have been taken by any person,
and no law or policy shall have been proposed, enacted, promulgated or
applied,
(i) which makes it illegal or otherwise directly or indirectly
restrains, cease trades, enjoins, prohibits or imposes
limitations or conditions on the completion of the Arrangement,
or which could reasonably be expected to have any such effects,
or which has a Materially Adverse Effect on either Discreet and
its subsidiaries taken as a whole or MGI; or
(ii) that, if the Arrangement were completed, could reasonably be
expected to have a Materially Adverse Effect on either Discreet
and its subsidiaries taken as whole or on MGI;
(h) Discreet shall have received a legal opinion from legal counsel to
MGI, in form and substance acceptable to Discreet and its legal counsel,
acting reasonably;
(i) without limiting the effect of Subsection 8.1(d), the Director of
Investigation and Research appointed under the CA or any person authorized to
exercise the powers and perform the duties of the Director shall have issued
a certificate under Section 102(1) of the CA to the effect that he is
satisfied that he would not have sufficient grounds on which to apply to the
Competition Tribunal established pursuant to the CA under Section 92 of the
CA in respect of the Arrangement or the appropriate time period specified in
Section 123 of the CA shall have expired and the Director shall have
indicated in writing that he does not intend to take any action under Section
92 of the CA whether before or after the completion of the Arrangement, which
could materially interfere with or detrimentally affect the transactions
contemplated thereby;
(j) the number of MGI Common Shares held by persons entitled to
exercise a right of dissent under Section 185 of the OBCA in respect of the
Arrangement who have notified MGI of their
<PAGE>
intention to exercise their right of dissent at or before the Special
Meeting, plus the aggregate number of all fractional shares in respect of
which holders of MGI Common Shares are to receive cash payments pursuant to
the Arrangement, shall not exceed 9.99% of the total number of MGI Common
Shares on the Effective Date;
(k) from the date hereof up to and including the Effective Date there
shall have not occurred or arisen one or more events or changes that has or
would be reasonably likely to have a Material Adverse Effect on MGI;
(l) any applicable waiting periods under the HSR Act shall have expired
or been earlier terminated;
(m) Discreet shall have received a letter of Price Waterhouse MGI's
independent auditors dated the Effective Date, updating the letter referred to
in Section 7.10; and
(n) Discreet shall have received a letter from Price Waterhouse dated
the date of the Circular and confirmed in writing within two business days
prior to the Effective Date, addressed to MGI, regarding the appropriateness
of pooling of interest accounting for the Arrangement under the Accounting
Principal Board Opinion 16 if closed and consummated in accordance with, or
as contemplated by, this Agreement.
8.2 CONDITIONS FOR THE BENEFIT OF MGI
The obligations of MGI to complete the Arrangement shall be subject to
the fulfilment, or the waiver by MGI, of the following conditions, each of
which is for the exclusive benefit of MGI and may be waived by MGI at any
time, in whole or in part, in its sole discretion without prejudice to any
other rights that it may have:
(a) all necessary corporate action shall have been taken by Discreet to
authorize the execution and delivery of this Agreement and the consummation
of the Arrangement;
(b) the Arrangement, as proposed or with any amendment acceptable to
MGI, acting reasonably, shall have been approved by the MGI Shareholders at
the Special Meeting in compliance with applicable Securities Legislation;
(c) the Interim Order and the Final Order shall each have been obtained
in form and substance satisfactory to MGI, acting reasonably, and shall not
have been set aside or modified in a manner unacceptable to MGI, acting
reasonably, on appeal or otherwise;
(d) all material approvals or consents that are necessary in connection
with the Arrangement shall have been obtained on terms that do not have a
Material Adverse Effect on MGI or on Discreet and its subsidiaries taken as a
whole;
(e) Discreet shall have performed each covenant or obligation to be
performed by it hereunder in favour of MGI on or prior to the Effective Time,
if the failure, in the reasonable judgement of MGI, to comply with such
covenants would individually or in the aggregate have a Material Adverse
Effect on MGI or on Discreet and its subsidiaries taken as a whole or
materially impede the completion of the Arrangement or the other transactions
contemplated in this Agreement;
<PAGE>
(f) the representations and warranties of Discreet set forth in this
Agreement shall be true and correct in all respects on and as of the
Effective Date (as if made on and as of that date) except as affected by the
transactions contemplated or permitted by this Agreement, except to the
extent that any such representation or warranty is made as of a specified
date, in which case such representation or warranty shall have been true and
correct as of such date and except for any failures or breaches of
representations and warranties which would not have a Material Adverse Effect
on Discreet and its subsidiaries taken as a whole or materially impede the
completion of the Arrangement or the transactions contemplated herein;
(g) no judgement or order shall have been issued by any Governmental
Entity, no action, suit or proceeding shall have been taken by any person,
and no law or policy shall have been proposed, enacted, promulgated or
applied,
(i) which makes it illegal or otherwise directly or indirectly
restrains, cease trades, enjoins, prohibits or imposes
limitations or conditions on the completion of the Arrangement,
or which could reasonably be expected to have any such effects,
which has a Materially Adverse Effect on either Discreet and its
subsidiaries taken as a whole or on MGI; or
(ii) that, if the Arrangement were completed, could reasonably be
expected to have a Materially Adverse Effect on Discreet and its
subsidiaries taken as whole or on MGI;
(h) MGI shall have received a legal opinion from legal counsel to
Discreet, in form and substance acceptable to MGI and its legal counsel,
acting reasonably in the circumstances, including with respect to the
issuance and resale of Discreet Common Shares issued to the MGI Shareholders
under the Arrangement being tradeable, registered or exempt from prospectus
requirements in each of the provinces of Canada where MGI has shareholders
and such other opinion which may reasonably be required from counsel in the
United States;
(i) without limiting the effect of Subsection 8.2(d), the Director of
Investigation and Research appointed under the CA or any person authorized to
exercise the powers and perform the duties of the Director shall have issued
a certificate under Section 102(1) of the CA to the effect that he is
satisfied that he would not have sufficient grounds on which to apply to the
Competition Tribunal established pursuant to the CA under Section 92 of the
CA in respect of the Arrangement or the appropriate time period specified in
Section 123 of the CA shall have expired and the Director shall have
indicated in writing that he does not intend to take any action under Section
92 of the CA whether before or after the completion of the Arrangement, which
could materially interfere with or detrimentally affect the transactions
contemplated thereby;
(j) any applicable waiting periods under the HSR Act shall have expired
or been earlier terminated;
(k) the issuance of Discreet Common Shares pursuant to the Arrangement
will be, if required, registered under the U.S. Securities Act pursuant to a
registration statement declared effective by the SEC or pursuant to a rule of
the SEC and no stop order suspending such effectiveness shall have been
issued or proceedings therefor initiated or threatened by the SEC, or shall
be exempt from such registration and all such Discreet Common Shares shall be
listed for trading on NASDAQ;
<PAGE>
(l) MGI shall have received a letter from Price Waterhouse dated the
date of the Circular and confirmed in writing within two business days prior
to the Effective Date, addressed to MGI, regarding the appropriateness of
pooling of interest accounting for the Arrangement under the Accounting
Principal Board Opinion 16 if closed and consummated in accordance with, or
as contemplated by, this Agreement; AND
(m) MGI shall have received a letter from Arthur Andersen & Cie.,
Discreet's independent auditors, dated the Effective Date, updating the
letter referred to in Section 7.11.
8.3 NOTICE AND CURE PROVISIONS
Each party will give prompt notice to the other of the occurrence, or
failure to occur, at any time from the date hereof until the Effective Date,
of any event or state of facts which occurrence or failure would, or would be
likely to:
(a) cause any of the representations or warranties of any party contained
herein to be untrue or inaccurate in any material respect on the date
hereof or at the Effective Date; or
(b) result in the failure to comply with or satisfy any covenant,
condition or agreement to be complied with or satisfied by any party
hereunder prior to the Effective Date.
No party may elect not to complete the transactions contemplated hereby pursuant
to the conditions precedent contained in Sections 8.1 and 8.2 or any termination
right arising therefrom and no fees are payable under Section 11, unless
forthwith and in any event prior to the filing of the Final Order for acceptance
by the Director, the party intending to rely thereon has delivered a written
notice to the other party specifying in reasonable detail all breaches of
covenants, representations and warranties or other matters which the party
delivering such notice is asserting as the basis for the non-fulfilment or the
applicable condition precedent or termination right, as the case be. If any
such notice is delivered, provided that a party is proceeding diligently to cure
such matter, no party may terminate this Agreement until the later of August 31,
1998 and the expiration of a period of 10 days from such notice.
8.4 MERGER OF CONDITIONS
The conditions set out in Sections 8.1 and 8.2 shall be conclusively deemed
to have been satisfied, waived or released upon the filing of Articles of
Arrangement, as contemplated by this Agreement, and the issuance of a
certificate of arrangement and certificate of amendment in respect thereof under
the OBCA.
ARTICLE 9
OPTION
9.1 GRANT OF OPTION
In consideration of the agreement otherwise contained herein, MGI hereby
grants to Discreet, subject to and upon the terms and conditions hereof, the
right to purchase up to 4,795,442 MGI Common Shares at a price of $5.32 per
share.
9.2 COVENANTS OF MGI
MGI hereby covenants and agrees with Discreet as follows:
<PAGE>
(a) that MGI is duly authorized to create and issue the Option and that,
subject to the provisions of this Agreement and regulatory approval, MGI will
cause the MGI Common Shares issued pursuant to the exercise of the Option and
the certificates representing such MGI Common Shares to be duly issued and
delivered, all in accordance with the terms hereof;
(b) at all times prior to and including the Option Expiry Time, MGI shall
reserve and allot and conditionally issue out of its authorized capital that
number of MGI Common Shares as is sufficient to enable MGI to meet its
obligation to issue MGI Common Shares in respect of the exercise of the Option.
Upon payment of the Option Exercise Price therefor, all MGI Common Shares
acquired pursuant to the Option shall be fully paid and non-assessable;
(c) that, subject to the express provisions hereof, MGI will at all times
prior to and including the Option Expiry Time, maintain its corporate existence;
and, subject to the express provisions hereof, it will do or cause to be done
all things necessary to preserve and keep in full force and effect its corporate
existence; provided, however, that nothing herein contained shall prevent MGI
from abandoning any rights and franchises of MGI, if in the opinion of the
directors or officers of MGI, it would be advisable and in the best interests of
MGI to do so;
(d) as soon as practicable following the date hereof, MGI shall make
application to list and reserve for issuance such additional number of MGI
Common Shares as are to be issued as a result of the exercise of the Option and
shall take all such reasonable steps and actions and do all such reasonable
things that may be required to maintain, if the Arrangement is not completed
prior to the Termination Date, the listing and posting for trading of the MGI
Common Shares on The Toronto Stock Exchange until the Option Expiry Time;
(e) MGI shall take all such reasonable best steps and actions and do all
such reasonable things that may be required to maintain, if the Arrangement is
not completed prior to the Termination Date, its status as a "REPORTING ISSUER"
not in default of the requirements of the applicable Securities Legislation of
each jurisdiction where it is or may, from time to time, be a reporting issuer.
(f) MGI will make all requisite filings, registrations and notices,
including those required to be made with the appropriate securities commissions
and The Toronto Stock Exchange, and MGI shall pay all corresponding fees, in
connection with the grant and the exercise of the Option.
9.3 SECURITIES QUALIFICATION REQUIREMENTS
(a) If, in the opinion of counsel, any instrument is required to be filed
with or any permission, order or ruling is required to be obtained from any
securities regulatory authority or any other step is required under any federal
or provincial law of a jurisdiction in which MGI is a reporting issuer or
equivalent thereof, before any securities or property which Discreet is entitled
to receive pursuant to the exercise of the Option may properly and legally be
delivered upon the due exercise of the Option, MGI covenants that it will use
its reasonable best efforts to file such instrument, obtain such permission,
order or ruling or take all such other actions, at its expense, as is required
or appropriate in the circumstances.
(b) MGI will give written notice of the issue of MGI Common Shares
pursuant to the exercise of the Option, in such detail as may be required, to
The Toronto Stock Exchange and any other stock exchange upon which the MGI
Common Shares are listed or to each securities commission or similar regulatory
authority in each jurisdiction in Canada in which there is legislation requiring
the giving of any such notice in order that the subsequent disposition of the
MGI Common Shares so issued
<PAGE>
will not be subject to the prospectus requirements of such legislation.
9.4 ADJUSTMENT
(a) If and whenever at any time from the date hereof and prior to the
Option Expiry Time MGI shall:
(i) subdivide, redivide or change its outstanding MGI Common Shares
into a greater number of shares; or
(ii) reduce, combine or consolidate its outstanding MGI Common Shares
into a smaller number of shares;
the Option Exercise Number shall be adjusted immediately after the effective
date of such subdivision, redivision, change, reduction, combination or
consolidation by multiplying the Option Exercise Number by the fraction of
which:
(i) the numerator shall be the total number of MGI Common Shares
outstanding immediately after such date; and
(ii) the denominator shall be the total number of MGI Common Shares
outstanding immediately prior to such date,
and such adjustment shall be made successively whenever any event referred to
in this Subsection 9.4(a) shall occur (and all adjustments in this Subsection
are cumulative).
(b) If and whenever from the date hereof, MGI shall distribute rights,
options or warrants exercisable within a period of forty-five days after the
record date for such distribution to subscribe for or purchase MGI Common Shares
or securities exchangeable for or convertible into MGI Common Shares at a price
per share or at an exchange or conversion value per share in the case of
securities exchangeable for or convertible into MGI Common Shares equal to or
less than 95% of the Current Market Price for MGI Common Shares determined as of
the record date for such distribution, to all or substantially all of the
holders of the MGI Common Shares (any such event being called a "RIGHTS
OFFERING"), the Option Exercise Number shall be adjusted effective immediately
after the record date on which holders of MGI Common Shares are determined for
the purposes of the Rights Offering to the Option Exercise Number determined by
multiplying the Option Exercise Number in effect on such record date by the
fraction,
(i) the numerator of which shall be the aggregate of:
(A) the number of MGI Common Shares issued and outstanding on such
record date; and
(B) the number of MGI Common Shares offered pursuant to the Rights
Offering or the maximum number of MGI Common Shares for or into
which the securities so offered pursuant to the Rights Offering
may be exchanged or converted, as the case may be; and
(ii) the denominator of which shall be the aggregate of:
<PAGE>
(A) the number determined by dividing either the product of:
1) the number of MGI Common Shares so offered; and
2) the price at which each of such MGI Common Shares is offered;
or the product of:
1) the maximum number of MGI Common Shares for or into which the
securities so offered pursuant to the Rights Offering may be
exchanged or converted; and
2) the exchange or conversion value of each one of such securities
so offered,
as the case may be, by the Current Market Price of MGI Common Shares
determined as of such record date.
To the extent that such options, rights or warrants are not exercised prior to
the expiry date thereof, the Option Exercise Number shall be re-adjusted
effective immediately after such expiry date to the Option Exercise Number which
would then have been in effect based upon the number of MGI Common Shares or
securities exchangeable for or convertible into MGI Common Shares actually
delivered on the exercise of such options, rights or warrants.
(c) If and whenever at any time from the date hereof and prior to the
Option Expiry Time, MGI shall issue or distribute to the holders of all or
substantially all of MGI's outstanding MGI Common Shares securities of MGI
including rights, options or warrants to acquire shares of MGI (other than
rights, options or warrants referred to in Subsection 9.4(b)) or securities
convertible into or exchangeable for shares of MGI or property or assets
including evidences of indebtedness, then upon exercise of the Option Discreet
shall be entitled to receive, and shall accept for the same aggregate
consideration, in addition to the MGI Common Shares to which it was theretofore
entitled upon such exercise, the kind and amount of shares or other securities
or property which Discreet would have been entitled to receive as a result of
such issue or distribution as if, on the effective date thereof, Discreet had
been the registered holder of the number of MGI Common Shares to which it was
theretofore entitled upon such exercise and if determined appropriate by the
directors of MGI, appropriate adjustments shall be made as a result of any such
subdivision, redivision, change, reduction, combination, consolidation, issue or
distribution to the rights and interests of Discreet thereafter so that the
provisions of this Article 9 shall thereafter apply correspondingly to any
shares, other securities or other property thereafter deliverable upon the
exercise of the Option and any such adjustments shall be made by and set forth
in an agreement supplemental hereto approved by the directors of MGI and absent
manifest error, shall for all purposes be conclusively deemed to be an
appropriate adjustment.
(d) If and whenever at any time from the date hereof and prior to the
Option Expiry Time, there is a reclassification of the MGI Common Shares or a
capital reorganisation of MGI other than as described in Subsection 9.4(a),
9.4(b) or 9.4(c) or a consolidation, amalgamation or merger of MGI with or into
any other body corporate, trust, partnership or other entity, or a sale or
conveyance of the property and assets of MGI as an entirety or substantially as
an entirety to any other body corporate, trust, partnership or other entity or
the payment by MGI of a stock dividend (other than a stock dividend declared in
the ordinary course of business) (other than the Arrangement), then upon
exercise of the Option Discreet, to the extent it has not exercised the Option
prior to the effective date of such reclassification, reorganization,
consolidation, amalgamation, merger, sale, conveyance or payment, upon the
exercise of such right thereafter, shall be entitled to receive and shall accept
the kind and
<PAGE>
number of shares or other securities or property of MGI or of the body
corporate, trust, partnership or other entity resulting from such
reclassification, reorganization, merger, amalgamation, consolidation or
payment, or to which such sale or conveyance may be made, as the case may be,
that Discreet would have been entitled to receive on such reclassification,
capital reorganization, consolidation, amalgamation, merger, sale, conveyance
or payment, if, on the record date or the effective date thereof, as the case
may be, Discreet had been the registered holder of the number of MGI Common
Shares receivable upon the exercise of the Option, subject to adjustment
thereafter in accordance with provisions the same, as nearly as may be
possible, as those contained in this Section 9.4; provided, however, that no
such action shall be carried into effect unless all necessary steps shall
have been taken so that Discreet shall thereafter be entitled to receive such
kind and number of shares or other security and property. If determined
appropriate by MGI to give effect to or to evidence the provisions of this
Section, MGI, its successor, or such purchasing body corporate, partnership,
trust or other entity, as the case may be, shall, when becoming aware of any
such reclassification, reorganization, subdivision, consolidation,
amalgamation, merger, sale, conveyance or payment, enter into an agreement or
indenture which shall provide, to the extent possible, for the application of
the provisions set forth in this Agreement with respect to the rights and
interests thereafter of the Discreet to the end that the provisions set forth
in this Agreement shall thereafter correspondingly be made applicable, as
nearly as may reasonably be, with respect to any shares, other securities or
property to which Discreet is entitled on the exercise of the Option
thereafter. Any agreement entered into shall provide for adjustments which
shall be as nearly equivalent as may be practicable to the adjustments
provided in this Section 9.4 and which shall apply to successive
reclassifications, reorganizations, amalgamations, consolidations, mergers,
sales, conveyances or payments.
(e) In any case in which this Section 9.4 shall require that an adjustment
shall become effective immediately after a record date, for an event referred to
herein, MGI may defer, until the occurrence of such event, issuing to Discreet,
if Discreet exercises the Option after such record date and before the
occurrence of such event the additional MGI Common Shares or other securities or
property issuable upon such exercise by reason of the adjustment required by
such appropriate instrument evidencing Discreet's right to receive such
additional MGI Common Shares, other securities or property, as the case may be,
upon the occurrence of the event requiring such adjustment and the right to
receive any property, as the case may be, declared in favour of holders of
record of MGI Common Shares, other securities or property, as the case may be,
on and after the date of exercise or such later date as Discreet would, but for
the provisions of this Subsection 9.4(e), have become the holder of record of
such additional MGI Common Shares, other securities or property, as the case may
be, pursuant to the due exercise of the Option held by such holder.
(f) After any adjustment pursuant to this Section, the term "MGI COMMON
SHARES" where used in this Agreement shall be interpreted to mean securities of
any class or classes which, as a result of all prior adjustments pursuant to
this Section, Discreet is entitled to receive upon the exercise of the Option,
and the number of MGI Common Shares indicated in any exercise made pursuant to a
Warrant shall be interpreted to mean the number of securities which, as a result
of all prior adjustments pursuant to this Section 9.4, Discreet is entitled to
receive upon the exercise of the Option.
(g) Anything in this Section 9.4 to the contrary notwithstanding, no
adjustment shall be made in the number of MGI Common Shares issuable upon
exercise of the Option if the issue of MGI Common Shares is being made pursuant
to any stock option or stock purchase plan in force from time to time for
directors, officers or employees of MGI.
(h) All securities of any class which Discreet is at the time in question
entitled to receive on the exercise of the Option, whether or not as a result of
adjustments made pursuant to this Section 9.4,
<PAGE>
shall, for the purposes of the interpretation of this Agreement, be deemed to
be securities which Discreet is entitled to acquire pursuant to the Option.
(i) In the event of any question arising with respect to the adjustments
provided for in this Section 9.4, such question shall be conclusively determined
by MGI's auditors and such determination shall be binding upon MGI, Discreet and
all other interested persons.
(j) No adjustment will be required if Discreet is otherwise entitled to
participate in the event which triggers the adjustment pursuant to this Section
9.4 on the same basis as Discreet would have been entitled had it exercised the
Option and subscribed for MGI Common Shares immediately prior to such event.
9.5 PROCEEDINGS PRIOR TO ANY ACTION REQUIRING ADJUSTMENT
As a condition precedent to the taking of any action which would require an
adjustment in any of the subscription rights arising pursuant to the exercise of
the Option, including the number of MGI Common Shares which are to be received
upon the exercise thereof, MGI shall take such corporate action which may, in
the opinion of counsel, be necessary in order that MGI have allotted and
reserved for issue in its authorized capital and enabling MGI to validly and
legally deliver all other securities which the holders of such Option are
entitled to receive on the full exercise thereof in accordance with the
provisions hereof.
9.6 CERTIFICATE OF ADJUSTMENT
MGI shall from time to time immediately after the occurrence of any event
which requires an adjustment or readjustment as provided in Section 9.4, deliver
a certificate of MGI to Discreet specifying the nature of the event requiring
the same and the adjustment necessitated thereby and setting forth in reasonable
detail the method of calculation and the facts upon which such calculation is
based, which certificate and the amount of the adjustment specified therein
shall be verified by MGI's auditors, upon whose verification Discreet shall be
entitled to rely provided that, if MGI has already given the required notices
under Section 9.8 covering all the relevant facts in respect of such event and
if Discreet consents in writing, no further notice need be given under this
Section 9.6.
9.7 ADJUSTMENT RULES
The adjustments provided for in this Article 9 are cumulative and shall
apply (without duplication) to successive actions requiring an adjustment under
the provisions of Section 9.4; provided that, notwithstanding any other
provision of this Article 9, no adjustment shall be made in the number of MGI
Common Shares which may be subscribed for on the exercise of the Option unless
it would result in a change of at least one MGI Common Share (provided, however,
that any adjustments which by reason of this Section 9.7 are not required to be
made shall be carried forward and taken into account in any subsequent
adjustment).
9.8 NOTICE OF SPECIAL MATTERS
MGI covenants that, so long as the Option remains outstanding, it will give
prior written notice to Discreet of any event which requires an adjustment to
the subscription rights attaching to any of the Option pursuant to this Article
9. MGI covenants and agrees that such notice shall contain the particulars of
such event in reasonable detail and, if determinable, the required adjustment in
the manner provided
<PAGE>
for in this Article 9. MGI further covenants and agrees that it shall
promptly, as soon as the adjustment calculations are reasonably determinable,
file a certificate of MGI with Discreet showing how such adjustment shall be
computed.
9.9 EXERCISE OF OPTION
(a) Upon and subject to the provisions of this Article, Discreet may, at
its election, exercise the right hereby conferred on it to subscribe for MGI
Common Shares by paying the Option Exercise Price by way of certified cheque or
recognized bank draft payable to or to the order of MGI.
(b) Provided that Discreet is not in material breach of this Agreement,
the Option may be exercised in whole or in part at any time and from time to
time at or prior to the Option Expiry Time following the occurrence of any of
the following events (any of which shall constitute an "Option Event"):
(i) any person (other than Discreet or any affiliate of Discreet)
shall have commenced a tender offer or exchange offer to purchase
any MGI Common Shares such that, upon consummation of such offer,
the offeror together with any person or persons acting jointly or
in concert with the offeror, shall have acquired 20% or more of
the outstanding MGI Common Shares;
(ii) any person, together with any person (other than Discreet or any
affiliate of Discreet) or persons acting jointly or in concert
with such person, shall have acquired 9.9% or more of the then
outstanding MGI Common Shares; or
(iii) the MGI Shareholders shall not have approved the Arrangement
at the Special Meeting, such meeting shall not have been held or
shall have been cancelled prior to termination of this Agreement
or MGI's Board of Directors shall have withdrawn or modified in a
manner adverse to Discreet its approval or recommendation of the
Arrangement, this Agreement or the transactions contemplated
hereby, in each case where such action was not occasioned by the
occurrence of one or more events or changes that has or would be
reasonably likely to have a Material Adverse Effect on Discreet
and its subsidiaries, taken AS a whole, and in each case after
any person (other than Discreet or any affiliate of Discreet)
shall have made an Alternative Proposal.
In the event Discreet wishes to exercise the Option, Discreet shall deliver to
MGI a written notice specifying the total number of MGI Common Shares which it
wishes to acquire together with a certified cheque or bank draft in the amount
of the Option Exercise Price multiplied by the total number of MGI Common Shares
to be acquired.
9.10 EFFECT OF EXERCISE OF OPTION
(a) Upon valid exercise of the Option as provided in Section 9.9, the MGI
Common Shares in respect of which the Option are validly exercised shall be
deemed to have been issued, and Discreet shall be deemed to have become the
holder of record of such securities on the date of such exercise (herein called
the "OPTION EXERCISE DATE"), unless the transfer books of MGI shall be closed by
law on the said date of such valid exercise, in which case such securities shall
be deemed to have been issued, such person shall be deemed to have become the
holder of record of such securities and the Option Exercise Date shall be deemed
to be, on the date on which such transfer books are next reopened. The
<PAGE>
MGI Common Shares issued upon the valid exercise of the Option shall be
entitled only to dividends declared in favour of shareholders of record on
and after the Option Exercise Date from which date such shares will for all
purposes be and be deemed to be issued and outstanding as fully paid and
non-assessable MGI Common Shares.
(b) When the transfer books of MGI have been opened for a period not
exceeding five Business Days after valid exercise of the Option as aforesaid,
MGI shall forthwith deliver a certificate or certificates evidencing the
appropriate number of MGI Common Shares to Discreet.
9.11 OPTION VOID AFTER EXPIRE TIME
After the Option Expiry Time, the Option is void and of no further value or
effect.
9.12 COMPANY MAY CONSOLIDATE, ETC. ON CERTAIN TERMS
Subject to Subsection 9.4(d), nothing in this Article 9 shall prevent any
consolidation, reorganization, arrangement, amalgamation or merger of MGI with
or into any other body corporate or bodies corporate or a person; provided,
however, that the body corporate or person formed by such consolidation or
amalgamation or into which such merger shall have been made shall execute and
deliver to Discreet prior to or contemporaneously with such consolidation,
reorganization, amalgamation, arrangement or merger, an agreement supplemental
hereto wherein the due and punctual performance and observance of all the
covenants and conditions of this Article 9 to be performed or observed by MGI
shall be assumed by such body corporate. Discreet shall be entitled to receive
and shall be fully protected in relying upon an opinion of counsel that any such
consolidation, amalgamation arrangement or merger, and any supplemental
agreement or indenture executed in connection therewith, comply with the
provisions of this Section 9.12.
9.13 SUCCESSOR BODY CORPORATE SUBSTITUTED
In case MGI, pursuant to Section 9.12, shall be consolidated, amalgamated,
reorganized, arranged or merged with or into any other body corporate or bodies
corporate, or person, the successor body corporate or person formed by such
consolidation, reorganization, arrangement or amalgamation or into which MGI
shall have been merged as aforesaid, shall succeed to and be substituted for MGI
under this Article 9 with the same effect as nearly as may be possible as if it
had been a party to this Article 9. Such changes may be made in the Option as
may be appropriate in view of such consolidation, reorganization, arrangement,
amalgamation or merger.
ARTICLE 10
COMPETING TRANSACTION
10.1 DISCREET'S RIGHT TO INCREASE CONSIDERATION
Notwithstanding anything else contained in this Agreement, Discreet may, in
its sole discretion, within five (5) calendar days after receiving a notice
pursuant to Section 6.2 or 10.4, as the case may be, or otherwise becoming aware
of a potential Competing Transaction and prior to the Special Meeting, agree to
amend the Agreement to increase the consideration payable to MGI Shareholders
either through the issuance of additional Discreet Common Shares or through
cash, or a combination thereof, pursuant to the Arrangement to a consideration
at least equal in value to that offered under the Competing Transaction.
Notwithstanding Section 12.5, in the event that Discreet delivers a notice to
MGI in which it
<PAGE>
elects to increase such consideration in such manner, MGI will be deemed
automatically to have agreed to such amendment.
10.2 CASH EQUIVALENT VALUE OF NON-CASH CONSIDERATION
The cash equivalent value of any non-cash consideration of a Competing
Transaction or of the Arrangement shall be valued as of the close of business on
the date that the Competing Transaction is received by MGI and shall be mutually
agreed upon by a member of either the Investment Dealers Association ("IDA") or
the National Association of Securities Dealers Inc. ("NASD") designated by MGI
and by another member of the IDA or NASD designated by Discreet, each acting
reasonably. If the two members are unable to mutually agree on the cash
equivalent value of such non-cash consideration by 2:00 p.m. on the second day
following the date on which the Competing Transaction is received by MGI, MGI
and Discreet shall request a third member of the IDA or NASD to determine the
cash equivalent value of the non-cash consideration by 12:00 noon on the
following day. If that member does not make such determination by such time,
each of the initial members shall advise MGI and Discreet of their respective
professional judgement of the cash equivalent value of such non-cash
consideration and the cash equivalent value of such non-cash consideration shall
be the average of the amounts reflected in such judgements. Any such
determination made in accordance with the foregoing provisions shall be binding
on the parties hereto.
10.3 POSTPONEMENT OF SPECIAL MEETING AND TERMINATION
(a) Notwithstanding anything contained herein:
(i) if a Competing Transaction is made or announced at any time
within five calendar days prior to the scheduled date of the
Special Meeting, either Discreet or MGI may, by notice in writing
to the other parties hereto, require that the Special Meeting be
postponed to a date up to 12 calendar days after the date
scheduled for the Special Meeting; and
(ii) if Discreet undertakes to MGI, within two calendar days prior to
the scheduled time of the Special Meeting, to amend the
conversion ratios and/or payments provided for in the Arrangement
to increase the consideration offered to MGI Shareholders, either
Discreet or MGI may, by notice in writing to the other parties
hereto, require that the Special Meeting be postponed to a date
up to seven calendar days after the date scheduled for the
Special Meeting.
(b) MGI's Board of Directors shall not withdraw or modify their approval
or recommendation in respect of the Arrangement for a period of five
calendar days after providing information to Discreet regarding a Competing
Transaction pursuant to Section 6.2.
<PAGE>
ARTICLE 11
TERMINATION
11.1 TERMINATION
This Agreement may be terminated at any time prior to the Effective Date,
whether before or after approval of the matters presented in connection with the
Arrangement by the MGI Shareholders:
(a) by mutual consent of Discreet and MGI;
(b) by either Discreet or MGI (provided that the terminating party is not
then in material breach of any representation, warranty, covenant or agreement
contained in this Agreement) if there has been a breach of any representation,
warranty, covenant or agreement contained in this Agreement on the part of the
other party, such breach has a Material Adverse Effect on the party in breach,
on the other party or on the Arrangement or such breach materially impedes the
completion of the Arrangement, and best efforts are not being employed to cure
such breach within 10 days after notice thereof is given to the party committing
such breach and, in any event such breach has not been cured within 15 days;
(c) by either Discreet or MGI if the Arrangement shall not have been
consummated before the Termination Date (provided that the terminating party is
not then in material breach of any representation, warranty, covenant or
agreement contained in this Agreement);
(d) by either Discreet or MGI if any required approval of the MGI
Shareholders or the Court shall not have been obtained by reason of the failure
to obtain the required vote upon a vote taken at the Special Meeting or any
adjournment thereof;
(e) by either Discreet or MGI if (i) the conditions to such party's
obligation to close shall have become impossible to satisfy or (ii) any
permanent injunction or other order of a court or other competent authority
preventing the Arrangement shall have become final and non-appealable;
(f) by Discreet if the Board of Directors of MGI have withdrawn or
modified in a manner adverse to Discreet its approval or recommendation of the
Arrangement, this Agreement or the transactions contemplated hereby or shall
fail to reaffirm such approval or recommendation upon the other party's request,
or shall have resolved to do any of the foregoing provided that in such
circumstances this Agreement may not be terminated by Discreet unless MGI
Shareholders do not approve the Arrangement as required in the Interim Order or
the Arrangement is not submitted for their approval; or
(g) by Discreet if the certificate of arrangement has not been issued by
the Director giving effect to the Arrangement by 5:00 p.m. (Toronto time) on May
29, 1998 provided, however, that the termination right provided in this
subparagraph (g) shall expire if MGI has not received notice of the exercise of
such right by 7:00 p.m. (Toronto time) on May 29, 1998.
Where action is taken to terminate this Agreement pursuant to this Section 11.1
(other than in accordance with Subsection 11.1(g)) it shall be sufficient for
such action to be authorized by the Board of Directors of the party taking such
action.
11.2 EFFECT OF TERMINATION
(a) In the event of termination of this Agreement by either MGI or
Discreet as provided in
<PAGE>
Section 11.1 (other than in accordance with Subsection 11.1(g)), this
Agreement shall forthwith become void and have no further effect, and there
shall be no liability or further obligation on the part of Discreet or MGI or
their respective officers or directors hereunder, except that (i) the
provisions of Section 1.7 (Confidentiality), Article 9 (Option), Section 11.3
(Expenses and Termination Fees), and this Subsection 11.2(a) shall remain in
full force and effect and shall survive any such termination and abandonment,
and (ii) except as set forth in Section 11.3(f), no party shall be released
or relieved from any liability arising from the wilful breach by such party
of any of its representations, warranties, covenants or agreements as set
forth in this Agreement.
(b) In the event of termination of this Agreement by Discreet as provided
in subsection 11.1(g), this Agreement shall forthwith become void and have no
further effect and there shall be no liability or further obligation on the part
of Discreet or MGI or their respective officers or directors hereunder including
with respect to Article 9 (Option) and Section 11.3 (Expenses and Termination
Fees), except that (i) the provisions of Section 1.7 (Confidentiality) and this
subsection 11.2(b) shall remain in full force and effect and shall survive any
such termination and abandonment, and (ii) except as set forth in Section
11.3(f), no party shall be released or relieved from any liability arising from
the wilful breach by such party of any of its representations, warranties,
covenants or agreements as set forth in this Agreement.
11.3 EXPENSES AND TERMINATION FEES
(a) Subject to subsections 11.3(b), (c) and (d) below whether or not the
Arrangement is consummated, all costs and expenses incurred in connection with
this Agreement and the transactions contemplated hereby (including, without
limitation, the fees and expenses of its advisers, accountants and legal
counsel) shall be paid by the party incurring such expense, except that expenses
incurred in connection with printing the Circular, filing fees incurred in
connection with the Circular and legal fees relating to the Circular shall be
shared equally by MGI and Discreet.
(b) In addition to any amount payable pursuant to subsection 11.3(d), MGI
agrees to reimburse Discreet for all out-of-pocket costs and expenses incurred
by Discreet in connection with this Agreement and the transactions contemplated
hereby (including, without limitation, the fees and expenses of its advisors,
accountants and legal counsel) up to the sum of US$1,000,000, provided that
Discreet is not in material breach of any representation, warranty, covenant or
agreement contained in this Agreement, in the event that:
(i) Discreet or MGI terminates this Agreement in accordance with
subsection 11.1(d); or
(ii) Discreet terminates this Agreement in accordance with subsection
11.1(b); or
(iii) Discreet terminates this Agreement in accordance with
subsection 11.1(f) in circumstances where there is a Competing
Transaction.
(c) Discreet agrees to reimburse MGI for all out-of-pocket costs and
expenses incurred by MGI in connection with this Agreement and the transactions
contemplated hereby (including, without limitation, the fees and expenses of its
advisors, accountants and legal counsel) up to the sum of US$1,000,000, provided
that MGI is not in material breach of any representation, warranty, covenant or
agreement contained in this Agreement, in the event that MGI terminates this
Agreement in accordance with subsection 11.1(b).
(d) MGI shall pay Discreet (in addition to any amounts payable under
subparagraph (b)
<PAGE>
above) the sum of US$4,500,000 in the event that this Agreement is terminated
in accordance with subsection 11.1(d) or 11.1(f), in each case in
circumstances where there is an Alternative Proposal, and prior to such
termination or within twelve months after the date of such termination MGI
enters into a definitive amalgamation agreement or other business combination
agreement regarding a Competing Transaction or Alternative Proposal or
recommends that MGI Shareholders tender their MGI Common Shares in response
to a tender or exchange related to a Competing Transaction or Alternative
Proposal, or resolves to do any of the foregoing; provided, however, that
solely for the purposes of this Section 11.3(d), the term Alternative
Proposal shall have the meaning assigned to it in Section 1.1 except that the
words "20% or more" in subsections (ii) and (iii) of such definition shall be
deemed to be "more than 50%".
(e) All amounts payable pursuant to this Section 11.3 shall be paid within
one Business Day after the event triggering the applicable payment obligation.
(f) Each party acknowledges and agrees that if any amount is paid to
Discreet by MGI pursuant to subsections 11.3(b)(i) or (iii) or pursuant to
subsection 11.3(d), the amount or amounts so paid are in lieu of any damages or
any other payment which Discreet may be entitled to and shall constitute
payments of liquidated damages which are a genuine estimate of the damages which
Discreet will suffer or incur as a result of the event giving rise to such
damages and resultant termination of this Agreement and are not penalties. MGI
irrevocably waives any right it may have to raise as a defence that any such
liquidated damages are excessive or punitive. For greater certainty, the
parties agree that the payment of any amount pursuant to such subsections is the
sole monetary remedy available to Discreet and Discreet shall not have any
alternative right or remedy against MGI, including pursuant to subsection
11.3(g).
(g) Each party acknowledges and agrees that the payment of any amount to
Discreet by MGI pursuant to subsection 11.3(b)(ii) or to MGI by Discreet
pursuant to subsection 11.3(c) shall not relieve or have the effect of relieving
the party making such payment in any way from liability for damages incurred or
suffered by the other party as a result of the breach of this Agreement by the
party making such payment (which damages may include, but shall not be
restricted by, any amount paid pursuant to subsection 11.3(b)(ii) or subsection
11.3(c)) , whether or not such liability resulted from the wilful breach or bad
faith of the party making such payment.
ARTICLE 12
MISCELLANEOUS
12.1 NONSURVIVAL OF REPRESENTATIONS AND WARRANTIES
The representations and warranties of MGI, Discreet and Subco contained in
this Agreement or in any instrument delivered pursuant to this Agreement shall
not survive the Effective Time and shall expire and be terminated and
extinguished at the Effective Time. The confidentiality agreement referred to in
Section 12.6 shall survive the execution and delivery of this Agreement.
12.2 NOTICE
All notices and other communications hereunder shall be in writing and
shall be deemed given if delivered personally, or one business day after deposit
with a nationally recognized courier service for next Business Day delivery to
the parties at the following addresses (or at such other address for a party
<PAGE>
as shall be specified by like notice):
(a) if to Discreet, to:
Discreet Logic Inc.
10 Duke Street
Montreal, Quebec H3C 2L7
Facsimile number: (514) 954-7327
Attention: Chief Financial Officer
with a copy to:
Mark Macenka
Testa Hurwitz & Thibeault LLP
125 High Street
Boston, MA 02110
U.S.A.
Facsimile number: (617) 248-7100
(b) if to MGI, to:
MGI Software Corp.
40 West Wilmot Street
Richmond Hill, Ontario L4B 1H8
Facsimile number: (905) 707-3675
Attention: Chief Financial Officer
with a copy to:
P. Dougal Macdonald
Osler, Hoskin & Harcourt
1 First Canadian Place
P.O. Box 50
Toronto, Canada M5X 1B8
Facsimile number: (416) 862-6666
12.3 COUNTERPARTS
This Agreement may be executed in two or more counterparts, all of which
shall be considered one and the same agreement, it being understood that all
parties need not sign the same counterpart.
12.4 AMENDMENT
This Agreement may be amended by the parties hereto, by written instrument
executed by
<PAGE>
Discreet and MGI, at any time before or after approval of the matters
presented in connection with the Arrangement by the MGI Shareholders, but,
after any such approval, no amendment shall be made which by law requires
further approval by the MGI Shareholders without such further approval.
12.5 EXTENSION; WAIVER
At any time prior to the Effective Time, the parties hereto, by written
instrument executed by Discreet and MGI may, to the extent legally allowed, (i)
extend the time for the performance of any of the obligations or other acts of
the other parties hereto, (ii) waive any inaccuracies in the representations and
warranties of the other parties hereto contained herein or in any document
delivered pursuant hereto and (iii) waive compliance of the other parties hereto
with any of the agreements or conditions contained herein. Any agreement on the
part of a party hereto to any such extension or waiver shall be valid only if
set forth in a written instrument signed on behalf of such party.
12.6 ENTIRE AGREEMENT; NO THIRD PARTY BENEFICIARIES
This Agreement supersedes all prior agreements, arrangements or
understandings with respect to the subject matter hereof, other than the
confidentiality agreement described below. There are no representations,
warranties, agreements, covenants or conditions with respect to the subject
matter hereof except as contained herein in the confidentiality agreement dated
December 23, 1997 between Discreet and MGI or in any other written agreement,
document or instrument signed and delivered contemporaneously with or after the
execution and delivery of this Agreement, provided, for greater certainty, that
any such written agreement, document or instrument shall be binding only upon a
party which has executed the same.
12.7 GOVERNING LAW
This Agreement shall be governed by, and construed in accordance with, the
laws of the Province of Ontario and the laws of Canada applicable therein and
shall be treated in all respects as an Ontario contract and the parties consent
to the exclusive jurisdiction of the Ontario Court.
12.8 OTHER REMEDIES; SPECIFIC PERFORMANCE
Except as otherwise provided herein, any and all remedies herein expressly
conferred upon a party will be deemed cumulative with and not exclusive of any
other remedy conferred hereby, or by law or equity upon such party, and the
exercise by a party of any one remedy will not preclude the exercise of any
other remedy. The parties hereto agree that irreparable damage would occur in
the event that any of the provisions of this Agreement were not performed in
accordance with their specific terms or were otherwise breached. It is
accordingly agreed that the parties shall be entitled to an injunction or
injunctions to prevent breaches of this Agreement and to enforce specifically
the terms and provisions hereof in any Court, this being in addition to any
other remedy to which they are entitled at law or in equity.
12.9 SEVERABILITY
If any term or other provision of this Agreement is invalid, illegal or
incapable of being enforced by any rule of law, or public policy, all other
conditions and provisions of this Agreement shall nevertheless remain in full
force and effect so long as the economic and legal substance of the transactions
contemplated hereby is not affected in any manner adverse to any party. Upon
such determination that any term or other provision is invalid, illegal or
incapable of being enforced, the
<PAGE>
parties hereto shall negotiate in good faith to modify this Agreement so as
to effect the original intent of the parties as closely as possible in an
acceptable manner to the end that transactions contemplated hereby are
fulfilled to the extent possible.
12.10 ASSIGNMENT
Neither this Agreement nor any of the rights, interests or obligations
hereunder shall be assigned by any of the parties hereto (whether by operation
of law or otherwise) without the prior written consent of the other parties.
Subject to the preceding sentence, this Agreement will be binding upon, inure to
the benefit of and be enforceable by the parties and their respective successors
and permitted assigns.
<PAGE>
12.11 AUTHORITY OF DISCREET
Discreet is hereby authorized by Subco to act on its behalf and MGI shall
be entitled to and shall act on any notice given in accordance with Section 12.2
or agreement entered into by or on behalf of Subco by Discreet which represents
and warrants that it has irrevocable authority to bind Subco. Where
appropriate, references in this Agreement to Discreet shall be interpreted to
include Discreet and Subco.
IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to
be executed as of the date first written above.
MGI SOFTWARE CORP. DISCREET LOGIC INC.
By: /s/ Anthony DeCristofaro By: /s/ Francois Plamondon
----------------------------- -----------------------------------
Name: Anthony DeCristofaro Name: Francois Plamondon
Title: President and Title: Senior Vice President and
Chief Executive Officer Chief Financial Officer
1284517 ONTARIO INC.
By: /s/ Francois Plamondon
----------------------------
Name: Francois Plamondon
Title: President
<PAGE>
EXHIBIT 1 TO ARRANGEMENT AGREEMENT1 TO ARRANGEMENT AGREEMENT
PLAN OF ARRANGEMENT
UNDER SECTION 182
OF THE BUSINESS CORPORATIONS ACT (ONTARIO)
ARTICLE 1
INTERPRETATION
1.1 Definitions
In this Plan of Arrangement unless there is something in the subject matter or
context inconsistent therewith, the following terms shall have the respective
meanings set out below and grammatical variations of such terms shall have
corresponding meanings:
"AMALCO" means the corporation resulting from the Amalgamation.
"AMALCO COMMON SHARES" means the common shares of Amalco having the
attributes set forth in Appendix I hereto.
"AMALGAMATION" means the amalgamation of Subco and MGI pursuant to Section
2.3.
"ARRANGEMENT" means an arrangement under the provisions of Section 182 of
the OBCA, on the terms and conditions set forth in this Plan of
Arrangement, subject to and any amendment or variation thereto made in
accordance with Section 5.1 or made at the discretion of the Court in the
Final Order.
"ARRANGEMENT AGREEMENT" means the arrangement agreement dated as of March
2, 1998 between MGI, Discreet and Subco to which this Plan of Arrangement
is attached as Exhibit 1.
"BROKER SPECIAL WARRANTS" means the 175,000 broker special warrants issued
as additional compensation to Gordon Capital Corporation, Cannaccord
Capital Corporation and Griffiths McBurney Inc. pursuant to an agency
agreement by and among the aforementioned dealers and MGI and which
entitles the holders thereof, in the aggregate, to 175,000 compensation
options without additional payment to MGI; each compensation option
entitles the holder thereof to purchase, on or before December 29, 1998,
one MGI Common Share (subject to adjustment) at a price of $5.25 per share.
"BUSINESS DAY" means a day which is not a Saturday, Sunday or a day when
banks are not open for business in Montreal, Quebec and in Toronto,
Ontario.
"COURT" means the Ontario Court of Justice (General Division) Commercial
List or, if the Commercial List is unavailable, the Ontario Court (General
Division).
"DEPOSITARY" means The Trust Company of Bank of Montreal at its principal
office in Toronto,
<PAGE>
Ontario.
"DIRECTOR" means the Director appointed under Section 278 of the OBCA.
"DISSENT PROCEDURES" has the meaning set out in Section 3.1.
"DISSENTING SHAREHOLDER" means a holder of MGI Common Shares ("DISSENTING
SHARES") who dissents in respect of the Arrangement in strict compliance
with the Dissent Procedures.
"DISCREET" means Discreet Logic Inc.
"DISCREET COMMON SHARES" means the common shares in the share capital of
Discreet.
"EFFECTIVE DATE" means the date shown on the certificate of arrangement to
be issued by the Director giving effect to the Arrangement.
"EFFECTIVE TIME" means 12:00 a.m. (Montreal time) on the Effective Date.
"FINAL ORDER" means the final order of the Court approving the Arrangement
following the application therefor contemplated by Section 2.1 of the
Arrangement Agreement.
"INTEL WARRANTS" means the 1,022,757 common share purchase warrants
entitling the holder thereof until September 30, 2000 to purchase
1,022,757 MGI Common Shares, subject to adjustment, at the lower of (i)
$3.95 per MGI Common Share and (ii) the higher of the then current market
price of the MGI Common Shares and $3.20 per MGI Common Share.
"INTERIM ORDER" means the interim order of the Court made in connection
with the approval of the Arrangement following the application therefor
contemplated by Section 2.1 of the Arrangement Agreement.
"MGI" means MGI Software Corp.
"MGI COMMON SHARES" means the common shares in the share capital of MGI.
"MGI SHAREHOLDERS" at any time means the holders of outstanding MGI Common
Shares at such time.
"MGI STOCK OPTIONS" means the rights (whether or not vested) to purchase
MGI Common Shares which are from time to time outstanding under the MGI
Stock Option Plan.
"OBCA" means the BUSINESS CORPORATIONS ACT (Ontario).
"PLAN OF ARRANGEMENT", "HEREOF", "HEREUNDER" and similar expressions mean
this Plan of Arrangement, including the recitals and Schedules hereto, and
not any particular Article, Section or other part hereof and includes any
agreement or instrument supplementary or ancillary hereto.
"SPECIAL MEETING" means the special meeting of MGI Shareholders (including
any adjournment thereof) to be held to consider and, if deemed advisable,
to approve the Arrangement by way of special resolution (as defined under
the OBCA) of the MGI Shareholders.
<PAGE>
SUBCO" means 1284517 Ontario Inc., a wholly-owned subsidiary of Discreet
incorporated under the OBCA for the purpose of carrying out the
Arrangement.
1.2 NUMBER, GENDER AND PERSONS
In this Plan of Arrangement, unless the context otherwise requires, words
importing the singular number include the plural and VICE VERSA, words importing
any gender include all genders and words importing persons include individuals,
corporations, partnerships, associations, trusts, unincorporated organizations,
governmental bodies and other legal or business entities of any kind.
1.3 INTERPRETATION NOT AFFECTED BY HEADINGS, ETC.
The division of this Plan of Arrangement into Articles, sections and other
parts and the insertion of headings are for convenience of reference only and
shall not affect the construction or interpretation of this Plan of Arrangement.
1.4 DATE FOR ANY ACTION
In the event that any date on or by which any action is required or
permitted to be taken hereunder is not a Business Day, such action shall be
required or permitted to be taken on or by the next succeeding day which is a
Business Day.
1.5 TIME
All times expressed herein or in any letters of transmittal and election
forms are local time (Toronto, Ontario) unless otherwise stipulated herein or
therein.
1.6 CURRENCY
All references to currency in this Plan of Arrangement are to Canadian
dollars, being lawful money of Canada, and the sign "$" without more shall mean
Canadian dollars.
1.7 STATUTORY REFERENCES
Any reference in this Plan of Arrangement to a statute includes all
regulations made thereunder, all amendments to such statute or regulations in
force from time to time, and any statute or regulation that supplements or
supersedes such statute or regulations.
1.8 APPENDICES
The following are the Appendices to this Plan of Arrangement, which form an
integral part hereof:
Appendix A - Share Provisions for Amalco Common Shares;
Appendix B - General By-law No. 1 of Amalco.
<PAGE>
ARTICLE 2
ARRANGEMENT
2.1 BINDING EFFECT
This Plan of Arrangement will become effective on, and be binding on and
after, the Effective Time on (i) Subco, (ii) MGI, (iii) Discreet, as the sole
shareholder of Subco, and (iv) the MGI Shareholders.
2.2 EVENTS SEQUENTIAL
At the Effective Time, each of the provisions of this Article 2 shall occur
and be deemed to occur in the order set out below, without any further act or
formality.
2.3 THE ARRANGEMENT
(a) At the time which is the earliest moment on the Effective Date, MGI
and Subco (sometimes referred to hereinafter as "predecessor corporations") will
amalgamate to form Amalco with the same effect as if Section 179 of the OBCA
was applicable to such amalgamation and in connection with such amalgamation:
(i) all of the property of the predecessor corporations immediately before
the Amalgamation will continue to be property of Amalco;
(ii) all of the liabilities of the predecessor corporations immediately
before the Amalgamation will continue to be liabilities of Amalco;
(iii) all existing causes of action, claims or liabilities to
prosecution of or against a predecessor corporation immediately before
the Amalgamation will be unaffected;
(iv) all civil, criminal or administrative actions or proceedings pending
by or against a predecessor corporation immediately before the
Amalgamation may be continued to be prosecuted by or against Amalco;
(v) all convictions against, or rulings, orders or judgments in favour of
or against, a predecessor corporation immediately before the
Amalgamation may be enforced by or against Amalco;
(vi) the articles of arrangement in respect of the Arrangement shall be
deemed to be the articles of incorporation of Amalco and the
certificate of amendment in respect of the Arrangement shall be deemed
to be the certificate of incorporation of Amalco;
(vii) the name of Amalco will be "MGI Software Corp.";
(viii) the registered office of Amalco shall be situated in the City of
Toronto, Province of Ontario;
(ix) Amalco will be authorized to issue an unlimited number of Amalco
Common Shares having attached thereto the rights, privileges,
restrictions and conditions set forth in
<PAGE>
Appendix A hereto;
(x) there shall be no restrictions on the issue, transfer or ownership of
the shares of Amalco other than:
(A) a requirement that all share transfers be subject to the approval
of the Amalco Board of Directors;
(B) a limitation on the number of Amalco shareholders, exclusive of
persons who are in its (or a predecessor corporation's)
employment and exclusive of persons who, having been formerly in
its (or a predecessor corporation's) employment, were, while in
that employment, and have continued after termination of that
employment to be, shareholders of Amalco, is limited to not more
than fifty, two or more persons who are joint registered owners
of one or more shares being counted as one shareholder; and
(C) any invitation to the public to subscribe for the securities of
Amalco shall be prohibited;
(xi) there shall be no restrictions on the businesses which Amalco is
authorized to carry on;
(xii) the by-law of Amalco until repealed, amended, altered or added to,
shall be General By-law No. 1 of Subco attached hereto as Appendix B;
(xiii) the articles of incorporation of Amalco shall provide that the
board of directors of Amalco, without authorization of the
shareholders of Amalco may, from time to time, in such amounts and on
such terms as it deems expedient:
(1) borrow money upon the credit of Amalco;
(2) issue, reissue, sell or pledge debt obligations of Amalco;
(3) give a guarantee on behalf of Amalco to secure performance of an
obligation of any person; and
(4) charge, mortgage, hypothecate, pledge or otherwise create a
security interest in all or any of the currently owned or
subsequently acquired property and assets of Amalco including,
without limiting the generality of the foregoing, real and
personal property, movable and immovable property, tangible and
intangible assets, book debts, rates, powers, franchises and
undertakings, to secure any obligation of Amalco.
(xiv) the number of directors of Amalco shall be such number not more
than ten (10) nor less than one (1) as the board of directors may from
time to time determine; and
(xv) the first directors of Amalco shall be the persons whose names and
municipality of residence are set out below, who shall hold office
until the first annual meeting of shareholders of Amalco or the
signing of a resolution in lieu thereof or until their successors are
elected or appointed:
<PAGE>
NAME MUNICIPALITY OF RESIDENCE
Richard Szalwinski Westmount, Quebec
Francois Plamondon Montreal, Quebec
(b) Upon the Amalgamation, each Subco Common Share outstanding immediately
prior to the Amalgamation shall be converted into one Amalco Common Share and,
subject to section 4.4, each certificate representing such Subco Common Shares
shall represent the Amalco Common Shares into which such Subco Common Shares
were converted.
(c) Upon the Amalgamation, each MGI Common Share outstanding immediately
prior to the Amalgamation, other than the Dissenting Shares, shall be exchanged
for 0.162 Discreet Common Shares and, subject to section 4.4, each certificate
representing such MGI Common Shares shall represent the Discreet Common Shares
into which the MGI Common Shares formerly represented by such certificate were
exchanged, until a replacement certificate representing such Discreet Common
Shares is delivered in accordance with section 4.1.
(d) The MGI Stock Options, Broker Special Warrants and Intel Warrants
outstanding immediately prior to the Effective Time will be dealt with in
accordance with the Arrangement Agreement.
ARTICLE 3
RIGHTS OF DISSENT
3.1 RIGHTS OF DISSENT
(a) Holders of MGI Common Shares may exercise rights of dissent with
respect to such shares pursuant to and in the manner set forth in Section 185 of
the OBCA (the "DISSENT PROCEDURES") in connection with the Arrangement, as the
same may be modified by the Interim Order or the Final Order, and holders who
duly exercise such rights of dissent and who:
(i) are ultimately entitled to be paid fair value for their MGI
Common Shares shall be deemed to have transferred such MGI Common
Shares to Amalco for cancellation on the Effective Date; or
(ii) are ultimately not entitled, for any reason, to be paid fair
value for their MGI Common Shares shall be deemed to have
participated in the Arrangement on the same basis as any
non-dissenting holder of MGI Common Shares and shall receive
Discreet Common Shares on the basis determined in accordance with
Subsection 2.3(c) of this Plan of Arrangement,
but in no case shall Amalco or Discreet be required to recognize such holders as
holders of MGI Common Shares on and after the Effective Date, and the names of
such holders of Dissenting Shares shall be deleted from the registers of holders
of MGI Common Shares on the Effective Date.
<PAGE>
ARTICLE 4
CERTIFICATES AND FRACTIONAL SHARES
4.1 DELIVERY OF CERTIFICATES
Subject to the provisions of section 4.3, as soon as practicable after the
Effective Date, Discreet shall deliver to the Depositary such number of
certificates representing in the aggregate the Discreet Common Shares issued
pursuant to subsection 2.3(c) upon the exchange of outstanding MGI Common Shares
at such time pursuant to the Arrangement as are required and the Depositary
shall deliver to each registered shareholder a certificate representing the
number of Discreet Common Shares (disregarding fractions) to which such
shareholder is entitled upon the delivery by such shareholder to the Depositary
at its principal stock and bond offices in Toronto for cancellation of the
certificates formerly representing his or her MGI Common Shares, together with
all other required documents and instruments as the Depositary may reasonably
require. In the event of a transfer of ownership of MGI Common Shares which is
not registered in the transfer records of MGI, a certificate representing the
proper number of Discreet Common Shares may be issued to a transferee if the
certificate representing such MGI Common Shares is presented to the Depositary
accompanied by all documents required to evidence in effect such transfer. Until
surrendered as contemplated by this section 4.1, each certificate which
immediately prior to the Effective Date represented outstanding MGI Common
Shares that were exchanged for Discreet Common Shares on the Amalgamation shall
be deemed at all times on and after the Effective Date to represent only the
right to receive upon such surrender (i) a certificate representing Discreet
Common Shares as contemplated by this section 4.1, (ii) any dividends, amounts,
distributions, sale proceeds and accrued interest, net of any applicable
withholding or other taxes, held by the Depositary in trust for such holder
pursuant to section 4.2 and (iii) any proceeds to which any such holder may be
entitled under section 4.3.
4.2 DISTRIBUTIONS
All dividends or other amounts paid or distributions made on or after the
Effective Date on or in respect of any Discreet Common Shares to a holder
thereof before the delivery by such holder for cancellation of the certificate
formerly representing such holder's MGI Common Shares, shall be paid or made to
the Depositary to be held by it in trust for such holder. In addition, any
proceeds to which any such holder may be entitled under section 4.3 before the
delivery of such certificate shall be held by the Depositary in trust for such
shareholder. All monies so held in trust by the Depositary shall be invested by
it in interest bearing trust accounts upon such terms as the Depositary may deem
appropriate. Subject to the provisions of section 4.5, the Depositary shall pay
and deliver to any such holder, as soon as reasonably practicable after the
delivery to the Depositary for cancellation of the certificates formerly
representing the MGI Common Shares of such shareholder together with all other
required documents in accordance with section 4.1 and the delivery of the
replacement certificates referred to in such section, all dividends, amounts,
distributions, sale proceeds and accrued interest, net of any applicable
withholding or other taxes, held by the Depositary in trust for such holder
pursuant to this section 4.2. Notwithstanding the foregoing, no interest shall
be payable in respect of amounts which the Depositary shall have made available
at its principal stock and bond offices in Montreal or Toronto, as designated by
the holder thereof, or shall have mailed to the relevant holder, cheques to such
holder in payment of amounts due to such holder.
4.3 NO FRACTIONAL SHARES
<PAGE>
No certificates or script representing fractional Discreet Common Shares
shall be issued upon the surrender of certificates for exchange pursuant to
section 4.1 and no dividend, stock split or other change in the capital
structure of Discreet shall relate to any such fractional security and such
fractional interests shall not entitle the owner thereto to vote or to exercise
any rights as a security holder of Discreet. In lieu of any such fractional
securities, each person entitled to a fractional interest in Discreet Common
Shares will receive an amount of cash (rounded to the nearest whole cent) equal
to the product obtained when such fraction is multiplied by the average of the
closing sale prices of Discreet Common Shares on the Nasdaq National Market
(converted to Canadian dollars using the noon buying rate in New York City for
cable transfers in foreign currencies as certified for customs purposes by the
Federal Reserve Bank of New York for the days on which each such closing sale
price occurred) for the 20 trading days ending with the trading day that is two
(2) trading days prior to the Effective Date, such amount to be provided to the
Depositary by Discreet upon request.
4.4 LOST CERTIFICATES
If any certificate which immediately prior to the Effective Time
represented outstanding MGI Common Shares that were exchanged pursuant to
subsection 2.3(c) has been lost, stolen or destroyed, upon the making of an
affidavit of that fact by the person claiming such certificate to be lost,
stolen or destroyed, the Depositary will issue in exchange for such lost, stolen
or destroyed certificate, a certificate representing Discreet Common Shares (and
a cheque, any dividends or distributions with respect thereto pursuant to
section 4.2 and any cash for a fractional share pursuant to section 4.3)
deliverable in respect thereto. When authorizing such issuance and payment in
exchange for any lost, stolen or destroyed certificate, the person to whom a
certificate representing Discreet Common Shares and a cheque are to be issued
shall, as a condition precedent to the issuance thereof, give a bond
satisfactory to Discreet and the Depositary in such sum as Discreet may direct
or otherwise indemnify Discreet, MGI and the Depositary in a manner satisfactory
to them against any claim that may be made against Discreet, MGI or the
Depositary with respect to the certificate alleged to have been lost, stolen or
destroyed.
4.5 UNCLAIMED CERTIFICATES
Notwithstanding any of the other provisions hereof, any certificate which
immediately prior to the Effective Time represented outstanding MGI Common
Shares that were exchanged pursuant to subsection 2.3(c) that has not been
surrendered with all other instruments required by section 4.1 on or prior to
the sixth anniversary of the Effective Date shall cease to represent a claim or
interest of any kind or nature as a shareholder of MGI. On such date, the
Discreet Common Shares to which the former registered holder of such certificate
was ultimately entitled shall be deemed to have been surrendered to Discreet
together with all entitlements to dividends, distribution and cash for
fractional interests thereon held for such former registered holder for no
consideration.
<PAGE>
ARTICLE 5
AMENDMENT
5.1 PLAN OF ARRANGEMENT AMENDMENT
Subco and MGI reserve the right to amend, modify or supplement this Plan of
Arrangement at any time and from time to time provided that any such amendment,
modification, or supplement must be contained in a written document which is
filed with the Court and, if made following the Special Meeting, approved by the
Court and communicated to MGI Common Shareholders and Discreet in the manner
required by the Court (if so required).
Any amendment, modification or supplement to this Plan of Arrangement may
be proposed by MGI and Subco at any time prior to or at the Special Meeting with
or without any other prior notice or communication and, if so proposed and
accepted by the persons voting at the Special Meeting, shall become part of this
Plan for all purposes.
Any amendment, modification or supplement to this Plan of Arrangement which
is approved or directed by the Court following the Special Meeting shall be
effective only if it is consented to by MGI and Subco.
Any amendment, modification or supplement to this Plan of Arrangement may
be made following the Effective Date unilaterally by Amalco, provided that it
concerns a matter which, in the reasonable opinion of Amalco, is of an
administrative nature required to better give effect to the implementation of
this Plan of Arrangement and is not adverse to the financial or economic
interests of any holder of Amalco Common Shares.
<PAGE>
EXHIBIT 99.1
------------
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS,
NOTICE OF APPLICATION AND
MANAGEMENT INFORMATION CIRCULAR
CONCERNING AN ARRANGEMENT
INVOLVING
[LOGO]
MGI SOFTWARE CORP.
AND
[LOGO]
DISCREET LOGIC INC.
APRIL 15, 1998
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE NO.
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<S> <C>
LETTER TO SHAREHOLDERS........................................................................................ iii
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS..................................................................... iv
NOTICE OF APPLICATION......................................................................................... v
GLOSSARY OF TERMS AND EXPRESSIONS............................................................................. 2
EXCHANGE RATES................................................................................................ 4
SUMMARY....................................................................................................... 5
MANAGEMENT INFORMATION CIRCULAR............................................................................... 12
APPROVAL BY MGI SHAREHOLDERS.................................................................................. 12
THE TRANSACTION............................................................................................... 12
Background to the Transaction............................................................................... 12
Purpose of the Transaction.................................................................................. 15
Recommendation of the Board of Directors.................................................................... 16
Opinion of Financial Advisor................................................................................ 16
Details of the Transaction.................................................................................. 17
Arrangement Agreement....................................................................................... 19
Court Approval and Completion of the Arrangement............................................................ 26
Anticipated Accounting Treatment............................................................................ 27
Lock-Up Agreement........................................................................................... 28
Regulatory Approvals and Filings............................................................................ 28
MARKET FOR RESALE OF DISCREET COMMON SHARES................................................................... 29
RIGHTS OF DISSENT UNDER THE OBCA.............................................................................. 30
CANADIAN FEDERAL INCOME TAX CONSIDERATIONS.................................................................... 31
UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS............................................................... 34
RISK FACTORS.................................................................................................. 34
INFORMATION CONCERNING MGI.................................................................................... 42
Description of Business..................................................................................... 42
Description of Software Products............................................................................ 42
Business and Marketing Strategy............................................................................. 45
OEM and Distribution Arrangements........................................................................... 46
Selected Financial Information for MGI...................................................................... 47
Management's Discussion and Analysis........................................................................ 47
Capitalization.............................................................................................. 49
Description of Share Capital................................................................................ 49
Principal Holders of MGI Common Shares...................................................................... 49
Dividend Record and Policy.................................................................................. 49
Trading History............................................................................................. 49
Directors and Officers...................................................................................... 50
MGI Shares Held by Directors................................................................................ 52
Interest of Management and Others in Material Transactions.................................................. 52
Compensation of Directors and Executive Officers............................................................ 53
Summary Compensation Table.................................................................................. 53
Performance Graph........................................................................................... 56
Indebtedness of Officers and Directors to MGI............................................................... 56
Liability Insurance of Directors and Officers............................................................... 56
Auditors, Transfer Agent and Registrar...................................................................... 57
INFORMATION CONCERNING DISCREET............................................................................... 57
Description of Business..................................................................................... 57
Products.................................................................................................... 58
Advanced Systems............................................................................................ 58
</TABLE>
i
<PAGE>
<TABLE>
<CAPTION>
PAGE NO.
-----------
<S> <C>
System Components........................................................................................... 59
New Media Software.......................................................................................... 60
Customers................................................................................................... 61
Marketing and Sales......................................................................................... 61
Systems Integration, Service and Support.................................................................... 62
Research and Development.................................................................................... 62
Proprietary Rights.......................................................................................... 63
Manufacturing and Suppliers................................................................................. 64
Competition................................................................................................. 65
Employees................................................................................................... 65
Properties.................................................................................................. 65
Legal Proceedings........................................................................................... 66
Recent Acquisitions......................................................................................... 66
Selected Pro Forma Information Relating to Discreet......................................................... 67
Selected Consolidated Financial Information................................................................. 68
Management's Discussion and Analysis........................................................................ 69
Share and Loan Capital Structure............................................................................ 82
Principal Holders of Discreet Common Shares................................................................. 82
Directors and Officers...................................................................................... 83
Discreet Common Shares Held by Directors and Senior Officers................................................ 85
Dividend History............................................................................................ 85
Trading History............................................................................................. 85
Prior Sales................................................................................................. 85
Compensation of Directors and Executive Officers............................................................ 86
Summary Compensation Table.................................................................................. 86
Interest of Management and Others in Material Transactions.................................................. 92
Additional Information...................................................................................... 92
Auditors, Transfer Agent and Registrar...................................................................... 92
GENERAL PROXY INFORMATION..................................................................................... 93
Appointment of Proxyholders and Revocation of Proxies....................................................... 93
Exercise of Discretion by Proxyholders...................................................................... 93
PROCEDURES FOR THE SURRENDER OF SHARE CERTIFICATES............................................................ 94
LEGAL MATTERS................................................................................................. 94
APPROVAL OF MGI............................................................................................... 94
INDEX TO SCHEDULES............................................................................................ 95
SCHEDULE A -- SPECIAL RESOLUTION.............................................................................. A-1
SCHEDULE B -- PLAN OF ARRANGEMENT............................................................................. B-1
SCHEDULE C -- FAIRNESS OPINION OF FIRST MARATHON SECURITIES LIMITED........................................... C-1
SCHEDULE D -- MGI SOFTWARE CORP. -- FINANCIAL STATEMENTS...................................................... D-1
SCHEDULE E -- DISCREET LOGIC INC. -- CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997 and 1996, June 30, 1997..................................................... E-1
SCHEDULE F -- DISCREET LOGIC INC. -- CONSOLIDATED FINANCIAL STATEMENTS
July 31, 1996, 1995 and 1994.................................................................. F-1
SCHEDULE G -- PRO FORMA FINANCIAL STATEMENTS.................................................................. G-1
SCHEDULE H -- DISCREET LOGIC INC.'S QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED DECEMBER 31,
1997............................................................................................ H-1
SCHEDULE I -- DISCREET LOGIC INC.'S TRANSITION REPORT ON FORM 10-K FOR THE TRANSITION PERIOD FROM AUGUST 1,
1996 TO JUNE 30, 1997........................................................................... I-1
SCHEDULE J -- SECTION 185 OF THE BUSINESS CORPORATIONS ACT (ONTARIO).......................................... J-1
SCHEDULE K -- INTERIM ORDER................................................................................... K-1
</TABLE>
ii
<PAGE>
[LOGO]
April 15, 1998
Dear MGI Shareholder:
I am pleased to invite you to attend a special meeting (the "Special Meeting")
of the shareholders of MGI Software Corp. ("MGI") to be held at the Aurora Room
at the Sheraton Parkway Hotel, 600 Highway 7 East, Richmond Hill, Ontario at
10:00 a.m. (Toronto time) on May 22, 1998. Enclosed is a notice of the Special
Meeting, a management information circular ("Circular"), a form of proxy and a
letter of transmittal relating to the Special Meeting.
At the Special Meeting, shareholders of MGI will be asked to consider and vote
upon a special resolution approving an arrangement (the "Arrangement") providing
for the strategic combination of MGI and Discreet Logic Inc. ("Discreet") in
which each MGI common share would be exchanged for 0.162 Discreet common shares
and MGI would become a wholly-owned subsidiary of Discreet.
For the Arrangement to proceed, it must be approved by not less than two-thirds
of the votes cast at the Special Meeting by MGI shareholders.
Your board of directors is of the view that the terms of the Arrangement are
fair to, and in the best interests of, MGI and its shareholders. The board of
directors has unanimously approved the Arrangement and recommends that MGI's
shareholders vote FOR the resolution approving these matters.
The accompanying Circular provides a detailed description of the Arrangement,
the businesses of MGI and Discreet, related historical and pro forma financial
information, and information regarding a fairness opinion received by MGI from
its financial advisor, First Marathon Securities Limited. Please review this
information carefully so that you can reach an informed decision.
I hope that you will be able to attend the Special Meeting. EVEN IF YOU ARE
UNABLE TO ATTEND, IT IS STILL IMPORTANT THAT YOU BE REPRESENTED AT THE SPECIAL
MEETING AND I URGE YOU TO COMPLETE THE ENCLOSED GREEN FORM OF PROXY AND RETURN
IT TO THE TRUST COMPANY OF BANK OF MONTREAL PRIOR TO 5:00 P.M. ON MAY 21, 1998
IN THE POSTAGE PAID ENVELOPE PROVIDED. REGARDLESS OF THE NUMBER OF SHARES YOU
OWN, YOUR VOTE IS IMPORTANT.
Please note that in order to receive Discreet common share certificates for your
MGI common share certificates, you must also complete the enclosed blue letter
of transmittal and return it, together with the certificates representing your
MGI common shares to The Trust Company of Bank of Montreal, in accordance with
the enclosed letter of transmittal.
<TABLE>
<CAPTION>
<S> <C>
Yours very truly,
[LOGO]
[LOGO]
OREN ASHER
Chairman of the Board of Directors
</TABLE>
iii
<PAGE>
MGI SOFTWARE CORP.
40 WEST WILMOT STREET
RICHMOND HILL, ONTARIO, CANADA
L4B 1H8
------------------------
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
NOTICE IS HEREBY GIVEN that, pursuant to an order (the "Interim Order") of
the Ontario Court of Justice (General Division) dated April 9, 1998, a special
meeting (the "Special Meeting") of the shareholders of MGI Software Corp.
("MGI") will be held at the Aurora Room, Sheraton Parkway Hotel, 600 Highway 7
East, Richmond Hill, Ontario on May 22, 1998 at 10:00 a.m. (Toronto time) for
the following purposes:
(i) to consider and, if deemed advisable, to approve, with or without
variation, a special resolution (the "Special Resolution") to authorize
and approve an arrangement (the "Arrangement") under section 182 of the
BUSINESS CORPORATIONS ACT (Ontario) (the "OBCA") involving and affecting
MGI and its shareholders, Discreet Logic Inc. and 1284517 Ontario Inc.
(a wholly-owned subsidiary of Discreet Logic Inc.); and
(ii) to transact such further or other business, if any, as may properly
come before the Special Meeting, or any adjournment(s) or
postponement(s) thereof.
The full text of the Special Resolution and the Plan of Arrangement are set
out as Schedule A and Schedule B, respectively, to the accompanying Management
Information Circular (the "Circular") to which this Notice is attached.
Under the Interim Order, holders of common shares of MGI ("MGI Common
Shares") have been granted the right to dissent and to be paid the fair value of
their MGI Common Shares under section 185 of the OBCA in respect of the Special
Resolution. The dissent right is described in the attached Circular and the text
of section 185 is set out in Schedule J thereto.
Only MGI shareholders of record at the close of business on April 15, 1998
are entitled to notice of and to vote at the Special Meeting and any
adjournment(s) or postponement(s) thereof, except to the extent that a person
has transferred any MGI Common Shares after that date and the new holder of such
shares establishes proper ownership and demands not later than May 11, 1998 to
be included in the list of shareholders eligible to vote at the Special Meeting
by written notice to that effect to the Director of Corporate Communications of
MGI at the office of MGI noted above.
SHAREHOLDERS WHO ARE UNABLE TO BE PRESENT AT THE SPECIAL MEETING ARE
REQUESTED TO COMPLETE AND RETURN THE ENCLOSED FORM OF PROXY IN THE ENVELOPE
PROVIDED FOR THAT PURPOSE. PROXIES MUST BE RECEIVED AT THE TORONTO OFFICE OF
MGI'S REGISTRAR AND TRANSFER AGENT, THE TRUST COMPANY OF BANK OF MONTREAL,
BEFORE 5:00 P.M. (TORONTO TIME) ON THE LAST BUSINESS DAY PRIOR TO THE DAY OF THE
SPECIAL MEETING (OR OF ANY ADJOURNMENT OR POSTPONEMENT THEREOF), OR MAY BE
DEPOSITED WITH THE CHAIRMAN OF THE SPECIAL MEETING PRIOR TO THE COMMENCEMENT OF
THE SPECIAL MEETING ON THE DAY OF THE SPECIAL MEETING (OR ON THE DAY OF ANY
ADJOURNMENT OR POSTPONEMENT THEREOF).
DATED at Toronto, Ontario this 15th day of April, 1998.
By Order of the Board of Directors,
[LOGO]
ANTHONY DECRISTOFARO
President and
Chief Executive Officer
iv
<PAGE>
Court File No. 98-CL-002503
ONTARIO COURT (GENERAL DIVISION)
COMMERCIAL LIST
IN THE MATTER OF the BUSINESS CORPORATIONS ACT, (Ontario), R.S.O. 1990, c.
B.16, s. 182, as amended
AND IN THE MATTER OF a plan of arrangement of MGI SOFTWARE CORP.
NOTICE OF APPLICATION
TO: ALL HOLDERS OF COMMON SHARES OF MGI SOFTWARE CORP.
A LEGAL PROCEEDING HAS BEEN COMMENCED by the applicant. The claim made by
the applicant appears on the following page.
THIS APPLICATION will come on for a hearing before a Judge presiding over
the Commercial List on May 25, 1998, at 10:00 a.m., or as soon after that time
as the Application may be heard, at 393 University Avenue, Toronto, Ontario.
IF YOU WISH TO OPPOSE THIS APPLICATION, to receive notice of any step in the
application or to be served with any documents in the application, you or an
Ontario lawyer acting for you must forthwith prepare a notice of appearance in
Form 38A prescribed by the rules of court, serve it on the applicant's lawyer
or, where the applicant does not have a lawyer, serve it on the applicant, and
file it, with proof of service, in this court office, and you or your lawyer
must appear at the hearing.
IF YOU WISH TO PRESENT AFFIDAVIT OR OTHER DOCUMENTARY EVIDENCE TO THE COURT
OR TO EXAMINE OR CROSS-EXAMINE WITNESSES ON THE APPLICATION, you or your lawyer
must, in addition to serving your notice of appearance, serve a copy of the
evidence on the applicant's lawyer or, where the applicant does not have a
lawyer, serve it on the applicant, and file it, with proof of service, in the
court office where the application is to be heard as soon as possible, but not
later than 2 p.m. on the day before the hearing.
IF YOU FAIL TO APPEAR AT THE HEARING, JUDGMENT MAY BE GIVEN IN YOUR ABSENCE
AND WITHOUT FURTHER NOTICE TO YOU.
If you wish to defend this proceeding but are unable to pay legal fees,
Legal Aid may be available to you by contacting a local Legal Aid office.
<TABLE>
<CAPTION>
<S> <C>
Date: April 8, 1998 Issued by: (signed)L.J. SMITH
Local registrar
</TABLE>
Address of court office: 393 University
Avenue
Toronto, Ontario M5G
1E6
v
<PAGE>
TO: ALL HOLDERS OF COMMON SHARES
OF MGI SOFTWARE CORP.
AND TO: STIKEMAN, ELLIOTT
199 Bay Street
Suite 5300
Commerce Court West
Toronto ON M5L 1P9
Solicitors for Discreet Logic Inc.
and 1284517 Ontario Inc.
APPLICATION
1. MGI Software Corp. ("MGI") seeks:
(a) an interim order for advice and directions pursuant to section 182(5) of
the BUSINESS CORPORATIONS ACT (Ontario); and
(b) an order approving the Plan of Arrangement involving MGI and its
shareholders proposed by MGI and described in the Management Information
Circular to be dated on or about April 15, 1998 and mailed to holders of
common shares of MGI.
2. The grounds for the Application are:
(a) section 182 of the BUSINESS CORPORATIONS ACT (Ontario);
(b) all statutory requirements under the BUSINESS CORPORATIONS ACT (Ontario)
have been fulfilled;
(c) the Plan of Arrangement is fair and reasonable and put forward in good
faith;
(d) Rule 14.05(2) of the RULES OF CIVIL PROCEDURE (Ontario); and
(e) such further and other grounds as counsel may advise and this Honourable
Court may permit.
3. If made, the order approving the Plan of Arrangement will constitute the
basis for an exemption from the registration requirements of the United
States SECURITIES ACT OF 1933, as amended, with respect to the common shares
of Discreet Logic Inc. to be issued to the MGI Software Corp. stockholders
under the Arrangement.
4. The following documentary evidence will be used at the hearing of the
Application:
(a) the Affidavit of Oren Asher to be sworn, and the exhibits thereto; and
(b) such further and other material as counsel may advise and this
Honourable Court may permit.
5. The Notice of Application will be sent to all holders of common shares of
MGI at their addresses as they appear on the books of MGI at the close of
business on the day the directors of MGI select as the record date, and
pursuant to Rules 17.02(n) and 17.02(o), those shareholders whose addresses,
as they appear on the books of MGI, are outside Ontario.
Date of Issue: April 8, 1998 OSLER, HOSKIN & HARCOURT
P.O. Box 50
1 First Canadian Place
Toronto, Ontario
M5X 1B8
Larry P. Lowenstein
(416) 862-6454
Laura K. Fric
(416) 862-5899
(416) 862-6666 (fax)
Solicitors for the Applicant
vi
<PAGE>
[LOGO]
MGI SOFTWARE CORP.
MANAGEMENT INFORMATION CIRCULAR
RELATING TO A SPECIAL MEETING OF SHAREHOLDERS OF
MGI SOFTWARE CORP.
TO CONSIDER A PROPOSED ARRANGEMENT
INVOLVING
MGI SOFTWARE CORP.
AND
DISCREET LOGIC INC.
AND
1284517 ONTARIO INC.
(A WHOLLY-OWNED SUBSIDIARY OF DISCREET LOGIC INC.)
NOTE TO UNITED STATES SHAREHOLDERS
NEITHER THE TRANSACTION NOR THE DISCREET COMMON SHARES TO BE ISSUED TO MGI
SHAREHOLDERS PURSUANT THERETO HAVE BEEN APPROVED OR DISAPPROVED BY THE UNITED
STATES SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR
HAS THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS MANAGEMENT INFORMATION
CIRCULAR. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
APRIL 15, 1998
<PAGE>
GLOSSARY OF TERMS AND EXPRESSIONS
Unless the context otherwise requires, the following terms shall have the
following meanings when used in this Circular (including the Summary). These
defined terms are not used in the financial statements attached hereto. The
*(asterisk) appearing after the Discreet product names identifies the product as
being from Discreet.
"ALTERNATIVE PROPOSAL" means any offer or proposal for, or any indication of
interest in (i) an amalgamation, a consolidation, an arrangement or other
business combination involving MGI or any of its subsidiaries, (ii) the
acquisition of 20% or more of the outstanding shares in the share capital of MGI
(including without limitation by way of a tender offer or an exchange offer),
(iii) the acquisition of beneficial ownership or a right to acquire beneficial
ownership of, directly or indirectly, together with persons acting in concert,
20% or more of the then outstanding shares in the share capital of MGI, (iv) the
acquisition of any material assets (excluding the sale or distribution of assets
in the ordinary course of business) of MGI or any of its subsidiaries, or (v)
any public announcement of a proposal, plan or intention to do any of the
foregoing or any agreement to engage in any of the foregoing, in each case other
than the transactions contemplated by the Arrangement Agreement.
"AMALCO" means the corporation resulting from the Amalgamation.
"AMALCO COMMON SHARES" means the common shares in the share capital of Amalco.
"AMALGAMATION" means the amalgamation of Subco and MGI to be carried out
pursuant to the terms of the Plan of Arrangement.
"ARRANGEMENT" means the proposed arrangement to be carried out pursuant to the
terms of the Plan of Arrangement.
"ARRANGEMENT AGREEMENT" means the arrangement agreement dated as of March 9,
1998 by and among Discreet, MGI and Subco.
"BUSINESS DAY" means a day which is not a Saturday, Sunday or a day when banks
are not open for business in Montreal, Quebec and Toronto, Ontario.
"CANADIAN GAAP" means generally accepted accounting principles in effect in
Canada as of the date of the subject financial statements.
"CIRCULAR" means this management information circular of MGI prepared and sent
to the MGI Shareholders in connection with the Special Meeting.
"COMPETING TRANSACTION" means an offer made (i) to purchase or otherwise acquire
all of the outstanding MGI Common Shares held by Canadian MGI Shareholders
(other than an issuer bid), (ii) for a consideration per MGI Common Share having
a combined cash and cash equivalent value greater than the cash equivalent value
offered by Discreet for each MGI Common Share pursuant to the Arrangement, (iii)
by means of an Alternative Proposal which is available to all Canadian MGI
Shareholders, (iv) with conditions no more beneficial, taken as a whole, to the
person making the offer than those contained in the Arrangement Agreement for
the benefit of Discreet, and (v) in respect of which the Board of Directors of
MGI does not make any recommendation or which the Board of Directors of MGI
determines to be more favourable to the MGI Shareholders than the Arrangement.
"COURT" means the Ontario Court (General Division) Commercial List or, if the
Commercial List is unavailable, the Ontario Court (General Division).
"DEPOSITARY" means The Trust Company of Bank of Montreal at its principal office
in Toronto, Ontario, and includes any sub-depositary appointed thereby.
"DIRECTOR" means the Director appointed under section 278 of the OBCA.
"DISCREET" means Discreet Logic Inc., a company incorporated under Part IA of
the COMPANIES ACT (Quebec).
"DISCREET COMMON SHARES" means the common shares in the share capital of
Discreet.
"DISCREET SHAREHOLDERS" means the holders of Discreet Common Shares.
"DISCREET STOCK OPTION PLAN" means the Amended and Restated 1994 Restricted
Share and Option Plan of Discreet.
2
<PAGE>
"DISSENTING SHAREHOLDER" means a holder of MGI Common Shares who validly
dissents in respect of the Special Resolution and thereby becomes entitled to
receive fair value for their MGI Common Shares, in strict compliance with
section 185 of the OBCA.
"EFFECTIVE DATE" means the date shown in the certificate of arrangement to be
issued by the Director and giving effect to the Arrangement, which is expected
to be on or about May 27, 1998.
"EFFECTIVE TIME" means 12:00 a.m. on the Effective Date.
"EXCHANGE ACT" means the United States SECURITIES EXCHANGE ACT OF 1934, as
amended.
"FINAL ORDER" means the final order of the Court approving the Arrangement.
"FIRST MARATHON" means First Marathon Securities Limited.
"HSR ACT" means the United States HART-SCOTT-RODINO ANTITRUST IMPROVEMENTS ACT
OF 1976 (and the rules and regulations promulgated thereunder).
"IDA" means the Investment Dealers Association of Canada.
"INTEL" means Intel Corporation.
"INTERIM ORDER" means the interim order of the Court made in connection with the
approval of the Arrangement, a copy of which is attached to this Circular as
Schedule K.
"ITA" means the INCOME TAX ACT (Canada).
"LOCK-UP AGREEMENT" means the lock-up agreement dated as of March 9, 1998 by and
among Discreet, MGI and Mr. Oren Asher.
"MATERIAL ADVERSE EFFECT" means, when used in connection with Discreet or MGI,
any change, effect, event, occurrence or state of facts arising within or
specifically affecting such party that is, or would reasonably be expected to
be, material and adverse to the business, operations or condition, financial or
otherwise, of such party and its subsidiaries taken as a whole and, for greater
certainty, does not include any change, effect, event or occurrence (i)
affecting the Canadian, United States or any other economy or securities markets
in general (including any decline in the party's stock price), (ii) reasonably
attributable to the announcement of the Arrangement Agreement and the
transactions contemplated thereby, or (iii) relating to the computer software or
technology industry in general.
"MGI" means MGI Software Corp., a corporation amalgamated under the OBCA.
"MGI COMMON SHARES" means the common shares in the share capital of MGI.
"MGI SHAREHOLDERS" means the holders of MGI Common Shares.
"MGI STOCK OPTION PLAN" means MGI's stock option plan for the benefit of its
officers, directors and key employees.
"NASD" means the National Association of Securities Dealers, Inc. (United
States).
"NASDAQ" means the Nasdaq National Market System.
"NOTICE" means the Notice of Special Meeting of Shareholders attached to this
Circular.
"OBCA" means the BUSINESS CORPORATIONS ACT (Ontario).
"PLAN OF ARRANGEMENT" means the plan of arrangement proposed under section 185
of the OBCA, substantially in the form set out as Schedule B to this Circular,
as amended, modified or supplemented from time to time in accordance with its
terms.
"SEC" means the United States Securities and Exchange Commission.
"SECURITIES ACT" means the United States SECURITIES ACT of 1933, as amended.
"SECURITIES LEGISLATION" means the OBCA, the SECURITIES ACT (Quebec), the
SECURITIES ACT (Ontario) and the equivalent legislation in other provinces of
Canada, the Securities Act, the Exchange Act and the securities laws of the
states of the United States, all as now enacted or as the same may from time to
time be amended, reenacted or replaced, and the applicable rules, regulations,
rulings, orders and forms made or promulgated under such statutes and the
published policies of the regulatory authorities administering such statutes, as
well as the rules, regulations, by-laws and policies of the TSE, Nasdaq and the
NASD.
"SGI" means Silicon Graphics, Inc.
3
<PAGE>
"SPECIAL COMMITTEE" means the special committee of the MGI Board of Directors
formed to consider the Transaction.
"SPECIAL MEETING" means the special meeting of MGI Shareholders to be held to
consider and, if deemed advisable, to approve the Arrangement.
"SPECIAL RESOLUTION" means the resolution approving the Arrangement, the full
text of which is reproduced in Schedule A to this Circular.
"SUBCO" means 1284517 Ontario Inc., a wholly-owned subsidiary of Discreet
incorporated under the OBCA for the sole purpose of carrying out the
Arrangement.
"SUBCO COMMON SHARES" means the common shares in the share capital of Subco.
"TERMINATION DATE" means August 31, 1998 or such later date as may be agreed
upon in writing between the parties to the Arrangement Agreement.
"TRANSACTION" means the business combination of Discreet and MGI to be carried
out in accordance with the Arrangement Agreement.
"TSE" means The Toronto Stock Exchange.
"U.S. GAAP" means generally accepted accounting principles in effect in the
United States as of the date of the subject financial statements.
INTERPRETATION OF FINANCIAL INFORMATION
Except as otherwise indicated, dollar amounts set forth in this Circular are
expressed in Canadian dollars and "$" and "CDN$" shall mean Canadian dollars.
Readers should note that the financial information regarding Discreet is
generally indicated in United States dollars as indicated by "US$" or "U.S.$".
Except as otherwise indicated, financial information relating to MGI and
Discreet has been prepared in accordance with Canadian GAAP.
EXCHANGE RATES
On April 15, 1998, the noon rate in Toronto, payable in Canadian dollars, as
reported by the Bank of Canada was $1.4393 for each U.S.$1.00. The closing, low,
high and noon spot rates for the U.S. dollar in terms of Canadian dollars in
each of the periods indicated below as reported by the Bank of Canada were as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
THREE MONTHS ENDED -----------------------------------------------------
MARCH 31, 1998 1997 1996 1995 1994 1993
------------------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Closing.......................................... 1.4198 1.4305 1.3706 1.3640 1.4018 1.3217
Low.............................................. 1.4040 1.3345 1.3287 1.3275 1.3085 1.2400
High............................................. 1.4685 1.4399 1.3865 1.4267 1.4090 1.3484
Average Noon..................................... 1.4304 1.3844 1.3636 1.3726 1.3559 1.2898
</TABLE>
<TABLE>
<CAPTION>
FISCAL YEARS ENDED
JULY 31,
SIX MONTHS ENDED FIVE MONTHS ENDED ELEVEN MONTHS ENDED --------------------
DECEMBER 31, 1997 DECEMBER 31, 1996 JUNE 30, 1997 1996 1995
----------------- ------------------- --------------------- --------- ---------
<S> <C> <C> <C> <C> <C>
Closing................................ 1.4296 1.3705 1.3812 1.3751 1.3650
Low.................................... 1.3663 1.3283 1.3283 1.3274 1.3395
High................................... 1.4418 1.3785 1.4030 1.3870 1.4272
Average Noon........................... 1.3960 1.3580 1.3666 1.3620 1.3780
</TABLE>
4
<PAGE>
SUMMARY
THE FOLLOWING IS A SUMMARY OF CERTAIN INFORMATION CONTAINED ELSEWHERE IN
THIS CIRCULAR. REFERENCE IS MADE TO, AND THIS SUMMARY IS QUALIFIED IN ITS
ENTIRETY BY, THE MORE DETAILED INFORMATION CONTAINED IN THIS CIRCULAR AND THE
SCHEDULES HERETO. CERTAIN CAPITALIZED TERMS USED IN THIS SUMMARY ARE DEFINED
ELSEWHERE IN THIS CIRCULAR. MGI SHAREHOLDERS ARE URGED TO READ THIS CIRCULAR AND
THE SCHEDULES HERETO IN THEIR ENTIRETY. THIS CIRCULAR CONTAINS A NUMBER OF
FORWARD-LOOKING STATEMENTS WHICH REFLECT THE CURRENT VIEWS OF MGI AND/OR
DISCREET WITH RESPECT TO FUTURE EVENTS THAT ARE EXPECTED TO HAVE AN EFFECT ON
THEIR FUTURE INDIVIDUAL OR COMBINED FINANCIAL PERFORMANCE, INCLUDING BUT NOT
LIMITED TO FORWARD-LOOKING STATEMENTS REGARDING THE EXPECTED BENEFITS AND
SYNERGIES OF THE PROPOSED STRATEGIC BUSINESS COMBINATION, AND REGARDING THE
REASONS FOR THE TRANSACTION. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO
VARIOUS RISKS AND UNCERTAINTIES, INCLUDING THOSE SET FORTH UNDER "RISK FACTORS"
AND ELSEWHERE HEREIN, THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
HISTORICAL RESULTS OR THOSE CURRENTLY ANTICIPATED. READERS ARE CAUTIONED NOT TO
PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS. THE * (ASTERISK)
APPEARING AFTER THE DISCREET PRODUCT NAMES IDENTIFIES THE PRODUCT AS BEING FROM
DISCREET.
DATE, TIME AND PLACE OF THE SPECIAL MEETING
The Special Meeting will be held on May 22, 1998 at 10:00 a.m. (Toronto
time), at the Aurora Room, Sheraton Parkway Hotel, 600 Highway 7 East, Richmond
Hill, Ontario, Canada.
SHAREHOLDERS ENTITLED TO RECEIVE NOTICE
MGI fixed the close of business on April 15, 1998 as the Record Date for the
purpose of determining MGI Shareholders entitled to receive notice of the
Special Meeting. At that date, 24,012,462 Common Shares of MGI were outstanding,
each of which will be entitled to one vote in respect of the Special Resolution.
Any transferee after the Record Date who properly establishes ownership of
MGI Common Shares and requests in writing, no later than ten days before the
Special Meeting, that the transfer agent include the transferee's name in the
list of holders entitled to vote at the Special Meeting will be entitled to vote
thereat.
PURPOSE OF THE SPECIAL MEETING
The purpose of the Special Meeting is to consider and, if deemed advisable,
to approve, with or without variation, the Special Resolution approving the
Arrangement providing for the combination of MGI and Discreet in accordance with
the Plan of Arrangement consisting of (among other things) the amalgamation of
Subco and MGI, the exchange of each MGI Common Share for 0.162 Discreet Common
Shares, and all the outstanding Subco Common Shares becoming Amalco Common
Shares, and to consider such other matters as may properly come before the
Meeting. The full text of the Special Resolution is attached as Schedule A to
this Circular.
VOTES REQUIRED
Under the OBCA and subject to any further order of the Court, the
Arrangement must be approved by a special resolution passed by not less than
two-thirds of the votes cast at the Special Meeting by MGI Shareholders.
Mr. Oren Asher, Chairman of MGI's Board of Directors, beneficially owns or
has control over 2,817,423 MGI Common Shares (representing approximately 11.7%
of all outstanding MGI Common Shares). Pursuant to the terms of the Lock-Up
Agreement, Mr. Asher has agreed to vote all of his MGI Common Shares in favour
of the Special Resolution to approve the Arrangement. See "The
Transaction -- Lock-Up Agreement".
THE TRANSACTION
The Arrangement Agreement provides for the implementation, subject to the
satisfaction of certain conditions, of the Arrangement pursuant to the Plan of
Arrangement. Upon the Arrangement becoming effective, each MGI Common Share
outstanding immediately prior to the Arrangement (other than the MGI Common
Shares held by Dissenting Shareholders) shall be exchanged for 0.162 Discreet
Common Shares and each Subco Common Share outstanding immediately prior to the
Arrangement will become one Amalco Common Share. The MGI Stock Options,
Compensation Options and Intel Warrants outstanding immediately prior to the
Effective Time will each become options or warrants to acquire Discreet Common
Shares. See "The Transaction -- Arrangement Agreement -- MGI Stock Options",
"-- Compensation Options" and "-- Intel Warrants". Upon completion of the
Arrangement, it is the present intention of Discreet to proceed with the
5
<PAGE>
liquidation of Amalco into Discreet. The combined business will continue to
develop, market and support the existing Discreet and MGI product lines. See
"The Transaction -- Details of the Transaction". MGI Shareholders (other than
Dissenting Shareholders) generally will receive Discreet Common Shares without
any immediate Canadian federal income tax liability. See "Canadian Federal
Income Tax Considerations".
PURPOSE OF THE TRANSACTION
MGI and Discreet each believe that the combination of their two companies
will allow them to combine their individual resources to enhance their ability
to compete in, and profit from, the rapidly growing markets for digital photo
and video editing software. MGI and Discreet currently serve different segments
of this market and the combination of their complementary products and
distribution methodologies is expected to result in long-term benefits to the
businesses of both companies. MGI and Discreet believe that the strategic
combination of their businesses represented by the proposed Transaction
represents an effective strategy for the long-term development of their
businesses.
The Board of Directors of MGI considered a number of factors in its review
of the Transaction and the Arrangement Agreement. See "The
Transaction -- Purpose of the Transaction".
SPECIAL COMMITTEE REVIEW AND RECOMMENDATION OF THE BOARD OF DIRECTORS OF MGI
The Special Committee reviewed the terms of the Transaction and a number of
other factors and recommended that the MGI Board of Directors approve the
Arrangement, subject to receipt of the necessary approvals of the MGI
Shareholders and the Court. Based on the recommendation of the Special Committee
and its own review of the terms of the Transaction and a number of other
factors, the Board of Directors of MGI unanimously determined that the
consideration to be exchanged by Discreet for the MGI Common Shares under the
Arrangement is fair to MGI Shareholders and that the Arrangement is fair to the
MGI Shareholders and is in the best interests of MGI and the MGI Shareholders.
ACCORDINGLY, THE BOARD OF DIRECTORS HAS APPROVED THE TRANSACTION AND THE
ARRANGEMENT AGREEMENT AND UNANIMOUSLY RECOMMENDS THAT THE MGI SHAREHOLDERS VOTE
IN FAVOUR OF THE SPECIAL RESOLUTION AT THE SPECIAL MEETING. See "The
Transaction -- Recommendation of the Board of Directors".
FAIRNESS OPINION
First Marathon has delivered to the Board of Directors of MGI its written
opinion dated April 15, 1998 to the effect that, as of such date, the exchange
ratio of 0.162 Discreet Common Shares for each outstanding MGI Common Share is
fair from a financial point of view to the MGI Shareholders. The First Marathon
fairness opinion is reproduced as Schedule C to this Circular and should be read
in its entirety for a description of the procedures followed, matters considered
and assumptions made by First Marathon in arriving at its opinion. See "The
Transaction -- Opinion of Financial Advisor".
RISK FACTORS
MGI Shareholders should carefully consider the matters set forth under "Risk
Factors" beginning on page 34.
BUSINESS OF MGI
MGI designs, develops, markets and supports products in the digital
photography ("PC Photography"), digital video ("Video Publishing") and
three-dimensional graphics ("3D Graphics") markets in the multimedia segment of
the computer software industry. MGI also markets a digital desktop publishing
product in the desktop publishing ("DTP") segment of the computer software
industry. MGI's products are suitable for home and business PC users.
MGI currently distributes nine products: MGI PhotoSuite, MGI PC Photography
Kit (also sold as PC Photo Starter Kit), MGI PC Wedding Kit, MGI Sport Cards,
MGI PC Activity Kit, MGI PhotoGallery, MGI VideoWave, MGI 3DVision, and MGI
Calamus Publisher. MGI also produces and licenses original equipment
manufacturer versions of these products.
MGI PhotoSuite is a 32-bit software program that allows users to edit and
organize and be creative with their photographs on a personal computer and on
the Internet. MGI PC Photography Kit (also sold as PC PhotoStarter Kit) makes it
easy for regular film camera users to put photographs on a personal computer and
the Internet without using a digital camera or scanner. It offers 35-mm film, a
special version of MGI
6
<PAGE>
PhotoSuite, free processing of film to disk and a photo fun idea guide in one
package. MGI PC Wedding Kit allows users to put their wedding photos on a
personal computer and the Internet. Users can create co-ordinated,
professional-looking invitations, menu covers, place setting cards, wine bottle
labels and more on their own computer. The package includes a special version of
MGI PhotoSuite, free film processing to disk and an idea guide. MGI Sport Cards
is a kit that allows users to make professional-looking sport cards on a
personal computer using their sport or team photographs. The package includes
35-mm film, a special version of MGI PhotoSuite, an idea guide, sport card paper
and a coupon for free digital film processing. MGI PC Activity Kit allows users
to create crafts and jewellery with family photos on a personal computer. The
package includes a special version of MGI PhotoSuite, craft and jewellery
projects, free processing of film to disk and an idea guide. MGI PhotoGallery is
a CD-ROM collection of more than 500 professional-quality photographs that can
be used in presentations, reports and in creating Web pages on the Internet. MGI
VideoWave is a software that lets users quickly and easily capture, edit and
produce videos on a personal computer. MGI 3DVision is a 32-bit software program
that allows users to create three-dimensional artwork and animation that can be
used with other Windows software and the Internet. MGI Calamus Publisher is a
comprehensive digital publishing solution that can be used to create printed and
electronic materials such as newsletters, magazines, newspapers, advertisements,
brochures and catalogues. See "Information Concerning MGI -- Description of
Software Products".
BUSINESS OF DISCREET
Discreet develops, assembles, markets and supports non-linear, on-line
digital systems and software for creating, editing and compositing imagery and
special effects for film, video, HDTV, broadcast and the Web. Discreet's systems
and software are utilized by creative professionals for a variety of
applications, including feature films, television programs, commercials, music
and corporate videos, interactive game production, live broadcasting as well as
Web design. Discreet's systems have played key roles in the creation of special
visual effects for films such as TITANIC, FORREST GUMP, INDEPENDENCE DAY, THE
FIFTH ELEMENT, BATMAN & ROBIN, CONTACT and AIR FORCE ONE; television programs
and special events such as ABC's "WORLD NEWS TONIGHT WITH PETER JENNINGS" and
the 1996 United States Presidential elections on ABC and CBS; music videos by
artists including U2, REM, Rolling Stones and The Beatles; and commercials for
clients such as Nike, Pepsi, AT&T and McDonald's.
Discreet offers high-end turnkey systems and software focused towards three
markets: special effects, editing and broadcast production. Discreet's systems
include its inferno* and flame* systems (special effects), its fire* and smoke*
systems (editing) and its frost* system (broadcast production). Discreet's
flame* system is used to create, edit and composite special visual effects in an
on-line, real-time environment, providing instant feedback to the creative
professional. Discreet's inferno* system is an on-line, non-linear, resolution
independent, uncompressed digital system providing all of the features of flame*
with film tools and increased film resolution and colour control for digital
film work. Discreet's fire* system is an uncompressed, on-line, non-linear
digital video editing system with special effects capabilities. Discreet's
smoke* system is an uncompressed, on-line, non-linear digital video editing
system with limited special effects capabilities. In the broadcast production
market, Discreet offers its frost* system, a computer-based set of modelling,
animation and rendering tools for the creation and manipulation of 3D graphics,
including virtual sets for broadcast companies. Discreet's new media software
products include its recently acquired effect* and paint* products, and its
edit* and light* products. Discreet sells its systems and software through a
direct sales force as well as through distributors and resellers.
Discreet's goal is to become a leading supplier of digital tools used to
manipulate still and moving pictures to the high-end professional
post-production and broadcast markets, the desktop or new media market, and the
consumer markets. To achieve this goal, Discreet plans to further expand and
leverage its technology base, customer relationships and existing reputation,
extend its product line to include other aspects of the content creation
process, and expand its worldwide sales and distribution organization. See
"Information Concerning Discreet -- Description of Business".
COURT APPROVAL AND COMPLETION OF THE ARRANGEMENT
In addition to the requirement for the approval of MGI Shareholders and that
certain conditions be satisfied or waived, the implementation of the Arrangement
is subject to approval of the Court. Prior to the mailing of this Circular, MGI
obtained the Interim Order which is attached to this Circular as Schedule K.
7
<PAGE>
Following the Special Meeting and subject to the approval of the Special
Resolution by MGI Shareholders, MGI will make an application to the Court for
the Final Order. A copy of the Notice of Application for the Final Order is
attached to the front of the package of which this Circular forms a part. The
hearing in respect of the Final Order is scheduled to take place at 10:00 a.m.
on May 25, 1998 at 393 University Avenue, Toronto, Ontario, Canada or as soon
thereafter as counsel may be heard. At that hearing, any MGI Shareholder or
other interested party who wishes to participate or to be represented or to
present evidence or argument may do so, subject to filing with the Court and
serving such notice of appearance upon MGI's solicitors, and upon all other
parties who have filed a notice of appearance as provided in the Interim Order.
At the hearing for the Final Order, the Court will consider, among other things,
the fairness of the Arrangement.
The Arrangement will become effective on the Effective Date. This will occur
after the requisite shareholder and Court approvals have been obtained and all
other conditions set out in the Arrangement Agreement have been satisfied or
waived, which is expected to occur shortly after the Special Meeting. See "The
Transaction -- Court Approval and Completion of the Arrangement".
RIGHTS OF DISSENT
Under the Arrangement and the Interim Order, an MGI Shareholder is entitled
to dissent in respect of the Special Resolution in accordance with section 185
of the OBCA if MGI has received from such MGI Shareholder a written objection to
the Special Resolution at or prior to the Special Meeting. If the Arrangement
becomes effective, a Dissenting Shareholder of MGI will be entitled to be paid
the fair value of its shares in accordance with section 185 of the OBCA. Strict
compliance with the provisions of section 185 of the OBCA will be required in
order to validly exercise such rights of dissent. See Schedule J for the full
text of section 185 of the OBCA. See "Rights of Dissent under the OBCA".
CONDITIONS TO THE ARRANGEMENT
Completion of the Arrangement is subject to the satisfaction of a number of
conditions, including approval by the MGI Shareholders and the approval of the
Arrangement by the Court. See "The Transaction -- Arrangement
Agreement -- Conditions to Closing".
OPTION
MGI has granted to Discreet, in the Arrangement Agreement, an option to
purchase up to 4,795,442 MGI Common Shares at an exercise price of $5.32 per MGI
Common Share exercisable in certain specified circumstances, including where a
person other than Discreet has made an Alternative Proposal. See "The
Transaction -- Arrangement Agreement -- Discreet's Option to Acquire MGI Common
Shares".
TERMINATION
The Arrangement Agreement may be terminated and the Transaction may be
abandoned prior to the Effective Date notwithstanding approval by MGI
Shareholders under the circumstances specified in the Arrangement Agreement,
including, without limitation, by mutual consent of Discreet and MGI and by
either party if the Arrangement is not consummated by August 31, 1998. See "The
Transaction -- Arrangement Agreement -- Termination of Arrangement Agreement".
Under certain circumstances either MGI or Discreet may be required to pay to
the other termination fees and expenses if the Arrangement Agreement is
terminated. See "The Transaction -- Arrangement Agreement -- Expenses and
Termination Fees".
STOCK EXCHANGE LISTINGS
It is a condition to the Arrangement that the Discreet Common Shares to be
issued or reserved for issuance thereunder be listed for trading on Nasdaq.
Discreet is in the process of preparing the required Nasdaq National Market
Notification Form for the Listing of Additional Shares in respect of the listing
of such Discreet Common Shares on Nasdaq. Discreet does not currently intend to
list the Discreet Common Shares on the TSE or any other stock exchange in
Canada.
REGULATORY MATTERS
The proposed Transaction is subject to the receipt of certain regulatory
approvals. See "The Transaction -- Regulatory Approvals and Filings".
8
<PAGE>
CANADIAN FEDERAL INCOME TAX CONSIDERATIONS
Under Canadian federal income tax laws, no gain or loss will be recognized
upon the completion of the Arrangement by MGI Shareholders (other than
Dissenting Shareholders) who hold MGI Common Shares as capital property. MGI
Shareholders should consult their own tax advisors for advice with respect to
the Canadian tax consequences to them of the Arrangement. See "Canadian Federal
Income Tax Considerations".
UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The transfer of the MGI Common Shares pursuant to the Arrangement is
expected to be treated as a taxable transaction for United States federal income
tax purposes. In general, gain or loss should be recognized by U.S. MGI
Shareholders who receive Discreet Common Shares in exchange for MGI Common
Shares. Gain or loss should also generally be recognized by U.S. MGI
Shareholders who exercise statutory dissent rights. It is possible, however,
that the exchange of MGI Common Shares for Discreet Common Shares as a result of
the Arrangement could qualify as a non-taxable "reorganization" for United
States federal income tax purposes. U.S. MGI Shareholders are urged to consult
their own advisors. See "United States Federal Income Tax Considerations".
MARKET PRICES
Closing market prices of the MGI Common Shares on the TSE on March 6, 1998,
the last trading day before the proposed Arrangement was publicly announced, and
on April 15, 1998 were $4.55 and $4.35, respectively.
The last reported sale price of the Discreet Common Shares on Nasdaq on
March 9, 1998, the last trading day before the Arrangement was publicly
announced and on April 15, 1998, were U.S.$25 1/16 and U.S.$19 1/2,
respectively.
ANTICIPATED ACCOUNTING TREATMENT
The Transaction will be accounted for using the purchase method of
accounting under Canadian GAAP. Price Waterhouse, MGI's independent auditors,
have provided their opinion, based on circumstances existing as at April 15,
1998, that no conditions exist which relate to MGI that would preclude MGI from
being a party to a business combination with Discreet for which the pooling of
interests method of accounting under U.S. GAAP would apply. MGI has been advised
by Discreet that Discreet currently expects, but is not bound, to account for
the Transaction using the pooling of interests method of accounting under U.S.
GAAP. See "The Transaction -- Anticipated Accounting Treatment".
SELECTED FINANCIAL INFORMATION FOR MGI
The following table presents selected financial information for MGI for the
periods indicated. This table should be read in conjunction with the financial
statements of MGI set forth in Schedule D to this Circular.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31
----------------------------
1998 1997
------------- -------------
(thousands, except
share data)
<S> <C> <C>
Revenue............................................................................. $ 13,348 $ 5,144
Gross profit........................................................................ 10,688 3,815
Expenses............................................................................ 17,848 8,979
Loss for the year................................................................... (6,950) (7,403)
Loss per share...................................................................... (0.35) (0.48)
Weighted average number of common shares outstanding................................ 19,958,968 15,355,052
</TABLE>
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<PAGE>
BALANCE SHEET DATA
<TABLE>
<CAPTION>
YEAR ENDED JANUARY
31
--------------------
1998 1997
--------- ---------
(thousands)
<S> <C> <C>
Current assets................................................................................ $ 18,527 $ 7,891
Capital assets................................................................................ 1,487 952
Liabilities................................................................................... 3,344 2,385
Shareholders' equity.......................................................................... 16,670 6,458
</TABLE>
SELECTED CONSOLIDATED FINANCIAL INFORMATION FOR DISCREET
The following table presents selected consolidated financial information for
Discreet for the periods indicated. This table should be read in conjunction
with the consolidated financial statements of Discreet set forth in Schedule E
to this Circular.
STATEMENT OF OPERATIONS DATA
<TABLE>
<CAPTION>
SIX-MONTH FIVE-MONTH ELEVEN-MONTH
PERIOD ENDED PERIOD ENDED PERIOD ENDED
DECEMBER 31, DECEMBER 31, JUNE 30,
1997(1) 1996(1) 1997(2)
------------- ------------- ---------------
(thousands of dollars, except share data)
<S> <C> <C> <C>
Total revenues..................................................... U.S.$ 75,673 U.S.$ 40,096 U.S.$ 101,923
Total operating expenses(3)........................................ 31,399 17,585 46,082
Net income......................................................... 8,238 1,153 2,772
Earnings per share................................................. 0.29 0.04 0.10
Weighted average number of common shares outstanding............... 28,745,695 27,852,370 27,947,807
</TABLE>
BALANCE SHEET DATA
<TABLE>
<CAPTION>
AS AT
AS AT JUNE 30,
DECEMBER 31, 1997(1) 1997(2)
-------------------- ---------------
(thousands of dollars)
<S> <C> <C>
Current assets.............................................................. U.S.$ 60,297 U.S.$ 76,819
Property and equipment -- less accumulated depreciation and amortization.... 9,583 7,728
Current liabilities......................................................... 48,698 58,283
Total shareholders' equity.................................................. 64,744 46,476
</TABLE>
- ---------------
(1) The financial information as at December 31, 1997 and for the six-month
period ended December 31, 1997 and the five-month period ended December 31,
1996 has been derived from the unaudited interim consolidated financial
statements of Discreet.
(2) The financial information as at June 30, 1997 and for the eleven-month
period then ended has been derived from the audited consolidated financial
statements of Discreet.
(3) Before interest income, interest expense, foreign currency exchange gain
(loss) and provision for income taxes.
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<PAGE>
SELECTED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION FOR DISCREET
The following table presents selected unaudited pro forma consolidated
financial information for Discreet in respect of the eleven-month period ended
June 30, 1997 after giving effect to the Arrangement and the accounting for the
Arrangement as a purchase in accordance with Canadian GAAP. This table should be
read in conjunction with the pro forma consolidated financial statements of
Discreet, the notes thereto and the compilation report of Arthur Andersen & Cie
with respect thereto set forth in Schedule G to this Circular.
The pro forma consolidated statement of operations is not necessarily
indicative of the results of operations that would have occurred in the
eleven-month period ended June 30, 1997 or on that date had the Arrangement been
effected at the beginning of the period nor is it necessarily indicative of
future operating results of the combined entities. In preparing these pro forma
consolidated financial statements, no adjustments have been made to reflect the
additional costs or savings, if any, that could result from combining the
operations of Discreet and MGI. In preparing the pro forma financial statements,
management has made certain estimates and assumptions that affect the amounts
reported in the pro forma financial statements. Actual amounts recorded upon
consummation of the Transaction may differ from these estimates.
PRO FORMA STATEMENT OF OPERATIONS DATA
<TABLE>
<CAPTION>
ELEVEN-MONTH PERIOD
ENDED
JUNE 30, 1997(1)
-------------------
(thousands of
dollars,
except share data)
<S> <C>
Total revenues................................................................................ U.S.$ 111,093
Total operating expenses(2)................................................................... 88,012
Net loss...................................................................................... (31,671)
Loss per share................................................................................ (0.99)
Weighted average number of common shares outstanding.......................................... 31,832,115
</TABLE>
PRO FORMA BALANCE SHEET DATA
<TABLE>
<CAPTION>
AS AT
JUNE 30,
1997(1)
---------------
(thousands
of dollars)
<S> <C>
Current assets.................................................................................... U.S.$ 89,546
Property and equipment -- less accumulated depreciation and amortization.......................... 8,750
Current liabilities............................................................................... 63,580
Total shareholders' equity........................................................................ 154,064
</TABLE>
- ---------------
(1) The financial information as at June 30, 1997 and for the eleven-month
period then ended has been derived from the unaudited pro forma consolidated
financial statements of Discreet.
(2) Before interest income, interest expense, foreign currency exchange loss and
provision for income taxes.
11
<PAGE>
MANAGEMENT INFORMATION CIRCULAR
THIS CIRCULAR IS FURNISHED BY MGI IN CONNECTION WITH THE SOLICITATION BY OR
ON BEHALF OF THE MANAGEMENT OF MGI OF PROXIES TO BE USED AT THE SPECIAL MEETING
TO BE HELD ON MAY 22, 1998 AT THE TIME AND PLACE AND FOR THE PURPOSES SET FORTH
IN THE ACCOMPANYING NOTICE, OR ANY POSTPONEMENT OR ADJOURNMENT THEREOF.
It is anticipated that this Circular and the accompanying form of proxy will
be first mailed to MGI Shareholders on or about April 17, 1998. Unless otherwise
stated, information contained in this Circular is given as at April 15, 1998.
The principal executive and registered office of MGI is located at 40 West
Wilmot Street, Richmond Hill, Ontario L4B 1H8, and its telephone number is (905)
764-7000.
Information contained in this Circular concerning Discreet and Subco has
been obtained from information that is publicly available or has been furnished
by such companies to MGI for the purposes of this document. Such companies have
advised MGI that they have reviewed such information as included in this
Circular. MGI has not made any independent investigation of such information.
No persons have been authorized to give any information or to make any
representations other than those contained in this Circular in connection with
the solicitation of proxies or the offering of securities and, if given or made,
such information or representation must not be relied upon as having been
authorized by MGI or Discreet.
APPROVAL BY MGI SHAREHOLDERS
Under the OBCA and subject to any further order of the Court, the Special
Resolution must be passed by not less than two-thirds of the votes cast in
respect of the Special Resolution by MGI Shareholders, present or voting by
proxy, at the Special Meeting. As of April 15, 1998, MGI's issued and
outstanding share capital consisted of 24,012,462 MGI Common Shares. Each MGI
Shareholder is entitled to one vote for each MGI Common Share registered in the
shareholder's name on the list of MGI Shareholders at the close of business on
April 15, 1998.
MGI has fixed the close of business on April 15, 1998 as the record date for
the purpose of determining MGI Shareholders entitled to receive notice of the
Special Meeting. Any transferee after that date who properly establishes
ownership of the relevant shares and requests in writing, no later than ten days
before the Special Meeting, that the transfer agent include the transferee's
name in the list of holders entitled to vote at such Special Meeting, will be
entitled to vote thereat.
As at April 15, 1998, Mr. Oren Asher, Chairman of MGI's Board of Directors,
beneficially owns 2,817,423 MGI Common Shares, representing approximately 11.7%
of all outstanding MGI Common Shares. As at April 15, 1998, to the knowledge of
the directors and officers of MGI, no other person beneficially owns, or
exercises control or direction over, more than 10% of the outstanding MGI Common
Shares. Mr. Asher has entered into the Lock-Up Agreement in which he has agreed,
subject to the terms and conditions thereof, to vote all of his MGI Shares in
favour of the Arrangement. See "The Transaction -- Lock-Up Agreement". All of
the directors and officers of MGI have indicated their intention to vote all of
their MGI Common Shares in favour of the Special Resolution to approve the
Arrangement.
THE TRANSACTION
BACKGROUND TO THE TRANSACTION
The terms of the Arrangement Agreement are the result of arm's length
negotiations between representatives of MGI and Discreet. The following is a
summary of the background of these negotiations and the review of the
Transaction undertaken by the Special Committee and the Board of Directors of
MGI.
In late November, 1997, Mr. Anthony DeCristofaro, the President and Chief
Executive Officer of MGI, was contacted by Mr. Richard Szalwinski, President,
Chief Executive Officer and Chairman of the Board of Directors of Discreet. This
was the first time that MGI was contacted by Discreet and led to an initial
meeting on December 3, 1997, at MGI's offices in Toronto. At this initial
meeting, Mr. DeCristofaro met with Mr. Szalwinski and Mr. Francois Plamondon,
the Chief Financial Officer of Discreet and made a presentation of MGI's
business and provided a product overview and market assessment.
12
<PAGE>
The next meetings between MGI and Discreet were held in Montreal on December
22 and 23, 1997. Mr. DeCristofaro and Mr. Oren Asher, the Chairman of MGI, met
with Mr. Szalwinski, Mr. Plamondon and Mr. Timothy Getz, Discreet's Vice
President, Corporate Development, on the evening of December 22 and shared their
respective views on the current status and future direction and vision of the
digital imaging software market. The following day, the same individuals met at
Discreet's offices to familiarize each other with their respective companies'
histories, organizations and product ranges. On December 23, 1997, MGI and
Discreet entered into a Confidentiality Agreement relating to their discussions
and the mutual exchange of information in connection with a possible business
transaction or strategic relationship.
On January 18, 1998, Mr. Joel Goldman, MGI's Chief Financial Officer, Mr.
DeCristofaro and Mr. Asher met with Messrs. Szalwinski, Plamondon and Getz at
MGI's offices to discuss issues regarding the direction of the market, the
impact on (and implications for) the companies, and business issues that might
be addressed in any business relationship or transaction.
The next meeting between the parties was held on January 27, 1998, in
Toronto among Messrs. DeCristofaro, Szalwinski and Plamondon where the parties
continued their general business discussions from prior meetings. However, these
meetings did not include any discussion of specific financial terms of a
possible transaction. Shortly after that meeting, Mr. Plamondon requested
certain documents relating to the history and current status of MGI, which were
provided to him.
The next meeting between the parties was held on February 5, 1998 in
Montreal. At this meeting, Messrs. DeCristofaro and Asher met with Messrs.
Szalwinski, Plamondon and Getz and the participants outlined their respective
views on market trends, discussed the complementary nature of the two companies'
product lines, the complementary nature of their respective corporate cultures,
and had a general discussion of appropriate transaction structures for a
possible business combination, general business integration issues in the event
of a business combination and a wide range of valuation expectations. The
parties agreed to contact each other during the following week, however, no
further meetings were scheduled at that time.
Throughout this period from December 23, 1997 through February 5, 1998 of
preliminary discussions regarding a possible business relationship between MGI
and Discreet, the management representatives on the MGI Board of Directors
(Messrs. Asher, DeCristofaro and Goldman) had apprised the remaining MGI
directors that these general business discussions were underway with Discreet
and had generally kept all such directors informed of the status of these
discussions on a continuing basis.
A follow-up meeting was subsequently scheduled and held in Toronto on
February 11, 1998 among Mr. Plamondon and Messrs. DeCristofaro, Asher and
Goldman. At that meeting, more specific discussions were held regarding pricing
and valuation models applicable to a share for share exchange transaction. Mr.
Plamondon agreed to relate these discussions to Mr. Szalwinski. Mr. Szalwinski
found the preliminary discussions of the potential structure, among other
things, acceptable, and authorized Discreet's management to continue further
discussions later that week.
Over the next several weeks the senior management teams of each company,
along with their professional advisors, explored the feasibility of a potential
transaction and conducted technical, legal and business due diligence regarding
the other company.
On February 13, a conference call was held between Mr. Asher, Mr. Goldman,
MGI's legal counsel, Mr. Plamondon and Ms Nancy Cleman, Discreet's General
Counsel, during which pricing and other details of a possible transaction were
discussed.
On February 16, MGI and Discreet signed a letter agreement permitting
Discreet to conduct extensive due diligence on MGI and providing certain
restrictions on MGI's ability to solicit or negotiate other offers.
On February 19, 1998, Mr. Terrence Higgins, Discreet's Vice President,
Advanced Systems Products and Mr. Chafye Nemri, Discreet's Director of Labs, met
with Mr. DeCristofaro in Toronto to review and assess the architecture of
certain key MGI products.
On February 20, 1998, Mr. Remi Makhoul, Director, Business Development of
Discreet, met with Messrs. DeCristofaro and Goldman and certain other MGI
personnel to conduct more extensive financial due diligence in respect of a
possible merger transaction. On the same day Ms Cleman also met with Mr. Goldman
13
<PAGE>
to conduct more extensive legal due diligence in respect of a possible merger
transaction. These due diligence discussions continued among these individuals
and the companies' respective financial and legal advisors on February 21 and 22
with the review of various legal, financial and general business matters.
On February 25 and 26, 1998, Messrs. Szalwinski and Plamondon met with
Messrs. Asher, DeCristofaro and Goldman to discuss various aspects of a possible
business combination, including how a combined entity might be structured
following a merger transaction, significant issues arising in a possible merger
transaction agreement and the potential future roles of certain key individuals.
During the period of these more advanced discussions from February 11, 1998
through March 2, 1998, the management representatives on the MGI Board of
Directors apprised the remaining MGI directors of the continuing progress of
discussions with Discreet regarding a possible strategic merger and had
generally continued to keep all such directors informed of the status of these
discussions. In late February, a package of documents describing Discreet's
history and current status, and including analysts' reports and press clippings,
was distributed to all MGI directors. At that time, one of MGI's non-management
directors, Mr. Dennis Bennie, was assigned the task of selecting and negotiating
the engagement of a financial advisor to provide a fairness opinion and related
financial services to the MGI Board of Directors, or any special committee of
the MGI Board of Directors that might be formed to consider a possible strategic
merger transaction.
In late February, MGI organized its due diligence team consisting of MGI
staff and external advisors, which began performing technical, legal, financial
and general business due diligence on Discreet. Formal due diligence meetings
were held in Montreal on February 27, 1998 among various representatives of MGI,
its external advisors and Discreet.
On February 27, 1998, Discreet's counsel provided MGI and its counsel with
an initial draft of the Arrangement Agreement which led to intensive
negotiations among the parties and their advisors over the next several days.
On March 2, 1998, the MGI Board of Directors met to review and discuss
various issues relating to the proposed transaction, including approving the
selection of First Marathon as financial advisor and the status of negotiations
with Discreet and due diligence of Discreet. At that meeting, the MGI Board
authorized management to continue negotiations regarding a possible transaction.
Also at that meeting, the MGI Board considered whether it would be appropriate
to create a special committee of directors to review and consider the proposed
transaction. The Board concluded that it was not necessary to do so at that time
since none of the directors then had any interest in the proposed transaction
other than as an MGI Shareholder. However, the MGI Board acknowledged that, in
the course of further negotiations, certain of the directors might enter into
agreements with Discreet which could make a special committee desirable.
Over the next several days, intensive negotiations and due diligence
continued and on March 5, 1998, the MGI Board of Directors held another meeting.
At that meeting, Mr. Oren Asher advised the MGI Board that, at Discreet's
request, he had agreed to enter into an agreement with Discreet whereby he would
agree to vote all of his MGI Common Shares in favour of the proposed
transaction. See "The Transaction -- Lock-Up Agreement". As a result of this
proposed lock-up agreement, the MGI Board reviewed its analysis at the March 2,
1998 meeting and constituted a special committee of directors, consisting of all
members of the MGI Board of Directors other than Mr. Asher, to review and
consider the proposed transaction and make a recommendation to the entire MGI
Board (the "Special Committee"). That discussion was followed by a presentation
from First Marathon to the Special Committee regarding the fairness of the
proposed terms of the Transaction, from a financial point of view, to the MGI
Shareholders. In that presentation, First Marathon provided the Special
Committee with its oral opinion that the proposed terms of the Transaction were
fair to the MGI Shareholders from a financial point of view. That March 5
meeting also included a detailed review of the status of negotiations, the
proposed structure of the Transaction, the form of the proposed Arrangement
Agreement, and the effect of the Transaction on the MGI Shareholders. After
extensive discussions, the Special Committee recommended and the MGI Board
provided authority to management, within certain parameters, to enter into a
definitive Arrangement Agreement, substantially in the form of the agreement
tabled at the meeting, with Discreet regarding a Transaction.
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Intensive negotiations and due diligence continued over the next several
days until March 9, 1998, when the definitive Arrangement Agreement was settled
and signed and a press release was issued.
On April 13, 1998, the MGI Board of Directors ratified the final Arrangement
Agreement and the entering into of the Transaction, subject to receipt of
written confirmation of First Marathon's opinion and receipt of all necessary
approvals of the MGI Shareholders and the Court. At that meeting, the MGI Board
also approved the contents of this Circular and the date of the Special Meeting.
First Marathon provided its written fairness opinion to MGI on April 15, 1998,
and a copy is attached as Schedule C to this Circular.
PURPOSE OF THE TRANSACTION
MGI and Discreet each believe that the strategic combination of their two
companies will allow them to combine their individual resources to enhance their
ability to compete in, and profit from, the rapidly growing market for digital
multimedia software. MGI and Discreet currently serve different segments of this
market and the combination of their complementary products and distribution
channels is expected to benefit the current business lines of both companies.
MGI and Discreet believe that the strategic combination of their businesses
represents an effective strategy for the long-term development of their
businesses.
The Board of Directors of MGI has reviewed the terms of the Transaction as
set out in the Arrangement Agreement and has unanimously determined (Mr. Asher
refraining from voting based on the potential conflict of interest arising from
the Lock-Up Agreement) that the consideration to be exchanged by Discreet for
the MGI Common Shares under the Arrangement is fair to MGI Shareholders and that
the Arrangement is fair to MGI Shareholders and is in the best interests of MGI
and the MGI Shareholders. ACCORDINGLY, THE MGI BOARD OF DIRECTORS HAS APPROVED
THE TRANSACTION AND THE ARRANGEMENT AGREEMENT AND UNANIMOUSLY RECOMMENDS TO MGI
SHAREHOLDERS THAT THEY VOTE IN FAVOUR OF THE SPECIAL RESOLUTION AT THE SPECIAL
MEETING.
The MGI Board of Directors based its approval of the Transaction on its
determination that the financial terms of the Arrangement are fair to MGI and
the MGI Shareholders and upon a number of other factors, including, the
following:
- the combined company is expected to provide a much broader scope of
digital photo and video editing software products then are currently
manufactured by either company as a result of the combination of MGI's and
Discreet's technology and complementary product lines;
- the combined company is expected to be in a position to benefit from the
complementary distribution channels currently employed by each of MGI and
Discreet in their own businesses including the ability to leverage
Discreet's technology through MGI's current product installed base;
- the combined company should be able to leverage the Discreet brand and
combine marketing efforts to enhance the overall branding and marketing of
MGI's current products in the retail segment;
- the financial resources of the combined company are expected to provide
additional capital to develop and expand MGI's business;
- Discreet has an experienced management team which, when combined with
MGI's management team, should add value to the continued growth and
development of MGI's business;
- the combination of MGI and Discreet is expected to result in a company
with greater financial, technological and human resources to develop new
generations of products; and
- the financial terms of the Transaction represent a premium of
approximately 26% over the closing market price of MGI Common Shares on
March 6, 1998, the last trading day prior to the execution of the
Arrangement Agreement.
The MGI Board of Directors also considered the following information in
concluding that the financial and other terms of the Arrangement are fair to MGI
and the MGI Shareholders:
- its knowledge of the respective businesses, operations, property, assets,
financial condition, operating results and prospects of MGI and Discreet;
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- current industry, economic and market conditions and trends and its
informed expectations of the future of the software industry in general
and the digital imaging software market in particular;
- the opinion of First Marathon that the exchange ratio in the Transaction
of 0.162 Discreet Common Shares for each MGI Common Share is fair, from a
financial point of view, to the MGI Shareholders;
- the terms of the Arrangement Agreement;
- the structure and accounting and tax treatment of the Transaction;
- the respective corporate cultures and strategies of MGI and Discreet; and
- the long-term strategic goals of MGI.
The MGI Board of Directors also considered the fact that the Arrangement
must be approved by a special resolution passed by not less than two-thirds of
the votes cast at the Special Meeting by MGI Shareholders, and by the Court
which, MGI is advised, will consider, among other things, the fairness of the
Arrangement to the MGI Shareholders. The MGI Board also considered the fact that
the Arrangement includes provisions which will permit MGI Shareholders who are
opposed to the Arrangement to, upon compliance with certain conditions, dissent
from the approval of the Special Resolution in accordance with the OBCA and be
paid the fair value of their MGI Common Shares as provided therein. See "Rights
of Dissent under the OBCA".
In considering the proposed Transaction, the MGI Board of Directors
recognized that there were certain risks associated with the Transaction,
including the risk that the potential benefits described above may not be
realized or that there may be higher than expected costs associated with the
achievement of such benefits. The MGI Board of Directors also considered the
factors described in this Circular under the heading "Risk Factors".
In view of the variety of factors considered in connection with its
evaluation of the Transaction, the MGI Board of Directors did not find it
practicable to and did not quantify or otherwise assign relative strengths to
the specific factors considered in reaching its determination.
RECOMMENDATION OF THE BOARD OF DIRECTORS
THE MGI BOARD OF DIRECTORS HAS CONCLUDED THAT THE TRANSACTION IS FAIR TO AND
IN THE BEST INTERESTS OF MGI AND ITS SHAREHOLDERS AND THEREFORE UNANIMOUSLY
RECOMMENDS THAT MGI SHAREHOLDERS VOTE IN FAVOUR OF THE SPECIAL RESOLUTION AND
THEREBY APPROVE THE IMPLEMENTATION OF THE ARRANGEMENT.
OPINION OF FINANCIAL ADVISOR
On February 27, 1998, First Marathon was retained as financial advisor to
MGI. The services rendered by First Marathon consisted of advising and assisting
the Special Committee of the Board of Directors of MGI in its evaluation of the
Transaction including the preparation and delivery of the fairness opinion
referred to below.
MGI has agreed to pay a fee to First Marathon which is not conditional upon
the successful completion of the proposed Transaction. First Marathon is
considered to be independent of MGI within the meaning of Policy Statement 9.1
of the Ontario Securities Commission. First Marathon was subject to no
limitations imposed by the Special Committee in connection with its advice or in
the scope of its investigation.
First Marathon made a presentation to the MGI Board of Directors on March 5,
1998 which included its verbal opinion that the terms of the Arrangement were
fair, from a financial point of view, to the MGI Shareholders. This opinion was
confirmed in the written fairness opinion provided by First Marathon on April
15, 1998 which is attached hereto as Schedule C. In arriving at its fairness
opinion, First Marathon reviewed and relied upon the following: (i) audited
financial statements for MGI from the time of incorporation to January 31, 1998;
(ii) revenue and operating projections for MGI prepared by the management of MGI
for the three fiscal years ending January 31, 2001; (iii) documentation related
to the October 1, 1997 private placement of MGI Common Shares and Intel
Warrants; (iv) MGI prospectuses dated August 9, 1996, February 25, 1997 and
December 8, 1997; (v) supplemental agreements dated April 11, 1996, March 13,
1996 and January 23, 1996 between MGI, Globex Biotechnologies Incorporated and
Wayne Bradbury; (vi) agreement dated October 3, 1995 between Ditek Software
Corporation and MGI; (vii) audited financial statements for
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Discreet for the 11 months ended June 30, 1997 and for the four years ended July
31, 1996; (viii) unaudited interim financial statements for Discreet for the six
months ended December 31, 1997; (ix) certain public information regarding the
trading history of MGI Common Shares and Discreet Common Shares; (x) certain
public information relating to the business, operations, financial performance
and stock trading history of selected comparable public companies; (xi) public
data with respect to selected transactions of a comparable nature; (xii) the
Arrangement Agreement; (xiii) draft of the Circular to shareholders of MGI dated
April 15, 1998; (xiv) discussions with representatives of senior management of
MGI and Discreet; (xv) certain industry reports and statistics as First Marathon
considered relevant; (xvi) the certificate dated April 15, 1998 from senior
officers of MGI attesting to the accuracy and completeness of information
provided to First Marathon; and (xvii) such other information, discussion and
analysis as First Marathon considered necessary or appropriate in the
circumstances.
In assessing the fairness of the exchange ratio in the Transaction of 0.162
Discreet Common Shares for each MGI Common Share, from a financial point of
view, to the MGI Shareholders, First Marathon: (i) compared the Transaction
value to the historical market prices for the MGI Common Shares; (ii) compared
the Transaction value to the value per MGI Common Share implied by First
Marathon's analyses of comparable companies and comparable transactions; (iii)
reviewed with MGI management any prior informal indications of interest for MGI
and the likelihood of a party, other than Discreet, being interested in
acquiring MGI on terms more favourable than those of the Transaction; (iv)
reviewed the historic share exchange ratio between MGI and Discreet; (v)
considered the outlook for Discreet, including the pro forma impact of the
Transaction; (vi) considered any benefits accruing to Discreet as a result of
the Transaction, including the use of tax loss carry-forwards; and (vii)
considered any other factors or analyses which First Marathon judged, based on
its experience in rendering such opinions, to be relevant.
In connection with its review, First Marathon relied upon and assumed the
completeness, accuracy and fair representation of all financial and other
information, data, advice, opinions and representations obtained by First
Marathon from public sources or information provided to First Marathon by MGI,
Discreet and their respective advisers or otherwise pursuant to its engagement.
First Marathon did not attempt to independently verify the accuracy or
completeness of any such information, data, advice, opinions and
representations.
First Marathon's opinion was rendered on the basis of securities markets,
economic and general business and financial conditions prevailing as of April
15, 1998 and the conditions and prospects, financial or otherwise, of MGI and
Discreet as they are reflected in the information, data and other material
reviewed by First Marathon and as they were represented to First Marathon in its
discussions with management of MGI and Discreet.
Assumptions were made in the First Marathon opinion with respect to, among
other things, industry performance, and general business, market and economic
conditions.
Based upon and subject to the foregoing, First Marathon has delivered to the
Board of Directors of MGI its written opinion dated April 15, 1998, to the
effect that the exchange ratio of 0.162 Discreet Common Shares for each
outstanding MGI Common Share was fair, as of such date, from a financial point
of view, to the MGI Shareholders. A copy of the fairness opinion of First
Marathon, which sets forth the scope of review and assumptions and limitations
upon which the opinion is based, is attached to this Circular as Schedule C and
should be read carefully by MGI Shareholders in its entirety.
DETAILS OF THE TRANSACTION
On March 9, 1998 MGI, Discreet and Subco entered into the Arrangement
Agreement providing for the Arrangement under section 182 of the OBCA whereby
MGI will amalgamate with Subco to form Amalco, a wholly-owned subsidiary of
Discreet, and the MGI Shareholders will become shareholders of Discreet.
Upon the Arrangement becoming effective, each MGI Common Share outstanding
immediately prior to the Effective Date (other than MGI Common Shares held by
Dissenting Shareholders) shall be exchanged for 0.162 Discreet Common Shares. In
addition, all outstanding options and warrants to acquire an MGI Common Share
will become options and warrants to acquire 0.162 Discreet Common Shares. Upon
the Arrangement becoming effective, each Subco Common Share outstanding
immediately prior to the Arrangement will become
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one Amalco Common Share, resulting in Amalco becoming a wholly-owned subsidiary
of Discreet. The Arrangement is subject to a number of conditions, including the
approval of MGI Shareholders of the Special Resolution at the Special Meeting,
the receipt of all requisite regulatory approvals and the receipt of the Final
Order. See "The Transaction -- Arrangement Agreement -- Conditions to Closing".
There are currently 24,012,462 MGI Common Shares issued and outstanding,
which, assuming that there will be no Dissenting Shareholders, will be exchanged
for approximately 3,890,019 Discreet Common Shares upon the completion of the
Arrangement. In addition, 3,030,425 MGI Common Shares have been reserved for
issuance under the MGI Stock Option Plan and MGI has issued Compensation Options
(as defined under "The Transaction -- Arrangement Agreement -- Compensation
Options") to acquire 175,000 MGI Common Shares and Intel Warrants (as defined
under "The Transaction -- Arrangement Agreement -- Intel Warrants") to acquire
1,022,757 MGI Common Shares. Upon completion of the Arrangement, 490,928
Discreet Common Shares will be reserved for issuance under the MGI Stock Option
Plan, 28,350 Discreet Common Shares will be reserved for issuance pursuant to
the exercise of the Compensation Options and 165,686 Discreet Common Shares will
be reserved for issuance under the Intel Warrants. Assuming the full exercise of
all outstanding options under the MGI Stock Option Plan, of all Compensation
Options and of all Intel Warrants and assuming that there would be no Dissenting
Shareholders, on a PRO FORMA basis, 4,574,983 Discreet Common Shares would be
issued upon completion of the Arrangement.
As of March 31, 1998, there were 29,551,779 Discreet Common Shares issued
and outstanding. In addition, 3,159,925 Discreet Common Shares have been
reserved for issuance under the Discreet Stock Option Plan and a further 80,000
Discreet Common Shares have been reserved for issuance under Discreet's 1995
Non-Employee Director Stock Option Plan and 1997 Special Limited Non-Employee
Director Stock Option Plan. Assuming a maximum number of 32,791,704 Discreet
Common Shares outstanding immediately prior to the Arrangement on a PRO FORMA
basis, including the exercise of all the outstanding options under the Discreet
Stock Option Plan, Discreet's 1995 Non-Employee Director Stock Option Plan and
the 1997 Special Limited Non-Employee Director Stock Option Plan, the maximum of
4,574,983 Discreet Common Shares that will be issued to the MGI Shareholders and
the holders of all options under the MGI Stock Option Plan, all Compensation
Options and all Intel Warrants pursuant to the Arrangement would represent
approximately 12.2% of the outstanding Discreet Common Shares immediately
following the completion of the Arrangement on a PRO FORMA basis.
No certificates representing fractional Discreet Common Shares will be
issued pursuant to the Arrangement. In lieu of such fractional shares, each
fractional interest in a Discreet Common Share will entitle the holder thereof
to receive from Discreet an amount of cash (rounded to the nearest whole cent)
equal to the product obtained when such fraction is multiplied by the average of
the closing sale price of the Discreet Common Shares on the Nasdaq (converted to
Canadian dollars using the noon buying rate in New York City for cable transfers
in foreign currencies as certified for customs purposes by the Federal Reserve
Bank of New York for the days on which each such closing sale price occurred)
for the 20 trading days ending with the trading day that is two trading days
prior to the Effective Date.
The foregoing description of the Transaction is qualified in its entirety by
reference to the full text of the Plan of Arrangement, a copy of which is
attached as Schedule B to this Circular.
SUBCO
Subco was incorporated on March 5, 1998 under the OBCA as a wholly-owned
subsidiary of Discreet for the sole purpose of facilitating the Arrangement.
Subco has not previously carried on business and has no material assets and no
liabilities. The authorized share capital of Subco consists of an unlimited
number of common shares, of which 100 common shares are issued and outstanding
and are owned by Discreet. Upon the Amalgamation, each issued and outstanding
Subco Common Share will become one Amalco Common Share resulting in Amalco
becoming a wholly-owned subsidiary of Discreet.
AMALCO
As a result of the Amalgamation, Subco and MGI will continue as Amalco,
which will be responsible for the obligations of each of Subco and MGI. Discreet
will own all of the issued and outstanding Amalco Common
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Shares. It is the current intention of Discreet to proceed with the liquidation
of Amalco into Discreet after the Amalgamation.
ARRANGEMENT AGREEMENT
The material terms of the Arrangement Agreement may be summarized as
follows.
SUPPORT OF TRANSACTION
Each of the parties to the Arrangement Agreement has agreed to, and Discreet
has agreed to cause its subsidiaries (including Subco) to, use all reasonable
efforts to satisfy the conditions precedent to be satisfied by it and to do all
other things necessary, including all such things as may be required to secure
all necessary approvals, to permit the completion of the Arrangement in
accordance with the provisions of the Arrangement Agreement. MGI has agreed
that, subject to the fiduciary obligations of the Board of Directors of MGI to
the MGI Shareholders, it shall convene the Special Meeting and use all
reasonable efforts to secure the approval of the MGI Shareholders. In addition,
Mr. Oren Asher has separately agreed to vote all his MGI Common Shares in favour
of the Arrangement. See "The Transaction -- Lock-Up Agreement".
CONDITIONS TO CLOSING
The obligations of the parties to complete the Transaction upon the terms
set out in the Arrangement Agreement are subject to a number of conditions, the
material terms of which are summarized below. If each of the following
conditions has not been satisfied or waived prior to August 31, 1998, any party
may terminate the Arrangement Agreement.
MUTUAL CONDITIONS
The obligations of each of Discreet, Subco and MGI to complete the
Arrangement are subject to the following conditions:
(i) the Arrangement, as proposed or with any amendment acceptable to each of
Discreet and MGI, acting reasonably, shall have been approved by the MGI
Shareholders at the Special Meeting in compliance with applicable
Securities Legislation;
(ii) the Interim Order and the Final Order shall each have been obtained in
form and substance satisfactory to each of Discreet and MGI, acting
reasonably, and shall not have been set aside or modified in a manner
unacceptable to each of Discreet and MGI, acting reasonably, on appeal
or otherwise;
(iii) all material approvals, waivers or consents that are necessary in
connection with the Arrangement shall have been obtained on terms that
do not have a Material Adverse Effect on MGI or on Discreet and its
subsidiaries taken as a whole;
(iv) no judgement or order shall have been issued by any domestic or foreign
court or tribunal or governmental agency or other regulatory authority
or administrative agency or commission or any elected or appointed
public official, no action, suit or proceeding shall have been taken by
any person, and no law or policy shall have been proposed, enacted,
promulgated or applied,
(a) which makes it illegal or otherwise directly or indirectly restrains,
cease trades, enjoins, prohibits or imposes limitations or conditions
on the completion of the Arrangement, or which could reasonably be
expected to have any such effects, or which has a Material Adverse
Effect on either Discreet and its subsidiaries taken as a whole or on
MGI; or
(b) that, if the Arrangement were completed, could reasonably be expected
to have a Material Adverse Effect on either Discreet and its
subsidiaries taken as a whole or on MGI; and
(v) any applicable waiting periods under the HSR Act shall have expired or
been earlier terminated.
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CONDITIONS IN FAVOUR OF DISCREET AND SUBCO
The obligations of Discreet and Subco to complete the Arrangement are
subject to the following conditions:
(i) all necessary corporate or similar action shall have been taken by MGI
to authorise the execution and delivery of the Arrangement Agreement and
the consummation of the Arrangement;
(ii) MGI shall have performed each covenant or obligation to be performed by
it under the Arrangement Agreement in favour of Discreet on or prior to
the Effective Time, if the failure, in the reasonable judgement of
Discreet, to comply with such covenant would individually or in the
aggregate have a Material Adverse Effect on Discreet and its
subsidiaries taken as a whole or on MGI or materially impede the
completion of the Arrangement or the other transactions contemplated in
the Arrangement Agreement;
(iii) the representations and warranties of MGI set forth in the Arrangement
Agreement shall be true and correct in all respects on and as of the
Effective Time (as if made on and as of that date) except as affected
by the transactions contemplated or permitted by the Arrangement
Agreement, except to the extent that any such representation or
warranty is made as of a specified date, in which case such
representation or warranty shall have been true and correct as of such
date, and except where any failure to be true and correct would not
have a Material Adverse Effect on MGI;
(iv) Discreet shall have received a legal opinion from legal counsel to MGI,
in form and substance acceptable to Discreet and its legal counsel,
acting reasonably;
(v) the number of MGI Common Shares held by persons entitled to exercise a
right of dissent under Section 185 of the OBCA in respect of the
Arrangement who have notified MGI of their intention to exercise their
right of dissent at or before the Special Meeting, plus the aggregate
number of all fractional shares in respect of which MGI Shareholders are
to receive cash payments pursuant to the Arrangement shall not exceed
9.99% of the total number of MGI Common Shares on the Effective Date;
(vi) from the date of the Arrangement Agreement up to and including the
Effective Date there shall not have occurred or arisen one or more
events or changes that has or would be reasonably likely to have a
Material Adverse Effect on MGI;
(vii) Discreet shall have received a letter of Price Waterhouse, MGI's
independent auditors, dated the Effective Date, in connection with the
financial disclosure of MGI in this Circular; and
(viii) Discreet shall have received letters from Price Waterhouse dated the
date of this Circular and confirmed in writing within two business days
prior to the Effective Date addressed to MGI, regarding the
appropriateness of pooling of interest accounting in relation to MGI
for the Arrangement under U.S. GAAP in accordance with the Accounting
Principal Board Opinion 16 if the Arrangement is closed and consummated
in accordance with, or as contemplated by, the Arrangement Agreement.
CONDITIONS IN FAVOUR OF MGI
The obligation of MGI to complete the Arrangement is subject to the
following conditions:
(i) all necessary corporate action shall have been taken by Discreet to
authorise the execution and delivery of the Arrangement Agreement and
the consummation of the Arrangement;
(ii) Discreet shall have performed each covenant or obligation to be
performed by it under the Arrangement Agreement in favour of MGI on or
prior to the Effective Time, if the failure, in the reasonable
judgement of MGI, to comply with such covenants would, individually or
in the aggregate, have a Material Adverse Effect on MGI or on Discreet
and its subsidiaries taken as a whole or materially impede the
completion of the Arrangement or the other transactions contemplated in
the Arrangement Agreement;
(iv) the representations and warranties made by Discreet in the Arrangement
Agreement shall be true and correct in all respects on and as of the
Effective Date (as if made on and as of that date) except as affected
by the transactions contemplated or permitted by the Arrangement
Agreement, except to the extent that any such representation or
warranty is made as of a specified date, in which case such
representation or warranty shall have been true and correct as of such
date and except for any failures
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or breaches of representations and warranties which would not have a
Material Adverse Effect on Discreet and its subsidiaries taken as a
whole or materially impede the completion of the Arrangement or the
transactions contemplated in the Arrangement Agreement;
(v) MGI shall have received a legal opinion from legal counsel to Discreet,
in form and substance acceptable to MGI and its legal counsel, acting
reasonably in the circumstances, including with respect to the issuance
and resale of Discreet Common shares issued to the MGI Shareholders
under the Arrangement being tradeable, registered or exempt from
prospectus requirements in each of the provinces of Canada where MGI has
shareholders and such other opinion which may reasonably be required
from counsel in the United States;
(vi) the issuance of Discreet Common Shares pursuant to the Arrangement will
be, if required, registered under the Securities Act pursuant to a
registration statement declared effective by the SEC or pursuant to a
rule of the SEC and no stop order suspending such effectiveness shall
have been issued or proceedings therefor initiated or threatened by the
SEC, or shall be exempt from such registration and all such Discreet
Common Shares shall be listed for trading on Nasdaq;
(vii) MGI shall have received a letter from Price Waterhouse dated the date
of this Circular and confirmed in writing within two Business Days
prior to the Effective Date, addressed to MGI, regarding the
appropriateness of pooling of interest accounting in relation to MGI
for the Arrangement under U.S. GAAP in accordance with the Accounting
Principal Board Opinion 16 if the Arrangement is closed and consummated
in accordance with, or as contemplated by, the Arrangement Agreement;
and
(viii) MGI shall have received a letter of Arthur Andersen & Cie, Discreet's
independent auditors, dated the Effective Date, in connection with the
financial disclosure of Discreet in this Circular.
REPRESENTATIONS AND WARRANTIES
In the Arrangement Agreement each of MGI and Discreet made customary
representations and warranties to the other regarding, among other things, (i)
its due incorporation and qualification and the due incorporation and
qualification of each of its subsidiaries; (ii) its capitalization; (iii) its
corporate power and authority to enter into, and its due authorization,
execution and delivery of, the Arrangement Agreement; (iv) required governmental
approvals; (v) the absence of any material adverse changes in its business or
condition; (vi) the absence of undisclosed liabilities; (vii) its securities
laws filings; (viii) the performance of its obligations under the Arrangement
Agreement and the consummation of the Arrangement not violating its articles and
by-laws, applicable law and certain material agreements (and the current
compliance therewith); and (ix) its financial statements. Additionally, MGI made
representations and warranties to Discreet with respect to title to its
properties and assets, litigation, labour and employment relations, employee
benefit plans, the binding nature of its material contracts, the filing of its
tax returns and the payment of certain taxes, certain environmental matters and
the possession and compliance with certain governmental licenses. Each of the
parties has also agreed to give the other parties prompt notice of any
inaccuracies in its representations and warranties, as well as notice of any
events that may result in the failure of any closing conditions to be satisfied
and notice of any additional third party consents required in connection with
the Arrangement.
COVENANTS
MGI and Discreet have agreed to cooperate with each other and, as described
above, to generally take all such actions as may be necessary for the completion
of the Transaction. See "The Transaction -- Arrangement Agreement -- Support of
Transaction". The Arrangement Agreement also contains certain specific covenants
of the parties as described below.
BUSINESS IN THE ORDINARY COURSE
MGI, Discreet and Subco have agreed that prior to the Effective Date, unless
Discreet shall otherwise agree in writing or as otherwise expressly contemplated
or permitted by the Arrangement Agreement, MGI shall conduct its businesses in
the ordinary course of business consistent with past practice. The parties have
agreed that prior to the Effective Date, unless MGI shall otherwise agree in
writing or as otherwise expressly contemplated or permitted by the Arrangement
Agreement, Discreet shall (and shall cause each of its
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subsidiaries to) conduct its and their respective businesses in the ordinary
course of business consistent with past practice.
NO SOLICITATION
MGI has agreed that it will not, directly or indirectly, (i) take any action
to solicit, initiate or encourage any Alternative Proposal, (ii) engage in any
discussion or negotiations with, or disclose any non-public information relating
to MGI to, or otherwise assist or facilitate, or enter into any agreement or
understanding with, or afford access to the properties, books or records of MGI
to anyone that has advised MGI that it may be considering making, or that has
made, an Alternative Proposal, or (iii) agree to, approve or recommend any
Alternative Proposal. Notwithstanding the foregoing commitment, if an
unsolicited Alternative Proposal, or an unsolicited expression of interest to
make an Alternative Proposal, shall be received by the Board of Directors of MGI
prior to the approval of the Special Resolution by the MGI Shareholders at the
Special Meeting, then, to the extent the Board of Directors of MGI believes in
good faith (after consultation with its financial advisor) that such Alternative
Proposal would constitute a Competing Transaction, then MGI and its officers,
directors, employees, investment bankers, financial advisors, attorneys,
accountants and other representatives retained by it may furnish information in
connection therewith and the Board of Directors of MGI shall be entitled to
consider, negotiate, approve, recommend to its shareholders and enter into an
agreement in respect of such Competing Transaction and such actions shall not be
considered a breach of the Arrangement Agreement; provided, that in each such
event MGI notifies Discreet of such determination by the Board of Directors of
MGI and provides Discreet with a true and complete copy of the Alternative
Proposal document with such deletions as are necessary to protect confidential
information relating to the business of the third party, provided that material
terms or the identity of the person making the Alternative Proposal may not be
deleted, if the Alternative Proposal is in writing, or a complete written
summary on the same basis, if it is not in writing, and provide Discreet with
all documents containing or referring to non-public information of MGI that are
supplied to such third party; provided further, that (A) the Board of Directors
of MGI has determined, with the advice of MGI's investment bankers, that such
third party has demonstrated that there is reasonable assurance that any
required financing will be obtained and there are no other apparent impediments
to such third party commencing and completing such transaction, (B) MGI may not
provide any non-public information to any such third party if it has not prior
to the date of the Arrangement Agreement provided (or does not simultaneously
with providing such information to such third party provide) such information to
Discreet or Discreet's representatives, and (C) MGI provides such non-public
information pursuant to a non-disclosure agreement substantially the same as or
otherwise at least as restrictive on such third party as the confidentiality
agreement between Discreet and MGI dated December 23, 1997 is on Discreet. MGI
will notify Discreet immediately (and no later than 24 hours) after receipt of
any Alternative Proposal or any notice that any person is considering making an
Alternative Proposal or any request for non-public information relating to MGI
or for access to the properties, books or records of MGI by any person that has
advised MGI that it may be considering making, or that has made, an Alternative
Proposal, and will keep Discreet fully informed of the status and
non-confidential details of any such Alternative Proposal notice, request or any
correspondence or communications related thereto and shall provide Discreet with
a true and complete copy of such Alternative Proposal notice or request or
correspondence or communications related thereto with such deletions as are
necessary to protect confidential information relating to the business of the
third party, if it is in writing, or a complete written summary, on the same
basis, if it is not in writing.
COMPETING TRANSACTION
DISCREET'S RIGHT TO INCREASE CONSIDERATION. Discreet may, in its sole
discretion, within five days after receiving notice of a Competing Transaction
from MGI or otherwise becoming aware of a potential Competing Transaction and
prior to the Special Meeting, agree to amend the Arrangement Agreement to
increase the consideration payable to MGI Shareholders either through the
issuance of additional Discreet Common Shares or through cash, or a combination
thereof, pursuant to the Arrangement to a consideration at least equal in value
to that offered under the Competing Transaction. MGI shall be deemed to have
agreed to such increase.
POSTPONEMENT OF SPECIAL MEETING AND TERMINATION. If a Competing Transaction
is made or announced at any time within five calendar days prior to the
scheduled date of the Special Meeting, either Discreet or MGI may, by notice in
writing to the other parties to the Arrangement Agreement, require that the
Special Meeting
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be postponed to a date up to 12 days after the date scheduled for the Special
Meeting. If Discreet undertakes to MGI, within two days prior to the scheduled
time of the Special Meeting, to amend the exchange ratio and/or payments
provided for in the Arrangement to increase the consideration offered to MGI
Shareholders, either Discreet or MGI may, by notice in writing to the other
parties to the Arrangement Agreement, require that the Special Meeting be
postponed to a date up to seven calendar days after the date scheduled for the
Special Meeting.
VALUE OF NON-CASH CONSIDERATION. The cash equivalent value of any non-cash
consideration of a Competing Transaction or of the Arrangement shall be valued
as of the close of business on the date that the Competing Transaction is
received by MGI and shall be mutually agreed upon by a member of either the IDA
or the NASD designated by MGI and by another member of the IDA or the NASD
designated by Discreet, each acting reasonably. If the two members are unable to
agree on the cash equivalent value of such non-cash consideration by 2:00 p.m.
on the second day following the date on which the Competing Transaction is
received by MGI, MGI and Discreet shall request a third member of the IDA or the
NASD to determine the cash equivalent value of the non-cash consideration by
12:00 noon on the following day. If that member does not make such determination
by such time, each of the initial members shall advise MGI and Discreet of their
respective professional judgement of the cash equivalent value of such non-cash
consideration and the cash equivalent value of such non-cash consideration shall
be the average of the amounts reflected in such judgements. Any such
determination made in accordance with the foregoing provisions shall be binding
on the parties to the Arrangement Agreement.
EXPENSES AND TERMINATION FEES
Whether or not the Arrangement is consummated, all costs and expenses
incurred in connection with the Arrangement Agreement and the transactions
contemplated thereby (including, without limitation, the fees and expenses of
advisers, accountants and legal counsel) will be paid by the party incurring
such expense, except that expenses incurred in connection with printing the
Circular, filing fees incurred in connection with the Circular and legal fees
relating to the Circular will be shared equally by MGI and Discreet. The
estimated costs and fees of MGI in connection with the Transaction including,
without limitation, financial advisors' fees, bank fees, filing fees, legal and
accounting fees and mailing fees are approximately $950,000.
MGI has agreed to reimburse Discreet for all out-of-pocket costs and
expenses incurred by Discreet in connection with the Arrangement Agreement and
the transactions contemplated thereby (including, without limitation, the fees
and expenses of its advisors, accountants and legal counsel) up to the sum of
U.S.$1,000,000, provided that Discreet is not in material breach of any
representation, warranty, covenant or agreement contained in the Arrangement
Agreement, in the event that: (i) Discreet or MGI terminates the Arrangement
Agreement if any required approval of the MGI Shareholders or the Court shall
not have been obtained by reason of the failure to obtain the required vote upon
a vote taken at the Special Meeting or any adjournment thereof; or (ii) Discreet
terminates the Arrangement Agreement if there has been a breach of any
representation, warranty, covenant or agreement contained in the Arrangement
Agreement on the part of MGI, if such breach has a Material Adverse Effect on
MGI, on Discreet or on the Arrangement or such breach materially impedes the
completion of the Arrangement, and best efforts are not being employed to cure
such breach within ten days after notice thereof is given to the party
committing such breach and, in any event such breach has not been cured within
15 days; or (iii) Discreet terminates this Agreement if the Board of Directors
of MGI has withdrawn or modified in a manner adverse to Discreet its approval or
recommendation of the Arrangement, the Arrangement Agreement or the transactions
contemplated thereby or shall fail to reaffirm such approval or recommendation
upon Discreet's request, or shall have resolved to do any of the foregoing, and
the MGI Shareholders do not approve the Arrangement as required in the Interim
Order or the Arrangement is not submitted for their approval, in all cases in
circumstances where there is a Competing Transaction.
MGI has also agreed to pay Discreet (in addition to any amounts otherwise
payable as described above) the sum of U.S.$4,500,000 in the event that the
Arrangement Agreement is terminated in accordance with (i) or (iii) above, in
each case in circumstances where there is an Alternative Proposal, and prior to
such termination or within twelve months after the date of such termination MGI
enters into a definitive amalgamation agreement or other business combination
agreement regarding a Competing Transaction or Alternative
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Proposal or recommends that MGI Shareholders tender their MGI Common Shares in
response to a tender or exchange related to a Competing Transaction or
Alternative Proposal, or resolves to do any of the foregoing provided, however,
that solely for these purposes, the term "Alternative Proposal" means any offer
or proposal for, or any indication of interest in (i) an amalgamation, a
consolidation, an arrangement or other business combination involving MGI or any
of its subsidiaries, (ii) the acquisition of more than 50% of the outstanding
shares in the share capital of MGI (including without limitation by way of a
tender offer or an exchange offer), (iii) the acquisition of beneficial
ownership or a right to acquire beneficial ownership of, directly or indirectly,
together with persons acting in concert, or more than 50% of the then
outstanding shares in the share capital of MGI, (iv) the acquisition of any
material assets (excluding the sale or distribution of assets in the ordinary
course of business) of MGI or any of its subsidiaries, or (v) any public
announcement of a proposal, plan or intention to do any of the foregoing or any
agreement to engage in any of the foregoing, in each case other than the
transactions contemplated by the Arrangement Agreement.
Discreet has agreed to reimburse MGI for all out-of-pocket costs and
expenses incurred by MGI in connection with the Arrangement Agreement and the
transactions contemplated thereby (including, without limitation, the fees and
expenses of its advisors, accountants and legal counsel) up to the sum of
U.S.$1,000,000, provided that MGI is not in material breach of any
representation, warranty, covenant or agreement contained in this Agreement, in
the event that MGI terminates this Agreement in the event there has been a
breach of any representation, warranty, covenant or agreement contained in the
Arrangement Agreement on the part of Discreet, if such breach has a Material
Adverse Effect on Discreet, on MGI or on the Arrangement or such breach
materially impedes the completion of the Arrangement, and best efforts are not
being employed to cure such breach within ten days after notice thereof is given
to the party committing such breach and, in any event such breach has not been
cured within 15 days.
DISCREET'S OPTION TO ACQUIRE MGI COMMON SHARES
MGI has granted to Discreet in the Arrangement Agreement the right to
purchase up to 4,795,442 MGI Common Shares at a price of $5.32 per MGI Common
Share (the "Option"). Provided that Discreet is not in material breach of the
Arrangement Agreement, the Option may be exercised following the occurrence of
any of the following events: (i) any person (other than Discreet or any
affiliate of Discreet) shall have commenced a tender offer or exchange offer to
purchase any MGI Common Shares such that, upon consummation of such offer, the
offeror together with any person or persons acting jointly or in concert with
the offeror, shall have acquired 20% or more of the outstanding MGI Common
Shares; (ii) any person, together with any person (other than Discreet or any
affiliate of Discreet) or persons acting jointly or in concert with such person,
shall have acquired 9.9% or more of the then outstanding MGI Common Shares; or
(iii) the MGI Shareholders shall not have approved the Arrangement at the
Special Meeting, such meeting shall not have been held or shall have been
cancelled prior to termination of the Arrangement Agreement or the Board of
Directors of MGI shall have withdrawn or modified in a manner adverse to
Discreet its approval or recommendation of the Arrangement, the Arrangement
Agreement or the transactions contemplated thereby, in each case where such
action was not occasioned by the occurrence of one or more events or changes
that has or would be reasonably likely to have a Material Adverse Effect on
Discreet and its subsidiaries, taken as a whole, and in each case after any
person (other than Discreet or any affiliate of Discreet) shall have made an
Alternative Proposal. In the circumstances described above, the Option may be
exercised in whole or in part at any time and from time to time until its expiry
on the earlier of (iv) the Effective Date, (v) the date which is twelve months
from the date of the Arrangement Agreement, and (vi) the termination of the
Arrangement Agreement, prior to the occurrence of any event described in clauses
(i), (ii) or (iii) of this paragraph.
Pursuant to the Arrangement Agreement, MGI has agreed that, if and whenever
at any time from the date of the Arrangement Agreement and prior to the expiry
of the Option, MGI shall reorganize its capital structure or enter into any
transactions (other than the Transaction) which has the effect of changing the
capital structure of MGI, the terms of the Option (including the number of MGI
Common Shares or other securities to be acquired thereunder and the applicable
exercise price) shall be adjusted to provide Discreet with the same economic
result as it would have had if the Option had been exercised immediately prior
to such event.
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TERMINATION OF ARRANGEMENT AGREEMENT
The Arrangement Agreement may be terminated and the Transaction may be
abandoned prior to the Effective Date notwithstanding approval by the MGI
Shareholders under the circumstances specified in the Arrangement Agreement,
including, without limitation, by mutual consent of Discreet and MGI and by
either party if the Arrangement is not consummated by August 31, 1998. The
Arrangement Agreement may be terminated at any time prior to the Effective Date:
(i) by either Discreet or MGI (provided that the terminating party is not then
in material breach of any representation, warranty, covenant or agreement
contained in the Arrangement Agreement) if there has been a breach of any
representation, warranty, covenant or agreement contained in the Arrangement
Agreement on the part of the other party, such breach has a Material Adverse
Effect on the party in breach, on the other party or on the Arrangement or such
breach materially impedes the completion of the Arrangement, and best efforts
are not being employed to cure such breach within ten days after notice thereof
is given to the party committing such breach and, in any event such breach has
not been cured within 15 days; (ii) by either Discreet or MGI if the Arrangement
shall not have been consummated before the Termination Date (provided that the
terminating party is not then in material breach of any representation,
warranty, covenant or agreement contained in the Arrangement Agreement); (iii)
by either Discreet or MGI if any required approval of the MGI Shareholders or
the Court shall not have been obtained by reason of the failure to obtain the
required vote upon a vote taken at the Special Meeting or any adjournment
thereof; (iv) by either Discreet or MGI if (A) the conditions to such party's
obligation to close shall have become impossible to satisfy or (B) any permanent
injunction or other order of a court or other competent authority preventing the
Arrangement shall have become final and non-appealable; (v) by Discreet if the
Board of Directors of MGI has withdrawn or modified in a manner adverse to
Discreet its approval or recommendation of the Arrangement, the Arrangement
Agreement or the transactions contemplated thereby or shall fail to reaffirm
such approval or recommendation upon Discreet's request or shall have resolved
to do any of the foregoing, provided that in such circumstances the Arrangement
Agreement may not be terminated by Discreet unless MGI Shareholders do not
approve the Arrangement as required in the Interim Order or the Arrangement is
not submitted for their approval; (vi) by Discreet if the certificate of
arrangement has not been issued by the Director giving effect to the Arrangement
by 5:00 p.m. (Toronto time) on May 29, 1998 provided, however, that Discreet
shall have given notice to MGI of the exercise of such right by 7:00 p.m.
(Toronto time) on May 29, 1998.
In the event of the termination of the Arrangement Agreement, it shall,
except for the payment obligations of MGI and Discreet described under "The
Transaction -- Details of the Transaction -- Expenses and Termination Fees",
except for the Option described under "The Transaction -- Details of the
Transaction -- Discreet's Option to Acquire MGI Common Shares", and except for
certain confidentiality obligations of the parties, become void and of no force
and effect and there shall be no liability or further obligation on the part of
any party except for liability in respect of fraud or wilful misconduct.
MGI STOCK OPTIONS
MGI has in place the MGI Stock Option Plan pursuant to which options for the
purchase of an aggregate of 3,030,425 MGI Common Shares were outstanding as at
April 15, 1998 (the "MGI Stock Options") with option exercise prices ranging
from $1.00 to $4.50 per MGI Common Share. Under the terms of the Arrangement
Agreement, upon the Amalgamation of MGI and Subco becoming effective, MGI's
obligations with respect to each outstanding MGI Stock Option, whether vested or
not, will be assumed by Discreet and, on such assumption, the rights to acquire
MGI Common Shares under the MGI Stock Option Plan shall become rights to acquire
Discreet Common Shares. Each MGI Stock Option so assumed by Discreet under the
Arrangement Agreement shall continue to have, and be subject to, the same terms
and conditions set forth in the MGI Stock Option Plan and agreement pursuant to
which such MGI Stock Option was issued as in effect immediately prior to the
Effective Date, except that (i) such MGI Stock Option will be deemed to
constitute an option to purchase that number of Discreet Common Shares equal to
the product of the number of MGI Common Shares that the holder of such option
would have been entitled to receive had such holder exercised such options
immediately prior to the Effective Date (not taking into account whether such
option was in fact exercisable) multiplied by the exchange ratio of 0.162
Discreet Common Shares for each MGI Common Share, rounded down to the nearest
whole number of Discreet Common Shares, and (ii) the per share exercise price
for the Discreet Common Shares issuable upon exercise of such assumed MGI Stock
Option will be equal to the quotient
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determined by dividing the exercise price per MGI Common Share at which such MGI
Stock Option was exercisable immediately prior to the Effective Date by the
exchange ratio, and rounding the resulting exercise price up to the nearest
whole cent. There would have therefore been outstanding as at April 15, 1998
under the MGI Stock Option Plan, after giving effect to the Transaction, options
to purchase 490,928 Discreet Common Shares at exercise prices ranging from $6.18
to $27.78 per Discreet Common Share.
COMPENSATION OPTIONS
Pursuant to an agency agreement dated January 16, 1997 by and among MGI and
Gordon Capital Corporation, Cannacord Capital Corporation and Griffiths McBurney
Inc., MGI issued to the aforementioned dealers 175,000 broker special warrants
entitling the holders thereof, in the aggregate, to 175,000 compensation options
(the "Compensation Options") without additional payment to MGI. Each
Compensation Option entitles the holder thereof to purchase, on or before
December 29, 1998, one MGI Common Share at a price of $5.25 per share, subject
to adjustment. Pursuant to the terms and conditions of the Arrangement
Agreement, on the Effective Date, MGI's obligations with respect to each
outstanding Compensation Option will be assumed by Discreet and, on such
assumption, the right to obtain MGI Common Shares under the Compensation Options
shall become the right to obtain Discreet Common Shares. Each Compensation
Option so assumed by Discreet under this Agreement shall continue to have, and
be subject to, the same terms and conditions as in effect immediately prior to
the Effective Date, except that (i) such Compensation Options will be deemed to
constitute options to purchase that number of Discreet Common Shares equal to
the product of the number of MGI Common Shares that the holders of such
Compensation Options would have been entitled to receive had such holder
exercised such Compensation Options immediately prior to the Effective Date
multiplied by the exchange ratio of 0.162 Discreet Common Shares for each MGI
Common Share, rounded down to the nearest whole number of Discreet Common
Shares, and (ii) the per share exercise price for the Discreet Common Shares
issuable upon exercise of such Compensation Options will be equal to the
quotient determined by dividing the exercise price per MGI Common Share at which
such Compensation Options were exercisable immediately prior to the Effective
Date by the exchange ratio, and rounding the resulting exercise price up to the
nearest whole cent.
INTEL WARRANTS
MGI entered into a warrant agreement (the "Intel Warrant Agreement") dated
as of September 30, 1997 with Intel providing for the issuance to Intel of
1,022,757 common share purchase warrants (the "Intel Warrants") entitling the
holder thereof to purchase, until September 30, 2000, 1,022,757 MGI Common
Shares at an exercise price equal to the lower of (i) $3.95 per MGI Common Share
and (ii) the higher of the then current market price of the MGI Common Shares
and $3.20 per MGI Common Share. Pursuant to the terms and conditions of the
Arrangement Agreement, on the Effective Date, MGI's obligations with respect to
the outstanding Intel Warrants will be assumed by Discreet and, on such
assumption, the rights to acquire MGI Common Shares under the Intel Warrants
shall become rights to acquire Discreet Common Shares under the Intel Warrants.
The Intel Warrants so assumed by Discreet under the Arrangement Agreement shall
continue to have, and be subject to, the same terms and conditions as set forth
in the Intel Warrant Agreement as in effect immediately prior to the Effective
Date, except that (i) the Intel Warrants will be deemed to constitute warrants
to purchase that number of Discreet Common Shares equal to the product of the
number of MGI Common Shares that the holder of the Intel Warrants would have
been entitled to receive had such holder exercised such warrant immediately
prior to the Effective Date multiplied by the exchange ratio of 0.162 Discreet
Common Shares for each MGI Common Share, rounded down to the nearest whole
number of Discreet Common Shares, and (ii) the per share exercise price for the
Discreet Common Shares issuable upon exercise of the Intel Warrants will be
equal to the quotient determined by dividing the exercise price per MGI Common
Share at which the Intel Warrants were exercisable immediately prior to the
Effective Date by the exchange ratio, and rounding the resulting exercise price
up to the nearest whole cent.
COURT APPROVAL AND COMPLETION OF THE ARRANGEMENT
An arrangement under the OBCA requires Court approval after the approval
thereof by the shareholders of the subject corporation. Prior to the mailing of
this Circular, MGI obtained the Interim Order providing for the calling, holding
and conduct of the Special Meeting and other procedural matters. A copy of the
Interim
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Order is attached as Schedule K to this Circular. The Notice of Application for
the Final Order appears at the front of this package of which this Circular
forms a part.
Subject to the approval of the Special Resolution by the MGI Shareholders
and the determination of the Court, the hearing in respect of the Final Order is
scheduled to take place on May 25, 1998 at 10:00 a.m. (Toronto time) in the
Court, at 393 University Avenue, Toronto, Ontario. At that hearing, any MGI
Shareholder or other interested party who wishes to participate or to be
represented or to present evidence or arguments may do so, subject to filing a
notice of appearance with the Court and serving such notice of appearance upon
MGI's solicitors, and upon all other parties who have filed a notice of
appearance, and satisfying other requirements as provided in the Interim Order.
The Court will consider, among other things, the fairness of the Arrangement to
the MGI Shareholders. The Court may approve the Arrangement either as proposed
or as amended in any manner that the Court may direct, subject to compliance
with such terms and conditions, if any, as the Court shall order. However, it is
a condition to the completion of the Arrangement that the Final Order be, in
form and substance, reasonably satisfactory to MGI and Discreet.
Assuming that the Final Order is granted and that the other conditions to
the Arrangement Agreement are satisfied, or waived by the party or parties
entitled, it is anticipated that the following will occur substantially
simultaneously: the Articles of Arrangement will be filed with the Director to
give effect to the Arrangement and the various other documents necessary to
complete the Arrangement Agreement will be delivered.
Subject to the foregoing, it is anticipated that the Arrangement will be
completed not later than May 29, 1998.
ANTICIPATED ACCOUNTING TREATMENT
The Transaction will be accounted for by Discreet using the purchase method
of accounting under Canadian GAAP.
MGI has been advised by Discreet that Discreet currently expects, but is not
bound, to account for the Transaction using the pooling of interests method of
accounting under U.S. GAAP. This accounting method permits the recorded assets,
liabilities and shareholders' equity of both Discreet and MGI to be carried
forward on a consolidated basis by Discreet, after giving effect to the
Arrangement, at their recorded historical amounts. No recognition of goodwill
will be required as result of the Arrangement and consequently, there will be no
amortization of goodwill from the Arrangement reflected in Discreet's future
financial periods.
MGI has received an opinion from its independent auditors, Price Waterhouse,
based on circumstances existing as at April 15, 1998, to the effect that no
conditions exist which relate to MGI that would preclude MGI from being a party
to a business combination with Discreet for which the pooling of interests
method of accounting under U.S. GAAP would apply. However, in certain
circumstances, including in the event that the number of MGI Common Shares held
by persons entitled to exercise a right of dissent who have notified MGI of
their intention to exercise their right of dissent plus the aggregate number of
all fractional shares in respect of which MGI Shareholders are to receive cash
payment pursuant to the Arrangement exceeds 9.99% of the number of outstanding
MGI Common Shares on the Effective Date, the Arrangement may not qualify for
treatment as a pooling of interests under applicable accounting rules and MGI's
independent auditors may not be able to render an updated favourable opinion
regarding such qualification as of the Effective Date. Under the Arrangement
Agreement, Discreet's obligation to consummate the Arrangement is conditional
upon the delivery of such updated favourable opinion. The inability of MGI's
independent auditors to deliver such updated favourable opinion could entitle
Discreet to abandon the Arrangement.
To help ensure that the parties meet the pre-requisites for pooling of
interests accounting treatment under U.S. GAAP, each director and executive
officer of Discreet and of MGI has executed and delivered a written agreement to
the effect that such person will not sell, transfer, or otherwise reduce his or
her interest or risk in his or her MGI Common Shares or Discreet Common Shares
prior to the day after Discreet publishes financial statements which reflect 30
days of combined operations post-Transaction, subject to certain DE MINIMIS
exceptions.
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LOCK-UP AGREEMENT
Discreet, MGI and Mr. Oren Asher have entered into the Lock-Up Agreement,
the material terms of which are summarized below.
Mr. Asher represented and warranted to Discreet that he is the sole legal
and beneficial owner of 2,817,423 MGI Common Shares. Subject to the terms of the
Lock-Up Agreement, Mr. Asher has agreed to vote all of his MGI Common Shares in
favour of the Arrangement and not to exercise rights of dissent, if any, under
applicable legislation or otherwise and to exercise the voting rights attaching
to his MGI Common Shares and otherwise, in his capacity as a shareholder, use
his best efforts to oppose any proposed action by MGI, its shareholders or any
other person: (i) in respect of any amalgamation, merger, sale of MGI's assets,
take-over bid, plan of arrangement, reorganisation, recapitalisation,
liquidation or winding-up of, reverse take-over or other business combination or
similar transaction involving MGI, other than the Arrangement, (ii) which might
be regarded as being directed towards or likely to prevent or delay the
successful completion of the Arrangement, or (iii) to change the business or
condition (financial or otherwise) of MGI which in the sole judgement of
Discreet, acting reasonably could, individually or in the aggregate, have a
Material Adverse Effect on MGI.
Except for any action taken in accordance with the Arrangement Agreement or
to otherwise fulfil his fiduciary duties as a director of MGI, from and after
the date of the Lock-Up Agreement until the earlier of 12:00 a.m. on the
Effective Date or the termination of the Lock-Up Agreement, Mr. Asher has agreed
that he will not, in his capacity as a shareholder, directly or indirectly, (i)
take any action to solicit, initiate or encourage any Alternative Proposal, (ii)
engage in any discussion or negotiation with, or disclose any non-public
information relating to MGI, or otherwise assist or facilitate, or enter into
any agreement or understanding with, or afford access to the properties, books
or records of MGI to, any person, entity or group (other than Discreet and its
affiliates, agents, and representatives) that has advised MGI that it may be
considering making, or that has made, an Alternative Proposal or (iii) agree to,
approve or recommend any Alternative Proposal.
REGULATORY APPROVALS AND FILINGS
Neither Discreet nor MGI is aware of any material licences or regulatory
permits that it holds which might be adversely affected by the Transaction or of
any approval or other action by any federal, provincial, state or foreign
government or administrative or regulatory agency that would be required to be
obtained prior to completion of the Transaction, except as described below.
HSR ACT AND ANTITRUST LAWS (UNITED STATES)
Under the HSR Act and the regulations promulgated thereunder by the United
States Federal Trade Commission (the "Federal Trade Commission"), the
Transaction may not be consummated as currently contemplated until notifications
have been filed by both Discreet and Intel, a shareholder of both Discreet and
MGI, and certain information about Discreet and Intel has been furnished to the
Federal Trade Commission and the Antitrust Division of the United States
Department of Justice (the "Antitrust Division") and the applicable waiting
period has expired or been terminated.
Pursuant to the applicable regulations under the HSR Act, the waiting period
is 30 days after filings by both Discreet and Intel are made. The waiting period
may be reduced if early termination of the waiting period is requested and
granted. The waiting period may be extended if a request for additional
information ("second request") is made by the Federal Trade Commission or the
Antitrust Division and would then expire 20 days after substantial compliance
with the second request.
Filings by Discreet and Intel are expected to be made during the week of
April 20, 1998, and early termination of the waiting period will be requested.
At any time before or after the consummation of the Transaction, and whether
or not the waiting period under the HSR Act has expired or been terminated, the
Federal Trade Commission, the Antitrust Division or other persons could take
action under the U.S. antitrust laws to seek to enjoin, modify or dissolve the
Transaction if it would be likely to substantially lessen competition in any
line of commerce in any section of the United States or otherwise result in
violation of its antitrust laws. It is not expected that such action will be
taken. Nevertheless, there can be no assurance that a challenge of the
Transaction will not be made or, if such a challenge is made, of the result
thereof.
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MARKET FOR RESALE OF DISCREET COMMON SHARES
STOCK EXCHANGE LISTINGS
It is a condition to the Transaction that the Discreet Common Shares to be
issued or reserved for issuance pursuant to the Arrangement be listed for
trading on Nasdaq. Discreet is in the process of preparing the required Nasdaq
National Market Notification Form for the Listing of Additional Shares in
respect of the listing of such Discreet Common Shares on Nasdaq. Discreet does
not currently intend to list the Discreet Common Shares on the TSE or any other
stock exchange in Canada.
QUALIFICATION AND RESALE OF THE DISCREET COMMON SHARES
CANADA
The distribution of Discreet Common Shares to MGI Shareholders upon the
Arrangement taking effect will be exempt from the prospectus and registration
requirements of securities legislation in each of the Provinces of Canada.
Subject to certain restrictions applicable to distributions of shares from
"control blocks", the resale of Discreet Common Shares by MGI Shareholders who
receive Discreet Common Shares upon the Arrangement taking effect will be freely
transferable in Ontario. MGI Shareholders who are resident in provinces other
than Ontario may be subject to restrictions on the resale of Discreet Common
Shares in certain circumstances and, accordingly, any such MGI Shareholders
desiring to resell any Discreet Common Shares should consult with their legal
advisor before engaging in such trade. However, such Discreet Common Shares will
be freely transferable on Nasdaq as set forth below.
UNITED STATES
The Discreet Common Shares to be issued to holders of MGI Common Shares will
not be registered under the Securities Act. Such Shares will be issued in
reliance upon the exemption from registration provided by Section 3(a)(10) of
the Securities Act. Section 3(a)(10) of the Securities Act exempts from the
registration requirements of the Securities Act securities that are issued in
exchange for other outstanding securities, where the terms, conditions and
fairness of the issuance of such securities have been approved by a court
expressly authorized to grant approval to the proposed issuance, after a hearing
upon the fairness of the terms and conditions of the issuance at which hearing
all persons to whom such securities will be issued have the right to appear.
Under Section 182 of the OBCA, the Court is authorized to conduct a hearing
to determine the fairness of the terms and conditions of the Arrangement,
including the proposed issuance of securities in exchange for other outstanding
securities. The Court rendered the Interim Order on April 9, 1998, and subject
to the approval of the Arrangement by the MGI Shareholders, a hearing on the
fairness of the Arrangement will be held on May 25, 1998 by the Court.
The Discreet Common Shares received by MGI Shareholders in the Transaction
will be freely transferable, except for Discreet Common Shares received by
persons who are deemed to be "affiliates" (as such term is defined for purposes
of Rule 145 under the Securities Act) of MGI at the time the Transaction is
submitted for a vote to MGI Shareholders. Persons who may be deemed to be
affiliates of MGI generally include individuals or entities that control, are
controlled by, or are under common control with, MGI and may include certain
officers and directors as well as principal stockholders of MGI. Rule 145(d)
under the Securities Act requires that, for specified periods, resales of
Discreet Common Shares acquired pursuant to the Arrangement by affiliates of MGI
be made in compliance with the volume limitations, manner of sale provisions and
current information requirements of Rule 144 under the Securities Act. The
volume limitations should not pose any material limitations on any MGI
Shareholder who owns less than one percent of Discreet's outstanding Common
Shares after the Arrangement unless, pursuant to Rule 144, such stockholder's
shares are required to be aggregated with those of another shareholder. Pursuant
to the Arrangement, each director, and executive officer, of MGI has executed
and delivered to Discreet an agreement to the effect that such person will not
offer to sell or otherwise dispose of any Discreet Common Shares issued to such
person pursuant to the Arrangement unless such disposition is made in conformity
with Rule 145 of the Securities Act, pursuant to an effective registration
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statement or upon the delivery to Discreet of a written opinion of counsel that
such disposition is otherwise exempt from registration under the Securities Act.
RIGHTS OF DISSENT UNDER THE OBCA
DISSENT RIGHTS UNDER THE OBCA FOR ARRANGEMENT
Under the OBCA, holders of MGI Common Shares have a right to dissent with
respect to the Arrangement. As a result, any Dissenting Shareholder is entitled
to be paid the fair value (determined as at the close of business on the day
before the Special Resolution is adopted) of all, but not less than all, of the
shares of the same class beneficially held by it in accordance with section 185
of the OBCA, if the shareholder dissents to the Arrangement and the Arrangement
becomes effective.
A holder of MGI Common Shares is not entitled to dissent with respect to the
Arrangement, if such holder votes any of such shares beneficially held by it in
favour of the Special Resolution authorising the Arrangement. THE EXECUTION OR
EXERCISE OF A PROXY DOES NOT CONSTITUTE A WRITTEN OBJECTION FOR PURPOSES OF THE
RIGHTS TO DISSENT UNDER THE OBCA.
PROCEDURE FOR DISSENT UNDER THE OBCA
The following summary does not purport to provide a comprehensive statement
of the procedures to be followed by an MGI Shareholder seeking to exercise its
dissent rights under the OBCA and section 185 of the OBCA is set forth in its
entirety in Schedule J. The OBCA requires adherence to the procedures
established therein and failure to adhere to such procedures may result in the
loss of all rights of dissent. ACCORDINGLY, EACH MGI SHAREHOLDER WHO MIGHT
DESIRE TO EXERCISE RIGHTS OF DISSENT SHOULD CAREFULLY CONSIDER AND COMPLY WITH
THE PROVISIONS OF SECTION 185 OF THE OBCA AND CONSULT ITS LEGAL ADVISOR.
An MGI Shareholder wishing to exercise its dissent rights and receive
payment of the fair value of its MGI Common Shares is required to send a written
objection to the Special Resolution to MGI at or before the Special Meeting.
MGI's address for such purpose is 40 West Wilmot Street, Richmond Hill, Ontario,
Canada, L4B 1H8, Attention: Josef Zankowicz. A vote against the Special
Resolution or a withholding of votes does not constitute a written objection.
Within ten days after the Special Resolution is approved by the MGI
Shareholders, MGI (or Amalco or Discreet as its successor) must so notify such
shareholder who is then required, within twenty days after receipt of such
notice (or if such shareholder does not receive such notice within twenty days
after learning of the approval of the Special Resolution), to send to MGI (or
Amalco or Discreet as its successor) a written notice containing its name and
address, the number and class of shares in respect of which the shareholder
wishes to dissent and a demand for payment of the fair value of such shares and,
within thirty days after sending such written notice, to send to MGI (or Amalco
or Discreet as its successor) or its transfer agent the share certificate or
certificates representing the MGI Common Share or MGI Common Shares in respect
of which the shareholder dissents.
An MGI Shareholder who fails to send to MGI (or Amalco or Discreet as its
successor), within the appropriate time frame, a written objection to the
Special Resolution, demand for payment of fair value and certificates
representing the shares in respect of which the shareholder dissents, forfeits
the right to make a claim under section 185 of the OBCA. The transfer agent of
MGI (or Amalco or Discreet as its successor) will endorse on the share
certificates validly received from a Dissenting Shareholder a notice that the
holder is a Dissenting Shareholder and will forthwith return the share
certificates to the Dissenting Shareholder.
On sending a demand for payment to MGI, a Dissenting Shareholder ceases to
have any rights as a shareholder, other than the right to be paid the fair value
of such holder's shares as determined under section 185 of the OBCA, except
where:
(a) the Dissenting Shareholder withdraws the demand for payment before MGI
(or Amalco or Discreet as its successor) makes an offer to pay for the
Dissenting Shareholder's shares pursuant to the OBCA,
(b) MGI (or Amalco or Discreet as its successor) fails to make an offer as
hereinafter described and the Dissenting Shareholder withdraws the demand
for payment, or
(c) the proposal contemplated in the applicable Special Resolution does not
proceed,
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in which case the Dissenting Shareholder's rights as a shareholder of MGI will
be reinstated as of the date the Dissenting Shareholder sent the demand for
payment.
If the proposal contemplated in the applicable Special Resolution becomes
effective, MGI (or Amalco or Discreet as its successor) will be required to
send, not later than the seventh day after the later of (i) the Effective Date
or (ii) the demand for payment is received, to each Dissenting Shareholder whose
demand for payment has been received, a written offer to pay for such Dissenting
Shareholder's shares such amount as the Board of Directors of MGI (or Amalco or
Discreet as its successor) considers fair value thereof accompanied by a
statement showing how the fair value was determined. MGI (or Amalco or Discreet
as its successor) must pay for the shares of a Dissenting Shareholder within ten
days after an offer made as described above has been accepted by a Dissenting
Shareholder, but any such offer lapses if MGI (or Amalco or Discreet as its
successor) does not receive an acceptance thereof within thirty days after such
offer has been made.
If such offer is not made or accepted within fifty days after the Effective
Date, MGI (or Amalco or Discreet as its successor) may apply to a court of
competent jurisdiction to fix a fair value for the shares of any Dissenting
Shareholder. There is no obligation of MGI (or Amalco or Discreet as its
successor) to apply to the court. If MGI (or Amalco or Discreet as its
successor) fails to make such an application, a Dissenting Shareholder has the
right to so apply within a further twenty days. A Dissenting Shareholder is not
required to give security for costs in such an application.
Upon an application to a court, all Dissenting Shareholders whose shares
have not been purchased by MGI (or Amalco or Discreet as its successor) will be
joined as parties and be bound by the decision of the court, and MGI (or Amalco
or Discreet as its successor) will be required to notify each Dissenting
Shareholder of the date, place and consequences of the application and of the
right to appear and be heard in person or by counsel. Upon any such application
to a court, the court may determine whether any person is a Dissenting
Shareholder who should be joined as a party, and the court will then fix a fair
value for the shares of all Dissenting Shareholders who have not accepted an
offer to pay. The final order of a court will be rendered against MGI (or Amalco
or Discreet as its successor) in favour of each Dissenting Shareholder and for
the amount of the fair value of the shareholder's shares as fixed by the court.
The fair value of such shares as determined by a court will not necessarily be
the same as, and could vary significantly from, the fair market value of such
shares as determined by the Board of Directors of MGI for purposes of
determining the exchange ratio. The court may, in its discretion, allow a
reasonable rate of interest on the amount payable to each such Dissenting
Shareholder from the date on which the applicable Special Resolution was adopted
until the date of payment.
Discreet's obligation to complete the Arrangement is conditional on the
number of MGI Common Shares in respect of which dissent rights are exercised and
not withdrawn plus the aggregate number of all fractional shares in respect of
which MGI Shareholders are to receive cash payment pursuant to the Arrangement
not exceeding 9.99% of the total number of MGI Common Shares on the Effective
Date.
CANADIAN FEDERAL INCOME TAX CONSIDERATIONS
In the opinion of Osler, Hoskin & Harcourt, counsel to MGI, the following is
a general summary of the principal Canadian federal income tax considerations of
the Transaction generally applicable to MGI Shareholders who deal at arm's
length with Discreet and MGI, who hold their MGI Common Shares and will hold
their Discreet Common Shares as capital property and, in the case of holders who
are not residents of Canada, who do not hold or use and are not deemed to hold
or use their MGI Common Shares, and will not hold or use and will not be deemed
to hold or use their Discreet Common Shares in connection with a business
carried on in Canada, all for the purposes of the ITA.
Shares will generally be considered to be capital property to a holder
unless the holder holds them in the course of carrying on a business of buying
or selling securities or acquired them in a transaction or transactions
considered to be an adventure in the nature of trade. Certain holders resident
in Canada whose shares might not otherwise qualify as capital property may be
able to make an irrevocable election permitted by subsection 39(4) of the ITA to
have every "Canadian security" owned by the holder in the taxation year of the
election and in all subsequent taxation years deemed to be capital property.
Shares held by certain financial institutions, including a bank, a trust
company, a credit union, an insurance corporation, a registered securities
dealer or a corporation
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controlled by one or more of the foregoing, will generally not be held as
capital property and will be subject to special "mark-to-market" rules.
This summary is based on the current provisions of the ITA, the regulations
thereunder (the "Regulations"), the Canada-United States Income Tax Convention
(1980) (the "Convention") and counsel's understanding of the current published
administrative and assessing practices of Revenue Canada. This summary also
takes into account all specific proposals to amend the ITA and Regulations
publicly announced by the Department of Finance of Canada prior to the date
hereof (collectively, the "Proposed Tax Amendments"). No assurance can be given
that the Proposed Tax Amendments will be enacted or will be enacted as tabled,
announced or advised. This summary does not otherwise take into account or
anticipate any changes in law, whether by judicial, governmental or legislative
decision or action, nor does it take into account provincial, territorial or
foreign tax legislation or considerations which may differ significantly from
those discussed herein.
THIS SUMMARY IS OF A GENERAL NATURE ONLY AND IS NOT INTENDED TO BE, NOR
SHOULD IT BE CONSTRUED TO BE, LEGAL OR TAX ADVICE TO ANY PARTICULAR MGI
SHAREHOLDER. ACCORDINGLY, MGI SHAREHOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS
FOR ADVICE WITH RESPECT TO THEIR OWN PARTICULAR CIRCUMSTANCES, INCLUDING THEIR
PLACE OF RESIDENCE. IN PARTICULAR, FINANCIAL INSTITUTIONS THAT ARE SUBJECT TO
THE "MARK-TO-MARKET" RULES ARE URGED TO CONSULT THEIR OWN TAX ADVISORS IN
RESPECT OF THE INCOME TAX CONSEQUENCES TO THEM OF THE TRANSACTION, AS THE
FOLLOWING DISCUSSION DOES NOT APPLY TO SUCH FINANCIAL INSTITUTIONS.
RESIDENTS OF CANADA
The following summary is generally applicable to an MGI Shareholder who is a
resident or who is deemed to be a resident of Canada for the purposes of the
ITA.
ARRANGEMENT
No gain or loss will be realised when MGI Common Shares held by an MGI
Shareholder are exchanged for Discreet Common Shares upon the Arrangement.
Discreet Common Shares received by an MGI Shareholder on the Arrangement will be
deemed to have been acquired at a cost equal to the adjusted cost base to the
MGI Shareholder of the MGI Common Shares immediately before the Arrangement.
It is understood that, under the administrative practice of Revenue Canada,
if an MGI Shareholder receives cash in an amount not exceeding $200 in lieu of a
fraction of a Discreet Common Share on the Arrangement, the holder may ignore
the computation of any gain or loss on the partial disposition and reduce the
adjusted cost base of the Discreet Common Shares received on the Arrangement by
the amount of such cash. Alternatively, the holder may include the gain or loss
in the computation of the holder's income if the holder chooses to do so.
DISCREET COMMON SHARES
Dividends received on the Discreet Common Shares will be subject to the tax
treatment generally applicable to taxable dividends paid by Canadian
corporations on ordinary common shares.
A disposition of Discreet Common Shares will give rise to a capital gain (or
capital loss) to the extent that the proceeds of disposition, net of any
reasonable costs of disposition, exceed (or are less than) the adjusted cost
base of the Discreet Common Shares to the holder immediately before the
disposition. The cost of Discreet Common Shares acquired under the Arrangement
will be averaged with the adjusted cost base to the holder of all other Discreet
Common Shares then held by the holder as capital property for the purposes of
determining the adjusted cost base to such holder of each Discreet Common Share
held.
A holder will be required to include in his income three-quarters of the
amount of any capital gain (a "taxable capital gain") resulting from the
disposition of a Discreet Common Share and will be entitled to deduct
three-quarters of the amount of any capital loss (an "allowable capital loss")
resulting from the disposition of a Discreet Common Share against taxable
capital gains realised by the holder in the year of disposition. Allowable
capital losses in excess of taxable capital gains may be carried back and
deducted in any of the three preceding
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years or carried forward and deducted in any following year against taxable
capital gains realised in such years to the extent and under the circumstances
described in the ITA.
Canadian-controlled private corporations are subject to a refundable tax of
6 2/3% on investment income that will be refunded when the corporation pays
taxable dividends (at a rate of one dollar for every three dollars of taxable
dividends paid). For this purpose, investment income includes interest and
taxable capital gains but not dividends deductible in computing taxable income.
The Discreet Common Shares received by an MGI Shareholder on the Arrangement
will be qualified investments under the ITA for trusts governed by a registered
retirement savings plan, registered retirement income fund or a deferred profit
sharing plan, and will not be foreign property for purposes of the ITA.
RESIDENTS OF THE UNITED STATES
The following summary of Canadian federal income tax considerations is
generally applicable to an MGI Shareholder who is a non-resident or is deemed to
be a non-resident of Canada for the purposes of the ITA and who is a resident of
the United States for purposes of the Convention.
ARRANGEMENT
No gain or loss will be realised when MGI Common Shares held by an MGI
Shareholder are exchanged for Discreet Common Shares upon the Arrangement.
DISCREET COMMON SHARES
Dividends paid or credited or deemed to be paid or credited by Discreet on
the Discreet Common Shares will be subject to Canadian withholding tax. The rate
of the withholding tax as reduced by the Convention is 15% (reduced further to
5% if the beneficial owner is a company which owns at least 10% of the voting
stock of Discreet).
A holder will generally not be subject to tax under the ITA on any capital
gain, or entitled to deduct any capital loss, realised on the disposition of
Discreet Common Shares unless such shares are taxable Canadian property to the
holder for purposes of the ITA. Even if such shares are taxable Canadian
property to the holder, the holder may be entitled to relief under the
Convention. Generally, the Convention provides that gains realized by a resident
of the United States on the alienation of shares of a corporation are not
subject to Canadian tax unless the shares derive their value principally from
real property situated in Canada.
A Discreet Common Share will be taxable Canadian property of a holder if, at
any time within the five-year period immediately preceding the disposition of
the Discreet Common Share, 25% or more of the issued shares of any class or
series of Discreet were owned by the holder, by persons with whom the holder did
not deal at arm's length, or by a combination thereof, or if the MGI Common
Shares which were exchanged for Discreet Common Shares on the Arrangement were
taxable Canadian property, which will be the case if, at any time within the
five-year period immediately preceding the Arrangement, 25% or more of issued
shares of any class or series of MGI were owned by the holder, by persons with
whom the holder did not deal at arm's length, or by a combination thereof.
DISSENTING SHAREHOLDERS
Holders of MGI Common Shares are permitted to dissent from the Arrangement
in the manner set out in section 185 of the OBCA. A Dissenting Shareholder will
be entitled, in the event the Arrangement becomes effective, to be paid the fair
value of the MGI Common Shares held by such holder determined as at the
appropriate date. See "Rights of Dissent under the OBCA". Under the current
administrative practice of Revenue Canada, where a holder of MGI Common Shares
dissents from the Arrangement and receives a cash payment for his shares from
the amalgamated corporation, the holder of MGI Common Shares is considered to
have realised proceeds of disposition rather than a deemed dividend. Dissenting
Shareholders should consult their own tax advisors in this regard. Additional
income tax considerations may be relevant to Dissenting Shareholders who fail to
perfect or who withdraw their claims pursuant to the right of dissent.
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UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The exchange of MGI Common Shares for Discreet Common Shares is not expected
to constitute a "reorganization" within the meaning of Section 368 of the
Internal Revenue Code of 1986, as amended (the "Code"). Instead, the exchange of
MGI Common Shares for Discreet Common Shares is expected to constitute a taxable
transaction for U.S. federal income tax purposes. Notwithstanding the foregoing,
however, it is possible that the exchange of MGI Common Shares for Discreet
Common Shares could constitute a non-taxable "reorganization" for U.S. federal
income tax purposes.
Because the tax consequences under United States federal, state and local
tax laws of an exchange of shares of a foreign corporation are complex, holders
of MGI Common Shares who are "United States persons" as defined in the Code
should consult their tax advisors as to the particular tax consequences to them
of participation in the Transaction based on their circumstances. In particular,
holders of MGI Common Shares who are United States persons should be aware that
the Code imposes adverse tax consequences on shareholders of certain foreign
corporations, including, among other things, foreign corporations that are
treated as (i) passive foreign investment companies, as defined in Section 1297
of the Code, (ii) foreign personal holding companies, as defined in Section 552
of the Code, (iii) controlled foreign corporations, as defined in Section 957 of
the Code, and (iv) foreign investment companies, as defined in Section 1246 of
the Code. It is not possible to ascertain with certainty whether MGI or Discreet
is currently or will in the future be subject to these provisions of the Code.
Finally, if the Transaction constitutes a "reorganization" for U.S. federal
income tax purposes, holders of MGI Common Shares will be required to file
certain information with the U.S. Internal Revenue Service. If such information
is not filed, such holders may recognize gain notwithstanding the status of the
Transaction as a "reorganization". Consequently, such holders are strongly urged
to carefully consider with their tax advisors the United States federal, state
and local tax consequences of the Transaction.
RISK FACTORS
THE FOLLOWING FACTORS SHOULD BE CONSIDERED CAREFULLY BY MGI SHAREHOLDERS IN
EVALUATING WHETHER TO APPROVE THE ARRANGEMENT. AS DESCRIBED BELOW, A NUMBER OF
FACTORS COULD ADVERSELY AFFECT THE VALUE OF THE DISCREET COMMON SHARES. BEFORE
VOTING IN FAVOUR OF THE SPECIAL RESOLUTION, MGI SHAREHOLDERS SHOULD CAREFULLY
CONSIDER, IN LIGHT OF THEIR OWN FINANCIAL CIRCUMSTANCES, THE FACTORS SET FORTH
BELOW AS WELL AS OTHER INFORMATION CONTAINED IN THIS CIRCULAR. THESE FACTORS
SHOULD BE CONSIDERED IN CONJUNCTION WITH THE OTHER INFORMATION INCLUDED IN THIS
CIRCULAR. THIS CIRCULAR CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING
OF SECTION 27A OF THE SECURITIES ACT AND SECTION 21E OF THE EXCHANGE ACT. ACTUAL
RESULTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED IN THESE FORWARD-LOOKING
STATEMENTS AS A RESULT OF A VARIETY OF FACTORS, INCLUDING THOSE SET FORTH BELOW
AND ELSEWHERE IN THIS CIRCULAR.
RISKS RELATING TO THE TRANSACTION
INTEGRATION AND MANAGEMENT OF THE COMBINED BUSINESS
MGI and Discreet have entered into the Arrangement Agreement with the
expectation that the Arrangement will result in long-term beneficial synergies
for the combined business. These include the combination of the companies'
technologies and product offerings to create better, more cost-effective
products and the combined businesses' ability to offer integrated solutions.
Achieving the anticipated benefits of the Transaction will depend in part upon
whether the integration of the two companies' businesses is accomplished in an
efficient and effective manner, and there can be no assurances as to the extent
that this will occur, if at all. The anticipated benefits of the Transaction may
not be fully achieved unless the operations of MGI are successfully combined
with those of Discreet in a timely manner. The combination of the two companies
will require, among other things, the integration of certain of the product
lines, technologies, information systems and administrative, sales and marketing
functions. Historically, the sales models used by MGI's and Discreet's sales
organizations have differed significantly. There can be no assurance that the
combined company will be able to take full advantage of the combined sales
force's efforts. The success of this process will be influenced by the ability
of the combined business to retain key management, sales, research and
development personnel. There is no assurance that this integration will be
accomplished smoothly or successfully. In addition, the integration of
operations following the Transaction taking effect will require the dedication
of management
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resources, which may temporarily distract attention from the day-to-day business
of the combined company. Any material difficulties encountered in the transition
process could have an adverse impact on the results of the combined company and
could delay or reduce the anticipated benefits and synergies resulting from the
merger of Discreet and MGI. In addition, as commonly occurs with mergers of
technology companies, during the pre-merger and integration phases, aggressive
competitors may undertake initiatives to attract customers through various
incentives which could have a material adverse effect on the business, results
of operations and financial condition of Discreet, MGI and/or the combined
entity.
RISKS ASSOCIATED WITH FIXED EXCHANGE RATIO
As a result of the Arrangement, each outstanding MGI Common Share will be
exchanged for 0.162 Discreet Common Shares. The Arrangement Agreement does not
provide for adjustment of this exchange ratio based on fluctuations in the price
of Discreet Common Shares. The specific dollar value of the consideration to be
received by MGI Shareholders in the Transaction will depend on the market price
of Discreet Common Shares at the Effective Time. The market prices of Discreet
Common Shares and MGI Common Shares as of a recent date are set forth herein
under "Information Concerning Discreet -- Trading History" and "Information
Concerning MGI -- Trading History" and MGI Shareholders are advised to obtain
recent market quotations for Discreet Common Shares and MGI Common Shares. No
assurance can be given as to the market prices of Discreet Common Shares or MGI
Common Shares at any time before the Effective Date or as to the market price of
Discreet Common Shares at any time thereafter.
INTEGRATION OF ACQUIRED COMPANIES
Discreet has recently completed the acquisitions of D-Vision Systems, Inc.,
Lightscape Technologies, Inc. and substantially all the assets of Denim
Software, L.L.C. and the combined company may acquire other companies, products
or technologies in the future. There can be no assurance that these acquisitions
and the Transaction with MGI can be effectively integrated, that such
acquisitions will not result in costs or liabilities that could materially and
adversely affect the combined company's business, operating results and
financial condition, or that the combined company will obtain the anticipated or
desired benefits of such transaction. In addition to the proposed Transaction
with MGI, Discreet has recently completed the purchase of certain products and
technology through acquisitions. There can be no assurance that the products and
technologies recently acquired will be successful or will achieve market
acceptance, or that Discreet will not incur disruptions and unexpected expenses
in integrating the operations of the acquired businesses with those of Discreet.
In addition, with these recent acquisitions, Discreet has for the first time
entered the market with special effects software that runs on the Apple
Macintosh and Microsoft Windows NT operating systems and editing software that
runs on the Microsoft Windows NT operating system. In this market, Discreet
expects to confront competitors that have substantially greater financial,
technical and marketing resources than Discreet. Furthermore, Discreet
anticipates that products developed for these markets will initially be sold
primarily through Discreet's current distribution channels. No assurance can be
given that Discreet can successfully develop an effective distribution channel
in such markets. Finally, there can be no assurance that Discreet will not incur
disruptions and unexpected expenses in integrating the operations of Denim
Software, L.L.C., D-Vision Systems, Inc. and Lightscape Technologies, Inc. with
those of Discreet.
In the normal course of business, Discreet evaluates potential acquisitions
of businesses, products and technologies that would complement or expand
Discreet's business. There can be no assurance that Discreet will be able to
successfully negotiate, finance or integrate any such acquired businesses,
products or technologies. Furthermore, the integration of an acquired business
may cause a diversion of management time and resources. There can be no
assurance that a given acquisition, when consummated, will not materially
adversely affect Discreet.
COSTS OF INTEGRATION; TRANSACTION EXPENSES
Discreet and MGI estimate they will incur direct transaction costs of
approximately U.S.$3 million associated with the Transaction, which will be
included in the purchase price allocation for Canadian GAAP financial statements
and charged to operations upon consummation of the Transaction for U.S. GAAP
financial statements. Discreet and
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MGI believe the combined entity may incur additional charges to operations,
which is not currently reasonably estimable, in the quarter in which the
Transaction occurs or the following quarter, to reflect costs associated with
integrating the two companies. There can be no assurance that the combined
company will not incur additional material charges in subsequent quarters to
reflect additional costs associated with the Transaction.
LACK OF PUBLIC MARKET FOR DISCREET COMMON SHARES IN CANADA
The Discreet Common Shares are not listed on any Canadian stock exchange.
Discreet does not intend to list the outstanding Discreet Common Shares or the
Discreet Common Shares to be issued pursuant to the Arrangement on the TSE or
any other stock exchange in Canada.
EFFECT OF TRANSACTION ON CUSTOMERS
There is no assurance that the present and potential customers of MGI and
Discreet will continue their current or historical buying patterns following the
Transaction and any significant delay or reduction in orders could have an
adverse effect on the business and results of operations of the combined
business. Certain customers may defer purchasing decisions as they evaluate the
proposed Transaction, other merger and product announcements within the same
industry, the combined company's future product strategy and current and
anticipated product offerings of competitors. Customers may ultimately decide to
purchase competitors' products in lieu of the combined company's products. In
addition, by increasing the breadth of Discreet's and MGI's respective
businesses, the Transaction may make it more difficult for the combined company
to enter into new, or to maintain existing, relationships with strategic
partners, including customer relationships, some of whom may view the combined
company as a more direct competitor than either MGI or Discreet as an
independent company.
COMPETITION
The software industry in general and the digital imaging software market in
particular in which MGI and Discreet compete is extremely competitive and
characterized by frequent and rapid changes in technology and customer
preferences. MGI and Discreet compete with other software vendors for access to
distribution channels and customers. Competition is generally based on product
features and functionality, ease of use, quality of customer support, timeliness
of product upgrades and price, among other factors. As the market for the
software products of MGI and Discreet continues to develop and other software
vendors expand their product lines to include products that compete with those
of MGI and Discreet, competition may intensify. A number of competitors and
potential competitors of MGI and Discreet possess significantly greater
financial, technical, marketing and sales and other resources than either of
them or than will be possessed by Discreet following completion of the
Transaction. Accordingly, there can be no assurance that the future products
produced by Discreet will be successful or gain market acceptance.
Following the Transaction, Discreet believes that its ability to compete
will depend on elements both within and outside its control, including the
success and timing of new product development and product introductions by
Discreet and its competitors, product performance and price, distribution and
customer support. There can be no assurance that Discreet will be able to
compete successfully with respect to these factors. Although Discreet believes
that it has certain technological and other advantages over its competitors,
maintaining such advantages will require continued investment by Discreet in
research and development, sales and marketing and customer service and support.
There can be no assurance that Discreet will have sufficient resources to make
such investment or that Discreet will be able to make the technological advances
necessary to maintain such competitive advantages. In addition, as Discreet
enters new markets (including the multimedia software market), distribution
channels, technical requirements and levels and bases of competition may be
different from those in Discreet's current markets and there can be no assurance
that Discreet will be able to compete favourably.
The market in which Discreet competes is characterized by intense
competition. In the realtime segment of the special effects market, Discreet's
flame* system competes with Quantel Limited's ("Quantel") Henry product. In
certain applications in the non-real-time segment of the market Discreet's
system competes with Avid Technology, Inc.'s ("Avid") Illusion product.
Discreet's inferno* system competes with Quantel's Domino
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product and Eastman Kodak Company's ("Kodak") Cineon product. Discreet's fire*
and smoke* systems compete with Quantel's Editbox product and Sony Corporation's
("Sony") range of proprietary editing equipment. In addition, Discreet expects
that the products gained from the acquisitions of Denim Software, L.L.C. and
D-Vision Systems, Inc. will compete with Adobe Systems Incorporated's special
effects products and Avid's and Media 100 Inc.'s range of editing products. Many
of Discreet's current and prospective competitors, including Quantel, Kodak,
Sony, Adobe and Avid, have significantly greater financial, technical,
manufacturing and marketing resources than Discreet. Moreover, these companies
may introduce additional products that are competitive with those of Discreet,
and there can be no assurance that Discreet's products would compete effectively
with such products. In addition, as personal computers become more powerful,
software suppliers may be able to introduce products for personal computers that
would be competitive with Discreet's products in terms of price and performance
for professional users.
CERTAIN FACTORS THAT MAY AFFECT DISCREET'S FUTURE RESULTS
Discreet's future results are subject to substantial risks and
uncertainties. Discreet's future financial performance will depend in part on
the successful development, introduction and customer acceptance of its existing
and new or enhanced products. In addition, in order for Discreet to achieve
sustained growth, the market for Discreet's systems and software must continue
to develop and Discreet must expand this market to include additional
applications within the film and video industries and develop or acquire new
products for use in related markets. There can be no assurance that Discreet
will be successful in marketing its existing or any new or enhanced products. In
addition, as Discreet enters new markets, distribution channels, technical
requirements and levels and bases of competition may be different from those in
Discreet's current markets and there can be no assurance that Discreet will be
able to compete favourably. The markets in which Discreet competes are
characterized by intense competition and many of Discreet's current and
prospective competitors have significantly greater financial, technical,
manufacturing and marketing resources than Discreet. These companies may
introduce additional products that are competitive with those of Discreet, and
there can be no assurance that Discreet's products will compete effectively with
such products. Furthermore, competitive pressures or other factors, including
Discreet's entry into new markets, may result in significant price erosion that
could have a material adverse effect on Discreet's business and results of
operations.
RISKS ASSOCIATED WITH PRODUCT DEVELOPMENT INTRODUCTIONS AND ANNOUNCEMENTS
The markets for Discreet's systems and software are characterized by
evolving industry standards, changing technologies and frequent new product
introductions. Discreet's future success will depend in part upon its ability to
enhance its existing systems and software and to develop and introduce new
products and features which meet changing customer requirements and emerging
industry standards on a timely basis. In addition, in connection with Discreet's
recent acquisitions, Discreet must integrate the edit*, effect*, paint* and
light* products into its product line and operations. There can be no assurance
that Discreet will be able to successfully integrate these newly acquired
products into its current product line in a timely manner, if at all. Discreet
has from time to time experienced delays in introducing new products and product
enhancements and there can be no assurance that Discreet will not experience
difficulties that could delay or prevent the successful development,
introduction and marketing of new products or product enhancements. In addition,
there can be no assurance that such new products or product enhancements will
meet the requirements of the marketplace and achieve market acceptance. Any such
failure could have a material adverse effect on Discreet's business and results
of operations. Furthermore, products such as those offered by Discreet may
contain undetected or unresolved software errors when they are first introduced
or as new or enhanced versions are released. Discreet has in the past discovered
software errors in certain of its new products and product enhancements. There
can be no assurance that, despite significant testing by Discreet, software
errors will not be found in new products and product enhancements after
commencement of commercial shipments, resulting in delays in or loss of market
acceptance. In addition, from time to time Discreet or others may announce
products, features or technologies which have the potential to shorten the life
cycle of or replace Discreet's then existing products. Such announcements could
cause customers to defer the decision to buy or determine not to buy Discreet's
products or cause Discreet's distributors to seek to return products to
Discreet, any of which would have a material adverse effect on Discreet's
business and results of operations. In addition, product announcements by SGI
and others in the past have caused customers to defer the decision to buy or
determine not to buy Discreet's
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products. See "Risk Factors -- Dependence on Single Workstation Vendor." In
addition, there can be no assurance that products or technologies developed by
others will not render Discreet's products or technologies non-competitive or
obsolete.
SINGLE MARKET FOR DISCREET'S SYSTEMS; RISKS ASSOCIATED WITH EXPANSION INTO NEW
MARKETS
To date, Discreet's products have been purchased primarily by creative
professionals for use in production and post-production in the film and video
industries. In order for Discreet to achieve sustained growth, the market for
Discreet's systems and software must continue to develop and Discreet must
expand this market to include additional applications within the film and video
industries and develop new products for use in related markets. Discreet
recently announced its multi-platform software initiative to develop and market
software across Apple Macintosh, Microsoft Windows NT and UNIX operating
systems, in addition to its existing real-time turnkey systems solutions,
targeted at two new market segments: institutional customers and prosumers
(professional consumers). While Discreet believes that the market recognition
which it has achieved through sales of flame*, effect*, inferno* and fire*
systems to creative professionals will facilitate its marketing efforts in new
markets, there can be no assurance that Discreet will be able to successfully
develop and market systems and software for other markets, or, if it does so,
that such systems and software will be accepted at a rate, and in levels,
sufficient to maintain growth. Further, the distribution channels, technical
requirements and levels and bases of competition in other markets are different
than those in Discreet's current market and there can be no assurance that
Discreet will be able to compete favorably in those markets.
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
A variety of factors may cause period-to-period fluctuations in the
operating results of each of MGI, Discreet and the combined company resulting
from the Transaction, including the integration of operations resulting from
acquisitions of companies, products or technologies, revenues and expenses
related to the introduction of new products or new versions of existing
products, changes in selling prices, delays in purchases in anticipation of
upgrades to existing products, or introduction of new products (including
products of third parties), currency fluctuations, dealer and distributor order
patterns or general economic trends. Historical operating results of each of MGI
and Discreet or the combined pro forma results set forth in this Circular cannot
be relied upon as indicative of future performance of the combined company
following completion of the Transaction.
Discreet believes that its operating results could vary significantly from
quarter to quarter. A limited number of system sales may account for a
substantial percentage of Discreet's quarterly revenue because of the high
average sales price of such systems and the timing of purchase orders.
Historically, Discreet has generally experienced greater revenue during the
period following the completion of the annual conference of the National
Association of Broadcasters ("NAB"), which is typically held in April.
Discreet's expense levels are based, in part, on its expectations of future
revenue. Therefore, if revenue levels are below expectations, particularly
following NAB, Discreet's operating results are likely to be adversely affected,
as was the case for the three-month periods ended April 30, 1996 and July 31,
1996. In addition, the timing of revenue is influenced by a number of other
factors, including the timing of individual orders and shipments, other industry
trade shows, competition, seasonal customer buying patterns, changes in customer
buying patterns in response to platform changes and changes in product
development, and sales and marketing expenditures. Because Discreet's operating
expenses are based on anticipated revenue levels and a high percentage of
Discreet's expenses are relatively fixed in the short term, variations in the
timing of recognition of revenue could cause significant fluctuations in
operating results from quarter to quarter and may result in unanticipated
quarterly earnings shortfalls or losses. There can be no assurance that Discreet
will be successful in maintaining or improving its profitability or avoiding
losses in any future period. Discreet believes that quarter-to-quarter
comparisons of its financial results are not necessarily meaningful and should
not be relied upon as an indication of future performance.
DISTRIBUTION SYSTEM; POTENTIAL DISTRIBUTION CHANNEL CONFLICT
Discreet currently markets its systems and software through its direct sales
organization and through distributors. Discreet further expects to increase its
indirect channel as a result of the Denim, D-Vision and
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Lightscape acquisitions. This marketing strategy may result in distribution
channel conflicts as Discreet's direct sales efforts may compete with those of
its indirect channels.
Currently, MGI's sales to a relatively small number of distributors account
for a substantial percentage of the revenues of MGI. MGI's agreements with these
distributors are generally non-exclusive and may be terminated by either party
without cause. There can be no assurance following the merger of MGI and
Discreet that these distributors will continue their current relationship with
the combined business on the same basis, or that they will not give higher
priority to the sale of other products, which could include products of
competitors. Combined with the fact of increasing concentration of channels of
distribution in the software industry, there can be no assurance that MGI will
be able to continue to obtain adequate distribution channels for all of its
products in the future.
DEPENDENCE ON SINGLE WORKSTATION VENDOR
Discreet's flame*, effect*, inferno*, fire* and frost* systems currently
include workstations manufactured by SGI. There are significant risks associated
with this reliance on SGI and Discreet may be impacted by the timing of the
development and release of products by SGI, as was the case during fiscal 1996.
In addition, there may be unforeseen difficulties associated with adapting
Discreet's products to future SGI products. Discreet is an authorized master
value added reseller ("VAR") of workstations manufactured by SGI. Discreet's
agreement with SGI is subject to annual renewal in May of each year and
termination by SGI for cause. The agreement with SGI has been extended through
June 30, 1998 and Discreet has no reason to believe that SGI will not renew such
agreement. In addition, although Discreet has no reason to believe that it will
be unable to obtain sufficient quantities of SGI workstations on a timely basis
or that its status as a master VAR will be changed, there can be no assurance
that Discreet will continue to be able to procure such workstations in
sufficient quantities or on a timely basis or that SGI will continue to
recognize Discreet as a master VAR. The success of Discreet also depends, in
part, on the continued market acceptance of SGI workstations, in general, and by
the professional film and video industries, in particular. Although Discreet
intends to continue to evaluate new hardware platforms and may adapt its
products as technological advances and market demands dictate, and although
Discreet has now entered the market for special effects and editing software,
Discreet believes that it will continue to derive substantially all of its
revenue for the foreseeable future from the sale and maintenance of systems
designed to include SGI workstations. As a result, financial, market and other
developments adversely affecting SGI or the sales of workstations, the
introduction or acquisition by SGI of products which are competitive with those
of Discreet, or the unanticipated timing or pricing of SGI products that could
cause customers to defer the decision to buy or determine not to buy Discreet's
then available products or systems, could have an adverse effect upon Discreet's
business and results of operations, as was the case for the three month period
ended January 31, 1996. As a master VAR, Discreet also obtains certain advance
access to SGI technology in order to develop compatible systems and to modify
and improve existing products. If Discreet were unable to obtain such advance
access, it could have an adverse impact on Discreet's business and results of
operations.
INTERNATIONAL REVENUES
For fiscal 1994, 1995 and 1996, and the eleven-month period ended June 30,
1997 revenues from customers outside North America were approximately
$4,048,000, $29,033,000, $47,711,000 and $58,171,000, respectively, representing
approximately 26%, 45%, 57% and 57%, respectively, of Discreet's total revenues.
During fiscal 1995, 1996 and the eleven months ended June 30, 1997, Discreet
expanded its direct sales force and distribution channels in Europe and the
Pacific Rim at a greater rate than in North America which resulted in revenues
from customers outside North America increasing at a significantly higher rate
than revenues from customers inside North America. Discreet expects that
revenues from customers outside North America will continue to account for a
substantial portion of its revenues. International sales are subject to a number
of risks, including the following: agreements may be difficult to enforce and
receivables difficult to collect through a foreign country's legal system;
foreign customers may have longer payment cycles; foreign countries could impose
additional withholding taxes or otherwise tax Discreet's foreign income, impose
tariffs or adopt other restrictions on foreign trade; fluctuations in exchange
rates could affect product demand; and the protection of intellectual property
in foreign countries may be more difficult to enforce. There can be no assurance
that these factors will
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not have a material adverse effect on Discreet's future international sales and,
consequently, on Discreet's business and results of operations. In addition,
fluctuations in exchange rates may render Discreet's products less competitive
relative to local product offerings, or could result in foreign exchange losses,
depending upon the currency in which Discreet sells its products. To date,
Discreet has not engaged in exchange rate hedging activities to minimize the
risks of such fluctuations. Discreet may seek to implement hedging techniques in
the future with respect to its foreign currency transactions. There can be no
assurance, however, that Discreet will be successful in such hedging activities.
LIMITED PROTECTION OF PROPRIETARY TECHNOLOGY; RISK OF THIRD PARTY INFRINGEMENT
CLAIMS
Discreet's success is dependent upon its proprietary technology. Although
Discreet has five patents and has 70 patent applications on its technology, it
relies principally on unregistered copyrights and trade secrets to protect its
intellectual property. Discreet generally seeks to enter into confidentiality
agreements with its employees and license agreements with its distributors and
to limit access to and distribution of its systems, software, documentation and
other proprietary information. Until fiscal 1996, substantially all of
Discreet's systems were sold without written license agreements. There can be no
assurance that Discreet will not be involved in litigation with respect thereto
or that the outcome of any such litigation might not be more unfavorable to
Discreet as a result of such omissions. Any such litigation could have a
material adverse effect on Discreet's business and results of operations.
Discreet uses both software and hardware keys with respect to its systems and
software but otherwise does not copy-protect its systems and software. It may be
possible for unauthorized third parties to copy Discreet's products or to
reverse engineer or obtain and use information that Discreet regards as
proprietary. There can be no assurance that Discreet's competitors will not
independently develop technologies that are substantially equivalent or superior
to Discreet's technologies. In addition, the laws of certain countries in which
Discreet's products are or may be distributed do not protect Discreet's products
and intellectual property rights to the same extent as the laws of Canada or the
United States. As the number of software products in the industry increases and
the functionality of these products further overlaps, Discreet believes that
software products generally may increasingly become the subject of claims that
such software products infringe the rights of others.
Significant and protracted litigation may be necessary to protect Discreet's
intellectual property rights, to determine the scope of the proprietary rights
of others or to defend against claims of infringement. Discreet attempts to
ensure that its systems, software and processes do not infringe any existing
proprietary rights of others and is not currently involved in any litigation
with respect to intellectual property rights. Discreet receives letters from
third parties, from time to time, inquiring about Discreet's products and
discussing intellectual property matters, which Discreet reviews to determine
the appropriate response, if any. There can be no assurance that third-party
claims alleging infringements will not be asserted against Discreet in the
future. For example, Discreet received a letter from Avid stating its belief
that certain of Discreet's recently acquired D-Vision products utilize
inventions claimed in a patent on a media editing system. Discreet has responded
to Avid's letter stating Discreet's belief that Discreet is not infringing any
valid claim of Avid's patent. To Discreet's knowledge, Avid has not initiated
any suit, action, or other proceeding alleging any infringement by Discreet of
such patent. If infringement is alleged by Avid, or any other holder of
protected intellectual property rights, Discreet could be required to
discontinue the use of certain software code or processes, to cease the
manufacture, use and sale of infringing products, to incur significant
litigation costs and expenses and to develop non-infringing technology or to
obtain licenses to use the allegedly infringed technology. There can be no
assurance that Discreet would be able to develop alternative technologies or to
obtain such licenses or, if a license were obtainable, that the terms would be
commercially reasonable or acceptable to Discreet. Moreover, there may be
pending or issued parents that extend to Discreet's products, which, together
with the growing use of patents to protect technology, increase the risk that
third parties may assert infringement claims against Discreet in the future.
There can be no assurance that a court to which any infringement claims are
submitted would not find that Discreet's products infringe any third party's
intellectual property rights. Further, such litigation, regardless of its
outcome, could result in substantial costs to and diversion of efforts by
Discreet. Litigation may also be necessary to enforce Discreet's intellectual
property rights. Any infringement claim or other litigation against or by
Discreet could have a material adverse effect on Discreet's business and results
of operations.
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RELIANCE ON SOLE SOURCE SUPPLIERS
Discreet is dependent on SGI as Discreet's sole source for video
input/output ("I/O") cards used in Discreet's systems. Discreet is also
dependant on a single workstation vendor. See "Risk Factors -- Dependance on
Single Workstation Vendor." Discreet also purchases electronic tablets
manufactured by Wacom Technology Corporation ("Wacom") and believes that while
alternative suppliers are available, there can be no assurance that alternative
electronic tablets would be functionally equivalent or be available on a timely
basis or on similar terms. Discreet generally purchases sole source or other
components pursuant to purchase orders placed from time to time in the ordinary
course of business and has no written agreements or guaranteed supply
arrangements with its sole source suppliers. Discreet has experienced quality
control problems and supply shortages for sole source components in the past and
there can be no assurance that Discreet will not experience significant quality
control problems or supply shortages for these components in the future.
Discreet does not maintain an extensive inventory of these components, and an
interruption in supply could have a material adverse effect on Discreet's
business and results of operations. Because of Discreet's reliance on these
suppliers, Discreet may also be subject to increases in component costs which
could adversely affect Discreet's business and results of operations.
Discreet's edit* product requires, and can only be used with, a Targa
videographic card manufactured by Truevision, Inc., which distributors
customarily purchase and resell to end users as part of a turn-key system.
Discreet believes that while alternative suppliers are available, it would take
a significant amount of time to integrate any such replacement cards with
Discreet's edit* product. There can be no assurance that alternative cards would
be functionally equivalent or be available to distributors or users on a timely
basis or at a similar price. An interruption in the supply or an increase in
price of these cards to edit* software users could have a material adverse
effect on Discreet's business and results of operations.
In addition, MGI currently derives most of its sales from versions of
products designed to operate on personal computers using the Windows operating
environment. Although MGI has devoted, and the combined company will continue to
devote, substantial efforts to the development of software products that are
designed to operate on Windows 95 and Windows NT, and to the development of
versions of its products which operate on platforms other than Microsoft's
Windows operating systems, should MGI be unable in a timely manner to develop
and market products that operate on Windows 95 or Windows NT, or their updated
versions, Discreet's future revenues from software products could be adversely
affected.
MANAGEMENT OF CHANGING BUSINESS
Since inception, Discreet has experienced substantial changes in its
operations which have placed significant demands on Discreet's management and
administrative, operational and financial resources. In addition, Discreet's
ability to manage growth will require it to continue to implement and improve
its operational, financing and management information systems, and to motivate
and effectively manage an increasing number of employees. If Discreet's
management is unable to manage growth effectively, the quality of Discreet's
products, its ability to retain key personnel and its results of operations
could be materially adversely affected.
DEPENDENCE ON KEY PERSONNEL
Discreet's success to date has depended to a significant extent upon a
number of key management and technical employees. The loss of the services of
one or more of these key employees could have a material adverse effect on
Discreet's business and results of operations. Discreet believes that its future
success will also depend in large part upon its ability to attract and retain
highly skilled technical, management and sales and marketing personnel.
Moreover, because the development, marketing and distribution of Discreet's
systems and software requires knowledge of film and video production and
post-production, key technical personnel must be proficient in a number of
disciplines. Competition for such technical personnel is intense, and the
failure of Discreet to hire and retain talented technical personnel or the loss
of one or more key employees could have an adverse effect on Discreet's business
and results of operations.
Because of the relative shortage of skilled professionals who possess
knowledge of film and video production and post-production, Discreet recruits a
significant percentage of its personnel from other industry participants. From
time to time, Discreet receives notification from other industry participants
demanding that
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Discreet refrain from recruiting such participants' employees. Although Discreet
cannot predict what action these participants may take, it believes that any
action taken by these participants with regard to these employees would not have
a material adverse effect on Discreet's business and results of operations.
CONTROL BY OFFICERS AND DIRECTORS
Discreet's officers and directors, in the aggregate, owned beneficially
approximately 38.8% of the Discreet Common Shares outstanding as of March 31,
1998. As a result, these shareholders, acting together, would effectively be
able to control most matters requiring approval by the shareholders of Discreet,
including the election of a majority of the directors or the approval of
significant corporate matters, including change of control transactions.
Discreet's articles provide for the issuance of Preferred Shares, the terms of
which may be fixed by the Board of Directors. These factors could have the
effect of delaying, deferring, dissuading or preventing a change of control of
Discreet.
EXCHANGE RATE FLUCTUATIONS
A significant proportion of Discreet's and MGI's products are sold in the
United States in U.S. dollars, while a large proportion of their costs are
incurred in Canadian dollars. As a result, the profitability and cash flow of
Discreet and MGI are affected by exchange rate fluctuations. A significant
increase in the value of the Canadian dollar relative to the U.S. dollar would
reduce the amount of funds available on conversion of U.S. dollar revenues into
Canadian dollars.
VOLATILITY OF STOCK PRICE
The market price of the Discreet Common Shares has historically been highly
volatile and following the completion of the Transaction may continue to be
highly volatile. Factors such as announcements of technological innovations or
new products by Discreet or its competitors, quarter-to-quarter variations in
Discreet's operating results, as well as market conditions in the computer
software or hardware industries and changes in earnings estimates by analysts
may have a significant impact on the market price of the Discreet Common Shares.
Furthermore, stock markets have from time to time experienced extreme price and
volume fluctuations, particularly in the high technology sector, that may be
unrelated to the operating performance of particular companies. These broad
market and industry specific fluctuations may adversely affect the market price
of the Discreet Common Shares regardless of operating performance.
INFORMATION CONCERNING MGI
MGI was incorporated under the laws of the Province of Ontario on September
22, 1995. The principal office of MGI is located at 40 West Wilmot Street,
Richmond Hill, Ontario, L4B 1H8. On April 30, 1996 MGI amalgamated with Globex
Biotechnologies Inc. ("Globex"), a reporting issuer in the Province of Ontario,
and continued operating under the name MGI Software Corp.
DESCRIPTION OF BUSINESS
MGI designs, develops, markets and supports products in the digital
photography ("PC Photography"), digital video ("Video Publishing") and
three-dimensional graphics ("3D Graphics") markets in the multimedia segment of
the computer software industry. MGI also markets a digital desktop publishing
product in the desktop publishing ("DTP") segment of the computer software
industry. MGI's products are suitable for home and business PC users.
DESCRIPTION OF SOFTWARE PRODUCTS
MGI currently distributes nine products: MGI PhotoSuite, MGI PC Photography
Kit (also sold as PC PhotoStarter Kit), MGI PC Wedding Kit, MGI Sport Cards, MGI
PC Activity Kit, MGI PhotoGallery, MGI VideoWave, MGI 3DVision, and MGI Calamus
Publisher. MGI also produces and licenses original equipment manufacturer
("OEM") versions of these products.
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PC PHOTOGRAPHY PRODUCTS
MGI PHOTOSUITE -- This is a 32-bit software program (MGI also offers a
16-bit version) that allows users to edit, organize and be creative with their
photographs on a personal computer and the Internet. Its features include
enhancement, re-touching, special effects, capturing images from other
applications, and cutting and pasting photographs. Over 700 templates are
included with the software which can be combined with photographs to quickly
create professional-looking collages, posters, photo greeting cards, sport
cards, calendars and slide shows with sound, Windows wallpaper and screensavers.
MGI PhotoSuite allows the user to work with photographs captured from the
Internet using Netscape Navigator or Microsoft Explorer, captured from other
software programs or digitized using a scanner or digital camera. MGI PhotoSuite
provides multimedia file management functions allowing users to easily and
quickly organize all of their photographs, graphics, sound files, music and
video clips into albums.
MGI PhotoSuite takes advantage of the fact that Microsoft Windows 95 allows
photographs to be placed as OLE-objects (object linking and embedding) in other
Windows applications, making MGI PhotoSuite compatible with many other
Windows-based software products. It supports popular graphic file formats,
including those most often used on the Internet. MGI PhotoSuite has been
designed to take advantage of Intel's MMX media enhancement technology which
speeds up the manipulation of photographs on Pentium-based computers.
MGI PhotoSuite can make any photograph Internet-ready by automatically
reducing its resolution and converting the image file to JPEG format. Photo
albums created using MGI PhotoSuite can be viewed using any Internet browser on
a selected background with miniature JPEG "thumbnails" of each picture, with
each full-sized picture and a description of the picture immediately available.
MGI PhotoSuite makes it easy for users to send their photographs to family
and friends through electronic mail. Using e-mail software that supports MAPI, a
messaging standard developed by Microsoft, users can automatically attach their
photos to an e-mail message. By clicking on the attachment, the receiver can
easily and quickly view the photos in MGI PhotoSuite.
With MGI PhotoSuite, regular film camera users are able to access on-line
photography services, such as PictureVision, Inc.'s PhotoNet, to order reprints
and personalized photo gifts. PhotoNet is an Internet service that allows users
to proof, store and order prints and to use photographs processed by
photofinishers via the Internet. As well, users are able to organize and archive
their photographs electronically through the Internet using a connection with
PhotoNet retailers and wholesalers, including Black's Photo, Ritz Cameras, Wolf
Camera Centers and Konica Quality Photo.
MGI PhotoSuite users can mail or take their roll of film to any PhotoNet
retailer and elect to have their processed photographs uploaded to an Online
PhotoCenter home page. Upon accessing the Online PhotoCenter, photographs can be
viewed and modified using MGI PhotoSuite, and then sent via the Internet or
stored. Although photographs are displayed on the Internet using a lower
resolution, which minimizes downloading time, PhotoNet retailers use high
resolution files to generate prints. Order can be picked up at the store or
mailed and payment can be made online by credit card.
MGI PhotoSuite is available on both CD-ROM and floppy disks for Windows 3.x,
Windows 95/NT and is also available for the Apple Macintosh but only for OEM
distribution. The software is sold with a CD library containing photographs,
video clips, and sounds.
MGI PhotoSuite received Windows Magazine's "Recommended" and Win 100 Awards,
Best Buy Awards from Home Office Computing and Small Business Computing
magazines, and the Connie Award for best product from The Toronto Sun newspaper.
A new version of PhotoSuite, MGI PhotoSuite II, based on new software
technology developed by MGI, made its debut at Demo 1998, a product showcase
conference for the computer industry. MGI PhotoSuite II is among the first
products of its kind to be integrated with a Web browser, allowing users quick
and easy access to photographs and related services through the Internet. The
application is built around a component architecture, which is essentially an
assembly of ActiveX controls combined with Scriplets and JavaScript into a
43
<PAGE>
Dynamic HTML interface. The interface, which accommodates both the novice and
advanced user, borrows the characteristics of a Web browser and behaves like a
Web page, making it intuitive and easy to navigate.
MGI PhotoSuite II delivers to business and home users a high level of
functionality, productivity and entertainment. It includes all the elements and,
tools (including professionally rendered templates) that users need to edit,
enhance, transform, organize, present, print, use and share photos quickly and
easily. In addition, it integrates digital photo devices, and enables users to
utilize the Web for PC photography applications.
MGI PC PHOTOGRAPHY KIT (ALSO SOLD AS PC PHOTOSTARTER KIT) -- This kit makes
it easy for regular film camera users to put photographs on a personal computer
and the Internet without using a digital camera or scanner. It offers 35-mm
film, a special version of MGI PhotoSuite, free processing of film to disk and a
photo fun idea guide in one package.
MGI PC WEDDING KIT -- This kit allows users to put their wedding photos on a
personal computer and the Internet. With MGI PC Wedding Kit couples can create
co-ordinated, professional-looking wedding invitations, menu covers, place
setting cards, wine bottle labels, and more on their own computer. MGI PC
Wedding Kit enables couples to customize their wedding day photographs as
special keepsakes that they can share with family and friends. The package
includes a special version of MGI PhotoSuite, and an idea guide to provide
creative inspiration organized around 13 projects in ten co-ordinated themes. It
also includes five coupons for free film to disk conversion, 20 wine labels, and
special templates and materials for creating distinctive wedding mementos.
MGI SPORT CARDS -- This kit allows users to make professional-looking sport
cards on a personal computer using their sport or team photographs. The package
includes 35-mm film, a special version of MGI PhotoSuite, an idea guide, sport
card paper and a coupon for free digital film processing. Users can choose sport
card templates from over 100 different sports to combine with their photos. MGI
Sport Card received an Editor's Choice award from PC Photo Magazine in October
of 1997.
MGI PC ACTIVITY KIT -- This kit allows users to create crafts and jewellery
with family photos on a personal computer. The package includes a special
version of MGI PhotoSuite, craft and jewellery projects, free processing of film
to disk and an idea guide.
MGI PHOTOGALLERY -- This is a CD-ROM collection of more than 500
professional-quality photographs that can be used in presentations, reports and
in creating Web pages on the Internet. The images are stored in low resolution
format so that they can be quickly accessed and incorporated into other software
programs for Windows or Apple Macintosh computers.
VIDEO PUBLISHING PRODUCTS
MGI VIDEOWAVE -- This software lets users quickly and easily capture, edit
and produce videos on a personal computer. Designed for the non-technical,
general business and home user, MGI VideoWave uses a different approach to video
production by eliminating the traditional timeline interface used by other video
editing software products. Its storyline interface for video composition,
"morphing" console, non-linear editing functionality and real-time preview let
users combine moving pictures, animation, graphics, photos, sound, music and
narration to "tell a story" in video.
MGI VideoWave features allow users to capture video and audio from any
analog source such as a video camera or videotape player, produce still images
from analog video sources or from AVI, QuickTime or MPEG movies, record video
conferences, produce video for e-mail attachments or streaming on the Internet,
edit video and audio, produce professional effects, titles and transitions,
preview edited video and record narration. Users can produce videos in AVI,
QuickTime, MPEG and Internet streaming video formats for playback on PCs,
Macintosh computers and the Internet or output back to tape.
MGI VideoWave is a 32-bit program for Microsoft Windows 95/NT. This program
supports Intel Indeo and Intel MMX media enhancement technology which speeds up
the manipulation of video on Pentium-based computers. The software has built-in
support for Microsoft NetShow compliant file formats including ClearVideo from
Iterated Systems, VDOLive from VDONet Corp., Web Theater from VXtreme Inc., and
VivoActive from Vivo Software, Inc., thereby offering broad capability for
distributing and viewing high-quality, full-motion video over the Internet and
corporate networks.
44
<PAGE>
The package ships with MGI's ActiveMovie player and MGI MPEG-1 Encoder
("MME") in order to minimize hard disk space needs, a media library for managing
video, photo and audio content, 45 built-in special and transition effects,
stock videos and a tutorial.
In November 1996, Byte Magazine editors gave a pre-production version of MGI
VideoWave the Best of Comdex Finalist Award, recognizing it as one of the best
new multimedia software products introduced at the Comdex trade show in Las
Vegas. In 1997, PC Magazine awarded two Editor's Choice Awards to MGI VideoWave,
recognizing it to be the best in its category. MGI VideoWave has also received
international awards from Windows Sources magazine in Australia, SVM Multimedia
magazine in France and PC Format Magazine in the United Kingdom.
3D GRAPHICS PRODUCTS
MGI 3DVISION -- This is a 32-bit software program for Microsoft Windows
95/NT that allows users to create three-dimensional artwork and animation that
can be used with other Windows software and the Internet. MGI 3DVision provides
users with a set of tools to edit and view 3D objects in real time, and allows
users to add textures, lighting and mappings, combine objects, turn
two-dimensional objects or text into three-dimensional objects, create animated
graphical image files for web pages and turn three-dimensional sculptures into
animated characters. The software is currently available for OEM distribution
only.
DESKTOP PUBLISHING PRODUCTS
MGI CALAMUS PUBLISHER -- This is a comprehensive desktop publishing solution
designed for the general business user, as well as for graphics and publishing
professionals using Microsoft Windows 95/NT. The software is designed to support
Intel's MMX media enhancement technology which improves the handling of large
documents and files on Pentium-based personal computers.
MGI Calamus Publisher can be used to create printed and electronic materials
such as newsletters, magazines, newspapers, advertisements, brochures and
catalogues. The software enables the user to lay out text and graphics on the
computer screen and to review the resulting product in order to refine the
document being created. The package includes word processing and graphics
features in addition to layout capabilities, and finished documents may be
printed on either a laser printer or using typesetting equipment. Through its
various modules, the software offers a variety of functions such as integrated
vector font graphics, advanced masking, trapping, photo re-touching and colour
separations. As well, an HTML export and import feature can be used to publish
documents electronically on the Internet or other media. The software is one of
the first products to support international languages and character sets within
the same document using Microsoft Unicode, a standard that allows the use of
every letter of every language in any document. MGI currently expects
distribution of MGI Calamus Publisher to commence by the end of fiscal 1998.
BUSINESS AND MARKETING STRATEGY
MGI's objective has been to achieve a significant market presence in the
digital multimedia segment of the computer software industry. In particular, MGI
has intended to capitalize on the growing popularity and market acceptance of
Microsoft Corporation's Windows operating systems by offering affordable, yet
technologically advanced products aimed at the emerging market for photo, video,
3D and digital publishing products.
MGI's business strategy has focused on the following approaches:
1) increasing the distribution of MGI products by photo and video
manufacturers and retailers;
2) creating partnerships or alliances with dominant photograph, video and
multimedia hardware manufacturers in order to increase the distribution
of MGI products;
3) designing, building and supporting software products for global markets;
4) establishing global electronic links between suppliers and MGI software
users by taking advantage of the Internet and interactive online
commerce; and
45
<PAGE>
5) designing products that take advantage of leading multimedia enabling
technology in order to make MGI's products more attractive to potential
customers.
MGI's marketing strategy has been to establish a broad user base as quickly
as possible through retail mass marketing and widespread distribution through
OEMs. The first stage in MGI's marketing strategy has involved bundling and
distributing special versions of its retail software through OEM partners that
are market leaders in photo, video, graphics and multimedia hardware. These
special versions have been included in new equipment sold by the OEM
distribution partners. At the same time, MGI has distributed the most recent
retail versions of its products to software retail distributors and retail
chains. These first two stages in MGI's marketing strategy have been designed to
create a substantial user base. This user base provides a substantial target
market for upgrades, future enhancements and related products to be sold by MGI
at additional cost.
In connection with MGI's strategy of creating alliances with dominant
hardware manufacturers, on September 30, 1997 MGI entered into various
agreements with Intel pursuant to which, among other things, Intel made a
strategic equity investment in MGI. See "The Transaction -- Arrangement
Agreement -- Intel Warrants". This equity investment was made to help foster the
ongoing business relationship between Intel and MGI. In connection with this
investment, Intel was granted certain rights to require MGI to use its best
efforts to register the MGI Common Shares held by Intel contemporaneously with
other registrations being effected by MGI under the Securities Act.
OEM AND DISTRIBUTION ARRANGEMENTS
MGI sells its products through traditional software distributors, OEMs of
both hardware and software, international distributors, value-added retailers,
hardware and software "superstores", retail dealers, mass merchants and photo
chains.
To date, MGI has entered into OEM distribution arrangements with Intel, AST
Research, Inc., Citizen America Corporation, Diamond Multimedia, ATI
Technologies Inc., Canon, Packard Bell, NEC, Eastman Kodak, Panasonic, Agfa,
Sony, Iomega, Miro Computer Products (now Pinnacle Data Systems Incorporated),
Yashica, Digital Vision, Konica, Adaptec and Sanyo.
MGI's products have to date been distributed in Canada and the United States
through a number of retail dealers and mass merchants, including: CompUSA,
Computer City, Microwarehouse, AFFES, Egghead, Electronic Boutique, Fry's
Electronics, Future Shop, Business Depot, Meijers, Office Max, Staples, Best
Buy, Office Depot, Micro Center and London Drug. Distributors of MGI's products
include Ingram Micro, Merisel, Multimicro Inc., Tech Data Corp., Beamscope,
Carson Group Inc., Brandess-Kalt-Aetna Group Inc., Pakor, Inc. and Minilab
Specialties, Inc.
In Europe, MGI distributes through Ingram Micro (U.K.) Ltd., Gem
Distribution and Sanger Limited in the United Kingdom, Photologic in Ireland,
Macrotron AG, Ingram Micro GMBH and ALSO ABC Trading GMBH in Germany, Primax in
France, Ingram Micro Belgium in Benelux, Future Systems S.N.C. in Italy and
Ingram Micro in Holland.
In Australia, MGI distributes through Marketing Results Pty. Limited and in
Asia MGI has entered into a partnership agreement with Mitsui & Co., Ltd. of
Japan, and also distributes its products through Samtek Corporation in Korea and
Maxtek in Taiwan.
There are a number of companies that MGI believes are, or will become,
significant participant in its key markets. MGI has formed marketing alliances
with several companies, including Kodak Digital Processing (a division of Kodak
Corp.), Wolf Camera & Video, Ritz Camera, PictureVision and Black Photo
Corporation (a division of Fuji Film Canada).
MGI also has a number of other arrangements of an informal nature with other
OEMs and distributors, including Compaq, Netscape, VDOnet, Iterated Systems,
VXtreme and Vivo Software. In certain cases these arrangements involve including
MGI promotional materials with their products and/or including parts of their
products in MGI products.
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<PAGE>
SELECTED FINANCIAL INFORMATION FOR MGI
The following table presents selected financial information for MGI for the
periods indicated. This table should be read in conjunction with the financial
statements of MGI set forth in Schedule D to this Circular. This table contains
financial information prepared in accordance with Canadian GAAP.
STATEMENTS OF OPERATIONS AND DEFICIT
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31
--------------------------
1998 1997
------------ ------------
(thousands, except share
data)
<S> <C> <C>
Revenue................................................................................ $13,348 $5,144
Gross profit........................................................................... 10,688 3,815
Expenses............................................................................... 17,848 8,979
Loss for the year...................................................................... (6,950) (7,403)
Loss per share......................................................................... (0.35) (0.48)
Weighted average number of common shares outstanding................................... 19,958,968 15,355,052
</TABLE>
BALANCE SHEET DATA
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31
--------------------------
1998 1997
------------ ------------
(thousands)
<S> <C> <C>
Current assets......................................................................... $18,527 $7,891
Capital assets......................................................................... 1,487 952
Liabilities............................................................................ 3,344 2,385
Shareholders' equity................................................................... 16,670 6,458
</TABLE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
LIQUIDITY AND CAPITAL RESOURCES
Since MGI was incorporated on September 22, 1995, it has raised an aggregate
of approximately $4,756,000 through private placements of MGI Common Shares
(other than special warrant offerings) and $1,500,000 in respect of the private
placement of the MGI Debentures (as defined below), none of which debentures
remain outstanding. MGI also raised approximately $4,289,000, net of the agents'
fee and offering expenses, in respect of an offering of 2,744,000 special
warrants on May 15, 1996, approximately $2,685,000, net of the agents' fee and
offering expenses, in respect of an offering of 1,200,000 special warrants on
January 16, 1997 and approximately $13,851,000, net of the agents' fee and
offering expenses, in respect of an offering of 3,500,000 special warrants on
September 29, 1997. As at January 31, 1998, MGI had net working capital of
approximately $15,183,000. In the event that the Transaction is not completed,
MGI may seek to raise additional capital to meet its ongoing financial
requirements.
As of January 31, 1998, MGI had no outstanding commitments for capital
expenditures except for commitments to pay for certain computer equipment and
related software which had been ordered but not delivered. The aggregate amount
of such commitments did not exceed $40,000. These commitments were funded
through MGI's working capital.
FINANCIAL YEAR ENDED JANUARY 31, 1998 COMPARED TO FINANCIAL YEAR ENDED
JANUARY 31, 1997
During the financial year ended January 31, 1998, MGI had a loss before
amortization of software acquisitions of $6,828,000 based upon sales of
$13,348,000 expenses including cost of sales of $20,508,000 and interest income
of $210,000. The increased losses experienced by MGI during the financial year
ended January 31, 1998 as compared to the financial year ended January 31, 1997
were due primarily to increased expenditures on infrastructure and marketing as
MGI continued to expand into retail channels throughout North America, Europe
and Asia Pacific. The expenses associated with the launching of MGI VideoWave in
April of 1997 and the development of MGI PhotoSuite II also contributed to
increased losses. During the
47
<PAGE>
financial year ended January 31, 1998, retail sales through distributors
continued to account for the majority of sales revenues of MGI.
Amortization of software acquisitions in the financial year ended 1998 was
$122,000. Amortization expense decreased significantly in the financial year
ended January 31, 1998 as compared to the financial year ended January 31, 1997
because of management's decision to write-off certain software acquisitions as
at January 31, 1997.
Research and development expenses of $4,758,000 for the year were comprised
mainly of salary expenses and fees paid to subcontractors for the development of
existing and new software. This significant increase in the corporation's
investment in research and development during the financial year ended January
31, 1998 as compared to the financial year ended January 31, 1997 was due to an
increase in salary expenses as the number of the corporation's employees
continued to grow. MGI's need for a greater number of employees was due to the
expansion of the corporation's product development department, the development
of its OEM business and the overall expansion of its business on a world-wide
scale. Research and development expenses of the corporation also included fees
paid to subcontractors for the development of existing and new software.
Marketing and selling expenses of $11,610,000 for the year included expenses
incurred to purchase advertising space in magazines, trade publications and
mail-order catalogues, as well as expenses incurred for direct mail programs and
trade shows. The increase in expenses in the financial year ended January 31,
1998 as compared to the financial year ended January 31, 1997 reflect the
expenses incurred by the corporation in entering new markets. More specifically,
additional sales and public relations staff were hired to achieve increased
sales. As well, marketing and promotional budgets were increased in order to
establish wider distribution of MGI's products and to support the launch of
additional products. During the financial year ended January 31, 1998, MGI had
also increased its presence at trade shows.
During the financial year ended January 31, 1998, MGI's activities were
focused primarily on continuing to establish an infrastructure and implementing
the business plan developed by MGI's management team. MGI's results for this
period were in line with management's expectations.
FINANCIAL YEAR ENDED JANUARY 31, 1997 COMPARED TO FINANCIAL YEAR ENDED
JANUARY 31, 1996
The results from the financial year ended January 31, 1997 cannot be
meaningfully compared to the period from incorporation to January 31, 1996, as
the latter was not a complete twelve month period. During the financial year
ended January 31, 1997, MGI had a loss before amortization of software
acquisitions and write-off of purchased software of $3,635,000 based upon sales
of $5,144,000, expenses including cost of sales of $8,903,000 and interest
income of $124,000. In comparison, during the period from incorporation to
January 31, 1996, MGI's loss before amortization of software acquisitions was
$263,000 based on sales of $521,000, expenses including cost of sales of
$826,000 and interest income of $42,000.
During the financial year ended January 31, 1997, management wrote off all
significant software acquisitions made during the period from incorporation to
January 31, 1996 amounting to $2,363,000. Amortization of software acquisitions
in the financial year ended 1997 was $1,405,000 compared to $414,000 in the
period from incorporation to January 31, 1996.
Retail sales through distributors accounted for the majority of sales
revenues in both periods. Research and development expenses of $1,731,000 during
the financial year ended January 31, 1997 (compared to research and development
expenses of $139,000 during the period from incorporation to January 31, 1996)
were comprised mainly of salary expenses and fees paid to subcontractors for the
development of existing and new software.
Marketing and selling expenses of $4,547,000 incurred during the financial
year ended January 31, 1997 (compared to $252,000 incurred during the period
from incorporation to January 31, 1996) included expenses incurred to purchase
advertising space in magazines, trade publications and mail-order catalogues, as
well as expenses incurred for direct mail programs.
During the financial year ended January 31, 1997, MGI's activities were
focused primarily on continuing to establish an infrastructure and implementing
the business plan developed by MGI's management team. MGI's results for this
period were in line with management's expectations.
48
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of MGI as at January 31,
1998 and April 15, 1998.
<TABLE>
<CAPTION>
OUTSTANDING AS AT OUTSTANDING AS AT
JANUARY 31, 1998 APRIL 15, 1998
AUTHORIZED ----------------- -----------------
----------- (audited) (unaudited)
<S> <C> <C> <C>
MGI Common Shares....................................... unlimited $ 32,019,301 $ 32,079,301(1)(2)(3)
<CAPTION>
(23,963,712 (24,012,462
shares) shares)
</TABLE>
- ------------
(1) In addition, options granted under the MGI Stock Option Plan to purchase an
aggregate of 3,030,425 MGI Common Shares were outstanding at April 15, 1998.
(2) An additional 175,000 MGI Common Shares (subject to adjustment) are issuable
pursuant to the exercise of Compensation Options. As additional compensation
in respect of the special warrant offering dated September 29, 1997, Gordon
Capital Corporation, Canaccord Capital Corporation and Griffiths McBurney &
Partners were issued 175,000 broker special warrants exercisable for
Compensation Options which expire on December 29, 1998. Each Compensation
Option is exercisable into one MGI Common Share, subject to adjustment, at
an exercise price of $5.25.
(3) In addition, up to 1,022,757 MGI Common Shares (subject to adjustment) are
issuable upon the exercise of 1,022,757 warrants issued to Intel, at the
lower of (i) $3.95 per MGI Common Share and (ii) the higher of the then
current market price of the MGI Common Shares and $3.20 per MGI Common
Share. The Intel Warrants expire on September 30, 2000.
DESCRIPTION OF SHARE CAPITAL
The authorized share capital of MGI consists of an unlimited number of MGI
Common Shares. As at April 15, 1998 there were 24,012,462 MGI Common Shares
issued and outstanding and the Intel Warrants exercisable for 1,022,757 MGI
Common Shares (subject to adjustment). There were also 175,000 MGI Common Shares
(also subject to adjustment) issuable upon the exercise of the Compensation
Options, and 3,030,425 options to purchase MGI Common Shares outstanding
pursuant to the MGI Stock Option Plan. All MGI Common Shares are entitled to
participate equally in any dividends declared thereon, and on liquidation or
distribution of the assets of MGI. All of the outstanding MGI Common Shares are
fully paid and non-assessable and each MGI Common Share has one vote per share
at all meetings of shareholders.
PRINCIPAL HOLDERS OF MGI COMMON SHARES
As at April 15, 1998, Mr. Oren Asher, Chairman of MGI, beneficially owned
2,817,423 MGI Common Shares, being 11.7% of all outstanding MGI Common Shares.
Mr. Asher may also be considered to be the beneficial owner of 145,416 MGI
Common Shares registered in the name of one of his children, being 0.6% of all
outstanding MGI Common Shares. In the aggregate, Mr. Asher could be considered
to be the beneficial owner of 2,962,839 MGI Common Shares, being 12.3% of all
outstanding MGI Common Shares. Pursuant and subject to the terms of the Lock-Up
Agreement, Mr. Asher has agreed to vote all of his 2,817,423 MGI Common Shares
in favour of the Special Resolution at the Special Meeting.
As at April 15, 1998, to the knowledge of the directors and officers of MGI,
no person, other than Mr. Asher, beneficially owns, or exercises control or
direction over, more than 10% of the outstanding MGI Common Shares.
DIVIDEND RECORD AND POLICY
Since the date of its incorporation, MGI has not paid any dividends on the
outstanding MGI Common Shares.
TRADING HISTORY
Prior to September 25, 1997, the MGI Common Shares traded on the Canadian
Dealing Network ("CDN") where trading commenced on May 10, 1996. On September
25, 1997, the MGI Common Shares were listed and posted for trading on the TSE.
The following table shows the reported high and low sale prices and volume of
49
<PAGE>
trading of the MGI Common Shares as reported by the CDN and the TSE, as
applicable, for the periods indicated.
<TABLE>
<CAPTION>
HIGH LOW VOLUME
--------- --------- ----------
<S> <C> <C> <C>
1996
Second Quarter............................................................................ $ 4.25 $ 2.50 2,216,802
Third Quarter............................................................................. 3.85 2.50 1,226,036
Fourth Quarter............................................................................ 3.30 2.50 988,864
1997
First Quarter............................................................................. $ 3.05 $ 2.50 683,023
Second Quarter............................................................................ 2.60 1.90 1,120,262
Third Quarter............................................................................. 6.75 2.20 3,398,786
Fourth Quarter............................................................................ 6.00 3.00 2,678,108
1998
January................................................................................... $ 4.25 $ 3.25 457,737
February.................................................................................. 4.75 3.30 955,835
March..................................................................................... 5.45 3.70 6,868,699
April (up to April 15, 1998).............................................................. 5.00 3.65 1,823,743
</TABLE>
On March 6, 1998, the last trading day prior to the announcement by MGI and
Discreet of the proposed Transaction, the closing price of the MGI Common Shares
on the TSE was $4.55. On April 15, 1998, the closing price of the MGI Common
Shares on the TSE was $4.35.
DIRECTORS AND OFFICERS
DIRECTORS
The following table sets forth the name, principal municipality of residence
of each of the directors of MGI, his present principal occupation and his
principal occupation during the past five years:
<TABLE>
<CAPTION>
NAME PRESENT PRINCIPAL OCCUPATION DIRECTOR SINCE
- ------------------------------- ---------------------------------------------------------- ----------------------
<S> <C> <C>
Oren Asher Chairman of the MGI Board of Directors September 22, 1995
Thornhill, Ontario
</TABLE>
Mr. Asher has been the Chairman of MGI's Board of Directors since January 2,
1996. Prior to that, Mr. Asher was President of Ditek Software Corp., a graphics
software development company which he founded in 1985 and which specializes in
computer-aided design and drafting.
<TABLE>
<CAPTION>
NAME PRESENT PRINCIPAL OCCUPATION DIRECTOR SINCE
- ------------------------------- ---------------------------------------------------------- ----------------------
<S> <C> <C>
Anthony DeCristofaro President and Chief Executive Officer of MGI April 30, 1996
Woodbridge, Ontario
</TABLE>
Mr. DeCristofaro has been the President and Chief Executive Officer of MGI
since December 27, 1995, and has more than 20 years of experience in the
high-technology industry. Prior to joining MGI, Mr. DeCristofaro was Vice
President and General Manager of AST Canada, a computer hardware company in
Toronto, whose annual revenues increased from $30 million to over $350 million
in four years. From 1987 to 1991, Mr. DeCristofaro was General Manager of NEC
Canada, a computer hardware company. Mr. DeCristofaro has also served on several
boards, including Delrina Corporation (a computer software company) from 1988 to
1992, and AST Canada from 1991 to 1995.
50
<PAGE>
<TABLE>
<CAPTION>
NAME PRESENT PRINCIPAL OCCUPATION DIRECTOR SINCE
- ------------------------------- ---------------------------------------------------------- ----------------------
<S> <C> <C>
Joel Goldman Chief Financial Officer of MGI April 30, 1996
King City, Ontario
</TABLE>
Mr. Goldman has been the Chief Financial Officer of MGI since October 2,
1995. Prior to his involvement with MGI, Mr. Goldman served five years as the
Controller for the Toronto-based manufacturer Jaltex Inc. and its predecessor
Jaltex Jewellery of Canada Limited. Prior to that, Mr. Goldman worked eight
years in public practice with Laventhol and Horwath, Chartered Accountants.
<TABLE>
<CAPTION>
NAME PRESENT PRINCIPAL OCCUPATION DIRECTOR SINCE
- ------------------------------- ---------------------------------------------------------- ----------------------
<S> <C> <C>
Harvey Goldberg Executive Vice-President, Toymax Inc. April 30, 1996
Thornhill, Ontario
</TABLE>
Mr. Goldberg is the Executive Vice President of Toymax Inc., a toy
manufacturing corporation, and the President of Toymax (H.K.) Limited, a toy
manufacturing and international distribution corporation. Mr. Goldberg has held
positions with Toymax for more than the past five years.
<TABLE>
<CAPTION>
NAME PRESENT PRINCIPAL OCCUPATION DIRECTOR SINCE
- ------------------------------- ---------------------------------------------------------- ----------------------
<S> <C> <C>
Dennis Bennie Chief Executive Officer, XDL Capital Corporation July 31, 1996
North York, Ontario
</TABLE>
Mr. Bennie has been the Chief Executive Officer since November 1996 of XDL
Capital Corporation, which invests in and works with potential high growth
companies in the Internet industry. Prior to this, Mr. Bennie co-founded Delrina
Corporation and was the Chairman and Chief Executive Officer from 1988 until the
sale of Delrina to Symantec Corporation in November 1995. Mr. Bennie was also
responsible for co-founding Ingram Micro Inc., Canada which is currently one of
the largest software distributors in Canada.
<TABLE>
<CAPTION>
NAME PRESENT PRINCIPAL OCCUPATION DIRECTOR SINCE
- ------------------------------- ---------------------------------------------------------- ----------------------
<S> <C> <C>
Rowland Hanson President, C.R.H. & Associates June 30, 1997
Seattle, Washington
</TABLE>
Mr. Hanson currently is, and has been for the past five years, the president
and founder of C.R.H. & Associates, a Seattle-based company which provides
management consulting services in strategic planning, marketing, communications
and general business development. Prior to that, Mr. Hanson served as Vice-
President of Corporate Communications at Microsoft where he participated in
developing and implementing the original branding strategy for Microsoft which
included the naming and launching of Windows.
OFFICERS
The executive officers of MGI that perform a policy-making function with MGI
include Messrs. Asher, DeCristofaro and Goldman, as well as the officer listed
below.
<TABLE>
<CAPTION>
NAME PRESENT PRINCIPAL OCCUPATION OFFICER SINCE
- ---------------------------------- -------------------------------------- ----------------------
<S> <C> <C>
Markus Gunn Vice-President of Worldwide Sales November 11, 1997
</TABLE>
Mr. Gunn joined MGI as a Director of Sales in January, 1996 after four years
as General Manager -- Germanic Markets for Corel Corp. in Ottawa.
51
<PAGE>
MGI SHARES HELD BY DIRECTORS
The following table lists the number of MGI Common Shares beneficially owned
or controlled by each director of MGI and their associates.
<TABLE>
<CAPTION>
NUMBER OF MGI
COMMON SHARES AS OF
NAME POSITION APRIL 15, 1998
- ------------------------------------------- ----------------------------------------------------- --------------------
<S> <C> <C>
Oren Asher................................. Chairman of the Board of Directors 2,817,423(1)
Anthony DeCristofaro....................... President, Chief Executive Officer and Director --
Joel Goldman............................... Chief Financial Officer and Director 195,915
Harvey Goldberg............................ Director --
Dennis Bennie.............................. Director 172,000
Rowland Hanson............................. Director --
</TABLE>
- ---------------
(1) Mr. Asher may also be considered to be the beneficial owner of 145,416 MGI
Common Shares registered in the name of one of his children.
As at April 15, 1998, the directors and senior officers of MGI, as a group,
beneficially owned directly or indirectly or exercised control and direction
over 3,330,754 MGI Common Shares, representing approximately 13.87% of the
issued and outstanding MGI Common Shares.
INTEREST OF MANAGEMENT AND OTHERS IN MATERIAL TRANSACTIONS
The following sets forth the interest of management and other related
parties in material transactions affecting MGI since the date of its
incorporation. Other than as set out below, no insider of MGI, or associate or
affiliate thereof, had any material interest, direct or indirect, in any
transaction since the date of MGI's incorporation or has any material interest,
direct or indirect, in any proposed transaction which has or will materially
affect MGI:
(a) Pursuant to an agreement dated as of October 3, 1995 (the "Ditek
PhotoSuite Agreement") between MGI and Ditek Software Corp. ("Ditek"),
MGI acquired from Ditek all of its rights in and to PhotoSuite (then
known as PhotoWorks) in exchange for certain securities of MGI. Because
Mr. Asher is associated with both MGI and Ditek as well as being an
executive officer of both companies, and because Mr. Goldman owns a
minority interest in Ditek, the Ditek PhotoSuite Agreement constitutes a
material transaction with a related party. MGI's determination that the
consideration payable to Ditek was fair and reasonable in the
circumstances was based in part upon the result of an independent
valuation of PhotoSuite arranged for by MGI;
(b) On September 27, 1996, MGI entered into an agreement to purchase from
Ditek all rights, title and interest to certain 3-D modelling software
for an amount of $1,564,287 plus 5% of all net receipts from sales or
leases of the technology for a period of four years. In consideration,
MGI issued an aggregate of 471,429 Common Shares and paid cash
consideration of $150,000. This transaction took place under subsection
85(1) of the ITA and was recorded on the books of MGI at a nominal value,
being the carrying amount in the books of the transferor except to the
extent of the cash consideration received. See Note 11 to the MGI
Financial Statements in Schedule D. The registered and principal office
of Ditek is 60 West Wilmot Street, Richmond Hill, Ontario L4B 1M6;
(c) For the year ended January 31, 1998, C.R.H. & Associates, a consulting
company of which Mr. Hanson is the president, received from MGI
approximately $13,000 as compensation for services it provided to MGI.
C.R.H. & Associates has been providing consulting services to MGI since
June 30, 1997; and
(d) During the last fiscal year, Mr. Bennie received consulting fees equal
to $12,000.
52
<PAGE>
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS
COMPENSATION OF DIRECTORS
Directors who are not employees of MGI do not receive an annual salary, and
no arrangement exists for the remuneration of directors as such. The directors
are eligible to receive grants under the MGI Stock Option Plan.
COMPENSATION OF EXECUTIVE OFFICERS
The following table and notes set forth the actual compensation or awards to
Mr. DeCristofaro, Mr. Asher, Mr. Goldman and Mr. Gunn being the only named
executive officers of MGI who earned more than $100,000 in salary and bonus in
fiscal 1998. For the 1996 financial year, the table sets out the actual
compensation paid or awarded to the named executive officers of MGI from the
date of its incorporation on September 22, 1995 to January 31, 1996.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
SECURITIES
UNDER OPTIONS
SALARY BONUS GRANTED ALL OTHER
NAME AND PRINCIPAL POSITION YEAR ($) ($) (#) COMPENSATION(1)
<S> <C> <C> <C> <C> <C>
Anthony DeCristofaro, 1998 125,000 160,324 -- --
President and 1997 125,000 99,660 -- --
Chief Executive Officer 1996(2) 10,417 2,536 300,000 --
Oren Asher, 1998 151,800(3) -- --
Chairman 1997 103,621(4) -- --
1996 33,200(4) -- 200,000
Joel Goldman, 1998 120,000 -- 25,000 --
Chief Financial Officer 1997 80,833 -- -- --
1996 20,000 -- 110,000 --
Markus Gunn, 1998 115,000 46,869 45,000 --
Vice-President of Worldwide Sales 1997 103,712 13,121 -- --
1996 7,727 -- 150,000 --
</TABLE>
(1) Does not include perquisites or other personal benefits, the value of which
did not exceed $10,000 in any of the two financial years ended January 31,
1998.
(2) Mr. DeCristofaro was appointed President and Chief Executive Officer on
December 27, 1995.
(3) Amount was paid as a consulting fee to a company owned by Mr. Asher
(4) Includes amounts paid as salary and consulting fees to a company owned by
Mr. Asher.
LONG-TERM INCENTIVE PLAN
There were no awards or payouts to any of the above named executive officers
during the financial year ended January 31, 1998 under any arrangements of the
Corporation which would constitute a long-term incentive plan.
53
<PAGE>
OPTION GRANTS DURING THE MOST RECENTLY COMPLETED FINANCIAL YEAR
The following table provides information concerning options granted to Mr.
Goldman and Mr. Gunn during the financial year ended January 31, 1998. There
were no options granted to Mr. DeCristofaro or Mr. Asher during this period.
<TABLE>
<CAPTION>
MARKET VALUE OF
% OF TOTAL OPTIONS SECURITIES
SECURITIES UNDER GRANTED TO EXERCISE OR UNDERLYING OPTIONS
OPTIONS GRANTED EMPLOYEES IN BASE PRICE ON THE DATE OF
NAME (#) FINANCIAL YEAR ($/SECURITY) GRANT ($/SECURITY) EXPIRATION DATE
<S> <C> <C> <C> <C> <C>
Joel Goldman 25,000 on May 30, 1997 2.81 2.15 2.15 May 30, 2002
Markus Gunn 20,000 on November 30, 2.25 3.86 3.86 November 30, 2002
1997 2.81 2.30 2.30 April 30, 2002
25,000 on April 30, 1997
</TABLE>
OPTIONS EXERCISED AND YEAR-END OPTION VALUES
There were no options exercised by Mr. DeCristofaro, Mr. Asher, Mr. Goldman
and Mr. Gunn during the financial year ended January 31, 1998. The following
table provides information concerning the number and value at January 31, 1998
of unexercised options held by the above-named executive officers. In the table,
"in-the-money" options are those where the exercise price was less than the
market price of the MGI Common Shares at January 31, 1998.
<TABLE>
<CAPTION>
VALUE(1) OF UNEXERCISED
UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT
JANUARY 31, 1998 JANUARY 31, 1998
(#) ($)
NAME EXERCISABLE NON-EXERCISABLE EXERCISABLE NON-EXERCISABLE
<S> <C> <C> <C> <C>
Anthony DeCristofaro 225,000 75,000 517,500 172,500
Oren Asher 150,000 50,000 345,000 115,000
Joel Goldman 82,500 52,500 189,750 92,000
Markus Gunn 37,500 157,500 86,250 283,750
</TABLE>
(1) Value is based on the difference between the option exercise price and the
fair market value at January 31, 1998, the fiscal year-end ($3.30 per
share), multiplied by the number of shares underlying the option.
EMPLOYMENT, CHANGE-IN-CONTROL AND SERVICE AGREEMENTS
MGI entered into an agreement with Mr. DeCristofaro pursuant to which he was
hired as the President and Chief Executive Officer of MGI effective December 27,
1995 (the "DeCristofaro Agreement"). The DeCristofaro Agreement provides that it
may be terminated by MGI with or without cause upon payment to Mr. DeCristofaro
of compensation equal to 18 months' base salary at the rate of $125,000 per year
and one years' bonus based on the preceding 12 months' sales, at the current
rate of bonus. The DeCristofaro Agreement further provides that in the event of
a change of control of MGI resulting in the resignation of Mr. DeCristofaro, Mr.
DeCristofaro shall give 3 months' notice of such resignation and receive a
lump-sum payment of an amount that is equal to 1.5 times his then-current annual
salary plus bonuses. Pursuant to the DeCristofaro Agreement, Mr. DeCristofaro
receives a salary of $125,000 per annum, exclusive of bonuses, benefits and
other compensation. In addition to the annual base salary, Mr. DeCristofaro was
entitled to receive an annual bonus equal to 2% of the gross sales (net of
returns and bad debts) of all software products by MGI throughout the world for
the fiscal year ending January 31, 1997, which resulted in him receiving a bonus
of $99,660. Mr. DeCristofaro was entitled to receive an annual bonus equal to 1%
of the gross sales (net of returns and bad debts) of all software products by
MGI throughout the world for the fiscal year ending January 31, 1998, as well as
0.5% of gross sales based on meeting budgeted losses, which resulted in him
receiving a bonus of $160,324.
54
<PAGE>
Mr. DeCristofaro also has been granted options to purchase 300,000 MGI Common
Shares at a price of $1.00 per share, which options expire on January 27, 2001.
Mr. DeCristofaro is also reimbursed for all expenses incurred from time to time
in connection with the carrying out of his duties.
MGI entered into an agreement with Mr. Goldman pursuant to which he was
hired as the Chief Financial Officer of MGI effective January 2, 1996 (the
"Goldman Agreement"), an employment/consulting agreement with Mr. Asher pursuant
to which he was retained to provide research and development services to MGI
effective January 2, 1996 (the "Asher Agreement") and an agreement with Mr. Gunn
pursuant to which he was hired as the Vice-President of Worldwide Sales
effective November 11, 1997 (the "Gunn Agreement"). The Goldman Agreement and
the Asher Agreement have the same terms and conditions as the DeCristofaro
Agreement except that they do not contain any bonus provisions and, in the event
of termination, each is entitled to compensation equal to 18 months' base
salary. The Gunn Agreement does not contain any bonus provisions or termination
or change of control clauses.
Mr. Asher currently receives consulting fees from MGI, which amounted to
$151,800 for the financial year ended January 31, 1998. Mr. Asher also has been
granted options to purchase 200,000 MGI Common Shares at a price of $1.00 per
share, which options expire on January 27, 2001.
Mr. Goldman currently receives a salary of $120,000 per annum, exclusive of
bonuses, benefits and other compensation. Mr. Goldman also has been granted
options to purchase 135,000 MGI Common Shares at a price of $1.00 to $2.15 per
share, which options expire on May 30, 2002 and January 27, 2001.
Mr. Gunn currently receives a salary of $115,000, exclusive of bonuses,
benefits and other compensation. Mr. Gunn also has been granted options to
purchase 195,000 MGI Common Shares at a price of $1.00 to $3.86 per share, which
options expire on January 27, 2001, April 30, 2002 and November 30, 2002.
COMPOSITION OF THE COMPENSATION COMMITTEE
In the last financial year, the Compensation Committee of MGI performed the
functions of determining compensation of MGI's executive officers. The report of
the Compensation Committee on these matters is set forth below. Mr. Bennie and
Mr. Goldberg served as members of the Compensation Committee for the financial
year ended January 31, 1998.
Neither Mr. Bennie nor Mr. Goldberg are or were officers or employees of
MGI. Mr. Asher currently serves as a director and sits on the audit and
compensation committees of Toymax Inc., a company in which Mr. Goldberg is an
executive officer.
REPORT ON EXECUTIVE COMPENSATION
MGI believes that executive compensation should be designed with the
objective of attracting and retaining qualified executives by providing
compensation packages which are competitive within the market place and by
compensating them in a manner which encourages individual performance consistent
with shareholder expectations. As such, the Board has approved a compensation
package that is comprised of a mix of salary, cash bonus and share options for
the President and Chief Executive Officer and a combination of salary and share
options for other executives.
For the salary component, executives are compensated on a level that would
be average by reference to competitor practices in the North American computer
software industry. The MGI Stock Option Plan provides for the granting of
non-transferable options to executives and service providers of MGI to align the
interests of management with those of MGI's shareholders. Pursuant to the MGI
Stock Option Plan, optionees may acquire common shares of MGI at 100% of the
fair market value on the date of the grant. The options granted to Mr.
DeCristofaro, Mr. Asher and Mr. Goldman in the financial year ended 1996 have
vested as to 50% on April 30, 1996, 25% on April 30, 1997 and an additional 25%
of such options shall vest on April 30, 1998. The options granted to Mr. Goldman
and Mr. Gunn in the financial year ended 1998 shall vest over four years as to
25% per year. All options expire not later than ten years from the date of the
grant. The amount and terms of outstanding options have been taken into account
when determining whether and how many new option grants would be made.
55
<PAGE>
The Compensation Committee has also implemented an annual bonus program for
the President and Chief Executive Officer, which provides for cash awards based
on a percentage of gross sales and budget expectations.
PERFORMANCE GRAPH
The following graph charts performance of an investment in MGI Common Shares
against the TSE 300 Stock Price Index assuming an investment of $100 on May 10,
1996 (the first day of trading of the MGI Common Shares on the Canadian Dealing
Network). No dividends were paid by MGI during this period.
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<CAPTION>
MGI COMMON SHARES TSE 300 STOCK PRICE INDEX
<S> <C> <C>
5/10/96 $100.00 $100.00
5/31/96 $137.93 $101.34
7/31/96 $103.45 $95.21
9/30/96 $110.34 $102.21
11/29/96 $87.93 $116.22
1/31/97 $96.55 $118.02
3/31/97 $89.66 $113.01
5/30/97 $74.14 $123.28
7/31/97 $117.24 $132.86
9/30/97 $196.55 $136.00
11/28/97 $133.10 $125.81
1/30/98 $113.79 $129.43
3/31/98 $132.76 $146.01
</TABLE>
<TABLE>
<CAPTION>
MAY 10, MAY 31, JULY 31, SEPT. 30, NOV. 29, JAN. 31, MARCH 31, MAY 30,
1996 1996 1996 1996 1996 1997 1997 1997
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Common Shares $ 100.00 $ 137.93 $ 103.45 $ 110.34 $ 87.93 $ 96.55 $ 89.66 $ 74.14
TSE 300 Stock $ 100.00 $ 101.34 $ 95.21 $ 102.21 $ 116.22 $ 118.02 $ 113.01 $ 123.28
Price Index
<CAPTION>
JULY 31, SEPT. 30, NOV. 28, JAN. 30, MARCH 31,
1997 1997 1997 1998 1998
<S> <C> <C> <C> <C> <C>
Common Shares $ 117.24 $ 196.55 $ 133.10 $ 113.79 $ 132.76
TSE 300 Stock $ 132.86 $ 136.00 $ 125.81 $ 129.43 $ 146.01
Price Index
</TABLE>
INDEBTEDNESS OF OFFICERS AND DIRECTORS TO MGI
Since the beginning of the financial year ended January 31, 1998, there has
been no indebtedness to MGI by any director or officer or associates, as defined
in the SECURITIES ACT (Ontario), R.S.O. 1990, c. S.5, of any such person.
LIABILITY INSURANCE OF DIRECTORS AND OFFICERS
MGI maintains directors' and officers' liability insurance for the benefit
of the directors and officers of MGI. The current annual policy limit is
$5,000,000. Protection is provided to directors and officers for wrongful acts
or omissions done or committed during the course of their duties as such. Under
the insurance coverage MGI is reimbursed for payments which it is required or
permitted to make to its directors and officers to indemnify them, subject to a
deductible of $25,000 per loss. Individual directors and officers are reimbursed
for losses incurred in their capacities as such, which are not subject to a
deductible. The annual premium for the period April 10, 1997 to April 9, 1998
was $23,072, all of which was paid by MGI.
56
<PAGE>
AUDITORS, TRANSFER AGENT AND REGISTRAR
The auditors of MGI for the year ended January 31, 1996 were Cogan +
Partners, Chartered Accountants, 255 Albert Street, Suite 904, Ottawa, Ontario,
K1P 6A9. The auditors of MGI for the year ended January 31, 1997 and January 31,
1998 were Price Waterhouse, Chartered Accountants, 5700 Yonge Street, Suite
1900, North York, Ontario, M2M 4K7.
The transfer agent and the registrar for the MGI Common Shares is The Trust
Company of Bank of Montreal at its office in Toronto.
INFORMATION CONCERNING DISCREET
In this section, "Discreet" refers to, depending on the context, Discreet,
its subsidiaries and its ventures collectively, or Discreet and its
subsidiaries.
DESCRIPTION OF BUSINESS
Discreet develops, assembles, markets and supports non-linear, on-line
digital systems and software for creating, editing and compositing imagery and
special effects for film, video, HDTV, broadcast and the Web. Discreet's systems
and software are utilized by creative professionals for a variety of
applications, including feature films, television programs, commercials, music
and corporate videos, interactive game production, live broadcasting, as well as
Web design. Discreet's systems have played key roles in the creation of special
visual effects for films such as TITANIC, FORREST GUMP, INDEPENDENCE DAY, THE
FIFTH ELEMENT, BATMAN & ROBIN, CONTACT and AIR FORCE ONE; television programs
and special events such as ABC's "WORLD NEWS TONIGHT WITH PETER JENNINGS" and
the 1996 United States Presidential elections on ABC and CBS; music videos by
artists including U2, REM, Rolling Stones and The Beatles; and commercials for
clients such as Nike, Pepsi, AT&T and McDonald's. Discreet believes that
creative professionals and designers require tools that simplify their work,
enabling them to devote more time to creative activities and less time to
technical tasks.
Discreet offers high-end turnkey systems focused towards three markets:
special effects, editing and broadcast production (its "Advanced Systems").
Discreet's Advanced Systems are comprised of proprietary software utilizing
workstations manufactured by SGI, scaleable disk arrays and other peripherals.
These can be networked together to enable users to manage data more efficiently
and collaborate in an integrated production environment. Discreet's systems
include its inferno* and flame* systems (special effects), its fire* and smoke*
systems (editing), and its frost* system (broadcast production). Discreet's
special effects and editing Advanced Systems are used to manipulate digital
media in an on-line, real-time environment, providing instant feedback to the
creative professional. These systems are currently or are currently being
designed to be resolution independent and to allow users to work on uncompressed
images from a variety of media sources in the full range of resolutions
necessary for film, video and HDTV. In the broadcast production market, Discreet
offers its frost* system, a set of modelling, animation and rendering tools for
the creation and manipulation of 3D environments, including virtual sets, for
broadcast companies. Discreet sells its Advanced Systems worldwide through a
direct sales force as well as through high-end, sophisticated distributors.
Discreet's goal is to become a leading supplier of digital tools used to
manipulate still and moving pictures to the high-end professional
post-production and broadcast markets, the desktop or new media market, and the
consumer markets. To achieve this goal, Discreet plans to further expand and
leverage its technology base, customer relationships and existing reputation,
extend its product line to include other aspects of the content creation
process, and expand its worldwide sales and distribution organization.
In its efforts to achieve its goal, Discreet recently made three
acquisitions to enter the new media marketplace and now offers editing and
special effects software which runs on the Microsoft Windows NT, the Apple
Macintosh and/or the Unix operating systems. Discreet's desktop or new media
software (its "New Media Software") products include its edit* software
(formerly D-Vision OnLine) (video editing), its effect* software (formerly Flint
and Illuminaire Composition) (special effects), its paint* software (formerly
Illuminaire Paint) (special effects), and its light* software (formerly
Lightscape) (radiosity). Discreet's New Media Software is primarily used to
create, manipulate, and finish computer graphics images, interactive and on-line
content. effect* provides 3D video composition, clip animation, and visual
effects enabling artists to combine, enhance and modify video frames or
sequences of frames with a very high level of efficiency and interactivity.
paint* is a
57
<PAGE>
vector-based, object-oriented painting and animation system for the manipulation
and enhancement of both multi-frame clips and single-frame graphic images. edit*
is a real-time non-linear, compressed editing software solution which performs
compositing, keying and visual effects on the desktop. light* is a 3D rendering
solution that uses advanced radiosity techniques to significantly enhance
realism and lighting accuracy in 3D environments created for virtual sets, film
and video effects, interactive games and architectural design projects.
Discreet is a company incorporated by articles of incorporation on September
10, 1991 under Part IA of the COMPANIES ACT (Quebec) whose head office is
located at 10 Duke Street, Montreal, Quebec, Canada H3C 2L7. Discreet has sales
offices in the United States in New York, Chicago, Los Angeles; Rio de Janeiro,
Brazil; London, England; Paris, France; Munich, Germany; Singapore; Bombay,
India; and Tokyo, Japan. As of March 31, 1998, Discreet had 397 employees.
PRODUCTS
The following table sets forth the Discreet products, their market, the date
of first shipment by Discreet, and their platform or operating system.
<TABLE>
<CAPTION>
DATE OF FIRST
SHIPMENT BY PLATFORM /
PRODUCT MARKET DISCREET OPERATING SYSTEM
- ---------------------------------------------------- ------------------------ ------------------- ---------------------
<S> <C> <C> <C>
ADVANCED SYSTEMS
inferno*............................................ Special effects October 1995 SGI Onyx2 / Unix
flame*.............................................. Special effects January 1993 SGI Octane / Unix
fire*............................................... Editing October 1996 SGI Onyx2 / Unix
smoke*.............................................. Editing October 1997 SGI Octane / Unix
frost* (includes product formerly sold as Vapour)... Broadcast Production October 1995 SGI Onyx2 and
SGI Octane / Unix
NEW MEDIA SOFTWARE
effect* (formerly Flint)............................ Special effects December 1993 SGI O2 / Unix
effect* (formerly Illuminaire Composition).......... Special effects June 1997 Microsoft NT and
Apple Macintosh
paint* (formerly Illuminaire Paint)................. Special effects June 1997 Microsoft NT and
Apple Macintosh
edit* (formerly D-Vision OnLine).................... Editing July 1997 Microsoft NT
light* (formerly Lightscape)........................ Radiosity December 1997 Microsoft NT
</TABLE>
ADVANCED SYSTEMS
Discreet's systems are designed to be intuitive and easy to use. Discreet's
systems provide the speed and operational flexibility demanded by the
professional film and video industries. The systems use a consistent interface
through which operations are controlled via on-screen menus (which users can
organize to fit their preferences) and a pressure-sensitive stylus. Discreet's
systems include a Sparks developers kit, which allows customers to integrate
their own proprietary software or third party software into Discreet's systems'
environments. Discreet's systems also offer comprehensive image input/output
("I/O") functions, allowing image or object data to be captured and exchanged
between workstations in a studio environment in a variety of formats. For sites
with multiple systems, work generated on other platforms can be imported and
placed directly onto Discreet's systems' local disk array for integration into
the current production. In addition, Discreet's image files can be transferred
among local disk arrays. For example, if a user prepares a production on an
effect* system, the user can transfer video or film data to the flame* or
inferno* systems or video data to the fire* system, for finishing with the
client. The flexible systems architecture can result in different system
configurations and enables clients to differentiate themselves from their
competitors by allowing them to customize their systems.
58
<PAGE>
SPECIAL EFFECTS SYSTEMS
FLAME* -- flame* is an on-line, resolution-independent, non-linear,
uncompressed digital system. The system is used by creative professionals to
create, edit and composite special visual effects in an on-line, real-time
environment. Easily integrated into a suite environment and possessing the power
and features necessary to serve as the core of a fully digital suite, flame* is
designed to allow the operator to create desired effects with near instantaneous
feedback. A complete flame* system includes the flame* software, an SGI Octane
workstation, a stone* disk array and various I/O devices.
INFERNO* -- inferno* is an on-line, non-linear, resolution-independent,
uncompressed digital system providing all the features of flame* with film
tools, and increased image resolution and colour control for digital film work.
The system also features tools for grain management, wire and scratch removal
and colour calibration. A complete inferno* system includes the inferno*
software, an SGI Onyx2 workstation, a stone* disk array and various I/O devices.
EDITING SYSTEMS
FIRE* -- fire* is an uncompressed, on-line, non-linear, digital video
editing system with special effects capabilities. fire* includes a sophisticated
toolset and a gestural, picture-based editing interface, which Discreet believes
specifically address the new and expanding requirements needed for on-line
finishing. Discreet expects to release a resolution independent (including HDTV)
fire* system during calendar 1998. A complete fire* system includes the fire*
software, an SGI Onyx2 workstation, stone* disk arrays and various I/O devices.
SMOKE* -- smoke*, like fire*, is an uncompressed, on-line, non-linear,
digital video editing system with limited special effects capabilities. smoke*
uses the same gestural, picture-based editing interface as fire*. The primary
difference in the two systems is the greater speed of interactivity and
processing of fire* as well as greater special effects capabilities than those
of smoke*. However, smoke's* special effects capabilities are modular; effects
modules may be purchased separately by the customer to augment the special
effects capabilities of the baseline smoke* system. A complete smoke* system
includes the smoke* software, an SGI Octane workstation, a stone* disk array and
various I/O devices.
BROADCAST PRODUCTION SYSTEMS
FROST* -- frost* is a computer-based set of modelling, animation and
rendering tools for the creation and manipulation of 3D graphics, including
virtual sets, for broadcast. Virtual sets are computer generated locales
typically used for news, sports and entertainment programming. frost* is
designed to operate on the SGI Onyx2 or SGI Octane workstation and allows the
user to work completely in real-time or through a combination of real-time and
post-produced components.
SYSTEM COMPONENTS
THE WORKSTATION
inferno*, fire*, and frost* run on SGI Onyx2 workstations, typically
configured with four or eight processors. flame*, smoke* and frost* run on the
SGI Octane workstation. The SGI hardware platforms are scaleable and upgradeable
(within the same machine) to fit the price and performance criteria of the
customer. Each system can be connected to other Discreet systems and to numerous
third party software, systems and devices.
DISK ARRAYS
Discreet offers stone*, a disk-based storage system for use with its video
and high-performance film applications, which is targeted at the production,
post-production and broadcast markets. stone* is designed to allow real-time
playback of uncompressed video frames in any order, efficiently store any mix of
resolutions and ensure image integrity by remaining operational in the event of
disk or power supply failure. Discreet commenced full commercial shipments of
stone* in April 1995. A disk array is comprised of a number of disks working
co-operatively to handle high speed data flows. flame*, inferno*, fire*, smoke*,
and frost* must be used with Discreet's stone* disk arrays.
59
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NETWORKING
Discreet offers wire*, a high-performance transport system for digital film
and video for use with multiple stone* disk arrays. wire* builds on Discreet's
disk technology and is designed, if the network provides sufficient bandwidth,
to provide real-time CCIR-601 instant access to images located on a disk
anywhere within a post-production facility. wire* can be configured as a
centralized or distributed network, or both. Discreet began commercial shipments
of wire* in the fourth quarter of fiscal 1997.
I/O
Third party video tape recorders can be controlled with flame*, inferno*,
fire* and smoke's* stylus and tablet. I/O edits can be implemented sequentially
using the EDL capabilities of the flame*, inferno*, fire* and smoke* systems.
Other third party devices, such as film scanners and recorders, can also be used
with Discreet systems for HDTV and film transfers.
NEW MEDIA SOFTWARE
Through three recent acquisitions, Discreet now offers software-only
solutions which run on the Windows NT and the Apple Macintosh operating systems.
These acquisitions are part of Discreet's strategy to expand the range of
creative professionals served by Discreet and to extend its product line to
include other aspects of the content creation process. See "Information
Concerning Discreet -- Recent Acquisitions". Discreet's New Media Software is
primarily used to create, manipulate, and finish computer graphics images,
interactive and on-line content.
SPECIAL EFFECTS SOFTWARE
EFFECT* -- Discreet offers two versions of its effect* software: effect* on
the SGI O2 workstation (formerly Flint) and effect* on the Apple Macintosh and
Microsoft Windows NT operating systems (formerly Illuminaire Composition).
effect* is a resolution-independent, non-linear, uncompressed digital system
used by creative professionals to create, edit and composite special visual
effects. effect* provides 3D video composition, clip animation, and visual
effects enabling artists to combine, enhance and modify video frames or
sequences of frames with a very high of level of efficiency and interactivity.
Discreet acquired the Illuminaire product line as part of Discreet's acquisition
of substantially all of the assets of Denim Software L.L.C. ("Denim") on June
12, 1997 (the "Denim Acquisition").
PAINT* -- (formerly Illuminaire Paint) -- paint* is an Apple Macintosh and
Microsoft Windows NT-based paint* software for effects, interactive content and
graphic design creation. paint* is resolution-independent, vector-based,
object-oriented painting and animation system for the manipulation and
enhancement of both multi-frame clips and single-frame graphic images. Discreet
acquired the Illuminaire product line as part of the Denim Acquisition.
EDITING SOFTWARE
EDIT* -- (formerly D-Vision OnLine) -- edit* is a real-time non-linear,
compressed editing software solution which performs compositing, keying and
visual effects on the desktop and runs on the Microsoft Windows NT operating
system. Discreet acquired edit* as part of the acquisition of all the
outstanding shares of capital stock of D-Vision Systems, Inc. ("D-Vision") in
July 1997 (the "D-Vision Acquisition").
RADIOSITY SOFTWARE
LIGHT* -- (formerly Lightscape) -- light* is a 3D rendering solution that
uses advanced radiosity techniques to significantly enhance realism and lighting
accuracy in 3D environments created for virtual sets, film and video effects,
interactive games and architectural design projects. light* runs on the
Microsoft Windows NT operating system. Discreet acquired light* as part of the
acquisition of all the outstanding shares of capital stock of Lightscape
Technologies, Inc. in December 1997 (the "Lightscape Acquisition").
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CUSTOMERS
Discreet's Advanced Systems are sold primarily to film and video production,
post-production and broadcast companies. Discreet's New Media software products
are sold in these markets as well as to institutional and educational customers,
designers and professional consumers.
No customer accounted for 10% or more of Discreet's total revenues in fiscal
1996 or 1997.
MARKETING AND SALES
MARKETING STRATEGY. To date, Discreet has marketed its systems and software
primarily to production and post-production companies in the film and video
industries. Discreet's principal marketing strategy has been to create awareness
of its systems and software through appearances at major international computer
graphics and broadcasting tradeshows, such as NAB, ACM SIGGRAPH (U.S.),
International Broadcasters Convention ("IBC") (Europe), INTERBEE (Japan) and
Montreaux (Europe). Discreet has supported this marketing strategy with
direct-mail advertising and advertisements in trade publications. In addition,
Discreet believes that the high quality of computer images generated using its
products results in significant industry awareness. With permission from its
customers, Discreet creates promotional materials utilizing content created
using Discreet's products.
Discreet is marketing its New Media Software products primarily through
direct mail advertising, advertising in trade publications, seminars and
roadshows, as well as at both international and local tradeshows. In addition,
Discreet provides co-operative advertising funding to a number of its
distributors who locally advertise its products. As Discreet broadens the
markets for its products, Discreet intends to expand its marketing efforts
accordingly.
SALES AND DISTRIBUTION. Discreet sells its Advanced Systems through its
direct sales organization, as well as through high-end distributors and
resellers. Sales activities in North America are conducted from Discreet's
Montreal headquarters, sales offices in Los Angeles, Chicago and New York and
field representatives based in Boston, San Francisco, and Atlanta. Discreet also
markets its systems and software through sales offices located in the United
Kingdom, Spain, France, Germany, Japan, Singapore, India, Hong Kong and Brazil.
Discreet's headquarters and each of its sales offices have sales and
demonstration capabilities. As of March 31, 1998, Discreet employed 39 direct
sales people and 23 demonstration artists worldwide.
Discreet uses distributors and resellers to sell its New Media Software and
in certain cases, its Advanced Systems products in geographic areas generally
not served by Discreet's direct sales organization. In addition, many of the
distributors who sell the New Media Software product line can also market
Discreet's systems for which the distributors or resellers will receive a
finder's fee for customer system purchases from Discreet. In the United States,
Discreet maintains a direct sales presence in its primary markets including New
York, Chicago and Los Angeles. Elsewhere in the United States, Discreet
typically sells its products through its distribution network which is managed
by Discreet's sales managers. Outside of the United States, Discreet maintains a
direct sales presence in its primary markets, including London, Paris, Munich,
Singapore and Tokyo. In other areas outside of the United States, Discreet
typically sells its products through its distribution network which is managed
by Discreet's sales managers. Generally, customers purchasing Discreet's
products and/or peripherals from the distributors will also purchase the
workstation hardware from the distributors. Discreet provides software and
systems integration training to its distributors. Discreet continued its
strategy of increasing its distributor relationships since the beginning of
fiscal 1997 and fiscal 1998 and increased the number of its distributors during
this period. Discreet currently has distribution relationships with over 250
distributors and resellers in over 60 countries. This compares with 48
distributors and resellers in 34 countries at the end of fiscal 1996. Discreet's
strategy of marketing its products directly to customers and indirectly through
distributors may result in distribution channel conflicts as Discreet's direct
sales efforts may compete with those of its indirect channels.
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INTERNATIONAL REVENUES. For fiscal 1995, 1996 and 1997, revenues from
customers outside North America accounted for approximately 45%, 57% and 57%,
respectively, of Discreet's total revenues. Discreet expects that revenues from
customers outside North America will continue to account for a substantial
portion of its revenues.
RESELLER ARRANGEMENTS. Discreet is a master value added reseller ("VAR") of
SGI workstations. There are significant risks associated with this reliance on
SGI and Discreet may be impacted by the timing of the development and release of
products by SGI, as was the case during fiscal 1996. In addition, Discreet has
faced and may in the future face unforeseen difficulties associated with
adapting Discreet's products to future SGI products. In May 1994, Discreet
entered into a Value-Added Reseller Agreement with SGI. The agreement grants to
Discreet a non-exclusive right to purchase and license certain hardware products
from SGI, including the SGI Onyx2, Octane, and O2 workstations for remarketing
by Discreet in the United States. Although the agreement contains no minimum
purchase requirements, the volume of systems purchased from SGI affects the
percentage discount received by Discreet. The agreement is subject to annual
renewal in May of each year and may be terminated by SGI for cause. The
agreement with SGI has been extended through June 30, 1998 and Discreet has no
reason to believe that SGI will not renew such agreement. Discreet also acts as
a reseller and systems integrator of certain peripheral devices used in
Discreet's systems, including audio and video I/O cards and electronic tablets.
Discreet receives discounts for the purchase price of these products.
BACKLOG. Discreet has no significant backlog and does not believe that its
backlog at any particular point in time is indicative of future sales levels.
SYSTEMS INTEGRATION, SERVICE AND SUPPORT
Discreet provides its customers with a variety of systems integration,
support and training services including on-site and telephone support, and
in-house and on-site training in the use of Discreet's products. These services
are generally provided under separately priced arrangements with Discreet's
customers. In some markets, these services are provided by Discreet's
distributors who are compensated for such services directly by the customer.
Discreet maintains a staff of persons dedicated to training its distributors in
the performance of these services. Discreet believes that its focus on customer
service provides it with important information about the evolving needs of its
customers. Discreet derived revenues of approximately U.S.$4,770,000,
U.S.$11,713,000 and U.S.$13,606,000 from these services in fiscal 1995, 1996 and
1997, respectively.
Discreet supports its customers in North and South America from Discreet's
Montreal office and through its distributors. Customers in Europe and the
Pacific Rim are supported from the offices of Discreet's European subsidiaries
and by distributors. As of March 31, 1998, Discreet employed a total of 85
persons worldwide in its customer support organization.
RESEARCH AND DEVELOPMENT
Discreet's research and product development efforts are focused on the
continued enhancement of its Advanced Systems and its New Media Software
products and the development of new products. Discreet employs a modular
development approach which it believes allows it to bring innovative technology
to market more rapidly than traditional analog or proprietary hardware-based
digital solutions and enables it to take advantage of advances in general
purpose workstation technology as they become available. Discreet intends to
continue to enhance and upgrade these products on a regular basis.
In fiscal 1995, 1996 and 1997, Discreet spent approximately U.S.$4,037,000,
U.S.$18,792,000 and U.S.$9,980,000 (net of tax credits), respectively, on
research and development, representing 6%, 22% and 10%, respectively, of total
revenues. Discreet's research and development staff consisted of 111 persons as
of March 31, 1998.
The markets for Discreet's systems and software are characterized by
evolving industry standards, changing technologies and frequent new product
introductions. Discreet believes that its future success will depend in part on
its ability to enhance its existing systems and software and to develop and
introduce new products and features which meet changing customer requirements
and emerging industry standards on a timely basis. In
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addition, as a master VAR of SGI workstations, Discreet obtains certain advance
access to SGI technology which facilitates its efforts to develop compatible
systems and to modify and improve existing products. If Discreet were unable to
obtain such advance access, it could have an adverse impact on Discreet's
business and results of operations.
On March 4, 1998, Discreet entered into a Strategic Development Agreement
with Intel to develop a new high-end special effects product. Discreet Logic
plans to develop new visual effects software for demanding real-time compositing
and image processing functions. The software will be designed to run on
multiprocessor workstations based on the IA-64 processors and is expected to
deliver powerful performance capabilities for the visual effects industry. Intel
will provide access to IA-64 technology, aid in optimization of the software,
and design components of Merced processor-based workstations to run the software
optimally.
PROPRIETARY RIGHTS
Discreet's success is dependent upon its proprietary technology. Although
Discreet currently has five patents and has 70 patent applications on its
technology, it relies principally on unregistered copyrights and trade secrets
to protect its intellectual property. Discreet generally seeks to enter into
confidentiality agreements with its employees and license agreements with its
distributors and to limit access to and distribution of its systems, software,
documentation and other proprietary information. Until fiscal 1996,
substantially all of Discreet's systems were sold without written license
agreements. There can be no assurance that Discreet will not be involved in
litigation with respect thereto or that the outcome of any such litigation might
not be more unfavourable to Discreet as a result of such omissions. Any such
litigation could have a material adverse effect on Discreet's business and
results of operations. Discreet licenses its New Media Software products under
"shrink-wrap" licenses (i.e., licenses included as part of the product
packaging). Shrink-wrap licenses are not negotiated with or signed by individual
licensees, and purport to take effect upon the opening of the product package.
Certain provisions of such licenses, including provisions protecting against
unauthorized use, copying, transfer and disclosure of the licensed program, may
be unenforceable under the laws of many jurisdictions. Discreet uses both
software and hardware keys with respect to its systems and software but
otherwise does not copy-protect its systems and software. It may be possible for
unauthorized third parties to copy Discreet's products or to reverse engineer or
obtain and use information that Discreet regards as proprietary. There can be no
assurance that Discreet's competitors will not independently develop
technologies that are substantially equivalent or superior to Discreet's
technologies. In addition, the laws of certain countries in which Discreet's
products are or may be distributed do not protect Discreet's products and
intellectual property rights to the same extent as the laws of Canada or the
United States. As the number of software products in the industry increases and
the functionality of these products further overlaps, Discreet believes that
software products generally may increasingly become the subject of claims that
such software products infringe the rights of others.
Significant and protracted litigation may be necessary to protect Discreet's
intellectual property rights, to determine the scope of the proprietary rights
of others or to defend against claims of infringement. Discreet is not currently
involved in any litigation with respect to intellectual property rights.
Discreet receives letters from third parties, from time to time, inquiring about
Discreet's products and discussing intellectual property matters, which Discreet
reviews to determine the appropriate response, if any. There can be no assurance
that third-party claims alleging infringements will not be asserted against
Discreet in the future. For example, Discreet received a letter from Avid
Technology, Inc. ("Avid") stating its belief that certain of Discreet's acquired
products in connection with the acquisition of the outstanding shares of the
share capital of D-Vision practice inventions claimed in a patent on a media
editing system. Discreet has responded to Avid's letter stating Discreet's
belief that it is not infringing upon any valid claim of Avid's patent. To
Discreet's knowledge, Avid has not initiated any suit, action, or other
proceeding alleging any infringement by Discreet of such patent. If infringement
is alleged by Avid, or any other holder of protected intellectual property
rights, Discreet could be required to discontinue the use of certain software
code or processes, to cease the manufacture, use and sale of infringing
products, to incur significant litigation costs and expenses, to develop
non-infringing technology or to obtain licenses to use the allegedly infringed
technology. There can be no assurance that Discreet would be able to develop
alternative technologies or to obtain such licenses or, if a license were
obtainable, that the terms would be commercially reasonable or acceptable to
Discreet. Moreover, there may be pending or issued patents that extend to
Discreet's products, which, together with the growing use of patents to protect
technology, increase the risk that
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third parties may assert infringement claims against Discreet in the future.
There can be no assurance that a court to which any infringement claims are
submitted would not find that Discreet's products infringe any third party's
intellectual property rights. Further, such litigation, regardless of its
outcome, could result in substantial costs to and diversion of efforts by
Discreet. Litigation may also be necessary to enforce Discreet's intellectual
property rights. Any infringement claim or other litigation against or by
Discreet could have a material adverse effect on Discreet's business and results
of operations.
MANUFACTURING AND SUPPLIERS
Discreet has historically relied on third-party vendors to manufacture and
supply all of the hardware components used in Discreet's systems. Manufacturing
at Discreet consists of assembly (including disk array assembly), testing and
value added systems integration. Discreet's manufacturing staff consisted of 8
persons as of March 31, 1998.
Discreet's flame*, effect*, inferno*, fire*, smoke* and frost* software
currently run on workstations manufactured by SGI. There are significant risks
associated with this reliance on SGI and Discreet may be impacted by the timing
of the development and release of products by SGI, as was the case during fiscal
1996. In addition, there may be unforeseen difficulties associated with adapting
Discreet's products to future SGI products. Discreet is an authorized master VAR
of workstations manufactured by SGI. Discreet's agreement with SGI is subject to
annual renewal in May of each year and termination by SGI for cause. The
agreement with SGI has been extended through June 30, 1998 and Discreet has no
reason to believe that SGI will not renew such agreement. In addition, although
Discreet has no reason to believe that it will be unable to obtain sufficient
quantities of SGI workstations on a timely basis or that its status as a master
VAR will be changed, there can be no assurance that Discreet will continue to be
able to procure such workstations in sufficient quantities on a timely basis or
that SGI will continue to recognize Discreet as a master VAR. The success of
Discreet also depends, in part, on the continued market acceptance of SGI
workstations, in general, and by the professional film and video industries, in
particular. Although Discreet intends to continue to evaluate new hardware
platforms and may adapt its products as technological advances and market
demands dictate, and although Discreet has now entered the market for content
creation software which runs on the Apple Macintosh and Windows NT operating
systems, Discreet believes that it will continue to derive substantially all of
its revenue for the foreseeable future from the sale and maintenance of systems
designed to include SGI workstations. As a result, financial, market and other
developments adversely affecting SGI or the sales of workstations, the
introduction or acquisition by SGI of products which are competitive with those
of Discreet, or the unanticipated timing or pricing of SGI products that could
cause customers to defer the decision to buy or determine not to buy Discreet's
then available products or systems, could have an adverse effect upon Discreet's
business and results of operations. As a master VAR, Discreet also obtains
certain advance access to SGI technology in order to develop compatible systems
and to modify and improve existing products. If Discreet were unable to obtain
such advance access, it could have an adverse impact on Discreet's business and
results of operations.
Discreet is dependent on SGI as Discreet's sole source for video I/O cards
used in Discreet's systems. Discreet also purchases electronic tablets
manufactured by Wacom Technology Corporation and believes that, while
alternative suppliers are available, there can be no assurance that alternative
electronic tablets would be functionally equivalent or be available on a timely
basis or on similar terms. Discreet generally purchases sole source or other
components pursuant to purchase orders placed from time to time in the ordinary
course of business and has no written agreements or guaranteed supply
arrangements with its sole source suppliers. Discreet has experienced quality
control problems and supply shortages for sole source components in the past and
there can be no assurance that Discreet will not experience significant quality
control problems or supply shortages for these components in the future.
Discreet does not maintain an extensive inventory of these components, and an
interruption in supply could have a material adverse effect on Discreet's
business and results of operations. Because of Discreet's reliance on these
vendors, Discreet may also be subject to increases in component costs which
could adversely affect Discreet's business and results of operations.
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COMPETITION
The market in which Discreet competes is characterized by intense
competition. In the high-end of the special effects market, Discreet's flame*
system competes with Quantel Limited's ("Quantel") Henry product. In certain
applications in the non-real-time segment of the market, Discreet's effect* on
the SGI O2 workstation competes with Avid's Illusion product. Discreet's
inferno* system competes with Quantel's Domino product and Eastman Kodak
Company's ("Kodak") Cineon product. Discreet's fire* and smoke* systems competes
with Quantel's Editbox product and Sony Corporation's ("Sony") range of
proprietary editing equipment. In addition, Discreet expects that the products
gained from the Denim Acquisition and the D-Vision Acquisition will compete with
Adobe Systems Incorporated's ("Adobe") special effects products and Avid's and
Media 100 Inc.'s ("Media 100") range of editing products. Many of Discreet's
current and prospective competitors, including Quantel, Avid, Kodak, Sony, and
Adobe have significantly greater financial, technical, manufacturing and
marketing resources than Discreet. Moreover, these companies may introduce
additional products that are competitive with those of Discreet, and there can
be no assurance that Discreet's products would compete effectively with such
products. In addition, as personal computers become more powerful, software
suppliers may be able to introduce products for personal computers that would be
competitive with Discreet's products in terms of price and performance for
professional users.
Discreet believes that its ability to compete depends on elements both
within and outside its control, including the success and timing of new product
development and introduction by Discreet and its competitors, product
performance and price, distribution and customer support. There can be no
assurance that Discreet will be able to compete successfully with respect to
these factors. Although Discreet believes that it has certain technological and
other advantages over its competitors, maintaining such advantages will require
continued investment by Discreet in research and development, sales and
marketing and customer service and support. There can be no assurance that
Discreet will have sufficient resources to make such investments or that
Discreet will be able to make the technological advances necessary to maintain
such competitive advantages. In addition, as Discreet enters new markets,
distribution channels, technical requirements and levels and bases of
competition may be different than those in Discreet's current markets and there
can be no assurance that Discreet will be able to compete favourably.
Furthermore, competitive pressures or other factors, including Discreet's entry
into new markets, may result in significant price erosion that could have a
material adverse effect on Discreet's business and results of operations.
EMPLOYEES
As of March 31, 1998, Discreet had 397 full-time employees. Of such
employees, 111 were employed in research and development, 104 in sales, 15 in
marketing, 85 in customer support, 8 in manufacturing and 74 in administration
and finance. Discreet believes that its future success will depend in large part
upon its ability to attract and retain highly skilled technical, management and
sales and marketing personnel. Moreover, because the development and marketing
of Discreet's Advanced Systems and New Media Software requires knowledge of film
and video production and post-production, key technical personnel must be
proficient in a number of disciplines. Competition for such technical personnel
is intense, and the failure of Discreet to hire and retain talented technical
personnel or the loss of one or more key employees could have an adverse effect
on Discreet's business and results of operations. Discreet's employees are not
represented by a labour union, and Discreet considers its employee relations to
be good.
PROPERTIES
In July 1997, Discreet agreed to rent space for its new headquarters in
Montreal from TGR Zone Corporation ("TGR Zone"), a company indirectly owned by
Discreet's Chairman, President and Chief Executive Officer. As part of this
agreement, TGR Zone assumed Discreet's lease commitment at its previous Montreal
location. The agreement provides that Discreet leases approximately 55,000
square feet of space at approximately $13.00 per square foot per annum subject
to normal escalation clauses. The lease is set to expire in July 2007. The lease
was signed in October 1997. As of March 31, 1998, Discreet leased sales offices,
research and development facilities and/or warehouse space in the United States,
Brazil, France, the United Kingdom, Spain, Germany, Singapore, India, Hong Kong
and Japan, pursuant to leases which expire from January 1998
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through February 2003. Discreet's current aggregate annual rental expense for
these additional facilities is approximately U.S.$1,175,000.
In August 1995, Discreet purchased an approximately 10,000 square foot
office building in London, England for use as a sales facility for approximately
L1,148,000 (or approximately U.S.$1,900,000 at March 31, 1998). Subsequently, in
December 1995, Discreet purchased an approximately 50,000 square foot office
building in Montreal, Quebec for $1,730,000. The carrying values of the Montreal
building and the London building were written down to their estimated fair
market values and the buildings were classified as assets held for sale. In
September 1997, Discreet sold the Montreal office building for a price not
materially different from its carrying value.
LEGAL PROCEEDINGS
On May 29, 1996, a lawsuit entitled SANDRA ESNER AND JERRY KRIM, ON BEHALF
OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED, VS. [ . . . ] DISCREET INC., ET
AL., Case No. 978584, was filed in the Superior Court of the State of
California, City and County of San Francisco. Named as defendants were Discreet,
certain of Discreet's former and existing directors, officers, and affiliates,
and certain underwriters and financial analysts. The plaintiffs purported to
represent a class of all persons who purchased Discreet Common Shares between
September 13, 1995, and May 1, 1996. The complaint alleged violations of
California law through material misrepresentations and omissions, among other
things. Discreet believes the allegations in the complaint are without merit and
has defended the lawsuit vigorously.
On June 13, 1996, a lawsuit entitled BRUCE FRIEDBERG, ON BEHALF OF HIMSELF
AND ALL OTHERS SIMILARLY SITUATED, VS. DISCREET INC., ET AL., Civ. No.
96-11232-EFH, was filed in the United States District Court, District of
Massachusetts. Named as defendants were Discreet and certain of Discreet's
former and existing directors and officers. The plaintiff purported to represent
a class of all persons who purchased Discreet Common Shares between November 14,
1995, and February 13, 1996. On October 11, 1996, the plaintiff filed an amended
complaint which asserted substantially the same factual allegations as the first
complaint and proposed the identical class period. The complaint alleged
violations of United States Federal Securities law through material
misrepresentations and omissions. Discreet believes the allegations in the
complaint are without merit and has defended the lawsuit vigorously.
On April 29, 1997, a lawsuit entitled ANTON PAPARELLA, SANDRA ESNER AND
GEOFFREY L. SHERWOOD, ON BEHALF OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED
VS. DISCREET INC., ET AL., case No. C-97-1570, was filed in the United States
District Court, Northern District of California. Named as defendants were
Discreet and certain of Discreet's former and existing officers, directors and
affiliates, and certain underwriters. The complaint asserted, in all material
respects, the same factual allegations and proposed the same class period as the
above-described California state court complaint filed in May 1996, except
asserts claims under federal securities law instead of state law. Discreet
believes the allegations in the California federal complaint are without merit
and has defended the lawsuit vigorously.
On or about November 25, 1997, a settlement of all three above-mentioned
shareholder class actions received final court approval. Under the
U.S.$10,800,000 settlement, Discreet contributed approximately U.S.$7,400,000
from its own funds with the remainder provided by insurance.
RECENT ACQUISITIONS
During the past two years, Discreet has carried out three material
acquisitions which are described below.
On June 12, 1997, Discreet, through its wholly-owned subsidiary 3380491
Canada Inc., acquired substantially all of the assets and assumed certain
liabilities of Denim, a Delaware limited liability company, pursuant to the
terms of an Asset Purchase Agreement dated as of June 12, 1997 among 3380491
Canada Inc., Denim, Sam Khulusi, Frank Khulusi, Westco Denim Investments Group,
Ltd., a California limited partnership, and Frank Khulusi Family Limited
Partnershiup, a California limited partnership. The purchased assets consist
primarily of Denim software products, including paint* and effect* and related
know-how and goodwill. The aggregate purchase price for the assets was comprised
of (i) approximately U.S.$9,126,000 in cash, (ii) the
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assumption of certain enumerated liabilities in an amount equal to no more than
approximately U.S.$2,209,000 in the aggregate, and (iii) the assumption of
certain on-going obligations under certain existing contracts of Denim.
On July 15, 1997, Discreet acquired all of the outstanding shares of capital
stock of D-Vision pursuant to a Stock Purchase Agreement dated as of July 10,
1997, among Discreet, D-Vision, the former stockholders of D-Vision and certain
other individuals. As a result of the D-Vision Acquisition, Discreet acquired
the edit* products for non-linear video and digital media editing solutions,
including related know-how and goodwill. The purchase price was paid in a
combination of 555,000 Discreet Common Shares and approximately U.S.$10,750,000
in cash.
On December 2, 1997, Discreet entered into an Agreement and Plan of Merger
and Reorganization (the "Merger Agreement") with Lantern Acquisition Corp., a
Delaware corporation and wholly-owned subsidiary of Discreet, and Lightscape
Technologies, Inc. ("Lightscape"), a Delaware corporation. As a result of the
merger of Lantern Acquisition Corp. and Lightscape, Discreet acquired, among
other products, the light* product (formerly Lightscape), a software which
integrates radiosity and raytracing with physically based lighting, know-how and
goodwill. The aggregate purchase price includes the assumption of approximately
U.S.$5,700,000 of net liabilities, not including costs associated with the
transaction, and up to U.S.$6,800,000 in contingent consideration to be paid
only if certain revenue objectives are achieved by Lightscape in calendar 1998
and 1999.
SELECTED PRO FORMA INFORMATION RELATING TO DISCREET
SELECTED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
The following table presents selected pro forma unaudited consolidated
financial information for Discreet in respect of the eleven-month period ended
June 30, 1997 after giving effect to the Arrangement and the accounting for the
Arrangement as a purchase. This table should be read in conjunction with the pro
forma consolidated financial statements of Discreet, the notes thereto and the
compilation report of Arthur Andersen & Cie with respect thereto set forth in
Schedule G to this Circular. Except as otherwise stated, this table contains
financial information prepared in accordance with Canadian GAAP.
The pro forma consolidated statement of operations is not necessarily
indicative of the results of operations that would have occurred in the
eleven-month period ended June 30, 1997 or on that date had the Arrangement
between Discreet and MGI been effected at the beginning of the period nor is it
necessarily indicative of future operating results of the combined entities. In
preparing these pro forma consolidated financial statements, no adjustments have
been made to reflect the additional costs or savings that could result from
combining the operations of Discreet and MGI. In preparation of the pro forma
financial statements, management has made certain estimates and assumptions that
affect the amounts reported in the pro forma financial statements. Actual
amounts recorded upon consummation of the transactions may differ from these
estimates.
PRO FORMA STATEMENT OF OPERATIONS DATA
<TABLE>
<CAPTION>
ELEVEN-MONTH PERIOD
ENDED
JUNE 30, 1997(1)
-------------------
(thousands of
dollars,
except share data)
<S> <C>
Total revenues..................................................................................... US$ 111,093
Total operating expenses(2)........................................................................ 88,012
Net loss........................................................................................... (31,671)
Net loss per share................................................................................. (0.99)
Weighted average common shares outstanding......................................................... 31,832,115
</TABLE>
67
<PAGE>
PRO FORMA BALANCE SHEET DATA
<TABLE>
<CAPTION>
AS AT
JUNE 30,
1997(1)
---------------
(thousands of
dollars)
<S> <C>
Current assets......................................................................................... US$ 89,546
Property and equipment -- less accumulated depreciation and amortization............................... 8,750
Current liabilities.................................................................................... 63,580
Total shareholders' equity............................................................................. 154,064
</TABLE>
- ------------
(1) The financial information as at June 30, 1997 and for the eleven-month
period then ended has been derived from the unaudited pro forma consolidated
financial statements of Discreet.
(2) Before interest income, interest expense, foreign currency exchange loss and
provision for income taxes.
PRO FORMA CONSOLIDATED CAPITALIZATION
The following table sets forth the capitalization of Discreet at the dates
indicated, and after giving effect to the Transaction. This table should be read
in conjunction with the Consolidated Financial Statements of Discreet appearing
elsewhere in this Circular.
<TABLE>
<CAPTION>
AS AT
AS AT MARCH 31, 1998 AS AT
AUTHORIZED JUNE 30, 1997(1) (ACTUAL)(2) MARCH 31, 1998(2)(3)
----------- ----------------- ----------------- ---------------------
(thousands of dollars)
<S> <C> <C> <C> <C>
Total Indebtedness.......................... U.S $[ -- ] U.S $[ -- ] U.S $[ -- ]
Shareholders' equity........................
Preferred Shares.......................... Unlimited -- -- --
Common Shares............................. Unlimited 80,402(4) 105,886(5) 203,227(6)
<CAPTION>
28,117,415 SHARES 29,551,779 SHARES 33,436,087 SHARES
<S> <C> <C> <C> <C>
Deficit................................... (33,112) (33,112)(7) (33,112)(7)
Translation Adjustment.................... (814) (814)(7) (814)(7)
----------------- ----------------- ---------------------
Total shareholders' equity................ 46,476 71,960 169,301
----------------- ----------------- ---------------------
Total Capitalization........................ U.S. $46,476 U.S. $71,960 U.S. $169,301
----------------- ----------------- ---------------------
----------------- ----------------- ---------------------
</TABLE>
- ---------------
(1) The financial information as at June 30, 1997 has been derived from the
audited consolidated financial statements of Discreet.
(2) The financial information as at March 31, 1998 has been derived from
unaudited interim consolidated financial statements of Discreet.
(3) To reflect issuance of 3,884,308 Discreet Common Shares to MGI Shareholders
pursuant to the Transaction as stated in the Arrangement Agreement dated
March 9, 1998.
(4) As at June 30, 1997, there were options outstanding to acquire 2,505,913
Discreet Common Shares.
(5) As at March 31, 1998, there were options outstanding to acquire 3,239,925
Discreet Common Shares.
(6) Following the completion of the Transaction, there will be options to
acquire 3,739,925 Discreet Common Shares, Warrants to acquire 165,687
Discreet Common Shares and Compensation Options entitling the holder thereof
to acquire 28,350 Discreet Common Shares.
(7) As at June 30, 1997.
SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following selected consolidated financial information relating to
Discreet for the periods indicated has been derived from the audited
consolidated financial statements and the unaudited consolidated financial
statements. The consolidated statement of operations and consolidated balance
sheet for the eleven-month period ended June 30, 1997 have been audited by
Arthur Andersen & Cie. as indicated in their report on these statements.
Information for the six-month periods ended December 31, 1997 and 1996 is
derived from Discreet's unaudited consolidated financial statements for such
periods. This table should be read in conjunction with the consolidated
financial statements of Discreet set forth in Schedule E to this Circular.
Except as otherwise indicated, this table contains financial information
prepared in accordance with Canadian GAAP.
68
<PAGE>
STATEMENTS OF OPERATIONS DATA
<TABLE>
<CAPTION>
SIX-MONTH FIVE-MONTH ELEVEN-MONTH
PERIOD ENDED PERIOD ENDED PERIOD ENDED
DECEMBER 31, DECEMBER 31, JUNE 30,
1997(1) 1996(1) 1997(2)
------------- ------------- ---------------
(thousands of dollars, except share data)
<S> <C> <C> <C>
Total revenues...................................................... U.S.$ 75,673 U.S.$ 40,096 U.S.$ 101,923
Total operating expenses(3)......................................... 31,399 17,585 46,082
Net income.......................................................... 8,238 1,153 2,772
Earnings per share.................................................. 0.29 0.04 0.10
Weighted average number of common shares outstanding................ 28,745,695 27,852,370 27,947,807
</TABLE>
BALANCE SHEET DATA
<TABLE>
<CAPTION>
AS AT AS AT
DECEMBER 31, JUNE 30,
1997(1) 1997(2)
------------------- --------------
(thousands of dollars)
<S> <C> <C>
Current assets............................................................... U.S.$ 60,297 U.S.$ 76,819
Property and equipment -- less accumulated depreciation and amortization..... 9,583 7,728
Current liabilities.......................................................... 48,698 58,283
Total shareholders' equity................................................... 64,744 46,476
</TABLE>
- ---------------
(1) The financial information as at December 31, 1997 and for the six-month
period ended December 31, 1997 has been derived from the unaudited interim
consolidated financial statements of Discreet.
(2) The financial information as at June 30, 1997 and for the eleven-month
period then ended has been derived from the audited consolidated financial
statements of Discreet.
(3) Before interest income, interest expense, foreign currency exchange gain
(loss) and provision for income taxes.
MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion should be read in conjunction with the Consolidated
Financial Statements of Discreet and Notes thereto prepared in accordance with
Canadian GAAP set forth in Schedules E and F to this Circular.
OVERVIEW
Discreet's revenues consist of product revenues (including licensing of its
software sales of Discreet's proprietary hardware and resale of third party
hardware) and revenues from maintenance and other services (including consulting
and training). In cases where Discreet has delivered hardware and/or software to
customers and has insignificant or noncritical vendor obligations related to
these deliveries, the revenue attributable to such obligations has been deferred
until such obligations have been fulfilled.
RECENT DEVELOPMENTS
LITIGATION SETTLEMENT
On May 29, 1996, June 13, 1996 and April 29, 1997 certain of Discreet's
shareholders filed class action lawsuits alleging violations of federal
securities laws and other claims against Discreet and certain of its officers
and directors, among others. The three lawsuits were filed in the Superior Court
of the State of California, the United States District Court, District of
Massachusetts and the United States District Court, Northern District of
California, respectively. On or about November 25, 1997, a settlement of all
three shareholder class actions received final court approval. Under the
U.S.$10,800,000 settlement, Discreet contributed approximately U.S.$7,400,000
from its own funds, with the remainder provided by insurance.
69
<PAGE>
RECENT ACQUISITIONS
On December 2, 1997, Discreet entered into the Merger Agreement with Lantern
Acquisition Corp., a Delaware corporation and wholly-owned subsidiary of
Discreet ("Merger Sub"), and Lightscape Technologies, Inc., a Delaware
Corporation ("Lightscape"). On December 30, 1997, pursuant to the Merger
Agreement, and upon the satisfaction of certain closing conditions, Merger Sub
merged (the "Merger") with and into Lightscape with Lightscape as the surviving
corporation and a wholly-owned subsidiary of Discreet. As a result of the
Merger, Discreet acquired, among other products, the Lightscape product, a
software application which integrates radiosity and raytracing with physically
based lighting, including related know-how and goodwill. The aggregate purchase
price for Lightscape includes the assumption of approximately U.S.$5,700,000 of
net liabilities (of which approximately U.S.$3,400,000 was paid at the closing),
not including costs associated with the transaction, and up to U.S.$6,800,000 in
contingent consideration to be paid only if certain revenue objectives are
achieved by Lightscape in calendar 1998 and 1999. The acquisition has been
accounted for as a purchase. Of the total purchase price and transaction costs,
U.S.$5,800,000 has been allocated to and capitalized as purchased in-process
research and development. The remainder, in the amount of U.S.$1,087,000, has
been allocated to and capitalized as purchased technology and goodwill. These
assets are being amortized on a straight-line basis over their estimated useful
lives of three to five years. The terms of the transaction were the result of
arm's-length negotiations between the representatives of Discreet and
Lightscape.
On July 15, 1997, Discreet acquired all of the outstanding shares of capital
stock of D-Vision, an Illinois corporation, pursuant to a Stock Purchase
Agreement dated as of July 10, 1997, among Discreet, D-Vision, the former
stockholders of D-Vision (the "Selling Stockholders") and certain other
individuals. As a result of the D-Vision Acquisition, Discreet acquired the
D-Vision OnLine (subsequently renamed D-Vision) and Pro software products for
non-linear video and digital media editing solutions including related know-how
and goodwill. The purchase price was paid in a combination of 555,000 newly
issued Discreet Common Shares and approximately U.S.$10,750,000 in cash. In
addition, approximately U.S.$4,000,000 of the cash consideration is being held
in escrow until September 30, 1999, subject to (i) earlier release from escrow
of up to U.S.$1,900,000 on September 30, 1998 and (ii) the resolution of any
indemnification claims made by Discreet pursuant to the Stock Purchase
Agreement. The cash used by Discreet to fund the acquisition was derived
primarily from cash flow from operations. The D-Vision Acquisition was accounted
for as a purchase. Purchased in-process research and development, in the amount
of U.S.$21,000,000, has been recorded and is included in other assets in the
consolidated balance sheet forming part of the consolidated financial statements
of Discreet included as Schedule E to the Circular. It is being amortized using
the straight-line method over three years. The terms of the transaction and the
consideration received by the D-Vision stockholders were the result of
arms-length negotiations between the representatives of Discreet and D-Vision.
D-Vision develops Microsoft Windows NT-based non-linear, digital editing
solutions.
Discreet, through its wholly-owned subsidiary 3380491 Canada Inc.
("Acquisition Sub"), acquired substantially all of the assets and assumed
certain liabilities of Denim pursuant to the terms of an Asset Purchase
Agreement dated as of June 12, 1997, among Acquisition Sub, Denim, Sam Khulusi,
Frank Khulusi, Westco Denim Investments Group, Ltd., a California limited
partnership, and Frank Khulusi Family Limited Partnership, a California limited
partnership. The purchased assets consisted primarily of Denim software
products, including Illuminaire Paint, Illuminaire Composition and Illuminaire
Studio and related know-how and goodwill. The aggregate purchase price for the
assets was comprised of (i) approximately U.S.$9,126,000 in cash, (ii) the
assumption of certain enumerated liabilities in an amount equal to no more than
approximately U.S.$2,209,000 in the aggregate, and (iii) the assumption of
certain on-going obligations under certain existing contracts of Denim. At
closing, cash consideration, of approximately U.S.$9,126,000, and certain
liabilities, of approximately U.S.$655,000 were paid. The cash used by Discreet
to fund the acquisition was derived primarily from cash flow from operations.
The transaction was accounted for using the purchase method. Purchased
in-process research and development, in the amount of approximately
U.S.$9,800,000, and goodwill, in the amount of U.S.$315,000 have been recorded
and are included as other assets in the consolidated balance sheet. These assets
are being amortized using the straight line method over three years. The terms
of the transaction and the consideration received by Denim were the result of
arms-length negotiations between the representatives of Discreet and Denim.
Denim developed Apple Macintosh and Microsoft Windows NT-based paint and
compositing software for producing effects, interactive content and graphics
design.
70
<PAGE>
RESTRUCTURING
During the fiscal year ended July 31, 1996, excluding a restructuring charge
of approximately U.S.$21,610,000 and its related tax effects, Discreet incurred
a net loss of approximately U.S.$24,390,000 on revenues of approximately
U.S.$83,997,000. In response to the financial results and other developments
facing the business, Discreet developed a restructuring plan during the fourth
fiscal quarter of 1996. While Discreet began implementation of its restructuring
plan in the fourth fiscal quarter of 1996 and had substantially completed the
implementation of the plan at the end of fiscal 1997, Discreet still has
approximately U.S.$3,335,000 in restructuring reserves primarily for the
estimated cost of terminating leases, resolving outstanding severance issues,
and the legal and taxation winding down of several subsidiaries.
CHANGE OF FISCAL YEAR
On January 9, 1997, the Board of Directors of Discreet approved the change
of Discreet's fiscal year end from July 31 to June 30. This change was effective
beginning with Discreet's second fiscal quarter of 1997. The consolidated
financial statements are presented for the six-month period ended December 31,
1997 and the five-month period ended December 31, 1996. Discreet prepares
consolidated financial statements, remeasures accounts in foreign currencies to
reflect changes in exchange rates and examines and adjusts certain reserve
accounts at the end of each quarter. Therefore, it is not practicable to recast
the prior fiscal period's results to reflect the new fiscal period.
Consequently, the results for the six month period ended December 31, 1997 are
not directly comparable to the results of the five month period ended December
31, 1996.
RESULTS OF OPERATIONS
The following table sets forth the percentages of total revenues represented
by certain line items in the statements of operations prepared in accordance
with Canadian GAAP:
<TABLE>
<CAPTION>
SIX-MONTH FIVE-MONTH ELEVEN-MONTH
PERIOD ENDED PERIOD ENDED PERIOD ENDED
DECEMBER 31, DECEMBER 31, JUNE 30,
1997 1996 1997
--------------- --------------- ---------------
<S> <C> <C> <C>
Total revenues............................... 100% 100% 100%
Cost of revenues............................. 41 51 47
--- --- ---
Gross profit............................... 59 49 53
--- --- ---
Operating expenses:
Research and development................... 16 10 10
Sales and marketing........................ 21 26 23
General and administrative................. 5 7 6
Litigation and related settlement
expense.................................. -- -- 6
--- --- ---
Total operating expenses................. 42 43 45
--- --- ---
Operating income........................... 17 6 8
Other income (expense), net.................. 1 2 1
--- --- ---
Income before income taxes................. 18 8 9
Provision for income taxes................... 8 5 6
--- --- ---
Net income................................. 10% 3% 3%
--- --- ---
--- --- ---
</TABLE>
SIX-MONTH PERIOD ENDED DECEMBER 31, 1997 AND FIVE-MONTH PERIOD ENDED
DECEMBER 31, 1996 (CANADIAN GAAP)
As discussed above, it is not practicable to recast prior quarterly results
to reflect new fiscal periodic reporting resulting from Discreet's previously
announced change in fiscal year end. Therefore, the results for the six-month
period ended December 31, 1997 are not directly comparable to the results of the
five-month period ended December 31, 1996.
71
<PAGE>
TOTAL REVENUES. Discreet's revenues consist of product revenues (including
licensing of its software, sales of Discreet's proprietary hardware, and resale
of third party hardware) and, to a lesser extent, revenues from maintenance and
other services (including consulting and training). In cases where Discreet has
delivered hardware and/or software to customers and has insignificant or
noncritical vendor obligations related to these deliveries, the revenue
attributable to such obligations has been deferred until such obligations have
been fulfilled.
Total revenues were U.S.$75,673,000 and U.S.$40,096,000 for the six-month
period ended December 31, 1997, and the five-month period ended December 31,
1996, respectively. The increase in total revenues in the six-month period ended
December 31, 1997, when compared to the five-month period ended December 31,
1996, was primarily due to the additional month in the fiscal 1998 period, and
an increase in worldwide revenues generated by Discreet's special effects and
editing (including initial commercial shipments of smoke*, Discreet's non-linear
digital editing tool introduced in the second quarter of fiscal 1998) product
lines. These increases were partially offset by a decrease in revenues in the
six-month period ended December 31, 1997, from Discreet's Broadcast Production
product line, as compared to the five-month period ended December 31, 1996.
Revenues from customers outside of North America were U.S.$39,965,000 (53%
of total revenues) and U.S.$21,779,000 (54% of total revenues) for the six-month
period ended December 31, 1997, and the five-month period ended December 31,
1996, respectively.
COST OF REVENUES. Cost of revenues consists primarily of the cost of
hardware sold (mainly workstations manufactured by SGI), cost of hardware
service contracts, cost of integration and hardware assembly, cost of service
personnel and the facilities, computing, benefits and other administrative costs
allocated to such personnel and the provision for inventory reserves. Cost of
revenues was U.S.$30,827,000 (41% of total revenues) and U.S.$20,290,000 (51% of
total revenues) for the six-month period ended December 31, 1997, and the
five-month period ended December 31, 1996, respectively. The decrease in cost of
revenues, as a percentage of total revenues, in the six-month period ended
December 31, 1997 when compared to the five-month period ended December 31,
1996, was primarily due to: (1) an increase in sales to Discreet's indirect
channel partners, whose purchases from Discreet are predominantly software only
and software and storage media bundles since these indirect channel partners are
themselves hardware resellers; (2) porting certain of Discreet's software
products to recently available, lower priced workstations, resulting in a lower
cost to Discreet for the hardware component of system sales; and (3) the
increased penetration of Discreet's products in the Asian market where customers
typically purchase from Discreet only software or software and storage media
bundles. The decrease in cost of revenues, as a percentage of total revenues, in
the six-month period ended December 31, 1997 when compared to the five-month
period ended December 31, 1996 is also attributable to lower margins realized on
systems sold in the three-month period ended October 31, 1996 under an
aggressive sales program, including product discounts, designed to reduce the
inventory on hand at the end of the fourth fiscal quarter of 1996. Discreet
expects that cost of revenues, as a percentage of total revenues, should
increase from its current level. However, cost of revenues remains difficult to
predict and is subject to fluctuations due to a number of factors including
product and product configuration mix and the proportion of direct and indirect
sales.
RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of the cost of research and development personnel and the facilities,
depreciation on research and development equipment, amortization of purchased
in-process research and development, acquired technologies and goodwill,
computing, benefits and other administrative costs allocated to such personnel,
and consulting fees. Expenditures for research and development, after deducting
Canadian federal and provincial tax credits, were U.S.$11,663,000 (16% of total
revenues) and U.S.$4,253,000 (10% of total revenues) for the six-month period
ended December 31, 1997, and the five-month period ended December 31, 1996,
respectively. The increase in research and development expenses in the six-month
period ended December 31, 1997 when compared to the five-month period ended
December 31, 1996, was primarily due to: (1) the additional month in the fiscal
1998 period; (2) an increase in the number of software engineers (including the
engineers joining Discreet as a result of the Denim Acquisition and D-Vision
Acquisition) to develop and enhance Discreet's existing products and to develop
new products; (3) an increase in depreciation charges on the additional research
and development equipment required for the additional personnel; and (4) an
increase in the amortization of purchased in-process research and development,
acquired technologies and goodwill. Research and development costs are
72
<PAGE>
expensed as incurred. Software development costs are considered for
capitalization once technical feasibility has been established. Discreet has not
capitalized any software development costs to date. Certain research and
development expenditures are incurred substantially in advance of related
revenue and in some cases do not generate revenues. Discreet expects that
research and development expenses will increase from current levels. Should
revenues increase, Discreet expects that research and development expenses, as a
percentage of total revenues, should remain approximately the same as their
current levels.
Discreet is entitled to research and development incentives in the form of
income tax credits from the Canadian federal government and from the Province of
Quebec. These income tax credits are earned based upon qualified Canadian
research and development salaries and other qualified research and development
expenditures. Discreet also earns income tax credits from the Canadian federal
government based upon qualified research and development equipment purchases and
has recorded such credits as a reduction of the carrying value of the equipment
when such credits are realized. See Note 6 of Notes to Discreet's consolidated
financial statements set forth in Schedule E to this Circular.
SALES AND MARKETING. Sales and marketing expenses consist primarily of
salaries, commissions and related benefits, facilities and administrative costs
allocated to Discreet's sales and marketing personnel, tradeshow expenses, and
dealer commissions. Sales and marketing expenses were U.S.$15,840,000 (21% of
total revenues) and U.S.$10,627,000 (26% of total revenues) for the six-month
period ended December 31, 1997, and the five-month period ended December 31,
1996, respectively. The increase in sales and marketing expenses, in the
six-month period ended December 31, 1997 when compared to the five-month period
ended December 31, 1996, is explained by the additional month in the fiscal 1998
period, the continued expansion of Discreet's direct and indirect sales
organization, including the operating costs of domestic sales offices and
foreign subsidiaries, and an increase in tradeshow activities. The decrease in
sales and marketing expenses, as a percentage of total revenues, in the
six-month ended December 31, 1997 when compared to the five-month period ended
December 31, 1996, is explained in part by the growth of sales to the indirect
channel partners which require a reduced level of expenditures than direct sales
to end-users. Discreet expects that sales and marketing expenses will increase
from their current levels. Should revenues increase, Discreet expects that sales
and marketing expenses, as a percentage of total revenues, should remain
approximately the same as their current levels.
GENERAL AND ADMINISTRATIVE. General and administrative expenses include the
costs of finance and accounting, human resources, facilities, corporate
information systems, legal and other administrative functions of Discreet and
reserves for doubtful accounts receivable. General and administrative expenses
were U.S.$3,896,000 (5% of total revenues) and U.S.$2,705,000 (7% of total
revenues) for the six-month period ended December 31, 1997, and the five-month
period ended December 31, 1996, respectively. The increase in general and
administrative expenses in the six-month period ended December 31, 1997 when
compared to the five-month period ended December 31, 1996 is explained by the
additional month in the later period being compared, and by an increase in
personnel. Discreet expects that general and administrative expenses will
increase from their current levels. Should revenues increase, Discreet expects
that general and administrative expenses, as a percentage of total revenues,
should remain approximately the same as their current levels.
OTHER INCOME (EXPENSE). Other Income (Expense) primarily consists of
foreign currency gains and losses and interest income and expense. Foreign
currency translation gains were U.S.$307,000 for the six-month period ended
December 31, 1997 compared to U.S.$458,000 for the five-month period ended
December 31, 1996. These gains and losses are primarily the result of Discreet
and each subsidiary translating intercompany balances denominated in a currency
other than its own functional currency. These balances are remeasured into the
functional currency of each company every reporting period. This remeasurement
results in either unrealized gains or losses depending on the exchange rate
fluctuation between the functional currency of each company and the currency in
which the monetary asset or liability is denominated.
PROVISION FOR INCOME TAXES. Discreet's provision for income taxes was
U.S.$5,872,000 and U.S.$1,962,000 for the six-month period ended December 31,
1997, and the five-month period ended December 31, 1996, respectively. The
provision for both periods is based upon the Canadian federal statutory rate of
38% and reflects the impact of various tax credits and foreign taxes. The tax
provision for the six-month period ended December 31, 1997 differed from the
statutory rate primarily as a result of no tax benefit being recorded on the
amortization of purchased in-process research and development. The tax provision
for the five-month period
73
<PAGE>
ended December 31, 1996 differed from the statutory rate primarily as a result
of Discreet not recording a benefit related to losses where the realization of
the benefit was uncertain. Discreet has foreign net operating loss carry
forwards which may be available to reduce future income tax liabilities.
FISCAL YEARS ENDED JUNE 30, 1997 AND JULY 31, 1996 (CANADIAN GAAP)
TOTAL REVENUES. Total revenues were U.S.$101,923,000 for the eleven-month
period ended June 30, 1997 and U.S.$83,997,000 for the year ended July 31, 1996.
Despite the fact that fiscal 1997 was an eleven-month period, total revenues
increased in fiscal 1997 over total revenues for fiscal 1996 due to new product
offerings during the year, namely fire* and Flint RT, as well as wider
acceptance of Discreet's premier resolution-independent effects system,
inferno*, and a growing installed base.
Revenues from customers outside of North America were U.S.$58,171,000 (57%
of total revenues) and U.S.$47,711,000 (57% of total revenues) for the
eleven-month period ended June 30, 1997 and the year ended July 31, 1996,
respectively.
COST OF REVENUES. Cost of revenues was U.S.$47,571,000 (47% of total
revenues) and U.S.$49,333,000 (59% of total revenues) for the eleven-month
period ended June 30, 1997 and the year ended July 31, 1996, respectively. The
decrease in cost of revenues as a percentage of total revenues was a result of
the following factors: (1) Discreet's growing penetration into the Asian market
where customers typically purchase only software or software and storage media
bundles, (2) the SGI workstation component of cost of revenues declined as
Discreet's installed base purchased additional software and storage media to add
on to existing workstations, and (3) provisions to write inventories down to
their net realizable values were lower for the eleven-month period ended June
30, 1997 as compared to the year ended July 31, 1996.
RESEARCH AND DEVELOPMENT. Expenditures for research and development, after
deducting Canadian federal and provincial tax credits, were U.S.$9,980,000 (10%
of total revenues) and U.S.$18,792,000 (22% of total revenues) for the
eleven-month period ended June 30, 1997 and the year ended July 31, 1996,
respectively. The decrease in research and development expenses, after deducting
tax credits, was a result of the following factors: (1) the provision, in the
amount of U.S.$2,500,000, recorded during the quarter ended April 30, 1996, to
reflect the uncertainty regarding the realizability of Discreet's investment in
the preferred shares of Essential Communications Corporation and (2) the
implementation of Discreet's restructuring plan which included the reduction of
personnel, discontinuation of the amortization expense as a result of the
write-off of the purchased in-process research and development associated with
the COSS/IMP acquisition, closure of certain research and development offices,
and consolidation of software research and development in its Montreal
headquarters during the fourth fiscal quarter of 1996 and the eleven-month
period ended June 30, 1997. See Note 18 of Notes to Discreet's consolidated
financial statements set forth in Schedule E of this Circular. These decreases
were partially offset by general salary increases.
SALES AND MARKETING. Sales and marketing expenses were U.S.$23,206,000 (23%
of total revenues) and U.S.$26,088,000 (31% of total revenues) for the
eleven-month period ended June 30, 1997 and the year ended July 31, 1996,
respectively. The decrease in sales and marketing expenses resulted primarily
from the implementation of Discreet's restructuring plan, which included a
reduction of personnel and the closure of the Florida sales office and the
relocation of the New York demonstration center during the fourth fiscal quarter
of 1996. These decreases were partially offset by the continued expansion of
Discreet's direct and indirect sales organization, including the operating costs
of domestic sales offices and foreign subsidiaries.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were
U.S.$6,396,000 (6% of total revenues) and U.S.$10,582,000 (13% of total
revenues) for the eleven-month period ended June 30, 1997 and the year ended
July 31, 1996, respectively. The decrease in general and administrative expenses
resulted primarily from the implementation of Discreet's restructuring plan
which included a reduction of administrative personnel as well as the closure of
administrative offices in Cambridge, Massachusetts. Additionally, in fiscal
1996, Discreet provided approximately U.S.$3,300,000 in reserves for potentially
uncollectible accounts receivable and provided U.S.$830,000 to reflect certain
recourse provisions associated with third party financing arrangements, and
reduced the carrying value of a building purchased in Montreal by $500,000
(approximately U.S.$365,000) to reflect the value expected to be realized upon
sale.
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RESTRUCTURING EXPENSE. In the fourth quarter of fiscal 1996, Discreet
recorded a restructuring expense of U.S.$21,610,000 (26% of total fiscal 1996
revenues). The focus of Discreet's restructuring plan was to solidify its senior
management team, reduce operating expenses through workforce reductions and
office closings, consolidate software research and development activities in
Montreal, discontinue certain product lines, and restructure its sales force to
emphasize indirect sales channels. While Discreet began implementation of its
restructuring plan in the fourth fiscal quarter of 1996 and had substantially
completed the implementation of the plan at the end of fiscal 1997, as at June
30, 1997, Discreet still had U.S.$4,272,000 in restructuring reserves primarily
for the estimated cost of terminating leases, resolving outstanding severance
issues, and the legal and taxation winding down of several subsidiaries. See
Note 16 to Notes of Discreet's consolidated financial statements set forth in
Schedule E to this Circular.
LITIGATION AND SETTLEMENT. In August of 1997, Discreet announced an
agreement-in-principle to settle all three of the class action shareholder
lawsuits outstanding against it for U.S.$10,800,000. In the fiscal year ended
July 31, 1996, Discreet had provided a U.S.$2,506,000 (3% of total revenues)
litigation reserve for legal costs associated with defending the class action
lawsuits. During the eleven-month period ended June 30, 1997, Discreet recorded
a provision of U.S.$6,500,000 (6% of total revenues) to accrue the additional
estimated settlement costs to be borne by Discreet.
On or about November 25, 1997, a settlement of all three shareholder class
actions received final court approval. Under the U.S.$10,800,000 settlement,
Discreet contributed approximately U.S.$7,400,000 from its own funds with the
remainder provided by insurance.
OTHER INCOME (EXPENSE). Foreign currency translation losses were
U.S.$188,000 during the eleven-month period ended June 30, 1997 compared to
gains of U.S.$179,000 during the year ended July 31, 1996.
PROVISION FOR INCOME TAXES. Discreet's provision for income taxes was
approximately U.S.$6,489,000 and U.S.$1,435,000 for the eleven-month period
ended June 30, 1997 and the year ended July 31, 1996, respectively. The
provision for all periods was based on the Canadian federal statutory rate of
38% and reflects the impact of various tax credits and foreign taxes. The tax
provision for these periods resulted from taxable earnings in jurisdictions
where Discreet did not have available tax loss carryforwards partially offset by
the realization of the benefit for some prior year tax losses for which no
benefit was previously recorded. In addition, in fiscal 1997, Discreet recorded
a provision for estimated litigation settlement costs for which no tax benefit
was recorded because of the uncertainty of realizing any tax benefit associated
with this charge. See Note 10 of Notes to Discreet's consolidated financial
statements set forth in Schedule E to this Circular. As of June 30, 1997,
Discreet had available approximately U.S.$15,150,000 of cumulative foreign net
operating loss carryforwards which may be available to reduce future income tax
liabilities.
LIQUIDITY AND CAPITAL RESOURCES (CANADIAN GAAP)
Discreet has funded its operations to date primarily through cash flow from
operations, borrowings under its demand line of credit, capital leases, the
private and public sales of equity securities, and the receipt of research and
development tax credits from the Canadian federal government and the Province of
Quebec. As of December 31, 1997, Discreet had cash of approximately
U.S.$12,649,000. In August 1997, Discreet amended its revolving demand line of
credit with a bank under which Discreet may borrow up to $7,000,000 (or
approximately U.S.$4,885,000 at December 31, 1997). Advances under the line
accrue interest monthly at the prime rate of the Banque Nationale de Paris (6.0%
at December 31, 1997) plus 0.25%. Additionally, Discreet has a $600,000
(approximately U.S.$419,000 at December 31, 1997) demand leasing facility, and a
$600,000 (approximately U.S.$419,000 at December 31, 1997) demand research and
development tax credit facility. Advances under these facilities accrue interest
monthly at the prime rate of the Banque Nationale de Paris (6.0% at December 31,
1997) plus 1%. The line and facilities are secured by essentially all of
Discreet's North American assets. As additional security, Discreet has assigned
to the bank its insurance on these assets. Discreet is required to maintain
certain financial ratios, including minimum levels of working capital, debt
service coverage and equity to assets ratios. As of December 31, 1997, no
amounts were outstanding under the demand line of credit, the demand leasing, or
the demand research and development tax credit facilities.
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Discreet's operating activities used cash of U.S.$4,196,000 and provided
cash of U.S.$17,290,000 for the six-month period ended December 31, 1997 and the
five-month period ended December 31, 1996, respectively. The principal uses of
cash for the six-month period ended December 31, 1997 were the disbursement of
funds used to settle the class action litigations and the decrease in accounts
payable and accrued expenses resulting from Discreet paying many of the
liabilities assumed in connection with the D-Vision Acquisition and the
Lightscape acquisition. These uses of cash were offset primarily by the receipt
of insurance proceeds related to the settlement of the class action litigations.
Net cash provided by operations in the five-month period ended December 31, 1996
was composed primarily of net income before non-cash charges and decreases in
accounts receivable and inventory.
Discreet's operating activities, including research and development tax
credits, provided cash of U.S.$26,011,000, used cash of U.S.$24,425,000, in the
eleven-month period ended June 30, 1997, and the fiscal year ended July 31, 1996
respectively. The principal sources of cash in the eleven-month period ended
June 30, 1997 were cash generated from operations, the decreases in inventory
and in income taxes receivable, and the increases in accounts payable and
accruals, deferred revenues and income taxes payable, offset by an increase in
accounts receivable, when compared to the fiscal year ended July 31, 1996.
Accounts receivable increased during fiscal 1997 as a result of Discreet
experiencing a greater level of sales and the timing of those sales being closer
to the end of the fourth fiscal quarter as compared to the fourth fiscal quarter
of 1996. Inventory decreased during fiscal 1997, as a result of an aggressive
sales program during the three-month period ended October 31, 1996, including
system discounting, designed to reduce the inventory on hand at the end of
fiscal 1996 as well as close monitoring of inventory throughout the eleven-month
period ended June 30, 1997. Accounts payable increased due to the increased
level of hardware purchases required at the end of the fourth quarter of fiscal
1997 to meet the quarter's revenue demands. Accrued liabilities increased due to
the provision recorded to accrue the estimated additional costs of settling the
three class action lawsuits brought against Discreet. This increase was
partially offset by a decrease in the accrued restructuring expenses.
Discreet's investing activities used cash of U.S.$13,874,000 in the
six-month period ended December 31, 1997 primarily for the D-Vision Acquisition
and the purchase of research and development equipment and related software.
During the six-month period ended December 31, 1997, Discreet received proceeds
from the sale of its Montreal land and office building which were previously
included on the balance sheet as assets held for resale. The proceeds of sale
were not materially different from the carrying value of these assets.
Discreet's investing activities used cash of U.S.$3,084,000 in the five-month
period ended December 31, 1996, primarily for renovations to the office building
in London, England and the purchase of computer equipment and software used in
the operations of Discreet's business, primarily in the research and development
area.
Discreet's investing activities used cash of U.S.$17,867,000 and
U.S.$24,223,000, in the eleven-month period ended June 30, 1997, and the fiscal
year ended July 31, 1996, respectively. The principal uses of cash in fiscal
1997 were the Denim Acquisition (approximately U.S.$9,126,000) and the purchase
of computer equipment and software, general office equipment, leasehold
improvements and furniture and fixtures used in the operation of Discreet's
business. In fiscal 1996, the principal uses of cash were the acquisition of
COSS/IMP (approximately U.S.$5,545,000), the purchase of the preferred shares of
Essential Communications Corporation (U.S.$2,500,000), the purchase of land and
an office building in London, England for L1,148,000 (approximately
U.S.$1,788,000), the purchase of land and an office building in Montreal, Quebec
for $1,730,000 (or approximately U.S.$1,250,000) and the purchase of computer
equipment and software, general office equipment, leasehold improvements, and
furniture and fixtures used in the operation of Discreet's business. The
principal uses of cash in fiscal 1995 were the purchase of computer equipment
and software, general office equipment, leasehold improvements, and furniture
and fixtures used in the operation of Discreet's business.
Financing activities provided cash of U.S.$776,000 and U.S.$840,000 in the
six-month period ended December 31, 1997 and five-month period ended December
31, 1996, respectively, from proceeds from common stock option exercises and the
issuance of shares under the Employee Stock Purchase Plan.
Financing activities provided cash of U.S.$1,479,000 and U.S.$30,310,000
during the eleven-month period ended June 30, 1997, and the fiscal year ended
July 31, 1996 respectively. In the fiscal year ended June 30, 1997, cash was
provided from common stock option exercises and the issuance of shares under the
Discreet Stock Option Plan. In fiscal 1996, cash was provided primarily from
proceeds from the issuance of approximately
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971,000 Discreet Common Shares in a secondary public offering which was
completed in December 1995, proceeds from the repayment of subscriptions
receivable, and proceeds from common stock option exercises less payment of
capital lease obligations.
Discreet incurred U.S.$6,265,000, and U.S.$15,871,000 of capital
expenditures during the eleven month period ended June 30, 1997, and the fiscal
year ended July 31, 1996, respectively, consisting primarily of computer
equipment, software and general office equipment and leasehold improvements. In
the fiscal year ended July 31, 1996, Discreet purchased an office building and
related land in London, England. Discreet incurred L1,034,000 (or approximately
U.S.$1,663,000), and L715,000 (or approximately U.S.$1,114,000) in capital
expenditures during the fiscal years ended June 30, 1997 and July 31, 1996,
respectively, for the refitting of the London property. In fiscal 1996, Discreet
also purchased an office building in Montreal, Quebec. The carrying values of
the Montreal building and the London building were written down to their
estimated fair market values and the buildings were classified as assets held
for sale. In September 1997, Discreet sold the Montreal office building for a
price not materially different from its carrying value.
As of December 31, 1997, Discreet did not have any material commitments for
capital expenditures.
Discreet's ability to meet its future liquidity requirements is dependent
upon its ability to operate profitably, or in the absence thereof, to obtain
additional financing. Discreet underwent a restructuring intended to decrease
operating expenses, however, there can be no assurance that Discreet will not
have to take further restructurings or be profitable in the future. Should
Discreet need to secure additional financing to meet its future liquidity
requirements, there can be no assurance that Discreet will be able to secure
such financing, or that such financing, if available, will be on terms favorable
to Discreet. Subject to the factors discussed under "Risk Factors", Discreet
believes that, with its current levels of working capital together with funds
generated from operations, it has adequate sources of cash to meet its
operations and capital expenditure requirements through calendar 1998.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
Information provided by Discreet from time to time including statements in
this management discussion and analysis which are not historical facts, are
so-called forward-looking statements, and are made pursuant to the safe harbor
provisions of the PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 of the United
States and releases of the SEC. In particular, statements contained in the
"Management's Discussion and Analysis" which are not historical facts
(including, but not limited to, statements regarding Discreet's anticipated cost
of revenues, statements regarding the anticipated adequacy of cash to meet
operations, statements concerning anticipated expense levels and such expenses
as a percentage of revenues, statements about the anticipated portion of
revenues from customers outside North America, and the implementation of the
restructuring plan) may constitute forward-looking statements. Discreet's actual
future results may differ significantly from those stated in any forward-looking
statements. Factors that may cause such differences include, but are not limited
to, the factors discussed below, other risks discussed in this section and
elsewhere in this management's discussion and analysis, and the other risks
discussed in "Risk Factors" and in Discreet's Annual Report on Form 10-K for the
fiscal year ended June 30, 1997, as well as, from time to time, in Discreet's
other filings with the SEC.
Discreet's future results are subject to substantial risks and
uncertainties. Discreet's future financial performance will depend in part on
the successful development, introduction and customer acceptance of its existing
and new or enhanced products. In addition, in order for Discreet to achieve
sustained growth, the market for Discreet's systems and software must continue
to develop and Discreet must expand this market to include additional
applications within the film and video industries and develop or acquire new
products for use in related markets. There can be no assurance that Discreet
will be successful in marketing its existing or any new or enhanced products. In
addition, as Discreet enters new markets, distribution channels, technical
requirements and levels and bases of competition may be different from those in
Discreet's current markets and there can be no assurance that Discreet will be
able to compete favorably. The markets in which Discreet competes are
characterized by intense competition and many of Discreet's current and
prospective competitors have significantly greater financial, technical,
manufacturing and marketing resources than Discreet. These companies may
introduce additional products that are competitive with those of Discreet, and
there can be no assurance that Discreet's products would compete effectively
with such products. Furthermore, competitive
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pressures or other factors, including Discreet's entry into new markets, may
result in significant price erosion that could have a material adverse effect on
Discreet's business and results of operations. Discreet has recently completed
the purchase of certain products and technology through acquisitions. There can
be no assurance that the products and technologies acquired from these companies
will be successful or will achieve market acceptance, or that Discreet will not
incur disruptions and unexpected expenses in integrating the operations of the
acquired businesses with those of Discreet.
Discreet's flame*, effect*, inferno*, fire* and frost* systems currently
include workstations manufactured by SGI. There are significant risks associated
with this reliance on SGI and Discreet may be impacted by the timing of the
development and release of products by SGI, as was the case during fiscal 1996.
In addition, there may be unforeseen difficulties associated with adapting
Discreet's products to future SGI products. Discreet derives a significant
portion of its total revenues from foreign sales. Foreign sales are subject to
significant risks, including unexpected legal, tax and exchange rate changes
(including the recent currency volatility in Asia) and other barriers. In
addition, foreign customers may have longer payment cycles and the protection of
intellectual property in foreign countries may be more difficult to enforce.
Discreet currently relies principally on unregistered copyrights and trade
secrets to protect its intellectual property. Any invalidation of Discreet's
intellectual property rights or lengthy and expensive defense of those rights
could have a material adverse effect on Discreet. Discreet receives letters from
third parties, from time to time, inquiring about Discreet's products and
discussing intellectual property matters, which Discreet reviews to determine
the appropriate response, if any. For example, Discreet received a letter from
Avid stating its belief that certain of Discreet's recently acquired D-Vision
products practice inventions claimed in a patent on a media editing system.
Discreet has responded to Avid's letter stating Discreet's belief that Discreet
is not infringing any valid claim of Avid's patent. To Discreet's knowledge,
Avid has not initiated any suit, action or other proceeding alleging any
infringement by Discreet of such patent. Discreet currently markets its systems
through its direct sales organization and through distributors. This marketing
strategy may result in distribution channel conflicts as Discreet's direct sales
efforts may compete with those of its indirect channels. Discreet currently
relies on SGI as the sole source for video input/output cards used in Discreet's
systems. Discreet's D-Vision (formerly named OnLine) software requires a
videographic card manufactured solely by Truevision, Inc. An interruption in the
supply or increase in the price of either one of these components could have a
material adverse effect on Discreet's business and results of operations. To
date, Discreet has depended to a significant extent upon a number of key
management and technical employees and Discreet's ability to manage its
operations will require it to continue to recruit and retain senior management
personnel and to motivate and effectively manage its employee base. The loss of
the services of one or more of these key employees could have a material adverse
effect on Discreet's business and results of operations. There can be no
assurance that these factors will not have a material adverse effect on
Discreet's future international sales and consequently, on the Company's
business and results of operations.
The market price of Discreet's common shares could be subject to significant
fluctuations in response to quarter-to-quarter variations in Discreet's
operating results, announcements of technological innovations or new products by
Discreet, its competitors or suppliers and other events or factors. In addition,
the stock market in recent years has experienced extreme price and volume
fluctuations that have particularly affected the market prices of many
technology companies and that have often been unrelated or disproportionate to
the operational performance of these companies. These fluctuations, as well as
general economic and market conditions, may materially and adversely affect the
market price of Discreet's common shares.
Discreet believes that its operating results could vary significantly from
quarter to quarter. A limited number of systems sales may account for a
substantial percentage of Discreet's quarterly revenue because of the high
average sales price of such systems and the timing of purchase orders.
Historically, Discreet has generally experienced greater revenues during the
period following the completion of the annual conference of the NAB, which is
typically held in April. Discreet's expense levels are based, in part, on its
expectations of future revenues. Therefore, if revenue levels are below
expectations, particularly following NAB, Discreet's operating results are
likely to be adversely affected as was the case for the three-month periods
ended April 30, 1996 and July 31, 1996. In addition, the timing of revenue is
influenced by a number of other factors, including: the timing of individual
orders and shipments, other industry trade shows, competition, seasonal customer
buying patterns, changes to customer buying patterns in response to platform
changes and changes in product development and sales and marketing expenditures.
Because Discreet's operating expenses are based on anticipated revenue
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levels and a high percentage of Discreet's expenses are relatively fixed in the
short term, variations in the timing of recognition of revenue could cause
significant fluctuations in operating results from quarter to quarter and may
result in unanticipated quarterly earnings shortfalls or losses. There can be no
assurance that Discreet will be successful in maintaining or improving its
profitability or avoiding losses in any future period. Discreet believes that
quarter-to-quarter comparisons of its financial results are not necessarily
meaningful and should not be relied upon as an indication of future performance.
RESULTS OF OPERATIONS
The following table sets forth the percentages of total revenues represented
by certain line items in the statement of operations prepared in accordance with
U.S. GAAP. See Note 18 to the consolidated financial statement set forth in
Schedule F of this Circular.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-------------------
1995 1996
-------- --------
<S> <C> <C>
Total revenues.............................................. 100% 100%
Cost of revenues............................................ 46 59
--- ---
Gross profit.............................................. 54 41
--- ---
Operating expenses:
Research and development.................................. 6 20
Sales and marketing....................................... 19 31
General and administrative................................ 8 13
Write-off of purchased research and development........... -- 10
Restructuring expense..................................... -- 18
Litigation and related settlement expense................. -- 3
--- ---
Total operating expenses................................ 33 95
--- ---
Operating income (loss)................................. 21 (54)
Total other income (expense)................................ 0 3
--- ---
Income (loss) before income taxes and minority interest..... 21 (51)
Provision for income taxes.................................. 9 2
--- ---
Net income (loss) before minority interest.................. 12 (53)
Minority interest........................................... 0 --
--- ---
Net income (loss)......................................... 12% (53)%
--- ---
--- ---
</TABLE>
FISCAL YEARS ENDED JULY 31, 1996 AND JULY 31, 1995 (U.S. GAAP)
TOTAL REVENUES. Total revenues were U.S.$83,997,000 in fiscal 1996, an
increase of 30% from U.S.$64,549,000 in fiscal 1995. Despite this increase,
total revenues in fiscal 1996 were significantly below management's
expectations, resulting in an operating loss of U.S.$44,914,000 in fiscal 1996
compared to operating income of U.S.$13,460,000 in fiscal 1995. The revenue
shortfall was due primarily to softening of demand in the high end visual
effects market segment, delays by Discreet in introducing new products aimed at
new market segments, as well as the announcement by SGI of a new Onyx
workstation approximately two weeks prior to January 31, 1996 which caused
Discreet to offer substantial discounts and other favorable terms regarding its
then current inventory of SGI workstations. Revenues in fiscal 1996 were also
affected by a decline of 14% in sales of flame* systems, including software and
hardware, partially offset by an increase in sales of Flint systems, including
software and hardware.
Revenues from customers outside of North America were U.S.$47,711,000 in
fiscal 1996, an increase of 64% from U.S.$29,033,000 in fiscal 1995, and
accounted for approximately 57% of total revenues in fiscal 1996, compared with
approximately 45% in fiscal 1995. During fiscal 1995 and fiscal 1996, Discreet
expanded its direct sales force and distribution channels in Europe and the
Pacific Rim at a greater rate than in North America which resulted in revenues
from customers outside of North America increasing at a higher rate than
revenues from customers inside North America.
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COST OF REVENUES. Cost of revenues was U.S.$49,333,000 in fiscal 1996, as
compared to U.S.$29,609,000 in fiscal 1995, an increase of 67%. Cost of revenues
was 59% and 46% of total revenues for fiscal 1996 and 1995, respectively. The
increase as a percentage of total revenues was due to fixed costs in cost of
revenues being a larger percentage of revenues in fiscal 1996 due to Discreet's
increased support, integration and manufacturing activities in anticipation of
higher revenues as well as increased discounting of the selling price of
Discreet's products in fiscal 1996 due to competitive pressures. In addition,
Discreet recorded U.S.$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. Without the inventory
reserves, cost of revenues in fiscal 1996 would have been 52% of total revenues.
RESEARCH AND DEVELOPMENT. Expenditures for research and development, after
deducting Canadian federal and provincial tax credits, were U.S.$16,902,000 in
fiscal 1996, an increase of 319% from U.S.$4,037,000 in fiscal 1995. Research
and development expenses, after deducting tax credits, were 20% and 6% of total
revenues for fiscal 1996 and 1995, respectively. Canadian federal and provincial
tax credits were U.S.$711,000 and U.S.$545,000 for fiscal 1996 and 1995,
respectively. The increases in expenditures for both periods were due primarily
to the hiring of additional software engineers to develop and enhance Discreet's
existing products and to develop new products, as well as an increase in
depreciation due to additional purchases of development equipment required for
the additional personnel. In connection with the investment in Essential
Communications Corporation, Discreet expensed U.S.$2,500,000 of research and
development expense in its third fiscal quarter of 1996 due to the uncertainty
regarding the realizability of the investment in the preferred shares. Without
the write-off, research and development expenses in fiscal 1996 would have been
17% of total revenues. See Notes 15 and 18 to Notes to Discreet's Consolidated
Financial Statements included in Schedule F to this Circular. Research and
development costs are expensed as incurred. Software development costs are
considered for capitalization once technical feasibility has been established.
Discreet has not capitalized any software development costs to date. Certain
research and development expenditures are incurred substantially in advance of
related revenue and in some cases do not generate revenues.
SALES AND MARKETING. Sales and marketing expenses were U.S.$26,088,000 in
fiscal 1996, an increase of 107% from U.S.$12,588,000 in fiscal 1995. Sales and
marketing expenses as a percentage of total revenues were 31% and 19% for fiscal
1996 and 1995, respectively. These increases resulted primarily from the
continued expansion of Discreet's direct sales organization, including the
opening of domestic sales offices and foreign subsidiaries, the payment of sales
commissions on increasing sales volumes and increased presence at major
tradeshows.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were
U.S.$10,582,000 in fiscal 1996, an increase of 118% from U.S.$4,855,000 in
fiscal 1995. General and administrative expenses as a percentage of total
revenues were 13% and 8% for fiscal 1996 and 1995, respectively. These increases
resulted from hiring several senior executive officers, as well as additional
finance, accounting and administrative personnel. The increase also reflected
general salary increases, increased occupancy expenses as Discreet hired
additional staff and increased professional fees and insurance premiums
associated with the growth of Discreet's infrastructure. In addition, Discreet
provided approximately U.S.$3,300,000 in reserves for potentially doubtful
accounts receivable in fiscal 1996, including U.S.$830,000 to reflect certain
recourse provisions in and other risks associated with certain third party
financing arrangements implemented in the third and fourth fiscal 1996 quarters.
See Note 2(f) of Notes to Discreet's Consolidated Financial Statements included
in Schedule F to this Circular. Also, in its third quarter of fiscal 1996,
Discreet reduced the carrying value of a building purchased in Montreal by
$500,000 (approximately U.S.$365,000) to reflect the amount expected to be
realized upon sale.
CHARGE FOR PURCHASED RESEARCH AND DEVELOPMENT. In connection with the
COSS/IMP acquisition, Discreet expensed U.S.$8,500,000 of in-process research
and development. This write-off represented approximately 10% of total revenues
for fiscal 1996. See Notes 15 and 18 of Notes to Discreet's Consolidated
Financial Statements included in Schedule F to this Circular.
RESTRUCTURING EXPENSE. In the fourth quarter of fiscal 1996, Discreet
recorded a restructuring expense of U.S.$15,000,000, representing approximately
18% of total revenues for 1996. The focus of Discreet's restructuring plan is to
solidify its senior management team, reduce operating expenses through workforce
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reductions and office closings, consolidate research and development activities
in Montreal, the discontinuance of certain product lines, and restructure its
sales force to emphasize indirect sales channels. Discreet began implementation
of its restructuring plan in the fourth fiscal quarter of 1996. See Notes 17 and
18 to Notes of Discreet's Consolidated Financial Statements included in Schedule
F to this Circular.
LITIGATION. In the three months ended July 31, 1996, Discreet provided a
U.S.$2,506,000 litigation reserve for legal costs associated with defending the
class action lawsuits. See Note 5 of Notes to Discreet's Consolidated Financial
Statements included in Schedule F to this Circular.
PROVISION FOR INCOME TAXES. Discreet's provision for income taxes for
fiscal 1996 was U.S.$1,435,000 compared to U.S.$5,490,000 for fiscal 1995. The
provision/benefit for all periods was based on the Canadian federal statutory
rate of 38% and reflects the impact of various tax credits, the effect of not
utilizing foreign subsidiaries' tax losses and the effect of the foreign taxes.
As at July 31, 1996, Discreet has U.S.$27,460,000 of foreign net cumulative
operating loss carryforwards which may be available to reduce further income tax
liabilities in those jurisdictions. The tax benefits of those tax carryforwards
have not been recognized due to the uncertainty of realizing the future tax
benefit. See Note 11 of Notes to Discreet's Consolidated Financial Statements
included in Schedule F to this Circular.
DIFFERENCES BETWEEN U.S. GAAP AND CANADIAN GAAP. These consolidated
financial statements included in Schedule F of this Circular have been prepared
in accordance with U.S. GAAP which conform in all material respects with
Canadian GAAP except as follows:
Under Canadian GAAP, the amount allocated to purchased in-process
research and development as part of the acquisition of COSS/IMP referred
to in Note 15 b) would not have been charged to operations in the first
quarter of 1996. Rather, the amount would have been capitalized to other
assets and it would have been amortized using the straight-line method
over its estimated life of 3 years. Following the adoption of the
restructuring plan referred to in Note 17 to the consolidated financial
statements included in Schedule F to this Circular, the unamortized
purchased in-process research and development would have been written off
in the fourth quarter of 1996 since, as a result of the plan, Discreet
decided to indefinitely postpone further development of the in-process
research and development acquired.
The above difference would not have required adjustments to reconcile the
balance sheet as at July 31, 1996 to the Canadian GAAP format. See Note 18 of
Notes to Consolidated Financial Statements included in Schedule F to this
Circular.
LIQUIDITY AND CAPITAL RESOURCES (U.S. GAAP)
As of July 31, 1996, the Company had cash of approximately U.S.$21,658,000.
Discreet's operating activities, including research and development tax
credits, used cash of U.S.$24,425,000 in fiscal 1996 and provided cash of
U.S.$8,304,000 in fiscal 1995. The principal uses of cash in fiscal 1996 were
the funding of the operating loss, the increase in accounts receivable, the
increase in inventory and an income tax receivable compared to an income tax
payable at the end of fiscal 1995. Accounts receivable increased during fiscal
1996 as a result of Discreet extending favorable payment terms (i.e. reduced
initial deposits and longer than normal payment terms) in January to existing
customers with timely payment histories as an enticement to purchase the current
SGI Onyx workstation. Due to competitive pressures, Discreet offered customers
more favorable payment terms in the form of lower initial deposits than in prior
fiscal years. Inventory increased during fiscal 1996, as a result of Discreet's
purchase of inventory to meet anticipated sales in the fiscal quarter ended
April 30, 1996. Net cash provided in fiscal 1995 was composed primarily of net
income plus depreciation and amortization and increases in customer deposits,
deferred revenue and accounts payable. Deferred revenue represents amounts
received from customers for post contract customer support, software upgrades
and computer hardware and software in advance of revenue recognition by
Discreet. Deferred revenue will fluctuate based upon the level of sales as well
as the timing of the shipment of software product upgrades and hardware.
Discreet's investing activities used cash of U.S.$24,223,000, and
U.S.$6,754,000 in fiscal 1996 and 1995 respectively. The principal uses of cash
in fiscal 1996 was for the acquisition of COSS/IMP (approximately
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<PAGE>
U.S.$5,545,000), the purchase of land and an office building in London, England
(L1,148,000, or approximately U.S.$1,788,000), the purchase of land and an
office building in Montreal, Quebec for CDN$1,730,000 (or approximately
U.S.$1,250,000) and the purchase of computer equipment and software, general
office equipment, leasehold improvements and furniture and fixtures used in the
operation of Discreet's business. The principal uses of cash in fiscal 1995 were
the purchase of computer equipment and software and general office equipment
used in the operation of Discreet's business and leasehold improvements and
furniture and fixtures.
Financing activities provided cash of U.S.$30,310,000 and U.S.$38,319,000 in
fiscal 1996 and 1995, respectively. In fiscal 1996, cash provided by financing
activities was primarily from proceeds from the issuance of approximately
971,000 Discreet Common Shares in a secondary public offering which was
completed in December 1995, proceeds from the repayment of subscriptions
receivable, and proceeds from common stock option exercises. In fiscal 1995,
cash provided by financing activities was primarily from the receipt of the net
proceeds of Discreet's initial public offering.
Discreet incurred U.S.$15,871,000 and U.S.$6,239,000 of capital expenditures
during fiscal 1996 and 1995 respectively, consisting primarily of computer
equipment, software and general office equipment and leasehold improvements. In
August 1995, Discreet purchased an office building and related land in London,
England. Discreet incurred L715,000 (or approximately U.S.$1,114,000) in capital
expenditures in fiscal 1996 for the refitting of the London property and expects
to incur approximately L725,000 (or approximately U.S.$1,129,000 as of July 31,
1996) of such costs in fiscal 1997. In fiscal 1996, Discreet purchased an office
building in Montreal, Quebec. The carrying values of the Montreal building and
the London building were written down to their estimated fair market values and
the buildings were classified as assets held for sale. As of July 31, 1996,
Discreet did not have any material commitments for capital expenditures.
SHARE AND LOAN CAPITAL STRUCTURE
The authorized share capital of Discreet consists of an unlimited number of
common shares and of an unlimited number of preferred shares. The holders of
Discreet Common Shares are entitled to one vote for each share on all matters
voted on by the Discreet shareholders and are entitled to receive such dividends
as may be declared by the directors out of funds legally available therefor and
to receive the remaining property of Discreet on dissolution. The holders of
Discreet Common Shares have no pre-emptive, redemption or conversion rights.
As at March 31, 1998, 29,551,779 Discreet Common Shares were outstanding. No
preferred shares were outstanding.
PRINCIPAL HOLDERS OF DISCREET COMMON SHARES
As at March 31, 1998, Mr. Richard J. Szalwinski, President, Chief Executive
Officer and Chairman of the Board of Directors, beneficially owned 5,181,896
Discreet Common Shares, being 17.5% of all outstanding Discreet Common Shares.
Mr. Szalwinski beneficially owned 2,682,296 of these Discreet Common shares
through 9002-1585 Quebec Inc.; and the balance, 2,499,600 Discreet Common Shares
through BHVR Communications Inc. Each of these companies is a holding
corporation owned by Mr. Szalwinski.
As at March 31, 1998, Mr. Thomas Cantwell, a director of Discreet,
beneficially owned 3,057,467 Discreet Common Shares, being 10.4% of all
outstanding Discreet Common Shares.
As at March 31, 1998, Mr. Gary L. Tregaskis, a director of Discreet,
beneficially owned 3,123,700 Discreet Common Shares, being 10.6% of all
outstanding Discreet Common Shares. Mr. Tregaskis beneficially owned 800,000 of
these Discreet Common Shares through Newco Trustee Company (Jersey) Limited re:
Gary Tregaskis Settlement, a trust establishment for his benefit.
As at March 31, 1998, to the knowledge of the directors and officers of
Discreet, no person, other than Mr. Szalwinski, Mr. Cantwell and Mr. Tregaskis,
beneficially owned, or exercised control or direction over, more than 10% of the
outstanding Discreet Common Shares.
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<PAGE>
DIRECTORS AND OFFICERS
The following table presents the name and municipality of residence of each
of the directors and officers of Discreet as well as their position with
Discreet:
<TABLE>
<CAPTION>
NAME AND MUNICIPALITY OF RESIDENCE POSITION
- --------------------------------------------- ------------------------------------------------------------------------
<S> <C>
EXECUTIVE OFFICERS
Richard J. Szalwinski(1) .................... President, Chief Executive Officer and Chairman of the Board of
Westmount, Quebec Directors
Francois Plamondon .......................... Executive Vice President, Chief Financial Officer, Treasurer and
Montreal, Quebec Secretary
Winston Rodrigues ........................... Senior Vice President, Advanced Systems and Operations
Saint-Lazare, Quebec
Graham Sharp ................................ Vice President, Advanced Systems Sales
Town of Mount Royal, Quebec
Terrence Higgins ............................ Vice President, Advanced Systems Products
Hudson, Quebec
OTHER OFFICERS
Timothy Getz ................................ Vice President, Corporate Development
Montreal, Quebec
Giovanni Tagliamonti ........................ Vice President, Finance and Control
Montreal, Quebec
OTHER DIRECTORS
Gary G. Tregaskis ........................... Director
London, England
Thomas Cantwell(1)(2) ....................... Director
Houston, Texas
Brian P. Drummond(1)(2) ..................... Director
Westmount, Quebec
Perry M. Simon(1) ........................... Director
Santa Monica, California
Pierre Desjardins(2) ........................ Director
Philadelphia, Pennsylvania
</TABLE>
- ---------------
(1) Member of the Compensation Committee
(2) Member of the Audit Committee
Richard J. Szalwinski, a founder of Discreet, has served as a Director since
May 1992 and as Chairman of the Board of Directors since March 1994. Mr.
Szalwinski served as acting President and Chief Executive Officer from February
1996 and assumed that position officially in July 1996. From May 1992 to
November 1994 Mr. Szalwinski served as Chief Executive Officer of Discreet and
served as President of Discreet from May 1992 to March 1994. Prior to founding
Discreet, he held several positions at Softimage Inc. from June 1988 to December
1991, most recently as a Director and Vice President of Sales. Mr. Szalwinski is
Chairman of the Board of Directors of Behaviour Communications Inc., a public
company.
Francois Plamondon joined Discreet in July 1996 and currently serves as
Executive Vice President, Chief Financial Officer, Treasurer and Secretary of
Discreet. Prior to joining Discreet, Mr. Plamondon was a partner at Ernst &
Young, Chartered Accountants, from August 1990 until July 1996.
Winston Rodrigues joined Discreet in October 1997 and currently serves as
Senior Vice President, Advanced Systems and Operations. Prior to joining
Discreet, Mr. Rodrigues was Vice President, Operations at Memotec Communications
Inc., a communications and networking company, from 1995 to 1997. From 1994 to
1995, Mr. Rodrigues was a Vice-President at Circo Craft Co. Inc., a manufacturer
of printed circuit boards; prior to that, he occupied various positions at IBM
Canada Ltd., most recently as a product manager.
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<PAGE>
Graham Sharp currently serves as Vice President, Advanced Systems Sales of
Discreet. Mr. Sharp joined Discreet in January 1996 as General Manager,
Asia-Pacific and served in that position until July 1996. Prior to joining
Discreet, Mr. Sharp served as Regional Sales Manager, Asia-Pacific for the
broadcast division of Avid, a publicly traded supplier of non-linear video and
audio editing systems, from January 1995 to January 1996. Prior to that, Mr.
Sharp served as Sales Director, Asia-Pacific at Dynatech Corporation, a publicly
traded supplier of broadcast and post-production equipment, from February 1993
to December 1994. Prior to that, Mr. Sharp served as a sales manager responsible
for worldwide sales for Alpha Image Ltd., a supplier of routing and distribution
equipment, from April 1989 to February 1993.
Terrence Higgins currently serves as Vice President, Advanced Systems
Products of Discreet and occupied various positions, including Vice President
Engineering from July 1995 to July 1996. Mr. Higgins joined Discreet in May 1993
as a software engineer and has served in various engineering capacities with
Discreet. Prior to joining Discreet, he served as a graphic research analyst for
the National Film Board of Canada, from February 1986 to May 1993.
Timothy Getz joined Discreet in April 1995 and currently serves as Vice
President, Corporate Development. Prior to joining Discreet, Mr. Getz was
Manager of Finance at Thinking Machines Corporation from July 1993 to April
1995.
Giovanni Tagliamonti joined Discreet in April 1995 and currently serves as
Vice President, Finance and Control, Prior to joining Discreet, Mr. Tagliamonti
held several positions with Arthur Andersen & Cie, Chartered Accountants, most
recently as Senior Audit and Business Advisory Manager.
Gary G. Tregaskis has served as a Director of Discreet since July 1992. Mr.
Tregaskis has been an independent consultant to Discreet since December 1995.
Prior to that, Mr. Tregaskis served as Director of Advanced Products of Discreet
from February 1994 to December 1995. He also served as Director of Advanced
System Division of Discreet from July 1992 to February 1994. Mr. Tregaskis
served as the Director of Research and Development at D.A. Technology, and
Australian software development corporation, from 1985 to June 1992.
Thomas Cantwell has served as a Director of Discreet since September 1992.
Dr. Cantwell has been an investor and venture capitalist since 1987. He has
served as President of Technical Computer Graphics, a computer distributor and
software development corporation since November 1987. Dr. Cantwell also serves
as a director of Supreme Industries, Inc., a public company and as Chairman of
Board of Directors of Paradigm Entertainment Inc., a privately held developer of
computer and video games.
Brian P. Drummond has served as a Director of Discreet since January 1996.
Mr. Drummond has served as President of Brican Investments Ltd., a private
holding company, since March 1979, Mr. Drummond was Vice Chairman and director
of Richardson Greenshields of Canada Limited, an investment dealer, from 1982 to
June 1997, Mr. Drummond also serves as a director of Atco Ltd. and Canadian
Utilities Limited, both public companies.
Perry M. Simon has served as a Director of Discreet since January 1996. Mr.
Simon has been President, Viacom Television for Viacom Entertainment, Viacom,
Inc., a television and film developer and producer, since September 1993. Prior
to that, Mr. Simon held several positions with NBC Entertainment, from 1985 to
1993, most recently as Executive Vice President-Prime-time Programs.
Pierre Desjardins has served as a Director of Discreet since January 1997.
Mr. Desjardins has been Chairman, President and Chief Executive Officer of Total
Containment, a manufacturer and distributor of underground systems and products
for the conveyance and containment of fuels, since September 1995. Prior to
that, Mr. Desjardins was President and Chief Executive Officer of Domtar Inc., a
producer of paper, pulp and forest products, from September 1990 to October
1994. Mr. Desjardins also served as President of Labatt Breweries of Canada from
1988 to September 1990. Mr. Desjardins also serves as a director of Canam Manac
Group Inc., a public company.
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<PAGE>
DISCREET COMMON SHARES HELD BY DIRECTORS AND SENIOR OFFICERS
The following table lists the number of Discreet Common Shares held by
directors and senior officers of Discreet and their associates.
<TABLE>
<CAPTION>
NUMBER OF DISCREET
COMMON SHARES AS OF
NAME MARCH 31, 1998
- -------------------------------------------------------------------------------------------------- --------------------
<S> <C>
Richard J. Szalwinski............................................................................. 5,181,896
Gary G. Tregaskis................................................................................. 3,123,700
Thomas Cantwell................................................................................... 3,057,467
Terrence Higgins.................................................................................. 110,518
</TABLE>
As at March 31, 1998, the directors and senior officers of Discreet, as a
group beneficially owned directly or indirectly or exercised control and
direction over 11,473,581 Discreet Common Shares, being approximately 38.8% of
the issued and outstanding Discreet Common Shares.
DIVIDEND HISTORY
Discreet has never declared or paid cash dividends and does not anticipate
paying any cash dividends in the foreseeable future.
TRADING HISTORY
The Discreet Common Shares are quoted on the Nasdaq. The following table
shows the high and low prices and volume of trading in the Discreet Common
Shares on the Nasdaq for the periods indicated.
<TABLE>
<CAPTION>
HIGH LOW VOLUME
--------- ----------- ---------
(in U.S.$) (000's)
<S> <C> <C> <C>
1996
First Quarter........................................................................... $ 28.25 $ 9.75 21,930
Second Quarter.......................................................................... 18.625 5.875 31,287
Third Quarter........................................................................... 8.625 3.25 17,740
Fourth Quarter.......................................................................... 9.125 5.375 9,554
1997
First Quarter........................................................................... $ 9.50 $ 5.75 10,548
Second Quarter.......................................................................... 18.125 5.875 27,038
Third Quarter........................................................................... 28.875 16.00 18,403
Fourth Quarter.......................................................................... 26.50 14.75 15,952
1998
January................................................................................. $ 23.00 $ 19.50 2,289
February................................................................................ 24.625 20.00 5,145
March................................................................................... 26.50 15.50 11,121
April (up to April 15, 1998)............................................................ 22.375 16.125 3,969
</TABLE>
On March 9, 1998, the last trading day prior to the announcement by MGI and
Discreet of the proposed Transaction, the last reported sale price of the
Discreet Common Shares on Nasdaq was U.S.$25 1/16. On April 15, 1998, the last
reported sale price of the Discreet Common Shares on Nasdaq was U.S.$19 1/2.
PRIOR SALES
On March 4, 1998, Discreet issued 645,000 Discreet Common Shares to Intel
Corporation on a private placement basis at a price of U.S.$21.00 per share. See
Note 18(a) to the Consolidated Financial Statements included in Schedule E to
this Circular.
On July 15, 1997 Discreet issued 555,000 Discreet Common Shares to the
former stockholders of D-Vision at a price of U.S.$19.18 per share.
In addition, since April 1, 1997, Discreet has from time to time, issued, in
the aggregate, 289,966 Discreet Common Shares pursuant to the exercise of
options granted pursuant to the Discreet Stock Option Plan at exercise prices
ranging from U.S.$0.0463 to U.S.$7.375.
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<PAGE>
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS
EXECUTIVE COMPENSATION SUMMARY
The following table sets forth summary information concerning the
compensation paid or earned for services rendered to Discreet in all capacities
during the fiscal years ended July 31, 1995 and 1996 and June 30, 1997 to (i)
Discreet's current Chief Executive Officer; and (ii) each of the four most
highly compensated executive officers of Discreet who earned more than $100,000
in salary and bonus in fiscal year 1997 (collectively, the "Named Executive
Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION(1) LONG TERM COMPENSATION
AWARDS
SECURITIES RESTRICTED
UNDER SHARES OR
OTHER ANNUAL OPTIONS/SARS RESTRICTED LTIP ALL OTHER
NAME AND SALARY BONUS COMPENSATION GRANTED SHARE UNITS PAYOUTS COMPENSATION
PRINCIPAL POSITION YEAR (U.S.$) (U.S.$) (U.S.$) (#) ($) ($) ($)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Richard J. Szalwinski(2) 1997 192,724 172,500 450,000
President, Chief Executive 1996 154,557 -- --
Officer and Chairman of the 1995 145,212 145,212 --
Board of Directors
Terrence Higgins(3) 1997 93,683 25,550 --
Vice President, Advanced 1996 121,549 -- 40,000
Systems Products 1995 57,813 -- 121,920
Francois Plamondon(4) 1997 133,833 50,920 --
Executive Vice President, 1996 -- -- 300,000
Chief Financial Officer, 1995 -- -- --
Secretary and Treasurer
Graham Sharp(5) 1997 183,337(6) 25,000 300,000
Vice President, Advanced 1996 98,572(7) -- 10,000
Systems Sales 1995 -- -- --
</TABLE>
(1) 1997 amounts represent salary and bonus actually paid or earned during the
eleven month period ended June 30, 1997.
(2) In August 1997, Mr. Szalwinski's annual salary was increased from
U.S.$230,000 to U.S.$255,500 effective July 1, 1997.
(3) In August 1997, Mr. Higgins' annual salary was increased from U.S.$102,200
to U.S.$109,500 effective July 1, 1997.
(4) In August 1997, Mr. Plamondon's annual salary was increased from
U.S.$145,500 to U.S.$182,500 effective July 1, 1997.
(5) In August 1997, Mr. Sharp's annual salary was increased from U.S.$125,000 to
U.S.$150,000 effective July 1, 1997.
(6) This amount includes U.S.$68,750 of sales commissions earned by Mr. Sharp
during fiscal 1997.
(7) Mr. Sharp joined Discreet in January 1996. This amount includes his salary
as well as U.S.$57,948 of sales commissions paid to Mr. Sharp for the seven
months of fiscal 1996 during which he was employed by Discreet.
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<PAGE>
OPTION GRANTS DURING THE MOST RECENTLY COMPLETED FINANCIAL YEAR
The following table sets forth each grant of stock options made during the
fiscal year ended June 30, 1997 to each of the Named Executive Officers.
<TABLE>
<CAPTION>
MARKET VALUE OF
SECURITIES
SECURITIES % OF TOTAL OPTIONS UNDERLYING
UNDER OPTIONS GRANTED TO OPTIONS ON THE
GRANTED EMPLOYEES IN FISCAL EXERCISE PRICE DATE OF GRANT
NAME (#) YEAR (U.S.$/SECURITY) (U.S.$/SECURITY) EXPIRATION DATE
<S> <C> <C> <C> <C> <C>
Richard J. Szalwinski 450,000 26.6 6.03 6.03 4/5/2007
Terrence Higgins(1) -- -- -- --
Francois Plamondon(1) -- -- -- --
Graham Sharp 300,000 17.8 4.50 4.50 8/12/2006
</TABLE>
(1) On August 11, 1997, Francois Plamondon was granted an option to purchase
50,000 Discreet Common Shares and Terrence Higgins was granted an option to
purchase 40,000 Discreet Common Shares, both at an exercise price per share
of U.S.$24.25.
AGGREGATE OPTION EXERCISES DURING THE MOST RECENTLY COMPLETED FINANCIAL YEAR
AND PRESENT YEAR-END OPTIONS VALUES
The following table sets forth, for each of the Named Executive Officers,
information with respect to the exercise of stock options during the year ended
June 30, 1997 and the year-end value of unexercised options.
<TABLE>
<CAPTION>
VALUE(2) OF UNEXERCISED
SECURITIES AGGREGATE UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT
ACQUIRED ON VALUE YEAR-END YEAR-END
EXERCISE REALIZED (#) (U.S.$)
NAME (#) ($)(1) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
<S> <C> <C> <C> <C>
Richard J. Szalwinski -- -- 0/450,000 --/4,710,915
Terrence Higgins -- -- 30,508/17,500 446,761/245,000
Francois Plamondon -- -- 0/300,000 --/3,300,000
Graham Sharp -- -- 3,125/306,875 --/3,600,000
</TABLE>
(1) Amounts disclosed in this column are calculated based on the difference
between the fair market value of the Discreet Common Shares on the date of
exercise and the exercise price of the options in accordance with
regulations promulgated under the Exchange Act, and do not reflect amounts
actually received by the Named Executive Officers.
(2) Value is based on the difference between the option exercise price and the
fair market value at June 30, 1997, the fiscal year-end (U.S.$16.50 per
share), multiplied by the number of shares underlying the option.
EMPLOYMENT AGREEMENTS
In August 1997, Discreet entered into an agreement with Richard Szalwinski,
whereby Mr. Szalwinski agreed to serve as President and Chief Executive Officer
of Discreet. Mr. Szalwinski previously had no employment agreement with
Discreet. Pursuant to such agreement, Mr. Szalwinski's annual base salary was
increased from U.S.$200,000 to U.S.$230,000, effective March 1, 1997. In
addition, pursuant to such agreement, Mr. Szalwinski is eligible to receive an
annual bonus of up to 75% of his base annual salary, based on Discreet meeting
the consolidated budgets and forecasts approved by the Board of Directors. In
the event that Discreet does not meet such consolidated budgets and forecasts,
the Board of Directors may, at its sole discretion, approve the payment of a
bonus of up to 75% of his base annual salary to Mr. Szalwinski if the Board of
Directors determines that Mr. Szalwinski's performance of his duties was
outstanding and that Discreet's failure to meet such consolidated budgets and
forecasts was not attributable to factors within Mr. Szalwinski's control. In
August 1997, the Board of Directors increased Mr. Szalwinski's annual base
salary to U.S.$255,500, effective
87
<PAGE>
July 1, 1997. The agreement provides that Mr. Szalwinski's employment with
Discreet may be terminated by Mr. Szalwinski upon three months written notice to
Discreet, in which case Discreet must pay to Mr. Szalwinski his salary and
benefits for the remaining time period specified in his notice of termination.
The agreement further provides that Discreet may terminate the agreement at any
time with or without cause, upon written notice. In the event Mr. Szalwinski's
employment is terminated by Discreet, without cause, Discreet must pay Mr.
Szalwinski a lump sum amount equal to twenty-four months base annual salary at
the time of such termination. In addition, Mr. Szalwinski was granted an
incentive stock option to purchase 450,000 Discreet Common Shares under the
Discreet Stock Option Plan at an exercise price of U.S.$6.03 per share. In the
event that Mr. Szalwinski's employment is terminated without cause, then all
options to purchase shares of Discreet which would have next vested, shall
immediately vest upon such termination. The agreement further provides that in
the event of a Reorganization, as defined in the Discreet Stock Option Plan,
then (i) the option to purchase the 450,000 Discreet Common Shares granted to
Mr. Szalwinski will become immediately vested or (ii) if the Board of Directors
elects, in accordance with the Discreet Stock Option Plan, not to accelerate the
vesting of the options granted pursuant to the Discreet Stock Option Plan, Mr.
Szalwinski will receive in substitution for all of his outstanding options to
purchase Discreet Common Shares, whether vested or not, such securities
(excluding options) of Discreet or of any merged, consolidated or otherwise
reorganized corporation or, only in the event of a merger of Discreet with one
of its subsidiaries, options of the merged company, all of which securities or
options shall be of equivalent value and liquidity.
In June 1996, Discreet entered into an agreement with Francois Plamondon,
whereby Mr. Plamondon became Senior Vice President, Chief Financial Officer,
Secretary and Treasurer of Discreet, effective August 1, 1996. Pursuant to such
agreement, Mr. Plamondon received an annual base salary of U.S.$145,500, and is
eligible to receive an annual bonus of up to U.S.$50,920, based on Discreet
meeting the consolidated budgets and forecasts approved by the Board of
Directors. In the event that Discreet does not meet such consolidated budgets
and forecasts, the Board of Directors may, at its sole discretion, approve the
payment of a bonus of up to U.S.$50,920 to Mr. Plamondon if the Board of
Directors determines that Mr. Plamondon's performance of his duties was
outstanding and that Discreet's failure to meet such consolidated budgets and
forecasts was not attributable to factors within Mr. Plamondon's control. In
August 1997, the Board of Directors increased Mr. Plamondon's annual base salary
from U.S.$145,500 to U.S.$182,500, effective July 1, 1997 and increased his
eligible annual bonus from U.S.$50,920 to 50% of his annual base salary. The
agreement provides that Mr. Plamondon's employment with Discreet may be
terminated by Mr. Plamondon upon three months written notice to Discreet, in
which case Discreet must pay to Mr. Plamondon his salary and benefits for the
remaining time period specified in his notice of termination. The agreement
further provides that Discreet may terminate the agreement at any time with or
without cause, upon written notice. In the event Mr. Plamondon's employment is
terminated by Discreet, without cause, Discreet must pay Mr. Plamondon a lump
sum amount equal to twelve months base annual salary at the time of such
termination. In addition, Mr. Plamondon was granted an incentive stock option to
purchase 300,000 Common Shares under the Discreet Stock Option Plan at an
exercise price of U.S.$5.50 per share. In the event that Mr. Plamondon's
employment is terminated without cause after August 1, 1997, then all options to
purchase shares of Discreet which would have next vested, shall immediately vest
upon such termination. The agreement further provides that in the event of a
Reorganization, as defined in the Discreet Stock Option Plan, then (i) the
option to purchase the 300,000 Discreet Common Shares granted to Mr. Plamondon
will become immediately vested or (ii) if the Board of Directors elects, in
accordance with the Discreet Stock Option Plan, not to accelerate the vesting of
the options granted pursuant to the Discreet Stock Option Plan, Mr. Plamondon
will receive in substitution for all of his outstanding options to purchase
Discreet Common Shares, whether vested or not, such securities (excluding
options) of Discreet or of any merged, consolidated or otherwise reorganized
corporation or, only in the event of a merger of Discreet with one of its
subsidiaries, options of the merged company, all of which securities or options
shall be of equivalent value and liquidity.
In November 1996, Discreet entered into an agreement with Graham Sharp
related to Mr. Sharp's employment as Senior Vice President-Sales & Marketing of
Discreet, effective July 23, 1996. Pursuant to such agreement, Mr. Sharp
receives an annual base salary of U.S.$125,000, and is eligible to receive sales
commissions of up to U.S.$75,000, based on Discreet meeting the sales and margin
contribution targets approved by the Board of Directors, and, in the event
Discreet exceeds such targets, an annual bonus of U.S.$25,000. The Board of
Directors may also, at its sole discretion, approve the payment of an additional
bonus
88
<PAGE>
to Mr. Sharp if Discreet exceeds the sales and margin contribution targets. In
addition, in the event Discreet does not meet such sales targets, the Board of
Directors may, at its sole discretion, approve the payment of a bonus to Mr.
Sharp if the Board of Directors determines that Mr. Sharp's performance of his
duties was outstanding and Discreet's failure to meet such targets was not
attributable to factors within Mr. Sharp's control. In August 1997, the Board of
Directors increased Mr. Sharp's annual base salary from U.S.$125,000 to
U.S.$150,000, effective July 1, 1997 and increased his eligible annual bonus
from U.S.$25,000 to up to 50% of his annual base salary. Under this agreement,
Mr. Sharp's eligibility to receive sales commissions remained unchanged. The
agreement provides that Mr. Sharp's employment with Discreet may be terminated
by Mr. Sharp upon three months written notice to Discreet, in which case
Discreet must pay to Mr. Sharp his salary and benefits for the remaining time
period specified in his notice of termination. The agreement further provides
that Discreet may terminate the agreement at any time, with or without cause,
upon written notice. In the event Mr. Sharp's employment is terminated by
Discreet, without cause, Discreet must pay Mr. Sharp a lump sum amount equal to
twelve months of his base annual salary at the time of such termination. In
addition, Mr. Sharp was granted an incentive stock option to purchase 300,000
Common Shares under the Discreet Stock Option Plan at an exercise price of
U.S.$4.50 per share. In the event that Mr. Sharp's employment is terminated
without cause after July 23, 1997, then all options to purchase shares of
Discreet which would have next vested, shall immediately vest upon such
termination. The agreement provides that in the event of a Reorganization, as
defined in the Discreet Stock Option Plan, then (i) the option to purchase the
300,000 Common Shares granted to Mr. Sharp will become immediately vested or
(ii) if the Board of Directors elects, in accordance with the Discreet Stock
Option Plan, not to accelerate the vesting of the options granted pursuant to
the Discreet Stock Option Plan, Mr. Sharp will receive in substitution for all
of his outstanding options to purchase Discreet Common Shares, whether vested or
not, such securities (excluding options) of Discreet or, only in the event of a
merger of Discreet with one of its subsidiaries, options of the merged company,
all of which securities or options shall be of equivalent value and liquidity.
Finally, Discreet agreed to reimburse Mr. Sharp's documented out-of-pocket
expenses incurred in connection with his move to Montreal.
COMPENSATION OF DIRECTORS
Employee directors do not receive cash compensation for their service as
members of the Board of Directors. Non-Employee Directors (as defined below)
receive an annual fee of U.S.$10,000 for services on the Board of Directors and
an additional U.S.$2,500 for services on each committee of the Board of
Directors. Non-Employee Directors also receive reimbursement of their expenses
for each Board of Directors or committee meeting attended. Discreet may from
time to time, and at the discretion of the Board of Directors (or the
Compensation Committee), grant stock options to directors in addition to the
options specified in the 1995 Non-Employee Director Stock Option Plan. See
"-- 1995 Non-Employee Director Stock Option Plan" and "-- 1997 Special Limited
Non-Employee Director Stock Option Plan."
1995 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN
The 1995 Non-Employee Director Stock Option Plan (the "Director Plan") was
adopted by the Board of Directors in March 1995 and approved by the shareholders
in April 1995. The Director Plan provides for the grant of options to purchase a
maximum of 200,000 Discreet Common Shares to Non-Employee Directors of Discreet.
89
<PAGE>
The Director Plan is administered by the Compensation Committee. The
Director Plan authorizes the grant (a) to each person who becomes a member of
the Board of Directors and who is not an employee, officer or direct or indirect
owner of 5% or more of the Discreet Common Shares of Discreet (a "Non-Employee
Director"), on the date such person is first elected to the Board of Directors
without further action by the Board of Directors, of an option to purchase
20,000 Discreet Common Shares and (b) to each person receiving an option
pursuant to clause (a) who is a Non-Employee Director on the fifth anniversary
of the date such person was first elected to the Board of Directors, during the
term of the Director Plan, of an option to purchase 15,000 Common Shares;
provided that such person has continuously served as a Non-Employee Director
during such 5-year period. The exercise price per share for all options granted
under the Director Plan will be equal to 100% of the fair market value per share
of the Discreet Common Shares as of the date of grant. The options become
exercisable in three equal annual instalments, with the first instalment
exercisable immediately, provided that with respect to the second and third
vesting dates that the optionee remains a director at that time. The term of
each option will be for a period of ten years from the date of grant. Options
may not be assigned or transferred except by will, by the laws of descent and
distribution or pursuant to a domestic relations order. Options issued pursuant
to the Director Plan are exercisable to the extent vested only while the
optionee is serving as a director of Discreet or within three months after the
optionee ceases to serve as a director of Discreet (except that if a director
dies or becomes disabled while he or she is serving as a director of Discreet,
the option shall be accelerated and shall be immediately vested and may be
exercised until the scheduled expiration date of the option). As of March 31,
1998, Discreet had outstanding options under the Director Plan to purchase an
aggregate of 60,000 Common Shares at a weighted average per share exercise price
of U.S.$14.85.
1997 SPECIAL LIMITED NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN
The 1997 Special Limited Non-Employee Director Stock Option Plan (the
"Limited Director Plan") was adopted by the Board of Directors in February 1997.
The Limited Director Plan is intended to promote the interests of Discreet by
aligning the interests of directors with the interests of Discreet and by
providing an inducement to the two individuals named below who are not employees
or officers of Discreet to continue to serve as members of its Board of
Directors and who are expected to contribute to Discreet's interests. The
Limited Director Plan provides for a one-time grant of options to purchase
10,000 Discreet Common Shares to each of Messrs. Drummond and Simon for a
maximum of 20,000 Discreet Common Shares reserved for issuance under the Limited
Director Plan.
The Limited Director Plan is administered by the Board of Directors. The
Limited Director Plan authorizes the grant to Messrs. Drummond and Simon. The
exercise price per share for all options granted under the Limited Director Plan
is equal to 100% of the fair market value per share of the Discreet Common
Shares as of the date of grant. The options become exercisable in three equal
annual instalments, with the first instalment exercisable immediately, provided
that with respect to the second and third vesting dates that the optionee
remains a director at that time. The term of each option will be for a period of
ten years from the date of grant. Options may not be assigned or transferred
except by will, by the laws of descent and distribution or pursuant to a
domestic relations order. Options issued pursuant to the Limited Director Plan
are exercisable to the extent vested only while the optionee is serving as a
director of Discreet or within three months after the optionee ceases to serve
as a director of Discreet (except that if a director dies or becomes disabled
while he or she is serving as a director of Discreet, the option shall be
accelerated and shall be immediately vested and may be exercised until the
scheduled expiration date of the option). As of March 31, 1998, Discreet had
outstanding options under the Limited Director Plan to purchase an aggregate of
20,000 Common Shares at a per share exercise price of U.S.$7.88.
AMENDED AND RESTATED 1994 RESTRICTED STOCK AND STOCK OPTION PLAN
The Discreet Stock Option Plan is intended to secure for Discreet and its
shareholders the benefits arising from share ownership by officers, employees,
consultants and directors (provided such directors are then also officers or
employees) of Discreet and its participating subsidiaries by providing them with
opportunities to participate in the ownership of Discreet and its future growth
through (a) the grant of options which qualify as "incentive stock options"
("ISOs") under Section 422(b) of the Internal Revenue Code of 1986, as amended
(the "Code"); (b) the grant of options which do not qualify as ISOs
("Non-Statutory Options"); and (c) awards
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<PAGE>
of Discreet Common Shares ("Awards"). Both ISOs and Non-Statutory Options are
referred to hereafter individually as an "Option" and collectively as "Options."
Options and Awards are referred to hereafter collectively as "Stock Rights."
The Discreet Stock Option Plan is administered by the Compensation Committee
of the Board of Directors of Discreet, which currently consists of Messrs.
Cantwell, Drummond, Simon, three outside directors of Discreet, and Mr.
Szalwinski, who is a member of management of Discreet. Subject to the provisions
of the Discreet Stock Option Plan, the Compensation Committee has the authority
to select the optionees and recipients of Awards and determine the terms of the
Options and Awards granted, including: (i) the number of Discreet Common Shares
subject to each Option or Award, (ii) the Option exercise terms, (iii) the
exercise price of the Option and the purchase price of Discreet Common Shares to
recipients of Awards, (iv) the type and the duration of transfer and other
restrictions, and (v) the time and form of payment upon exercise of an Option or
Award.
The exercise price per share of ISOs granted under the Discreet Stock Option
Plan cannot be less than the fair market value of the Discreet Common Shares on
the date of grant (or, in the case of ISOs granted to employees holding more
than 10% of the total combined voting power of all classes of shares of
Discreet, 110% of the fair market value of the Discreet Common Shares on the
date of grant). The Discreet Stock Option Plan provided that each Option shall
expire on the date specified in the option agreement, but not more than ten
years from its date of grant, and five years in the case of ISOs granted to an
employee holding more than 10% of the total combined voting power of all classes
of shares of Discreet.
Under the Code, each eligible employee may be granted ISOs only to the
extent that, in the aggregate under the Discreet Stock Option Plan and all stock
option plans of Discreet, ISOs do not become exercisable for the first time by
such employee during any calendar year with respect to more than $100,000 in
fair market value (determined at the time the ISOs are granted) of Discreet
Common Shares. Any Options granted to an employee in excess of such amount will
be treated as Non-Statutory Options.
The Discreet Stock Option Plan currently authorizes the issuance of up to
5,000,000 Discreet Common Shares. Any shares subject to an option which expires
or terminates may again be available for grant under the Discreet Stock Option
Plan, however, such shares are included in the determination of the aggregate
number of Discreet Common Shares deemed to have been granted to such employee
under the Discreet Stock Option Plan.
Each Option granted under the Discreet Stock Option Plan may be either fully
exercisable at the time of the grant or may become exercisable on such
installments as the Compensation Committee may specify. Each Option may be
exercised from time to time, in whole or in part, up to the total number of
shares with respect to which it is then exercisable.
An Option is not assignable or transferable by the option holder except by
will or the laws governing intestacy. Generally, no Option may be exercised
following three months after termination of employment. All Discreet Common
Shares issued pursuant to an Award shall be subject to certain restrictions on
their disposition and to certain obligations of resale to Discreet (at a price
equal to the price originally paid by the optionee), and shall not be sold,
assigned, transferred, pledged, hypothecated, or otherwise disposed of until
such restrictions lapse. This obligation of resale to Discreet extends for a
period of three months from the termination of employment.
An Option shall be exercised by giving written notice delivered to Discreet
at its office address, together with full payment of the exercise price. Payment
may be made by cash or check, or at the discretion of the Compensation
Committee, by tendering Discreet Common Shares or through the delivery of an
assignment of a sufficient amount of the proceeds from the sale of the Discreet
Common Shares acquired upon exercise. If the Compensation Committee exercises
such discretion with respect to an ISO, it must do so in writing at the time of
the grant of the ISO.
91
<PAGE>
The following table sets forth, as of March 31, 1998, the particulars of
Options granted under the Discreet Stock Option Plan or, for directors of
Discreet who are not officers, under the Director Plan and the Limited Director
Plan, by Discreet to the identified classes of persons, as a group:
<TABLE>
<CAPTION>
NUMBER OF DISCREET
OPTIONEE COMMON SHARES
- ---------------------------------------------------------------- ------------------ EXERCISE PRICE EXPIRY DATE
------------------ ------------
(U.S. DOLLARS) (MONTH/YEAR)
<S> <C> <C> <C>
All officers of Discreet (7 persons)............................ 1,471,644 $0.0463 - $24.25 6/04 - 3/08
All directors of Discreet who are not officers (3 persons)...... 80,000 $7.0625 - $18.75 1/06 - 2/07
All directors of all subsidiaries who are not officers of such
subsidiaries (1 person)....................................... 100,672 $0.0463 - $24.25 6/04 - 8/07
All other employees of Discreet and subsidiaries (160
persons)...................................................... 1,587,609 $0.0463 - $25.00 6/04 - 3/08
</TABLE>
The number of options available for grant under the Discreet Stock Option
Plan as of March 31, 1998 is 1,921,378.
As of March 31, 1998, there were 3,239,925 options outstanding under the
Discreet Stock Option Plan, the Director Plan and the Limited Director Plan with
a weighted average exercise price of U.S.$9.71.
INTEREST OF MANAGEMENT AND OTHERS IN MATERIAL TRANSACTIONS
Except as disclosed elsewhere in this Circular, including the Schedules
thereto, no director, officer of principal shareholder of Discreet or any
associate or affiliate of the foregoing persons has any material interest,
direct or indirect in any transaction which has materially affected or will
materially affect Discreet.
ADDITIONAL INFORMATION
Discreet is subject to the informational requirements of the Exchange Act,
and in accordance therewith files reports and other information with the SEC.
Under a multijurisdictional disclosure system adopted by the United States, such
reports and other information may be prepared in accordance with the disclosure
requirements of Canada, which requirements are different from those of the
United States. Such reports and other information filed by Discreet are
available for inspection and copying at the public reference facilities
maintained by the SEC at Room 1024, 450 Fifth Street, N.W., Judiciary Plaza,
Washington, D.C. 20549, and at the SEC's following regional offices: Chicago
Regional Office, Northwestern Atrium Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661; and New York Regional Office, 7 World Trade
Center, New York, New York 10048. Copies of such material can also be obtained
at prescribed rates from the Public Reference section of the SEC at 450 Fifth
Street, N.W., Judiciary Plaza, Washington, D.C. 20549.
AUDITORS, TRANSFER AGENT AND REGISTRAR
The auditors of Discreet are Arthur Andersen & Cie, Chartered Accountants, 5
Place Ville Marie, Suite 1000, Montreal, Quebec H3B 4X3.
The transfer agent and registrar for the Discreet Common Shares is Boston
EquiServe, Canton, MA.
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GENERAL PROXY INFORMATION
APPOINTMENT OF PROXYHOLDERS AND REVOCATION OF PROXIES
A SHAREHOLDER MAY APPOINT AS PROXYHOLDER A PERSON OTHER THAN THE DIRECTORS
AND OFFICERS OF MGI NAMED IN THE ACCOMPANYING FORM OF PROXY TO ATTEND AND VOTE
AT THE SPECIAL MEETING ON SUCH HOLDER'S BEHALF BY INSERTING THE NAME OF SUCH
OTHER PERSON, WHO NEED NOT BE A SHAREHOLDER, IN THE BLANK SPACE PROVIDED IN THE
FORM OF PROXY OR BY COMPLETING ANOTHER FORM OF PROXY. To ensure being counted,
the completed form of proxy must be received by MGI or must be presented to the
Chairman of the Special Meeting prior to the commencement of the Special Meeting
(or of any adjournment thereof), at the Toronto office of MGI's transfer agent
on or before 5:00 p.m. (Toronto time), on the Business Day prior to the day of
the Special Meeting (or of any adjournment thereof):
<TABLE>
<S> <C>
HAND DELIVERY MAIL OR FAX DELIVERY
The Trust Company of Bank of Montreal The Trust Company of Bank of Montreal
Toronto Securities Service Centre Stock Transfer Department
B-1 Level "B" Level North
1 First Canadian Place 129 Saint-Jacques Street
100 King Street West Montreal, Quebec
Toronto, Ontario H2Y 1L6
M5X 1A1 or
Fax: (514) 877-9182
</TABLE>
The shares represented by the proxy which is hereby solicited will be voted
or withheld from voting in accordance with the instructions of the shareholder
on any ballot that may be called for and, if the shareholder specifies a choice
with respect to any matter to be acted upon, the shares shall be voted
accordingly. If a choice is not specified by a shareholder with respect to the
Special Resolution to approve the Arrangement, such shares will be voted, on any
ballot that may be called for, in favour of the Special Resolution.
The enclosed proxy confers discretionary authority with respect to any
amendments or variations to the matters referred to in the Notice and any other
matters which may properly come before the Special Meeting.
In addition to revocation in any other manner permitted by law, a
shareholder who has executed a proxy has the power, under subsection 110(4) of
the OBCA, to revoke it by depositing an instrument in writing executed by the
shareholder (or the shareholder's attorney authorized in writing): (i) at the
registered office of MGI at any time up to and including the last business day
preceding the day of the Special Meeting (or any adjournment of the Special
Meeting), or (ii) with the Chairman of the Special Meeting on the day of the
Special Meeting (or any adjournment of the Special Meeting).
THE EXECUTION OF A PROXY DOES NOT CONSTITUTE A WRITTEN OBJECTION FOR THE
PURPOSES OF SECTION 185 OF THE OBCA. For information on Dissenting Shareholder
rights, see "Rights of Dissent Under the OBCA".
EXERCISE OF DISCRETION BY PROXYHOLDERS
THE PERSONS WHOSE NAMES ARE PRINTED ON THE ACCOMPANYING FORM OF PROXY WILL,
ON A SHOW OF HANDS OR ANY BALLOT THAT MAY BE CALLED FOR, VOTE THE SHARES IN
RESPECT OF WHICH THEY ARE APPOINTED IN ACCORDANCE WITH THE DIRECTION OF THE
SHAREHOLDER APPOINTING THEM. IF NO CHOICE IS SPECIFIED BY THE SHAREHOLDER, THE
SHARES WILL BE VOTED FOR THE SPECIAL RESOLUTION, ALL AS DESCRIBED HEREIN.
THE FORM OF PROXY CONFERS DISCRETIONARY AUTHORITY UPON THE PERSONS NAMED
THEREIN WITH RESPECT TO AMENDMENTS OR VARIATIONS TO MATTERS IDENTIFIED IN THE
NOTICE AND TO OTHER MATTERS WHICH MAY PROPERLY COME BEFORE THE SPECIAL MEETING.
AS AT THE DATE HEREOF, THE MANAGEMENT OF MGI KNOW OF NO SUCH AMENDMENT,
VARIATION OR OTHER MATTERS EXPECTED TO COME BEFORE THE SPECIAL MEETING. IF ANY
MATTERS WHICH ARE NOT NOW KNOWN SHOULD PROPERLY COME BEFORE THE SPECIAL MEETING,
THE PERSONS NAMED IN THE FORM OF PROXY WILL VOTE ON SUCH MATTERS IN ACCORDANCE
WITH THEIR BEST JUDGEMENT.
93
<PAGE>
PROCEDURES FOR THE SURRENDER OF SHARE CERTIFICATES
Following the effective Date, and upon return of a properly completed letter
of transmittal, together with certificates representing the MGI Common Shares,
certificates for the appropriate number of Discreet Common Shares will be issued
without charge.
No certificates representing fractional Discreet Common Shares will be
issued pursuant to the Arrangement. In lieu of such fractional shares, each
fractional interest in a Discreet Common Share will entitle the holder thereof
to receive from Discreet an amount of cash (rounded to the nearest whole cent)
equal to the product obtained when such fraction is multiplied by the average of
the closing sale price of a Discreet Common Share on the Nasdaq (converted to
Canadian dollars using the noon buying rate in New York City for cable transfers
in foreign currencies as certified for customs purposes by the Federal Reserve
Bank of New York for the days on which each such closing sale price occurred)
for the 20 trading days ending with the trading day that is two trading days
prior to the effective Date.
A letter of transmittal has been sent to MGI Shareholders with this
Circular. The details of the procedures for the exchange of certificates and the
deposit of such certificates with the Depositary and the addresses of the
offices of the Depositary are set out in such letter of transmittal.
LEGAL MATTERS
Osler, Hoskin & Harcourt, legal counsel to MGI, has advised MGI with respect
to the matters disclosed in this Circular and will pass upon certain tax
considerations in connection with the Arrangement.
Stikeman, Elliott, legal counsel to Discreet, has advised Discreet with
respect to the matters disclosed in this Circular and will pass upon certain tax
considerations in connection with the Arrangement.
APPROVAL OF MGI
The contents and the sending of this Circular have been approved by the
Board of Directors of MGI.
Discreet has provided the information contained in this Circular concerning
Discreet, its subsidiaries and the companies or partnerships in which it has
equity investments, its financial information and financial statements. The
Board of Directors has relied upon this information without having made any
independent inquiry as to the accuracy thereof. MGI assumes no responsibility
for the accuracy or completeness of such information, nor for any omission on
the part of Discreet to disclose facts or events which may affect the accuracy
of any such information.
[LOGO]
Dated at Toronto, Ontario, Canada ANTHONY DECRISTOFARO,
this 15th day of April, 1998 President and Chief Executive Officer
94
<PAGE>
INDEX TO SCHEDULES
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
SPECIAL RESOLUTION -- SCHEDULE A................................................................................ A-1
PLAN OF ARRANGEMENT -- SCHEDULE B............................................................................... B-1
FAIRNESS OPINION OF FIRST MARATHON SECURITIES LIMITED -- SCHEDULE C............................................. C-1
MGI SOFTWARE CORP. FINANCIAL STATEMENTS -- SCHEDULE D
MGI Software Corp. Financial Statements for the years ended January 31, 1998 and January 31, 1997............. D-1
Auditors' Report -- Price Waterhouse........................................................................ D-2
Balance Sheets.............................................................................................. D-3
Statements of Operations and Deficit........................................................................ D-4
Statements of Changes in Financial Position................................................................. D-5
Notes to Financial Statements............................................................................... D-6
MGI Software Corp. Financial Statements for the year ended January 31, 1996
Auditors' Report of Cogan+Partners.......................................................................... D-12
Balance Sheet............................................................................................... D-13
Statement of Earnings and Retained Earnings (Deficit)....................................................... D-14
Statement of Changes in Financial Position.................................................................. D-15
Notes to Financial Statements............................................................................... D-16
DISCREET LOGIC INC. -- CONSOLIDATED FINANCIAL STATEMENTS -- SCHEDULE E
Discreet Logic Inc. Consolidated Financial Statements for the eleven-month period ended June 30, 1997 and for
the six and five month period ended December 31, 1997 and December 31, 1996 (Canadian GAAP)................. E-1
Auditors' Report -- Arthur Andersen & Cie................................................................... E-2
Consolidated Balance Sheets................................................................................. E-3
Consolidated Statements of Shareholders' Equity............................................................. E-4
Consolidated Statements of Operations....................................................................... E-5
Consolidated Statements of Changes in Financial Position.................................................... E-6
Notes to Consolidated Financial Statements.................................................................. E-7
DISCREET LOGIC INC. -- CONSOLIDATED FINANCIAL STATEMENTS -- SCHEDULE F
Discreet Logic Inc. Consolidated Financial Statements for the years ended July 31, 1996, 1995 and 1994
(U.S. GAAP)................................................................................................. F-1
Auditors' Report -- Arthur Andersen & Cie................................................................... F-2
Consolidated Balance Sheets................................................................................. F-3
Consolidated Statements of Shareholders' Equity............................................................. F-4
Consolidated Statements of Operations....................................................................... F-5
Consolidated Statement of Cash Flows........................................................................ F-6
Notes to Consolidated Financial Statements (to include audited reconciliation note to Canadian GAAP)........ F-7
PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS -- SCHEDULE G
Unaudited Pro Forma Consolidated Financial Statements Combining Discreet's June 30, 1997 Financial Statements
and MGI's January 31, 1998 Financial Statements (Canadian GAAP)............................................. G-1
Compilation Report -- Arthur Andersen & Cie................................................................. G-2
Pro Forma Consolidated Balance Sheet........................................................................ G-3
Pro Forma Consolidated Statement of Operations.............................................................. G-4
Notes to the Unaudited Pro Forma Consolidated Balance Sheet and Unaudited Pro Forma Consolidated Statements
of Operations.............................................................................................. G-5
DISCREET LOGIC INC.'S QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1997 -- SCHEDULE
H............................................................................................................. H-1
DISCREET LOGIC INC.'S TRANSITION REPORT ON FORM 10-K FOR THE TRANSITION PERIOD FROM AUGUST 1, 1996 TO JUNE 30,
1997 -- SCHEDULE I............................................................................................ I-1
SECTION 185 OF THE BUSINESS CORPORATIONS ACT (ONTARIO) -- SCHEDULE J............................................ J-1
INTERIM ORDER -- SCHEDULE K..................................................................................... K-1
</TABLE>
95
<PAGE>
SCHEDULE A
SPECIAL RESOLUTION
ARRANGEMENT UNDER SECTION 182 OF THE BUSINESS CORPORATIONS ACT (ONTARIO)
BE IT RESOLVED AS A SPECIAL RESOLUTION THAT:
1. The arrangement (the "Arrangement") pursuant to section 182 of the BUSINESS
CORPORATIONS ACT (Ontario) involving MGI Software Corp. ("MGI"), Discreet
Logic Inc. ("Discreet") and Discreet's wholly owned subsidiary 1284517
Ontario Inc. ("Subco"), substantially as set forth in the plan of
arrangement (the "Plan of Arrangement") attached as Exhibit 1 to the
arrangement agreement (the "Arrangement Agreement") dated as of March 9,
1998 by and among MGI, Discreet, and Subco and which is attached as Schedule
B to the management information circular of MGI dated April 15, 1998 (the
"Circular") accompanying the notice of this special meeting of holders of
Common Shares of MGI is hereby authorized and approved;
2. notwithstanding the passage of this special resolution by the shareholders
of MGI or the approval of the Arrangement by the Ontario Court of Justice
(General Division), the directors of MGI are hereby authorized and
empowered, without further notice to or approval of the shareholders of MGI,
(i) to amend the Plan of Arrangement to the extent permitted thereby, and
(ii) not to proceed with the Arrangement at any time prior to the issuance
of a certificate of amendment giving effect to the Arrangement;
3. any one director or officer of MGI is hereby authorized and directed for and
on behalf of MGI, to execute and deliver articles of arrangement, with or
without the corporate seal affixed, and such other documents as are
necessary or desirable, to the Director under the BUSINESS CORPORATIONS ACT
(Ontario) in accordance with the Arrangement Agreement for filing; and
4. any one director or one officer of MGI is hereby authorized and directed for
and on behalf of MGI, to negotiate, finalize, execute and deliver all such
further documents, agreements, authorizations, certificates or other
instruments, with or without the corporate seal affixed, and to take any and
all such further action, in such officer's or director's sole discretion,
that such officer or director deems necessary or desirable, in order to
carry out the intent of this special resolution.
A-1
<PAGE>
SCHEDULE B
PLAN OF ARRANGEMENT
UNDER SECTION 182 OF THE BUSINESS CORPORATIONS ACT (ONTARIO)
ARTICLE 1
INTERPRETATION
1.1 DEFINITIONS
In this Plan of Arrangement unless there is something in the subject matter
or context inconsistent therewith, the following terms shall have the respective
meanings set out below and grammatical variations of such terms shall have
corresponding meanings:
"AMALCO" means the corporation resulting from the Amalgamation.
"AMALCO COMMON SHARES" means the common shares of Amalco having the
attributes set forth in Appendix I hereto.
"AMALGAMATION" means the amalgamation of Subco and MGI pursuant to Section
2.3.
"ARRANGEMENT" means an arrangement under the provisions of Section 182 of
the OBCA, on the terms and conditions set forth in this Plan of Arrangement,
subject to and any amendment or variation thereto made in accordance with
Section 5.1 or made at the discretion of the Court in the Final Order.
"ARRANGEMENT AGREEMENT" means the arrangement agreement dated as of March 9,
1998 between MGI, Discreet and Subco to which this Plan of Arrangement is
attached as Exhibit 1.
"BROKER SPECIAL WARRANTS" means the 175,000 broker special warrants issued
as additional compensation to Gordon Capital Corporation, Cannaccord Capital
Corporation and Griffiths McBurney Inc. pursuant to an agency agreement by
and among the aforementioned dealers and MGI and which entitles the holders
thereof, in the aggregate, to 175,000 compensation options without
additional payment to MGI; each compensation option entitles the holder
thereof to purchase, on or before December 29, 1998, one MGI Common Share
(subject to adjustment) at a price of $5.25 per share.
"BUSINESS DAY" means a day which is not a Saturday, Sunday or a day when
banks are not open for business in Montreal, Quebec and in Toronto, Ontario.
"COURT" means the Ontario Court of Justice (General Division) Commercial
List or, if the Commercial List is unavailable, the Ontario Court (General
Division).
"DEPOSITARY" means The Trust Company of Bank of Montreal at its principal
office in Toronto, Ontario.
"DIRECTOR" means the Director appointed under Section 278 of the OBCA.
"DISSENT PROCEDURES" has the meaning set out in Section 3.1.
"DISSENTING SHAREHOLDER" means a holder of MGI Common Shares ("Dissenting
Shares") who dissents in respect of the Arrangement in strict compliance
with the Dissent Procedures.
"DISCREET" means Discreet Logic Inc.
"DISCREET COMMON SHARES" means the common shares in the share capital of
Discreet.
"EFFECTIVE DATE" means the date shown on the certificate of arrangement to
be issued by the Director giving effect to the Arrangement.
"EFFECTIVE TIME" means 12:00 a.m. (Montreal time) on the Effective Date.
"FINAL ORDER" means the final order of the Court approving the Arrangement
following the application therefor contemplated by Section 2.1 of the
Arrangement Agreement.
B-1
<PAGE>
"INTEL WARRANTS" means the 1,022,757 common share purchase warrants
entitling the holder thereof until September 30, 2000 to purchase 1,022,757
MGI Common Shares, subject to adjustment, at the lower of (i) $3.95 per MGI
Common Share and (ii) the higher of the then current market price of the MGI
Common Shares and $3.20 per MGI Common Share.
"INTERIM ORDER" means the interim order of the Court made in connection with
the approval of the Arrangement following the application therefor
contemplated by Section 2.1 of the Arrangement Agreement.
"MGI" means MGI Software Corp.
"MGI COMMON SHARES" means the common shares in the share capital of MGI.
"MGI SHAREHOLDERS" at any time means the holders of outstanding MGI Common
Shares at such time.
"MGI STOCK OPTIONS" means the rights (whether or not vested) to purchase MGI
Common Shares which are from time to time outstanding under the MGI Stock
Option Plan.
"OBCA" means the BUSINESS CORPORATIONS ACT (Ontario).
"PLAN OF ARRANGEMENT", "HEREOF", "HEREUNDER" and similar expressions mean
this Plan of Arrangement, including the recitals and Schedules hereto, and
not any particular Article, Section or other part hereof and includes any
agreement or instrument supplementary or ancillary hereto.
"SPECIAL MEETING" means the special meeting of MGI Shareholders (including
any adjournment thereof) to be held to consider and, if deemed advisable, to
approve the Arrangement by way of special resolution (as defined under the
OBCA) of the MGI Shareholders.
"SUBCO" means 1284517 Ontario Inc., a wholly-owned subsidiary of Discreet
incorporated under the OBCA for the purpose of carrying out the Arrangement.
1.2 NUMBER, GENDER AND PERSONS
In this Plan of Arrangement, unless the context otherwise requires, words
importing the singular number include the plural and VICE VERSA, words importing
any gender include all genders and words importing persons include individuals,
corporations, partnerships, associations, trusts, unincorporated organizations,
governmental bodies and other legal or business entities of any kind.
1.3 INTERPRETATION NOT AFFECTED BY HEADINGS, ETC.
The division of this Plan of Arrangement into Articles, sections and other
parts and the insertion of headings are for convenience of reference only and
shall not affect the construction or interpretation of this Plan of Arrangement.
1.4 DATE FOR ANY ACTION
In the event that any date on or by which any action is required or
permitted to be taken hereunder is not a Business Day, such action shall be
required or permitted to be taken on or by the next succeeding day which is a
Business Day.
1.5 TIME
All times expressed herein or in any letters of transmittal and election
forms are local time (Toronto, Ontario) unless otherwise stipulated herein or
therein.
1.6 CURRENCY
All references to currency in this Plan of Arrangement are to Canadian
dollars, being lawful money of Canada, and the sign "$" without more shall mean
Canadian dollars.
B-2
<PAGE>
1.7 STATUTORY REFERENCES
Any reference in this Plan of Arrangement to a statute includes all
regulations made thereunder, all amendments to such statute or regulations in
force from time to time, and any statute or regulation that supplements or
supersedes such statute or regulations.
1.8 APPENDICES
The following are the Appendices to this Plan of Arrangement, which form an
integral part hereof:
Appendix A -- Share Provisions for Amalco Common Shares;
Appendix B -- General By-law No. 1 of Amalco.
ARTICLE 2
ARRANGEMENT
2.1 BINDING EFFECT
This Plan of Arrangement will become effective on, and be binding on and
after, the Effective Time on (i) Subco, (ii) MGI, (iii) Discreet, as the sole
shareholder of Subco, and (iv) the MGI Shareholders.
2.2 EVENTS SEQUENTIAL
At the Effective Time, each of the provisions of this Article 2 shall occur
and be deemed to occur in the order set out below, without any further act or
formality.
2.3 THE ARRANGEMENT
(a) At the time which is the earliest moment on the Effective Date, MGI and
Subco (sometimes referred to hereinafter as "predecessor corporations")
will amalgamate to form Amalco with the same effect as if Section 179 of
the OBCA was applicable to such amalgamation and in connection with such
amalgamation:
(i) all of the property of the predecessor corporations immediately
before the Amalgamation will continue to be property of Amalco;
(ii) all of the liabilities of the predecessor corporations immediately
before the Amalgamation will continue to be liabilities of Amalco;
(iii) all existing causes of action, claims or liabilities to prosecution
of or against a predecessor corporation immediately before the
Amalgamation will be unaffected;
(iv) all civil, criminal or administrative actions or proceedings
pending by or against a predecessor corporation immediately before
the Amalgamation may be continued to be prosecuted by or against
Amalco;
(v) all convictions against, or rulings, orders or judgments in favour
of or against, a predecessor corporation immediately before the
Amalgamation may be enforced by or against Amalco;
(vi) the articles of arrangement in respect of the Arrangement shall be
deemed to be the articles of incorporation of Amalco and the
certificate of amendment in respect of the Arrangement shall be
deemed to be the certificate of incorporation of Amalco;
(vii) the name of Amalco will be "MGI Software Corp.";
(viii) the registered office of Amalco shall be situated in the City of
Toronto, Province of Ontario;
(ix) Amalco will be authorized to issue an unlimited number of Amalco
Common Shares having attached thereto the rights, privileges,
restrictions and conditions set forth in Appendix A hereto;
B-3
<PAGE>
(x) there shall be no restrictions on the issue, transfer or ownership
of the shares of Amalco other than:
(A) a requirement that all share transfers be subject to the approval
of the Amalco Board of Directors;
(B) a limitation on the number of Amalco shareholders, exclusive of
persons who are in its (or a predecessor corporation's) employment
and exclusive of persons who, having been formerly in its (or a
predecessor corporation's) employment, were, while in that
employment, and have continued after termination of that
employment to be, shareholders of Amalco, is limited to not more
than fifty, two or more persons who are joint registered owners of
one or more shares being counted as one shareholder; and
(C) any invitation to the public to subscribe for the securities of
Amalco shall be prohibited;
(xi) there shall be no restrictions on the businesses which Amalco is
authorized to carry on;
(xii) the by-law of Amalco until repealed, amended, altered or added to ,
shall be General By-law No. 1 of Subco attached hereto as Appendix
B:
(A) the articles of incorporation of Amalco shall provide that the
board of directors of Amalco, without authorization of the
shareholders of Amalco may, from time to time, in such amounts and
on such terms as it deems expedient:
(1) borrow money upon the credit of Amalco;
(2) issue, reissue, sell or pledge debt obligations of Amalco;
(3) give a guarantee on behalf of Amalco to secure performance of
an obligation of any person; and
(4) charge, mortgage, hypothecate, pledge or otherwise create a
security interest in all or any of the currently owned or
subsequently acquired property and assets of Amalco including,
without limiting the generality of the foregoing, real and
personal property, movable and immovable property, tangible
and intangible assets, book debts, rates, powers, franchises
and undertakings, to secure any obligation of Amalco.
(xiii) the number of directors of Amalco shall be such number not more
than ten (10) nor less than one (1) as the board of directors may
from time to time determine; and
(xiv) the first directors of Amalco shall be the persons whose names and
municipality of residence are set out below, who shall hold office
until the first annual meeting of shareholders of Amalco or the
signing of a resolution in lieu thereof or until their successors
are elected or appointed:
<TABLE>
<CAPTION>
NAME MUNICIPALITY OF RESIDENCE
- --------------------------------------------------- ---------------------------------------------------
<S> <C>
Richard Szalwinski................................. Westmount, Quebec
Francois Plamondon................................. Montreal, Quebec
</TABLE>
(b) Upon the Amalgamation, each Subco Common Share outstanding immediately
prior to the Amalgamation shall be converted into one Amalco Common Share
and, subject to section 4.4, each certificate representing such Subco
Common Shares shall represent the Amalco Common Shares into which such
Subco Common Shares were converted.
(c) Upon the Amalgamation, each MGI Common Share outstanding immediately
prior to the Amalgamation, other than the Dissenting Shares, shall be
exchanged for 0.162 Discreet Common Shares and, subject to section 4.4,
each certificate representing such MGI Common Shares shall represent the
Discreet Common Shares into which the MGI Common Shares formerly
represented by such certificate were exchanged, until a replacement
certificate representing such Discreet Common Shares is delivered in
accordance with section 4.1.
B-4
<PAGE>
(d) The MGI Stock Options, Broker Special Warrants and Intel Warrants
outstanding immediately prior to the Effective Time will be dealt with in
accordance with the Arrangement Agreement.
ARTICLE 3
RIGHTS OF DISSENT
3.1 RIGHTS OF DISSENT
Holders of MGI Common Shares may exercise rights of dissent with respect to
such shares pursuant to and in the manner set forth in Section 185 of the OBCA
(the "DISSENT PROCEDURES") in connection with the Arrangement, as the same may
be modified by the Interim Order or the Final Order, and holders who duly
exercise such rights of dissent and who:
(a) are ultimately entitled to be paid fair value for their MGI Common
Shares shall be deemed to have transferred such MGI Common Shares to
Amalco for cancellation on the Effective Date; or
(b) are ultimately not entitled, for any reason, to be paid fair value for
their MGI Common Shares shall be deemed to have participated in the
Arrangement on the same basis as any non-dissenting holder of MGI Common
Shares and shall receive Discreet Common Shares on the basis determined
in accordance with Subsection 2.3(c) of this Plan of Arrangement,
but in no case shall Amalco or Discreet be required to recognize such holders as
holders of MGI Common Shares on and after the Effective Date, and the names of
such holders of Dissenting Shares shall be deleted from the registers of holders
of MGI Common Shares on the Effective Date.
ARTICLE 4
CERTIFICATES AND FRACTIONAL SHARES
4.1 DELIVERY OF CERTIFICATES
Subject to the provisions of section 4.3, as soon as practicable after the
Effective Date, Discreet shall deliver to the Depositary such number of
certificates representing in the aggregate the Discreet Common Shares issued
pursuant to subsection 2.3(c) upon the exchange of outstanding MGI Common Shares
at such time pursuant to the Arrangement as are required and the Depositary
shall deliver to each registered shareholder a certificate representing the
number of Discreet Common Shares (disregarding fractions) to which such
shareholder is entitled upon the delivery by such shareholder to the Depositary
at its principal stock and bond offices in Toronto for cancellation of the
certificates formerly representing his or her MGI Common Shares, together with
all other required documents and instruments as the Depositary may reasonably
require. In the event of a transfer of ownership of MGI Common Shares which is
not registered in the transfer records of MGI, a certificate representing the
proper number of Discreet Common Shares may be issued to a transferee if the
certificate representing such MGI Common Shares is presented to the Depositary
accompanied by all documents required to evidence in effect such transfer. Until
surrendered as contemplated by this section 4.1, each certificate which
immediately prior to the Effective Date represented outstanding MGI Common
Shares that were exchanged for Discreet Common Shares on the Amalgamation shall
be deemed at all times on and after the Effective Date to represent only the
right to receive upon such surrender (i) a certificate representing Discreet
Common Shares as contemplated by this section 4.1, (ii) any dividends, amounts,
distributions, sale proceeds and accrued interest, net of any applicable
withholding or other taxes, held by the Depositary in trust for such holder
pursuant to section 4.2 and (iii) any proceeds to which any such holder may be
entitled under section 4.3.
4.2 DISTRIBUTIONS
All dividends or other amounts paid or distributions made on or after the
Effective Date on or in respect of any Discreet Common Shares to a holder
thereof before the delivery by such holder for cancellation of the certificate
formerly representing such holder's MGI Common Shares, shall be paid or made to
the Depositary to be held by it in trust for such holder. In addition, any
proceeds to which any such holder may be entitled under section 4.3 before the
delivery of such certificate shall be held by the Depositary in trust for such
shareholder.
B-5
<PAGE>
All monies so held in trust by the Depositary shall be invested by it in
interest bearing trust accounts upon such terms as the Depositary may deem
appropriate. Subject to the provisions of section 4.5, the Depositary shall pay
and deliver to any such holder, as soon as reasonably practicable after the
delivery to the Depositary for cancellation of the certificates formerly
representing the MGI Common Shares of such shareholder together with all other
required documents in accordance with section 4.1 and the delivery of the
replacement certificates referred to in such section, all dividends, amounts,
distributions, sale proceeds and accrued interest, net of any applicable
withholding or other taxes, held by the Depositary in trust for such holder
pursuant to this section 4.2. Notwithstanding the foregoing, no interest shall
be payable in respect of amounts which the Depositary shall have made available
at its principal stock and bond offices in Montreal or Toronto, as designated by
the holder thereof, or shall have mailed to the relevant holder, cheques to such
holder in payment of amounts due to such holder.
4.3 NO FRACTIONAL SHARES
No certificates or script representing fractional Discreet Common Shares
shall be issued upon the surrender of certificates for exchange pursuant to
section 4.1 and no dividend, stock split or other change in the capital
structure of Discreet shall relate to any such fractional security and such
fractional interests shall not entitle the owner thereto to vote or to exercise
any rights as a security holder of Discreet. In lieu of any such fractional
securities, each person entitled to a fractional interest in Discreet Common
Shares will receive an amount of cash (rounded to the nearest whole cent) equal
to the product obtained when such fraction is multiplied by the average of the
closing sale prices of Discreet Common Shares on the Nasdaq National Market
(converted to Canadian dollars using the noon buying rate in New York City for
cable transfers in foreign currencies as certified for customs purposes by the
Federal Reserve Bank of New York for the days on which each such closing sale
price occurred) for the 20 trading days ending with the trading day that is two
(2) trading days prior to the Effective Date, such amount to be provided to the
Depositary by Discreet upon request.
4.4 LOST CERTIFICATES
If any certificate which immediately prior to the Effective Time represented
outstanding MGI Common Shares that were exchanged pursuant to subsection 2.3(c)
has been lost, stolen or destroyed, upon the making of an affidavit of that fact
by the person claiming such certificate to be lost, stolen or destroyed, the
Depositary will issue in exchange for such lost, stolen or destroyed
certificate, a certificate representing Discreet Common Shares (and a cheque,
any dividends or distributions with respect thereto pursuant to section 4.2 and
any cash for a fractional share pursuant to section 4.3) deliverable in respect
thereto. When authorizing such issuance and payment in exchange for any lost,
stolen or destroyed certificate, the person to whom a certificate representing
Discreet Common Shares and a cheque are to be issued shall, as a condition
precedent to the issuance thereof, give a bond satisfactory to Discreet and the
Depositary in such sum as Discreet may direct or otherwise indemnify Discreet,
MGI and the Depositary in a manner satisfactory to them against any claim that
may be made against Discreet, MGI or the Depositary with respect to the
certificate alleged to have been lost, stolen or destroyed.
4.5 UNCLAIMED CERTIFICATES
Notwithstanding any of the other provisions hereof, any certificate which
immediately prior to the Effective Time represented outstanding MGI Common
Shares that were exchanged pursuant to subsection 2.3(c) that has not been
surrendered with all other instruments required by section 4.1 on or prior to
the sixth anniversary of the effective Date shall cease to represent a claim or
interest of any kind or nature as a shareholder of MGI. On such date, the
Discreet Common Shares to which the former registered holder of such certificate
was ultimately entitled shall be deemed to have been surrendered to Discreet
together with all entitlements to dividends, distribution and cash for
fractional interests thereon held for such former registered holder for no
consideration.
B-6
<PAGE>
ARTICLE 5
AMENDMENT
5.1 PLAN OF ARRANGEMENT AMENDMENT
Subco and MGI reserve the right to amend, modify or supplement this Plan of
Arrangement at any time and from time to time provided that any such amendment,
modification, or supplement must be contained in a written document which is
filed with the Court and, if made following the Special Meeting, approved by the
Court and communicated to MGI Common Shareholders and Discreet in the manner
required by the Court (if so required).
Any amendment, modification or supplement to this Plan of Arrangement may be
proposed by MGI and Subco at any time prior to or at the Special Meeting with or
without any other prior notice or communication and, if so proposed and accepted
by the persons voting at the Special Meeting, shall become part of this Plan for
all purposes.
Any amendment, modification or supplement to this Plan of Arrangement which
is approved or directed by the Court following the Special Meeting shall be
effective only if it is consented to by MGI and Subco.
Any amendment, modification or supplement to this Plan of Arrangement may be
made following the effective Date unilaterally by Amalco, provided that it
concerns a matter which, in the reasonable opinion of Amalco, is of an
administrative nature required to better give effect to the implementation of
this Plan of Arrangement and is not adverse to the financial or economic
interests of any holder of Amalco Common Shares.
NOTE TO READERS: "APPENDIX A -- SHARE PROVISIONS FOR AMALCO COMMON SHARES" AND
"APPENDIX B -- GENERAL BY-LAW NO. 1 OF AMALCO" ARE AVAILABLE UPON REQUEST.
B-7
<PAGE>
SCHEDULE C
FAIRNESS OPINION OF FIRST MARATHON SECURITIES LIMITED
C-1
<PAGE>
C-2
<PAGE>
C-3
<PAGE>
C-4
<PAGE>
SCHEDULE D
MGI SOFTWARE CORP.
FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
MGI Software Corp. Financial Statements for the years ended January 31, 1998
and January 31, 1997
<TABLE>
<CAPTION>
PAGE
----------
<S> <C>
Auditors' Report -- Price Waterhouse.................................... D-2
Balance Sheets.......................................................... D-3
Statements of Operations and Deficit.................................... D-4
Statements of Changes in Financial Position............................. D-5
Notes to Financial Statements........................................... D-6
</TABLE>
MGI Software Corp. Financial Statements for the year ended January 31, 1996
<TABLE>
<CAPTION>
<S> <C>
Auditors' Report -- Cogan + Partners.................................... D-12
Balance Sheet........................................................... D-13
Statement of Earnings and Retained Earnings (Deficit)................... D-14
Statement of Changes in Financial Position.............................. D-15
Notes to Financial Statements........................................... D-16
</TABLE>
D-1
<PAGE>
MGI SOFTWARE CORP.
FINANCIAL STATEMENTS
JANUARY 31, 1998 AND 1997
(IN THOUSANDS OF DOLLARS)
AUDITORS' REPORT
To the Directors of
MGI Software Corp.
We have audited the balance sheets of MGI Software Corp. as at January 31,
1998 and 1997 and the statements of operations and deficit and changes in
financial position for the years then ended. These financial statements are the
responsibility of the company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
In our opinion, these financial statements present fairly, in all material
respects, the financial position of the company as at January 31, 1998 and 1997
and the results of its operations and the changes in its financial position for
the years then ended in accordance with generally accepted accounting
principles.
(Signed) PRICE WATERHOUSE
March 19, 1998 Chartered Accountants
D-2
<PAGE>
MGI SOFTWARE CORP.
BALANCE SHEETS
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
JANUARY 31
--------------------
1998 1997
--------- ---------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash............................................................................................ $ 1,754 $ 4,413
Note receivable (Note 4)........................................................................ 10,813 --
Accounts receivable............................................................................. 4,835 2,708
Prepaids and other assets....................................................................... 555 307
Inventories..................................................................................... 546 293
Investment tax credits receivable............................................................... 24 170
--------- ---------
18,527 7,891
Capital assets (Note 5)........................................................................... 1,487 952
--------- ---------
$ 20,014 $ 8,843
--------- ---------
--------- ---------
LIABILITIES
CURRENT LIABILITIES
Accounts payable and accrued liabilities........................................................ $ 3,344 $ 2,310
Due to related party............................................................................ -- 75
--------- ---------
3,344 2,385
SHAREHOLDERS' EQUITY
Capital stock (Note 6)............................................................................ 32,019 12,172
Special warrants (Note 6(a))...................................................................... -- 2,685
Deficit........................................................................................... (15,349) (8,399)
--------- ---------
16,670 6,458
--------- ---------
$ 20,014 $ 8,843
--------- ---------
--------- ---------
</TABLE>
Approved by the Board
<TABLE>
<S> <C>
(Signed) OREN ASHER (Signed) JOEL GOLDMAN
Director Director
</TABLE>
D-3
<PAGE>
MGI SOFTWARE CORP.
STATEMENTS OF OPERATIONS AND DEFICIT
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31
--------------------------
1998 1997
------------ ------------
<S> <C> <C>
REVENUE..................................................................................... $ 13,348 $ 5,144
COST OF SALES............................................................................... 2,660 1,329
------------ ------------
10,688 3,815
EXPENSES
Marketing and selling..................................................................... 11,610 4,547
Research and development (NOTE 7)......................................................... 4,758 1,731
Administration............................................................................ 1,005 1,144
Amortization of capital assets............................................................ 475 1,557
------------ ------------
17,848 8,979
------------ ------------
Loss before undernoted items................................................................ (7,160) (5,164)
Interest income............................................................................. 210 124
Write-off of purchased software (NOTE 5).................................................... -- (2,363)
------------ ------------
Loss for the year........................................................................... (6,950) (7,403)
Deficit, beginning of year.................................................................. (8,399) (677)
Reorganization costs (NOTE 2)............................................................... -- (319)
------------ ------------
Deficit, end of year........................................................................ $ (15,349) $ (8,399)
------------ ------------
------------ ------------
Loss per share.............................................................................. $ (0.35) $ (0.48)
------------ ------------
------------ ------------
Weighted average number of common shares outstanding........................................ 19,958,968 15,355,052
------------ ------------
------------ ------------
</TABLE>
D-4
<PAGE>
MGI SOFTWARE CORP.
STATEMENTS OF CHANGES IN FINANCIAL POSITION
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31
---------------------
1998 1997
---------- ---------
<S> <C> <C>
CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES
Loss for the year............................................................................... $ (6,950) $ (7,403)
Items not affecting cash
Amortization of capital assets................................................................ 475 1,557
Write-off of purchased software, included in capital assets................................... -- 2,363
Net change in noncash working capital amounts relating to operations (1,523) (785)
---------- ---------
(7,998) (4,268)
---------- ---------
FINANCING ACTIVITIES
Issue of common shares, net of issue costs...................................................... 17,162 6,261
Issue of special warrants, net of issue costs................................................... -- 2,685
Retirement of debentures........................................................................ -- (1,500)
---------- ---------
17,162 7,446
---------- ---------
INVESTING ACTIVITIES
Purchase of capital assets...................................................................... (1,010) (991)
Reorganization costs............................................................................ -- (262)
Increase in note receivable..................................................................... (10,813) --
---------- ---------
(11,823) (1,253)
---------- ---------
Increase (decrease) in cash resources during the year............................................. (2,659) 1,925
Cash, beginning of year........................................................................... 4,413 2,488
---------- ---------
Cash, end of year................................................................................. $ 1,754 $ 4,413
---------- ---------
---------- ---------
CASH CONSISTS OF
Cash............................................................................................ $ 1,754 $ 696
Short-term deposits............................................................................. -- 3,717
---------- ---------
$ 1,754 $ 4,413
---------- ---------
---------- ---------
</TABLE>
D-5
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS IN THOUSANDS OF DOLLARS)
1. NATURE OF OPERATIONS
MGI Software Corp. (the "company") was incorporated on September 22, 1995
under the laws of the Province of Ontario to develop, market and support
multimedia products in the digital photography, video editing,
three-dimensional graphics and page layout markets of the personal computer
software industry. The company's products are primarily directed toward
retail consumers but are also suitable for small businesses, companies and
governments. To date, the company's primary markets have been Europe, United
States and Asia Pacific.
2. REORGANIZATION
Effective April 30, 1996, MGI Software Corp. ("MGI"), a private company,
amalgamated with Globex Biotechnologies Inc. ("Globex"), a public company
whose shares are traded on the Canadian Dealer Network, and continued
operations under the name of MGI Software Corp. The amalgamation was
effected pursuant to the provisions of the Ontario Business Corporations Act
and involved the issuance of shares of the amalgamated company to the former
shareholders as follows: (a) 1 common share of the amalgamated company for
each 15 shares of Globex; and (b) 1 common share of the amalgamated company
for each common share of the predecessor MGI.
The amalgamation resulted in the shareholders of the predecessor MGI holding
98.4% of the common shares of the amalgamated company. Accordingly, the
transaction has been recorded in these accounts using the principles of
purchase accounting whereby predecessor MGI is considered to have acquired
Globex in exchange for shares. Prior to the amalgamation, Globex was
inactive and without assets and accordingly the substance of the
amalgamation is a capital reorganization of MGI. The consideration of
$207,000, attributed to the 206,433 common shares issued to the shareholders
of Globex (Note 6), liabilities assumed of $57,000 and legal costs incurred
in the amount of $55,000, was charged directly to deficit in the amount of
$319,000 as a capital reorganization cost.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION
Revenue from sale of merchandise is recognized at the time of shipment to
the customer, net of provision for returns. Royalties and licence fees are
recognized as earned in accordance with the terms of the related agreements.
INVENTORIES
Inventories are valued at the lower of cost and net realizable value. Cost
is determined on the weighted average cost basis.
CAPITAL ASSETS
Capital assets are recorded at the lower of cost, net of accumulated
amortization, and net recoverable amount. Amortization charges are
calculated on the following bases using the following annual rates:
<TABLE>
<S> <C>
Furniture and equipment....... 20% declining balance
Computer equipment............ 30% declining balance
Leasehold improvements........ over the remaining lease term
Computer software............. straight-line over 3 years
</TABLE>
RESEARCH AND DEVELOPMENT
Research costs are expensed as incurred. Development costs are expensed as
incurred unless a project meets the criteria under generally accepted
accounting principles for deferral and amortization. The company has not
deferred any development costs to date.
Government assistance is available to the company through the Industrial
Research Assistance Program ("IRAP") and income tax investment credits.
IRAP funds qualified research and development activities on preapproved
projects. IRAP assistance is recorded as a reduction of research and
development expenses in the year in which it is claimed.
Income tax investment credits are accounted for using the cost reduction
method and accordingly are deducted from the related research and
development expenses in the year of expenditure, provided there is
reasonable assurance they will be realized.
D-6
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS IN THOUSANDS OF DOLLARS)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FOREIGN CURRENCY TRANSLATION
Monetary assets and liabilities denominated in foreign currencies are
translated into Canadian dollars at the exchange rate prevailing at the
balance sheet date. Nonmonetary assets and liabilities and transactions are
translated at exchange rates prevailing at the respective transaction dates.
Exchange gains and losses are included in the statement of operations and
deficit.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
FINANCIAL INSTRUMENTS
Financial instruments are initially recorded at historical cost. If
subsequent circumstances indicate that a decline in the fair value of a
financial asset is other than temporary, the financial asset is written down
to its fair value. Unless otherwise indicated, the fair values of financial
instruments approximate their recorded amounts.
The fair values of cash on deposit with commercial banks, note receivable,
accounts receivable, and accounts payable and accrued liabilities
approximate recorded amounts because of the short period to receipt or
payment of cash.
4. NOTE RECEIVABLE
On January 8, 1998, the company purchased a commercial note from a
corporation in the amount of $10,813,000. This note, bearing interest at a
rate of 4.41% per annum, was repaid on February 5, 1998.
5. CAPITAL ASSETS
<TABLE>
<CAPTION>
1998
-------------------------------------
ACCUMULATED
COST AMORTIZATION NET
--------- --------------- ---------
<S> <C> <C> <C>
Furniture and equipment............................................................ $ 515 $ 115 $ 400
Computer equipment................................................................. 1,113 322 791
Leasehold improvements............................................................. 260 67 193
Computer software.................................................................. 356 253 103
--------- ----- ---------
$ 2,244 $ 757 $ 1,487
--------- ----- ---------
--------- ----- ---------
</TABLE>
<TABLE>
<CAPTION>
1997
-------------------------------------
ACCUMULATED
COST AMORTIZATION NET
--------- --------------- ---------
<S> <C> <C> <C>
Furniture and equipment.............................................................. $ 257 $ 42 $ 215
Computer equipment................................................................... 495 102 393
Leasehold improvements............................................................... 203 18 185
Computer software.................................................................... 290 131 159
--------- ----- ---------
$ 1,245 $ 293 $ 952
--------- ----- ---------
--------- ----- ---------
</TABLE>
During the year ended January 31, 1997, management determined that computer
software costs carried in the company's books in the amount of $2,363,000
should be written off and the loss charged to operations.
D-7
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS IN THOUSANDS OF DOLLARS)
6. CAPITAL STOCK
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Authorized
An unlimited number of common shares
An unlimited number of Class A voting special shares
Issued 23,963,712 (1997 -- 17,907,630) common shares........................................... $ 32,019 $ 12,172
--------- ---------
--------- ---------
</TABLE>
The common share transactions are as follows:
<TABLE>
<CAPTION>
1998 1997
---------------------- ----------------------
NUMBER OF NUMBER OF
SHARES AMOUNT SHARES AMOUNT
--------- ----------- --------- -----------
<S> <C> <C> <C> <C>
Issued, beginning of year................................................ 17,907,630 $ 12,172 13,110,768 $ 5,911
Issued during the year
For cash upon private placement (A).................................... 1,022,757 2,766 -- --
On conversion of debentures (B)........................................ -- -- 650,000 715
Upon exercise of purchase warrants for cash (B)........................ -- -- 650,000 975
On reorganization (NOTE 2)............................................. -- -- 206,433 207
Purchase of computer software, licences and rights (NOTE 11)........... -- -- 471,429 --
On conversion of special warrants (C).................................... 4,700,000 16,536 2,744,000 4,289
On exercise of broker compensation warrants (C).......................... 137,200 343 -- --
On exercise of employee stock options.................................... 196,125 202 75,000 75
--------- ----------- --------- -----------
23,963,712 $ 32,019 17,907,630 $ 12,172
--------- ----------- --------- -----------
--------- ----------- --------- -----------
</TABLE>
(a) On September 30, 1997, the company issued 1,022,757 common shares for
cash of $2,765,999 pursuant to the terms of a subscription agreement. In
addition, the same number of common share purchase warrants were issued
for an aggregate consideration of $1.00. Each warrant entitles the holder
to purchase one common share of the company, subject to adjustment, at
the lower of: (i) $3.95 per common share and (ii) the higher of the then
current market price of the common shares of the company and $3.20 per
common share. These common share purchase warrants expire on September
30, 2000. As at the year-end, all purchase warrants remained outstanding.
(b) On October 21, 1995, the company issued $1,500,000 aggregate principal
amount of debentures, payable on demand, bearing interest at 5.7% per
annum, payable quarterly, in arrears. The debentures were convertible at
any time at the option of the holder into units on the basis of one unit
for each $1.10 principal amount of debentures. Each unit consisted of one
share and one half of one common share purchase warrant. On February 26,
1996, the company retired an aggregate principal amount of $785,000 of
the debentures for cash and the issuance of an additional one-half of one
warrant upon the exercise of the conversion rights attached to the
debentures. On April 30, 1996, the remaining debentures in the amount of
$715,000 were converted into an aggregate of 650,000 common shares and
650,000 warrants. Each warrant was convertible into one common share for
cash of $1.50. On June 4, 1996, 200,000 warrants were exercised and on
December 31, 1996 all remaining warrants were exercised.
(c) On May 15, 1996, the company issued 2,744,000 special warrants at $1.75
each for net proceeds of $4,289,000 (net of issue costs of $513,000). On
August 19, 1996, the special warrants were converted into 2,744,000
common shares without additional consideration. As additional
compensation, the company issued 137,200 broker special warrants. Each
broker special warrant was converted into an option to purchase one
common share at a price of $2.50 per share. The options were exercised
and converted into 137,200 common shares.
On January 16, 1997, the company issued 1,200,000 special warrants at
$2.50 each for net proceeds of $2,685,000 (net of issue costs of
$315,000). On February 25, 1997, the special warrants were converted into
1,200,000 common shares without additional consideration.
On September 29, 1997, the company issued 3,500,000 special warrants at
$4.25 each for net proceeds of $13,851,273 (net of issue costs of
$1,024,000). On December 8, 1997, the special warrants were converted
into 3,500,000 common shares without additional consideration. As
additional compensation, the company issued 175,000 broker special
warrants. Each broker special warrant was converted into a compensation
option to purchase one common share at a price of $5.25 per share,
expiring on December 29, 1998. All compensation options remain
outstanding as at January 31, 1998.
D-8
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS IN THOUSANDS OF DOLLARS)
6. CAPITAL STOCK (CONTINUED)
(d) The company has an incentive plan under which options to purchase common
shares may be granted to its directors, officers, employees and service
providers at the discretion of the Board of Directors. Each option under
the incentive plan allows for the purchase of one common share and
expires not later than ten years from the date granted. The option
exercise price is set at amounts not less than the fair market value at
the date of grant. As at January 31, 1998, the company had stock options
outstanding as follows:
<TABLE>
<CAPTION>
NUMBER OF
FISCAL YEAR OPTIONS EXERCISE
ISSUED ISSUED EXPIRY PRICE
----------- ----------- -------------- ----------
<S> <C> <C> <C> <C>
Class of option holder
Employees and service providers............................ 1996 1,073,750 January 2001- $1.00
January 2006
1997 382,125 April 2001- $1.00-$3.65
April 2006
1998 799,800 February 2002- $2.15-$4.00
January 2003
Directors who are not executive officers................... 1996 30,000 January 2001 $1.00
1997 105,000 April 2002 $2.30
1998 50,000 June 2002 $2.30
Executive officers......................................... 1996 610,000 January 2001 $1.00
1998 25,000 May 2002 $2.15
-----------
3,075,675
-----------
-----------
</TABLE>
The options are subject to various vesting requirements as outlined in the
plan.
(e) At January 31, the company had incurred share issue costs of $1,851,000
(1997 -- $828,000). When realized, the tax benefit of these deductible
costs will be recorded as an increase in share capital.
7. RESEARCH AND DEVELOPMENT
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Gross research and development expenses........................................ $ 4,976 $ 1,823
IRAP funding................................................................... (218) --
Investment tax credits......................................................... -- (92)
--------- ---------
Research and development expenses, net......................................... $ 4,758 $ 1,731
--------- ---------
--------- ---------
</TABLE>
The IRAP funding received or receivable amounted to $218,000 (1997 -- $Nil).
At January 31, included in accounts receivable were IRAP receivables of
$29,000 (1997 -- $Nil).
Investment tax credits are calculated at the rate of 20% for qualifying
research and development expenditures and can be offset against future taxes
payable within the tax carry forward period of ten years.
D-9
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS IN THOUSANDS OF DOLLARS)
8. INCOME TAXES
The company's income tax provision has been determined as follows:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Loss for the year.................................................................................. $ 6,950 $ 7,403
--------- ---------
--------- ---------
Combined basic federal and provincial income tax recovery at 44.62%................................ $ 3,101 $ 3,303
Provincial research and development deduction...................................................... 218 43
Unrecorded benefit of noncapital losses............................................................ (3,319) (3,346)
--------- ---------
$ -- $ --
--------- ---------
--------- ---------
</TABLE>
The company has incurred losses for accounting purposes, the tax benefit of
which has not been included in these accounts. These losses are available to
be applied as a deduction against taxable income earned in the future and
are summarized approximately as follows:
Tax losses expiring in:
<TABLE>
<CAPTION>
PROVINCIAL FEDERAL
----------- ---------
<S> <C> <C>
2002........................................................................................... $ 300 $ 200
2003........................................................................................... 1,900 400
2004........................................................................................... 6,300 2,200
2005........................................................................................... 6,500 4,000
----------- ---------
15,000 6,800
Excess of amounts booked for accounting purposes over amounts claimed for tax (timing
differences), not subject to expiry
Amortization of capital assets............................................................. -- 4,000
Scientific research and development expenditures........................................... 3,000 4,500
Share issue costs.......................................................................... 1,400 1,400
Other...................................................................................... 200 200
----------- ---------
4,600 10,100
Less: Timing differences, the tax benefit of which has been recognized in the accounts......... (500) --
----------- ---------
4,100 10,100
----------- ---------
Losses for accounting purposes carried forward................................................. $ 19,100 $ 16,900
----------- ---------
----------- ---------
</TABLE>
The provincial losses exceed federal losses principally due to enhanced
provincial scientific research and development incentives.
The company has federal investment tax credits available to reduce future
income taxes otherwise payable of $1,277,000 which expire between 2005 and
2008. The benefit of these tax credits have not been recorded.
9. EXPORT SALES
The company's operations are located in Canada in one principal industry
segment, software development, across geographically diverse markets.
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Revenue by geographic area
Canada...................................................................... $ 251 $ 266
United States............................................................... 8,333 3,143
Europe...................................................................... 3,818 1,251
Asia Pacific................................................................ 946 484
--------- ---------
$ 13,348 $ 5,144
--------- ---------
--------- ---------
</TABLE>
D-10
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS IN THOUSANDS OF DOLLARS)
10. FINANCIAL OBLIGATIONS
The company is obligated under operating leases for the rental of
facilities. Minimum future rental payments under the company's current
leases in effect as at January 31, 1998, which expire on December 31, 2000,
are approximately as follows:
<TABLE>
<CAPTION>
<S> <C>
1999..................................................................................... $ 81
2000..................................................................................... 84
2001..................................................................................... 77
</TABLE>
11. RELATED PARTY TRANSACTIONS
Research and development fees are paid to a company controlled by a
significant shareholder. The total fees paid in 1998 were $151,800
(1997 -- $8,950).
Computer software was acquired in fiscal 1997 from a company related by
virtue of common shareholdings, as follows:
<TABLE>
<CAPTION>
<S> <C>
Cash payment.............................................................................................. $ 150,000
Issuance of 471,429 common shares recorded at a nominal value, being the carrying amount of the assets
acquired in the books of the transferor................................................................. --
---------
Book value of computer software acquired.................................................................. $ 150,000
---------
---------
</TABLE>
12. CREDIT RISK EXPOSURES
Concentrations of credit risk on trade accounts receivable are indicated in
the following table by the percentage of the total balance receivable by
individual customers. At January 31, 1998, three customers accounted for 76%
(1997 -- 54%) of total accounts receivable, as follows:
<TABLE>
<CAPTION>
1998 1997
----- -----
<S> <C> <C>
First customer.................................................................... 50% 19%
Second customer................................................................... 14% 18%
Third customer.................................................................... 12% 17%
</TABLE>
13. CONTINGENCY
The company has received correspondence alleging the company's infringement
of certain technology rights. Management believes that the allegations are
without merit and, however resolved, will not have a material adverse effect
on the company's financial position. No amount has been provided in these
financial statements in respect of these allegations. Loss, if any,
sustained upon ultimate resolution will be accounted for prospectively in
the year of settlement in the statement of operations.
14. SUBSEQUENT EVENT
On March 9, 1998, the company ("MGI") agreed, subject to shareholder and
regulatory approvals, to combine with Discreet Logic ("Discreet"). Each
share of MGI will be exchanged for 0.162 shares of Discreet shares.
Outstanding options to purchase MGI common shares will be converted at this
exchange ratio into options to acquire Discreet shares. In connection with
the transaction, MGI will grant Discreet an option, exercisable under
certain conditions, to purchase shares up to approximately 20% of MGI's
outstanding shares. Depending on the closing date of the transaction, the
time within which the losses and investment tax credits expire will
accelerate. In the event that the above transaction is not consummated as
anticipated, under certain circumstances there could be substantial costs
incurred by the company.
D-11
<PAGE>
AUDITORS' REPORT
To the Shareholders of
MGI SOFTWARE CORP.
We have audited the balance sheet of MGI SOFTWARE CORP. as at January 31,
1996 and the statements of earnings and retained earnings (deficit) and changes
in financial position for the period then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
In our opinion, these financial statements present fairly, in all material
respects, the financial position of the Company as at January 31, 1996 and the
results of its operations and the changes in its financial position for the
period then ended in accordance with generally accepted accounting principles.
Ottawa, Ontario (Signed) COGAN + PARTNERS
CANADA Chartered Accountants
February 29, 1996
D-12
<PAGE>
MGI SOFTWARE CORP.
BALANCE SHEET
AS AT JANUARY 31, 1996
<TABLE>
<CAPTION>
<S> <C>
ASSETS
CURRENT
Cash and term deposits.................................................................................... $ 2,488,066
Accounts receivable....................................................................................... 431,728
Other receivables......................................................................................... 81,272
Inventories............................................................................................... 62,327
Investment tax credits receivable (Note 2)................................................................ 78,449
------------
3,141,842
CAPITAL ASSETS (Note 3)................................................................................... 3,880,796
------------
$ 7,022,638
------------
------------
LIABILITIES
CURRENT
Accounts payable and accrued charges...................................................................... $ 289,034
Debentures payable (Note 4) 1,500,000
------------
1,789,034
------------
COMMITMENT (Note 5)
CONTINGENT LIABLITY (Note 6)
SHAREHOLDERS' EQUITY
CAPITAL STOCK (Note 7).................................................................................... 5,910,771
RETAINED EARNING (DEFICIT)................................................................................ (677,167)
------------
5,233,604
------------
$ 7,022,638
------------
------------
</TABLE>
APPROVED BY THE DIRECTORS
<TABLE>
<S> <C>
(Signed) OREN ASHER (Signed) JOEL GOLDMAN
Director Director
</TABLE>
(THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS)
D-13
<PAGE>
MGI SOFTWARE CORP.
STATEMENT OF EARNINGS AND RETAINED EARNINGS (DEFICIT)
FOR THE PERIOD ENDED JANUARY 31, 1996
<TABLE>
<CAPTION>
<S> <C>
SALES..................................................................................................... $ 521,178
COST OF SALES............................................................................................. 105,803
------------
GROSS PROFIT.............................................................................................. 415,375
------------
EXPENSES
Advertising and promotion............................................................................... 180,798
Amortization............................................................................................ 422,810
Interest expense........................................................................................ 21,375
Investment tax credits (Note 2)......................................................................... (52,637)
Office and miscellaneous................................................................................ 43,728
Professional fees....................................................................................... 101,212
Research and development................................................................................ 242,915
Salaries and benefits................................................................................... 54,535
Sub-contracting and consulting.......................................................................... 80,996
Travel.................................................................................................. 39,033
------------
1,134,765
------------
EARNING (LOSS) FROM OPERATIONS............................................................................ (719,390)
OTHER ITEM
Interest income......................................................................................... 42,223
------------
NET EARNINGS (LOSS)....................................................................................... (677,167)
RETAINED EARNINGS, BEGINNING OF PERIOD.................................................................... --
------------
RETAINED EARNINGS (DEFICIT), END OF PERIOD................................................................ $ (677,167)
------------
------------
</TABLE>
(THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS)
D-14
<PAGE>
MGI SOFTWARE CORP.
STATEMENT OF CHANGES IN FINANCIAL POSITION
FOR THE PERIOD ENDED JANUARY 31, 1996
<TABLE>
<CAPTION>
<S> <C>
OPERATING ACTIVITIES
Net earnings (loss).................................................................................... $ (677,167)
Item not affecting cash
Amortization....................................................................................... 422,810
Net change in non-cash working capital
accounts relating to operations (Note 8)............................................................. (364,742)
-------------
Cash used for operating activities..................................................................... (619,099)
-------------
FINANCING ACTIVITIES
Issue of common shares................................................................................. 5,910,771
Issue of debentures.................................................................................... 1,500,000
-------------
Cash provided by financing activities.................................................................. 7,410,771
-------------
INVESTING ACTIVITIES
Purchase of capital assets............................................................................. (4,303,606)
-------------
Cash used for investing activities..................................................................... (4,303,606)
-------------
INCREASE IN CASH AND TERM DEPOSITS DURING THE PERIOD..................................................... 2,488,066
CASH AND TERM DEPOSITS, BEGINNING OF PERIOD.............................................................. --
-------------
CASH AND TERM DEPOSITS, END OF PERIOD.................................................................... $ 2,488,066
-------------
-------------
</TABLE>
(THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS)
D-15
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1996
1. SIGNIFICANT ACCOUNTING POLICIES
(a) Inventories are valued at the lower of cost (determined on an average
basis) and net realizable value.
(b) Capital assets are recorded at cost less related investment tax credits.
Amortization charges are calculated on the following basis:
<TABLE>
<S> <C>
Furniture and equipment....... 20% declining balance
Computer equipment............ 30% declining balance
Computer software............. straight line over 3 years
Trademarks.................... straight line over 2 years
Leasehold improvements........ straight line over 5 years
</TABLE>
2. INVESTMENT TAX CREDITS RECEIVABLE
The investment tax credits were generated from qualified research and
development expenditures during the period. Receipt of the investment tax
credits is subject to Revenue Canada Taxation's review of the eligibility of
the expenditures.
3. CAPITAL ASSETS
<TABLE>
<CAPTION>
ACCUMULATED
COST AMORTIZATION NET
--------- ------------ ---------
<S> <C> <C> <C>
Furniture and equipment................................................... $ 67,891 $ 3,981 $ 63,910
Computer equipment........................................................ 40,882 2,722 38,160
Computer software......................................................... 4,153,982 414,389 3,739,593
Trademarks................................................................ 8,702 1,450 7,252
Leasehold improvements.................................................... 32,149 268 31,881
--------- ------------ ---------
$4,303,606 $ 422,810 $3,880,796
--------- ------------ ---------
--------- ------------ ---------
</TABLE>
The cost of capital asset additions during the period was reduced by
investment tax credits of $25,812.
4. DEBENTURES PAYABLE
5.70% unsecured convertible debentures, due on demand, convertible into one
common share of the company and one-half of a common share purchase warrant
for each $1.10 principal amount of debentures. Each common share purchase
warrant entitles holders to acquire one common share of the company until
December 31, 1996 for a price of $1.50.
On February 26, 1996, the company retired debentures for cash having an
aggregate principal amount of $785,000. The remaining debentures of $715,000
were replaced by new 4% unsecured convertible debentures for the same
amount, due on demand, convertible into one common share of the company and
one common share purchase warrant for each $1.10 principal amount of
debentures. Each common share purchase warrant entitles holders to acquire
one common share of the company until December 31, 1996 for a price of
$1.50.
5. COMMITMENT
The company is currently negotiating a lease for its premises. Under the
terms of the "Offer to Lease" agreement, the company will be committed to
the lease expiring December 31, 2000 with an option to renew for an
additional five years.
Under the terms of the offer made, the rental payments, including estimated
operating costs, for the next five years would be as follows:
<TABLE>
<S> <C>
1997....................................................... $ 32,595
1998....................................................... 32,595
1999....................................................... 33,920
2000....................................................... 33,920
2001....................................................... 33,920
</TABLE>
D-16
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
JANUARY 31, 1996
6. CONTINGENT LIABILITY
The Company has been named defendant in a lawsuit for trademark
infringement, unfair competition and trademark dilution. As no amount has
been specified in the claim made by the plaintiff, an estimate of the amount
of the contingent loss cannot be made. In management's opinion, this claim
is without substantial merit and even if successful, would not have a
material impact on the company. Any loss resulting from the resolution of
this claim would be accounted for as a prior period adjustment.
7. CAPITAL STOCK
<TABLE>
<S> <C>
Authorized --
Unlimited number of common shares
Unlimited number of Class A voting special shares
Issued --
13,110,768 common shares.............................................................................. $5,910,771
---------
---------
</TABLE>
The following transactions affected the capital stock of the company during
the period:
(a) On October 3, 1995, 1 common share was issued for $1. Immediately after
this transaction, the common share was purchased for cancellation for $1.
(b) On October 3, 1995, 7,270,768 common shares were issued in exchange for
300,000 Class "B" preferred shares, redeemable and retractable for a
total amount of $7,270,768, of Ditek Software Corp. The transaction took
place under subsection 85(1) of the Income Tax Act. Also on October 3,
1995, Ditek Software Corp. purchased, for cancellation, the 300,000 Class
"B" preferred shares by issuing a promissory note in the amount of
$7,270,768.
(c) On October 3, 1995, the company purchased, from Ditek Software Corp.,
all rights, title and interest in computer software called "Photoworks"
with a fair market value of $7,270,768. This transaction took place under
subsection 85(1) of the Income Tax Act. The transaction was recorded at
the cost amount to Ditek Software Corp. which totalled $70,771. In
consideration, the company issued 1,000,000 Class A voting special shares
redeemable and retractable for a total amount of $7,270,768. Also on
October 3, 1995, the company redeemed these shares and issued a demand
promissory note for the redemption amount of $7,270,768.
The above-noted transactions were completed by the offset of the
promissory note received from Ditek Software Corp. with the promissory
note issued by MGI Software Corp.
(d) On September 23, 1995, the Company entered into an agreement to acquire
all rights, title and interest in computer software called "Calamus" for
an amount of $750,000. In consideration, the company issued 750,000
common shares on October 18, 1995. The company has agreed to purchase
these common shares for $1 per share at the holder's option in the event
the company's common shares are not publicly traded by December 31, 1996.
In addition, certain distribution rights for this software will remain
with the vendor until February 28, 1996.
(e) On October 2, 1995, the company entered into an agreement to purchase
all rights, title and interest in computer software called "MediaMontage:
MediaCapture" and "MediaMerge" for an amount of $1,100,000. In
consideration, the Company issued 1,100,000 common shares on October 21,
1995.
(f) On October 18, 1995 and October 20, 1995, the company entered into
agreements to purchase certain licenses and distribution rights to the
"Photoworks" computer software for an amount of $2,300,000. In
consideration, the company issued an aggregate of 1,900,000 common shares
on October 19, 1995 and October 20, 1995 and a promissory note for
$400,000.
(g) During the period, the company issued 1,990,000 common shares for $1 per
share of cash consideration and 100,000 common shares at $1 per share for
services provided to the company.
(h) On January 27, 1996 the company approved the issuance of stock options
to officers, directors and employees to purchase 2,289,000 common shares
of the company. The issuance of stock options is subject to shareholder
approval, the proposed amalgamation between the company and Globex
Biotechnologies Inc. becoming effective and the receipt of any necessary
regulatory approvals. The issue of each stock option will become
effective on the later of January 27, 1996 and the date the particular
optionee becomes an officer, director or employee of the company. The
stock options will have an exercise price of $1 per share and a term of
10 years.
D-17
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
JANUARY 31, 1996
8. NET CHANGE IN NON-CASH WORKING CAPITAL ACCOUNTS RELATING TO OPERATIONS
<TABLE>
<S> <C> <C>
Decrease
(increase) -- accounts receivable................................................................. $(431,728)
-- other receivables................................................................... (81,272)
-- inventories......................................................................... (62,327)
-- investment tax credits receivable................................................... (78,449)
Increase
(decrease) -- accounts payable and accrued charges................................................ 289,034
---------
$(364,742)
---------
---------
</TABLE>
9. OPERATIONS
MGI Software Corp. was incorporated on September 22, 1995 under the
provisions of the Ontario Business Corporations Act and commenced operations
on the same date. The fiscal year end of the company is January 31.
10. SUBSEQUENT EVENT
The company ("MGI") has entered into an agreement to amalgamate with Globex
Biotechnologies Inc. ("Globex"), a public company. Under the terms of the
proposed amalgamation:
(i) The common shares of Globex will be converted into common shares of the
amalgamated corporation ("Amalco") on the basis of one Amalco common
share for fifteen Globex common shares.
(ii) The common shares of MGI will be converted into common shares of Amalco
on the basis of one Amalco common share for one MGI common share.
(iii) The convertible demand debentures of MGI will be converted into
convertible demand debentures of Amalco on the basis of $1 principal
amount of Amalco debentures for $1 principal amount of MGI debentures.
Assuming no additional share issuances of either amalgamating company, after
the completion of the amalgamation, the existing common shareholders of MGI
will own 98.4% of all the issued and outstanding shares of Amalco. This
transaction is expected to be completed in March 1996.
11. INCOME TAXES
No provision has been made for the potential benefit of the reduction of
future income taxes due to the income tax loss for the period of $159,438,
which is due to expire in the year 2003, or certain amounts which have been
expensed in the financial statements totalling $523,844 which have not yet
been claimed for income tax purposes (mainly research and development costs
and amortization).
D-18
<PAGE>
SCHEDULE E
DISCREET LOGIC INC.
CONSOLIDATED FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
DISCREET LOGIC INC. AND SUBSIDIARIES
Report of Arthur Andersen & Cie................................................................................ E-2
Consolidated Balance Sheets.................................................................................... E-3
Consolidated Statements of Shareholders' Equity................................................................ E-4
Consolidated Statements of Operations.......................................................................... E-5
Consolidated Statements of Changes in Financial Position....................................................... E-6
Notes to Consolidated Financial Statements..................................................................... E-7
</TABLE>
E-1
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AUDITORS' REPORT
To the Shareholders of
Discreet Logic Inc.:
We have audited the consolidated balance sheet of Discreet Logic Inc. (a
Quebec company) as at June 30, 1997, and the consolidated statements of
operations, shareholders' equity and changes in financial position for the
eleven-month period ended June 30, 1997. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audit.
We conducted our audit in accordance with generally accepted auditing
standards in Canada. Those standards require that we plan and perform an audit
to obtain reasonable assurance whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation.
In our opinion, these consolidated financial statements present fairly, in
all material respects, the financial position of the Company as at June 30,
1997, and the results of its operations and the changes in its financial
position for the eleven-month period ended June 30, 1997 in accordance with
generally accepted accounting principles in Canada.
<TABLE>
<S> <C>
Montreal, Canada (Signed) ARTHUR ANDERSEN & CIE
August 12, 1997 General Partnership
(April 8, 1998 for Note 18) Chartered Accountants
</TABLE>
E-2
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
AS AT AS AT
DECEMBER 31, JUNE 30,
1997 1997
------------ ---------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents................................................................... $ 12,649 $ 31,668
Accounts receivable......................................................................... 29,559 26,893
Inventory --
Resale.................................................................................... 9,725 10,867
Demonstration............................................................................. 4,073 3,054
Income taxes receivable..................................................................... -- 448
Other current assets........................................................................ 4,291 3,889
------------ ---------
60,297 76,819
Property and equipment -- less accumulated depreciation and amortization...................... 9,583 7,728
Deferred income taxes......................................................................... 2,467 3,489
Other assets.................................................................................. 39,122 12,188
Assets held for resale........................................................................ 4,241 5,248
------------ ---------
$ 115,710 $ 105,472
------------ ---------
------------ ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable............................................................................ $ 15,948 $ 23,687
Accrued expenses............................................................................ 20,877 20,399
Deferred revenue............................................................................ 5,740 8,103
Customer deposits........................................................................... 426 1,360
Income taxes payable........................................................................ 5,707 4,734
------------ ---------
48,698 58,283
------------ ---------
DEFERRED INCOME TAXES......................................................................... 2,268 713
------------ ---------
COMMITMENTS AND CONTINGENCIES (Notes 11 and 14)
SHAREHOLDERS' EQUITY
Preferred shares -- no par value
Authorized -- unlimited number of shares
Issued and outstanding -- none
Common shares -- no par value
Authorized -- unlimited number of shares
Issued and outstanding -- 28,840,493 shares and 28,117,415, respectively.................. 91,827 80,402
Deficit..................................................................................... (24,874) (33,112)
Cumulative translation adjustment........................................................... (2,209) (814)
------------ ---------
Total shareholders' equity.............................................................. 64,744 46,476
------------ ---------
$ 115,710 $ 105,472
------------ ---------
------------ ---------
</TABLE>
Approved on behalf of the Board of Directors:
<TABLE>
<S> <C>
(Signed) RICHARD J. SZALWINSKI (Signed) THOMAS CANTWELL
Director Director
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
E-3
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
CUMULATIVE TOTAL
COMMON TRANSLATION SHAREHOLDERS'
SHARES AMOUNT DEFICIT ADJUSTMENT EQUITY
----------- ----------- ----------- ----------- -----------
(unaudited) (unaudited) (unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C> <C>
BALANCE, July 31, 1996............................ 27,699,426 $ 78,923 $ (35,884) $ (696) $ 42,343
Exercise of common stock options................ 207,627 640 -- -- 640
Issuance of shares through Employee Stock
Purchase Plan................................. 55,545 200 -- -- 200
Net income...................................... -- -- 1,153 -- 1,153
Change in cumulative translation
adjustment.................................... -- -- -- (65) (65)
----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 1996........................ 27,962,598 $ 79,763 $ (34,731) $ (761) $ 44,271
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
</TABLE>
<TABLE>
<CAPTION>
CUMULATIVE TOTAL
COMMON TRANSLATION SHAREHOLDERS'
SHARES AMOUNT DEFICIT ADJUSTMENT EQUITY
------------ ----------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE, July 31, 1996............................. 27,699,426 $ 78,923 $ (35,884) $ (696) $ 42,343
Exercise of common stock options................. 321,577 1,128 -- -- 1,128
Issuance of shares through Employee Stock
Purchase Plan.................................. 96,412 351 -- -- 351
Net income....................................... -- -- 2,772 -- 2,772
Change in cumulative translation
adjustment..................................... -- -- -- (118) (118)
------------ ----------- ----------- ----------- -------------
BALANCE, June 30, 1997............................. 28,117,415 $ 80,402 $ (33,112) $ (814) $ 46,476
------------ ----------- ----------- ----------- -------------
------------ ----------- ----------- ----------- -------------
</TABLE>
<TABLE>
<CAPTION>
CUMULATIVE TOTAL
COMMON TRANSLATION SHAREHOLDERS'
SHARES AMOUNT DEFICIT ADJUSTMENT EQUITY
----------- ----------- ----------- ----------- -----------
(unaudited) (unaudited) (unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C> <C>
BALANCE, June 30, 1997............................ 28,117,415 $ 80,402 $ (33,112) $ (814) $ 46,476
Exercise of common stock options................ 137,421 559 -- -- 559
Issuance of shares through Employee Stock
Purchase Plan................................. 30,657 217 -- -- 217
Issuance of shares as part of the acquisition of
D-Vision...................................... 555,000 10,649 -- -- 10,649
Net income...................................... -- -- 8,238 -- 8,238
Change in cumulative translation
adjustment.................................... -- -- -- (1,395) (1,395)
----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 1997........................ 28,840,493 $ 91,827 $ (24,874) $ (2,209) $ 64,744
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
E-4
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SIX-MONTH FIVE-MONTH ELEVEN-MONTH
PERIOD ENDED PERIOD ENDED PERIOD ENDED
DECEMBER 31, DECEMBER 31, JUNE 30,
1997 1996 1997
------------ ------------ ------------
(unaudited) (unaudited)
<S> <C> <C> <C>
TOTAL REVENUES.................................... $ 75,673 $ 40,096 $ 101,923
COST OF REVENUES.................................. 30,827 20,290 47,571
------------ ------------ ------------
Gross profit.................................... 44,846 19,806 54,352
------------ ------------ ------------
OPERATING EXPENSES
Research and development, net of tax credits of
$718, $400 and $696, respectively............. 11,663 4,253 9,980
Sales and marketing............................. 15,840 10,627 23,206
General and administrative...................... 3,896 2,705 6,396
Litigation and related settlement expenses (Note
4)............................................ -- -- 6,500
------------ ------------ ------------
Total operating expenses...................... 31,399 17,585 46,082
------------ ------------ ------------
Operating income.............................. 13,447 2,221 8,270
------------ ------------ ------------
OTHER INCOME (EXPENSE)
Interest income................................. 399 489 1,234
Interest expense................................ (43) (53) (55)
Foreign currency exchange gain (loss)........... 307 458 (188)
------------ ------------ ------------
Total other income.......................... 663 894 991
------------ ------------ ------------
Income before provision for income taxes...... 14,110 3,115 9,261
PROVISION FOR INCOME TAXES........................ 5,872 1,962 6,489
------------ ------------ ------------
Net income.................................... $ 8,238 $ 1,153 $ 2,772
------------ ------------ ------------
------------ ------------ ------------
Earnings per share (Note 17)...................... $ 0.29 $ 0.04 $ 0.10
------------ ------------ ------------
------------ ------------ ------------
Weighted average common shares outstanding........ 28,745,695 27,852,370 27,947,807
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
E-5
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS)
<TABLE>
<CAPTION>
SIX-MONTH FIVE-MONTH ELEVEN-MONTH
PERIOD ENDED PERIOD ENDED PERIOD ENDED
DECEMBER 31, DECEMBER 31, JUNE 30,
1997 1996 1997
------------ ------------ ------------
(unaudited) (unaudited)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income...................................... $ 8,238 $ 1,153 $ 2,772
Adjustments to reconcile net income to cash
provided by operating activities --
Depreciation and amortization................. 8,546 2,597 6,155
Deferred income taxes......................... 2,577 (463) 503
Write-off of assets for restructuring......... 109 -- --
Changes in assets and liabilities --
Settlement of class action litigations........ (10,800) -- --
Insurance proceeds related to class action
litigation.................................. 3,459 -- --
Accounts receivable........................... (1,783) 2,614 (10,820)
Inventory..................................... 935 9,089 2,986
Income taxes receivable....................... 448 2,907 2,743
Other current assets.......................... (255) (527) (248)
Accounts payable and accrued expenses......... (13,347) (2,415) 15,135
Deferred revenue.............................. (2,363) 3,294 3,334
Income taxes payable.......................... 973 -- 4,734
Customer deposits............................. (933) (934) (1,258)
Due to related parties........................ -- (25) (25)
------------ ------------ ------------
Net cash provided by (used for) operating
activities................................ (4,196) 17,290 26,011
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment.............. (4,350) (3,084) (6,265)
Proceeds from disposal of property and
equipment..................................... 818 -- 5
Cash paid for D-Vision acquisition and related
costs......................................... (10,342) -- (2,481)
Cash paid for Denim acquisition and related
costs......................................... -- -- (9,126)
------------ ------------ ------------
Net cash used in investing activities......... (13,874) (3,084) (17,867)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from the exercise of stock options..... 559 640 1,128
Proceeds from the employee stock purchase
plan.......................................... 217 200 351
------------ ------------ ------------
Net cash provided by financing activities..... 776 840 1,479
------------ ------------ ------------
Foreign exchange effect on cash................... (1,725) (437) 387
------------ ------------ ------------
Increase (decrease) in cash and cash
equivalents..................................... (19,019) 14,609 10,010
CASH AND CASH EQUIVALENTS, beginning of period.... 31,668 21,658 21,658
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, end of period.......... $ 12,649 $ 36,267 $ 31,668
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
E-6
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
(INFORMATION AS AT AND FOR THE SIX-MONTH PERIOD ENDED DECEMBER 31, 1997 AND FOR
THE FIVE-MONTH PERIOD ENDED DECEMBER 31, 1996 IS UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
1. OPERATIONS
Discreet Logic Inc. (the "Company" or "Discreet") was incorporated under
Part 1A of the Quebec Companies Act on September 10, 1991. The Company and
its subsidiaries develop, assemble, market and support non-linear, digital
systems and software for creating, editing and compositing imagery and
special effects for film, video and HDTV. The Company's systems and software
are utilized by creative professionals, for a variety of applications,
including feature films, television programs, commercials, music videos,
interactive game production and live broadcasting.
The Company sells its systems and other products through its direct sales
organization, as well as through distributors and resellers. The Company
markets and sells its systems directly in North America and in certain
European and Pacific Rim countries. Sales activities in North America are
conducted from the Company's Montreal headquarters, sales offices in Los
Angeles, New York, and Chicago and field representatives based in Boston,
San Francisco and Atlanta. In fiscal 1996, the Company opened sales offices
in India, Hong Kong and Japan. The Company also markets its systems through
sales offices located in the United Kingdom, France, Germany, Singapore and
Brazil and through a network of distributors in over 60 countries.
The success of the Company is subject to a number of risks and
uncertainties, including, without limitation, the Company's ability to
successfully develop, introduce and gain customer acceptance of existing and
new or enhanced products; the need for the continued development of the
market for the Company's systems; the ability of the Company to expand its
current market to include additional applications and develop new products
for related markets; the risk that as the Company enters new markets, the
distribution channels, technical requirements and levels and basis of
competition may be different from those in the Company's current markets;
the presence of competitors with greater financial, technical,
manufacturing, marketing and distribution resources; the risk that the
products and technologies acquired by the Company through acquisitions will
not be successful, achieve market acceptance or be successfully integrated
with the Company's existing products and business; the risk of quarterly
fluctuations in the Company's operating results; the risk of the Company's
reliance on Silicon Graphics, Inc. ("SGI") for the workstations included in
the Company's systems including the impact of the timing of the development
and release of SGI products as well as unforeseen difficulties associated
with adapting the Company's products to future SGI products; the risk that
the Company derives a significant portion of its revenues from foreign
sales; the Company's reliance principally on unregistered copyrights and
trade secrets to protect its intellectual property; the risk that the
Company's direct sales efforts may compete with those of its indirect
channels; the risk of the Company's reliance on SGI as the sole source for
video input/output cards used in the Company's systems and the risk
resulting from the requirement of the Company's OnLINE software for a
videographic card manufactured solely by Truevision, Inc.; the Company's
dependence on key management and technical employees; market price
fluctuations due to quarter-to-quarter variations in the Company's operating
results, announcements of technological innovations or new products by the
Company or its competitors and the historical fluctuations in market prices
of technology companies generally; and other risks detailed from time to
time in the Company's filings with the Securities and Exchange Commission of
the United States.
2. SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements reflect the application
of the following significant accounting policies, as described below and
elsewhere in the notes to consolidated financial statements. These
consolidated financial statements are prepared in accordance with generally
accepted accounting principles in Canada, and are presented in United States
dollars ("U.S. Dollars").
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the consolidated financial statements, and the reported amounts of
revenues and expenses during the reporting periods. Actual results may
differ from these estimates.
(a) CHANGE OF FISCAL YEAR
On January 9, 1997, the Board of Directors of the Company approved the
change of the Company's fiscal year end from July 31 to June 30. This
change was effective beginning with the Company's second fiscal quarter
of 1997. The consolidated financial statements are presented for the
six-month period ended December 31, 1997, the five-month period ended
December 31, 1996 and for the eleven-month period ended June 30, 1997.
The Company prepares consolidated financial statements, remeasures
accounts in foreign currencies to reflect changes in exchange rates, and
examines and adjusts certain reserve accounts at the end of each quarter.
Therefore, it is not practicable to recast the
E-7
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1997
(INFORMATION AS AT AND FOR THE SIX-MONTH PERIOD ENDED DECEMBER 31, 1997 AND FOR
THE FIVE-MONTH PERIOD ENDED DECEMBER 31, 1996 IS UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
prior five-month period's results to reflect the current six-month fiscal
period. Consequently, the results for the six-month period ended December
31, 1997 are not directly comparable with those for the five-month period
ended December 31, 1996.
(b) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All subsidiaries are wholly owned. All significant
intercompany accounts and transactions have been eliminated upon
consolidation.
(c) REVENUE RECOGNITION
The Company recognizes revenue from software licenses, and the related
hardware and peripherals, upon shipment of the products. The Company
recognizes revenue from post contract customer support and other related
services ratably, as the obligations are fulfilled, or when the related
services are performed. Post contract customer support, training,
installation, systems integration and rental services, are performed
primarily under separately priced arrangements under which the Company
has recorded revenues of $7,542, $5,294 and $13,606 for the six-month
period ended December 31, 1997, the five-month period ended December 31,
1996 and the eleven-month period ended June 30, 1997, respectively. In
cases where the Company has delivered hardware and/or software to
customers and has insignificant or non critical vendor obligations
related to these deliveries, the revenue attributable to such obligations
has been deferred until such obligations have been fulfilled.
(d) RESEARCH AND DEVELOPMENT EXPENSES
The Company charges to operations research and development costs as
incurred and presents such expenses net of income tax credits from the
Canadian federal and Quebec provincial governments (see Note 6). Software
development costs are considered for capitalization when technological
feasibility is established. The Company sells software in a market that
is subject to rapid technological change, new product introductions and
changing customer needs. Accordingly, the Company has not capitalized
software development costs due to its inability to estimate the useful
life of software under development.
(e) TRANSLATION OF FOREIGN CURRENCIES
The Company's management has elected to present these consolidated
financial statements in U.S. dollars. The financial statements of the
Company and its subsidiaries are translated from their functional
currency into the reporting currency, the U.S. dollar, utilizing the
current rate method. Accordingly, assets and liabilities are translated
at exchange rates in effect at the end of the period, and revenues and
expenses are translated at the weighted average exchange rate during the
period. All cumulative translation gains or losses from the translation
into the Company's reporting currency are included as a separate
component of shareholders' equity in the consolidated balance sheets.
(f) CONCENTRATION OF CREDIT RISK
During fiscal 1997, the Company amended and restated its Maximum
Liability Agreement with a leasing company. The agreement provides that
the Company is contingently liable up to a maximum percentage of the
remaining principal payments outstanding related to the purchase of the
Company's products by customers financed by said leasing company. The
maximum liability is contingent on certain factors as defined in the
agreement. As at December 31, 1997 and June 30, 1997, the Company has
accrued $917 and $619, respectively, the maximum amount of the contingent
liability as a charge to general and administrative expenses.
The Company has no other significant off-balance sheet concentration of
credit risk such as foreign exchange contracts, option contracts or other
foreign currency hedging arrangements. The Company maintains the majority
of cash balances with three financial institutions and its accounts
receivable credit risk is not concentrated within any geographic area.
There were no accounts receivable from a single customer which exceeded
10 percent of total accounts receivable as at December 31, 1997 or as at
June 30, 1997.
E-8
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1997
(INFORMATION AS AT AND FOR THE SIX-MONTH PERIOD ENDED DECEMBER 31, 1997 AND FOR
THE FIVE-MONTH PERIOD ENDED DECEMBER 31, 1996 IS UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(g) CASH EQUIVALENTS
Cash equivalents are carried at cost, which approximates market value.
Cash equivalents are short-term, highly liquid investments with original
maturities of less than three months. Cash equivalents consist of
commercial paper and money market mutual funds as at June 30, 1997. There
were no cash equivalents at December 31, 1997.
(h) INVENTORY
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.
(i) PROPERTY AND EQUIPMENT
The Company provides for depreciation and amortization using the
straight-line and declining-balance methods over the estimated useful
lives of the assets as follows:
<TABLE>
<CAPTION>
JUNE 30,
ASSET CLASSIFICATION ESTIMATED USEFUL LIFE 1997
- --------------------------------------------------- ---------------------------------- DECEMBER 31, -----------
1997
-------------
(unaudited)
<S> <C> <C> <C>
Computer equipment, video equipment and software... 2-5 Years $ 17,494 $ 14,375
Leasehold improvements............................. Shorter of term of lease or useful
life 1,264 1,223
Furniture and fixtures............................. 5 years 2,204 1,798
Equipment under capital lease...................... 1,438 --
------------- -----------
22,400 17,396
Less -- Accumulated depreciation and
amortization..................................... (12,817) (9,668)
------------- -----------
$ 9,583 $ 7,728
------------- -----------
------------- -----------
</TABLE>
(j) OTHER ASSETS
Other assets include purchased in-process research and development,
acquired technology and goodwill. These assets result from various
business acquisitions. The amounts attributed to purchased in-process
research and development and acquired technology were determined by
independent valuations. Goodwill represents the excess of purchase price
over the fair market value of net assets acquired. Amortization is
calculated using the straight-line method over the following periods:
<TABLE>
<CAPTION>
<S> <C>
Purchased in-process research and development.................................. 3 years
Acquired technology............................................................ 5 years
Goodwill....................................................................... 3 years
</TABLE>
Management reviews the recoverability of these assets based on expected
future earnings and where applicable, writes such amounts down to net
realizable value.
E-9
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1997
(INFORMATION AS AT AND FOR THE SIX-MONTH PERIOD ENDED DECEMBER 31, 1997 AND FOR
THE FIVE-MONTH PERIOD ENDED DECEMBER 31, 1996 IS UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
3. OTHER ASSETS
Other assets consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1997 1997
------------ --------
(unaudited)
<S> <C> <C>
Purchased in-process research and development..... $ 36,600 $ 9,800
Acquired technology............................... 6,790 2,700
Goodwill.......................................... 1,586 315
------------ --------
44,976 12,815
Less -- Accumulated depreciation and
amortization.................................... 5,854 627
------------ --------
$ 39,122 $12,188
------------ --------
------------ --------
</TABLE>
4. LITIGATION AND RELATED SETTLEMENT EXPENSES
SECURITIES LITIGATION
On May 29, 1996, a lawsuit entitled SANDRA ESNER AND JERRY KRIM, ON BEHALF
OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED, VS. [...]DISCREET LOGIC
INC., ET AL., case No. 978584, was filed in the Superior Court of the State
of California, City and County of San Francisco. Named as defendants are the
Company, certain of the Company's former and existing directors, officers,
and affiliates, and certain underwriters and financial analysts. The
plaintiffs purport to represent a class of all persons who purchased the
Company's common stock between September 13, 1995, and May 1, 1996. The
complaint alleges violations of California law through material
misrepresentations and omissions, among other things. The Company believes
that the allegations in the complaint are without merit and has defended the
lawsuit vigorously.
On June 13, 1996, a lawsuit entitled BRUCE FRIEDBERG, ON BEHALF OF HIMSELF
AND ALL OTHERS SIMILARLY SITUATED, VS. DISCREET LOGIC INC., ET AL., civ. No.
96-11232-EFH, was filed in the United States District Court, District of
Massachusetts. Named as defendants are the Company and certain of the
Company's former and existing directors and officers. The plaintiff purports
to represent a class of all persons who purchased the Company's common stock
between November 14, 1995, and February 13, 1996. On October 11, 1996, the
plaintiff filed an amended complaint which asserts substantially the same
factual allegations as the first complaint and proposes the identical class
period. The complaint alleges violations of the United States Federal
Securities law through material misrepresentations and omissions. The
Company believes that the allegations in the complaint are without merit and
has defended the lawsuit vigorously.
On April 29, 1997, a lawsuit entitled ANTON PAPARELLA, SANDRA ESNER AND
GEOFFREY L. SHERWOOD, ON BEHALF OF THEMSELVES AND ALL OTHERS SIMILARLY
SITUATED VS. DISCREET LOGIC INC., ET AL., case No. C-97-1570, was filed in
the United States District Court, Northern District of California. Named as
defendants are the Company and certain of Company's former and existing
officers, directors and affiliates, and certain underwriters. The complaint
asserts, in all material respects, the same factual allegations and proposes
the same class period as the above-described California state court
complaint filed in May 1996, except asserts claims under federal securities
law instead of state law. The Company believes that the allegations in the
California federal complaint are without merit and has defended the lawsuit
vigorously.
In the year ended July 31, 1996, the Company had provided a $2,506
litigation reserve for legal costs associated with defending the class
action lawsuits. During the eleven-month period ended June 30, 1997, the
Company recorded a provision of $6,500 to accrue the additional estimated
settlement costs to be borne by the Company. At June 30, 1997, accrued
expenses included a reserve of $8,187 for these settlement costs.
On or about November 25, 1997, a settlement of all three shareholder class
actions received final court approval. Under the $10,800 settlement, the
Company contributed approximately $7,400 from its own funds, with the
remainder provided by insurance.
5. DEMAND LINE OF CREDIT, LEASING AND TAX CREDIT FACILITIES
In August of 1997, the Company amended its revolving demand line of credit
and leasing facility with its bank. The new agreement provides for a
revolving demand line of credit under which it can borrow up to CDN$7,000
(approximately $4,885 at December 31, 1997). Advances under the line accrue
interest monthly at the Canadian prime rate (6.0% at December 31, 1997) plus
0.25%. Additionally, the agreement provides for a CDN$600 (approximately
$419 at December 31,1997) demand leasing facility, and a
E-10
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1997
(INFORMATION AS AT AND FOR THE SIX-MONTH PERIOD ENDED DECEMBER 31, 1997 AND FOR
THE FIVE-MONTH PERIOD ENDED DECEMBER 31, 1996 IS UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
5. DEMAND LINE OF CREDIT, LEASING AND TAX CREDIT FACILITIES (CONTINUED)
CDN$600 (approximately $419 at December 31, 1997) demand research and
development tax credit facility. Advances under these facilities accrue
interest monthly at the Canadian prime rate (6.0% at December 31, 1997) plus
1%. The line and facilities are secured by essentially all of the Company's
North American assets. As additional security, the Company assigned to the
bank its insurance on these assets. The Company is required to maintain
certain financial ratios, including minimum levels of working capital, debt
service coverage and equity to asset ratios. As of December 31, 1997, no
amounts were outstanding under the demand line of credit, the demand
leasing, or the demand research and development tax credit facilities.
6. CANADIAN FEDERAL AND PROVINCIAL INCOME TAX CREDITS
The Company is entitled to research and development incentives in the form
of income tax credits from the Canadian federal government ("Federal") and
from the Province of Quebec ("Provincial"). Federal income tax credits are
received on qualified Canadian research and development expenditures and
equipment purchases. Provincial income tax credits are received on qualified
research and development salaries in the Province of Quebec. The Federal and
Provincial income tax credits are earned at 20% of qualified research and
development expenditures. Additionally, the Federal credit may be limited to
a credit against income taxes payable.
The Company recorded $718, $400 and $696 of income tax credits as a
reduction of research and development expenses for the six-month period
ended December 31, 1997, for the five-month period ended December 31, 1996
and for the eleven-month period ended June 30, 1997, respectively. These
income tax credits represent credits earned based on qualifying research and
development expenditures. In addition, the Company recorded $337, $35 and
$196 of income tax credits as a reduction in the carrying value of property
and equipment for the six-month period ended December 31, 1997, for the
five-month period ended December 31, 1996 and for the eleven-month period
ended June 30, 1997, respectively. These income tax credits represent
credits earned based on qualifying property and equipment purchases.
7. SHAREHOLDERS' EQUITY
The Company has never declared or paid cash dividends and does not
anticipate paying any cash dividends on its capital stock in the foreseeable
future. In the event cash dividends are declared or paid, the Company
anticipates that they would be declared and paid in U.S. dollars. Part 1A of
the Quebec Companies Act prohibits the Company from paying dividends that
would prevent it from discharging its liabilities when due or that would
bring the book value of its assets to an amount less than the sum of its
liabilities and its issued and paid-up share capital account. At December
31, 1997, the Company could not distribute any dividends.
8. STOCK OPTION AND STOCK PURCHASE PLANS
(a) RESTRICTED STOCK AND STOCK OPTION PLAN
On June 14, 1994, the Company's Board of Directors approved the
establishment of the 1994 Restricted Stock and Stock Option Plan (the
"Discreet Stock Option Plan") for the Company's officers, employees,
consultants and directors. Under the Discreet Stock Option Plan, the
Compensation Committee of the Board of Directors (the "Compensation
Committee") may grant stock options for a maximum of 5,000,000 common
shares. Under the terms of the Discreet Stock Option Plan, the purchase
price, which approximates fair market value, and vesting schedule
applicable to each option grant is determined by the Compensation
Committee.
On August 12, 1996, the Company's Board of Directors authorized the
repricing of 106,600 stock options previously granted under the Discreet
Stock Option Plan. The repricing provided for the exercise price of the
106,600 options to be reduced to $6.375 per share, representing the fair
value per common share on the date of repricing. Prior to the repricing,
such options had exercise prices ranging from $19.25 to $28.50 per share.
In exchange for the repriced options, the 159,900 stock options remaining
from these grants were forfeited.
On November 20, 1997, the shareholders approved an amendment to the
Company's 1994 Amended and Restated Restricted Stock and Stock Option
Plan to reserve an additional 2,000,000 shares of common stock for
issuance under this plan.
E-11
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1997
(INFORMATION AS AT AND FOR THE SIX-MONTH PERIOD ENDED DECEMBER 31, 1997 AND FOR
THE FIVE-MONTH PERIOD ENDED DECEMBER 31, 1996 IS UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
8. STOCK OPTION AND STOCK PURCHASE PLANS (CONTINUED)
(b) 1995 NONEMPLOYEE DIRECTOR STOCK OPTION PLAN
On March 27, 1995, the Company's Board of Directors adopted, and in April
1995, the shareholders approved, the 1995 Nonemployee Director Stock
Option Plan (the "Director Plan"). Under the Director Plan, the
Compensation Committee may grant options to purchase up to 200,000 common
shares to nonemployee directors of the Company. The Director Plan
authorizes the grant (a) to each person who becomes a member of the Board
of Directors and who is not an employee, officer or direct and indirect
owner of 5% or more of the common shares of the Company (a "Non-Employee
Director"), on the date such person is first elected to the Board of
Directors without further action by the Compensation Committee, of an
option to purchase 20,000 common shares and (b) to each person receiving
an option pursuant to clause (a) who is a Non-Employee Director on the
fifth anniversary of the date such person was first elected to the Board
of Directors, during the term of the Director Plan, of an option to
purchase 15,000 common shares, provided that such person has continuously
served as a Non-Employee Director during such 5-year period. The exercise
price will be the fair market value at the date of grant and the options
will expire 10 years from the date of grant. All options vest in three
equal annual installments, with the first vesting on the date of grant.
As of December 31, 1997, 60,000 options were granted and outstanding at
fair market value under the Director Plan.
(c) 1995 EMPLOYEE STOCK PURCHASE PLAN
On March 27, 1995, the Company's Board of Directors adopted, and in April
1995, the shareholders approved, the 1995 Employee Stock Purchase Plan,
whereby the Company has reserved and may issue to employees up to an
aggregate of 300,000 common shares in semiannual offerings over a ten
year period. Common shares are sold at 85% of fair market value. As of
December 31, 1997, 143,797 shares had been issued under the plan.
(d) 1997 SPECIAL LIMITED NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN
On February 10, 1997 the Company's Board of Directors adopted the 1997
Special Limited Non-Employee Director Stock Option Plan (the "1997
Plan"). Under the 1997 Plan, options to purchase 10,000 of the Company's
common shares were granted to each of two of the Company's non-employee
directors at the Fair Market Value (as defined in the 1997 Plan) of the
shares on the date of the grant, February 10, 1997. The total number of
common shares originally available for grant under the 1997 Plan was
20,000. The options granted pursuant of the 1997 Plan expire 10 years
from the date of grant and vest in three equal annual installments. As of
December 31, 1997, 20,000 options were granted and outstanding under the
1997 Plan.
(e) STOCK OPTION ACTIVITY
The following is a summary of all stock option activity:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996 JUNE 30, 1997
---------------------- ---------------------- ----------------------
PRICE PER PRICE PER PRICE PER
SHARES SHARE SHARES SHARE SHARES SHARE
--------- ----------- --------- ----------- --------- -----------
(unaudited) (unaudited)
<S> <C> <C> <C> <C> <C> <C>
Beginning outstanding, June 30,
1997, July 31, 1996 and July 31,
1996, respectively................ 2,505,913 $0.05-25.00 2,744,646 $0.05-28.50 2,744,646 $0.05-28.50
Options granted..................... 937,571 $8.94-24.25 1,030,036 $4.50- 7.38 1,689,638 $4.50-17.50
Options exercised................... (137,421) $0.05- 6.38 (207,627) $0.05- 6.38 (321,577) $0.05- 6.38
Options cancelled................... (31,770) $4.50- 6.38 (1,516,840) $0.05-28.50 (1,606,794) $0.05-28.50
--------- --------- ---------
Ending outstanding, December 31,
1997, December 31, 1996 and June
30, 1997, respectively............ 3,274,293 $0.05-25.00 2,050,215 $0.05-26.25 2,505,913 $0.05-25.00
--------- --------- ---------
--------- --------- ---------
Exercisable......................... 470,223 $0.05-25.00 410,942 $0.05-26.25 389,832 $0.05-25.00
--------- --------- ---------
--------- --------- ---------
</TABLE>
Options granted under these plans may be exercised over specific periods
not to exceed 10 years from the date granted.
E-12
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1997
(INFORMATION AS AT AND FOR THE SIX-MONTH PERIOD ENDED DECEMBER 31, 1997 AND FOR
THE FIVE-MONTH PERIOD ENDED DECEMBER 31, 1996 IS UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
9. RELATED PARTY TRANSACTIONS
(a) BEHAVIOUR ENTERTAINMENT INC. ("BEHAVIOUR")
As of December 31, 1997 and June 30, 1997, the Company had trade
receivables of $97 and $113 respectively, from Behaviour, a company owned
by the Company's Chairman and Chief Executive Officer. The Company also
purchased marketing services, in the amount of $250 from Behaviour in the
six-month period ended December 31, 1997.
(b) OTHER RELATED PARTY TRANSACTIONS
In July 1997, the Company agreed to rent space for its new headquarters
in Montreal from TGR Zone Corporation ("TGR Zone"), a company indirectly
owned by Discreet Logic's Chairman and Chief Executive Officer. As part
of this agreement, TGR Zone will assume the Company's lease commitment at
its previous Montreal location. The agreement provides that the Company
will lease approximately 54,115 square feet of space at approximately CDN
$13.00 (or approximately $9.09 at December 31, 1997) per square foot per
annum subject to normal escalation clauses. The lease is set to expire
July 2007. The commitments related to this lease are disclosed in Note
11.
10. PROVISION FOR INCOME TAXES
The reconciliation between the Canadian federal statutory income tax rate
and the effective tax rate is as follows:
<TABLE>
<CAPTION>
SIX-MONTH FIVE-MONTH ELEVEN-MONTH
PERIOD ENDED PERIOD ENDED PERIOD ENDED
DECEMBER 31, DECEMBER 31, JUNE 30,
1997 1996 1997
------------ ------------ ------------
(unaudited) (unaudited)
<S> <C> <C> <C>
Provision at the Canadian federal statutory
rate............................................ 38.0% 38.0% 38.0%
Foreign taxes..................................... 12.2 14.0 3.5
Effect of not utilizing foreign subsidiaries' tax
losses.......................................... 2.0 10.0 9.2
Effect of basis differences not benefited......... 12.1 4.9 27.8
Provincial taxes, net of federal tax abatements... (2.6) (1.9) (2.0)
Utilization of net operating loss................. (14.0) -- (10.2)
Other items....................................... (6.1) (2.0) 3.7
----- --- -----
41.6% 63.0% 70.0%
----- --- -----
----- --- -----
</TABLE>
As at December 31, 1997, the Company has $10,697 of cumulative foreign net
operating loss carryforwards which may be available to reduce future income
tax liabilities in those jurisdictions. The loss carryforwards will expire
beginning June 30, 2001.
These net operating loss carryforwards are subject to review and adjustment
by the respective tax authorities and may be limited in certain cases upon a
significant ownership change of the corporation, as defined.
The Company has not recorded the tax benefit relating to certain foreign net
operating loss carryforwards and to litigation and related settlement
expenses because their future realizability is uncertain.
E-13
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1997
(INFORMATION AS AT AND FOR THE SIX-MONTH PERIOD ENDED DECEMBER 31, 1997 AND FOR
THE FIVE-MONTH PERIOD ENDED DECEMBER 31, 1996 IS UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
11. COMMITMENTS AND CONTINGENCIES
(a) LEASE COMMITMENTS
The Company has both operating and capital lease commitments for certain
facilities and equipment which expire, at various dates, through June
2007. The following schedule outlines the future minimum rental payments
under these leases at December 31, 1997:
<TABLE>
<CAPTION>
OPERATING
LEASES
-----------
(unaudited)
<S> <C>
Period ended December 31,
1998............................................................................. $ 1,968
1999............................................................................. 1,553
2000............................................................................. 1,432
2001............................................................................. 1,322
2002 and thereafter.............................................................. 6,074
-----------
Total minimum lease payments....................................................... $ 12,349
-----------
-----------
</TABLE>
The above commitments include leases for locations which the Company
plans to close under the restructuring plan (see Note 16).
Rental expenses related to the operating leases were approximately
$1,090, $725 and $1,600 for the six-month period ended December 31, 1997,
the five-month period ended December 31, 1996 and the eleven-month period
ended June 30, 1997, respectively. Included in the minimum lease payment
commitment is approximately CDN$12,597 (approximately $8,806 at December
31, 1997) representing future payment due to a related party from which
the Company leases office space in Montreal.
(b) LETTERS OF GUARANTEE
The Company has provided letters of guarantee in the amount of $3,532 and
$329 as of December 31, 1997 and June 30, 1997, respectively.
(c) CONTINGENT CONSIDERATION
The Company has agreed to pay the previous shareholders of Brughetti
Corporation, a Canadian corporation acquired in 1995, up to an additional
$5,500 as contingent purchase price payable in cash or securities of the
Company, at the sole option of the Company. The contingent purchase price
is payable in three annual installments, beginning October 1996, and is
based upon a percentage of the amount by which revenues derived from
future sales of products and technologies purchased from Brughetti exceed
certain minimum annual revenues. In the event that the revenues, as
defined, exceed certain minimum annual revenue levels in fiscal 1996,
1997 and 1998, the contingent consideration payable would be up to
$1,500, $2,000 and $2,000 for fiscal 1996, 1997 and 1998, respectively.
If the minimum annual revenue levels for any fiscal year are not reached,
no payments are due for that year, provided, however, that the second and
third payments are subject to upward adjustment in the event that the
initial revenue thresholds are not met but revenue thresholds related to
the subsequent fiscal years are exceeded. In no event, however, will the
contingent consideration payable exceed an aggregate of $5,500. The
Company did not meet the minimum revenue levels for fiscal 1996 or for
the eleven-month period ended June 30, 1997, and no additional payment is
currently due.
Under the restructuring plan, the Company has discontinued the
development of the Brughetti products.
12. FINANCIAL INFORMATION BY GEOGRAPHIC AREA
The Company operates in one industry segment primarily digital image
processing solution systems for creating, editing, and compositing special
visual effects for film and video, including training and other services
incident to these products.
E-14
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1997
(INFORMATION AS AT AND FOR THE SIX-MONTH PERIOD ENDED DECEMBER 31, 1997 AND FOR
THE FIVE-MONTH PERIOD ENDED DECEMBER 31, 1996 IS UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
12. FINANCIAL INFORMATION BY GEOGRAPHIC AREA (CONTINUED)
Revenues by geographic destination and as a percentage of total revenues are
as follows:
<TABLE>
<CAPTION>
SIX-MONTH FIVE-MONTH ELEVEN-MONTH
PERIOD ENDED PERIOD ENDED PERIOD ENDED
DECEMBER 31, DECEMBER 31, JUNE 30,
1997 1996 1997
------------ ------------ ------------
(unaudited) (unaudited)
<S> <C> <C> <C>
GEOGRAPHIC AREA BY DESTINATION
North America................................... $ 35,708 $ 18,317 $ 43,752
Europe.......................................... 22,511 12,519 36,839
Pacific Rim..................................... 13,836 6,812 15,396
Other........................................... 3,618 2,448 5,936
------------ ------------ ------------
$ 75,673 $ 40,096 $ 101,923
------------ ------------ ------------
------------ ------------ ------------
GEOGRAPHIC AREA BY DESTINATION
North America................................... 47% 46% 42.9%
Europe.......................................... 30 31 36.1
Pacific Rim..................................... 18 17 15.2
Other........................................... 5 6 5.8
------------ ------------ ------------
100% 100% 100%
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
Revenues, net income and identifiable assets for the Company's Canadian,
U.S., U.K., Germany, French and other operations are as follows:
Intercompany transfers between geographic areas are at prices that
approximate arm's length transactions. Expenses incurred in one geographic
area that benefit other areas have been allocated based upon services
utilized.
<TABLE>
<CAPTION>
CANADA U.S. U.K. FRANCE GERMANY OTHER ELIMINATION CONSOLIDATED
--------- --------- --------- --------- ----------- --------- ----------- -----------
(unaudited)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Six-month period ended
December 31, 1997 --
Revenues................ $ 4,227 $ 34,048 $ 9,568 $ 7,632 $ 6,392 $ 13,806 $ -- $ 75,673
Transfers between
geographic
locations............. 28,146 9,608 694 356 205 2,230 (41,239) --
--------- --------- --------- --------- ----------- --------- ----------- -----------
Total revenues........ $ 32,373 $ 43,656 $ 10,262 $ 7,988 $ 6,597 $ 16,036 $ (41,239) $ 75,673
--------- --------- --------- --------- ----------- --------- ----------- -----------
--------- --------- --------- --------- ----------- --------- ----------- -----------
Net income (loss)..... $ 4,490 $ 2,296 $ (89) $ 564 $ 536 $ 579 $ (138) $ 8,238
--------- --------- --------- --------- ----------- --------- ----------- -----------
--------- --------- --------- --------- ----------- --------- ----------- -----------
Identifiable assets... $ 108,400 $ 25,614 $ 14,258 $ 9,419 $ 7,324 $ 33,032 $ (82,337) 115,710
--------- --------- --------- --------- ----------- --------- ----------- -----------
--------- --------- --------- --------- ----------- --------- ----------- -----------
</TABLE>
<TABLE>
<CAPTION>
CANADA U.S. U.K. FRANCE GERMANY OTHER ELIMINATION CONSOLIDATED
--------- --------- --------- --------- ----------- --------- ----------- -----------
(unaudited)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Five-month period ended
December 31, 1996 --
Revenues................ $ 2,971 $ 16,886 $ 4,346 $ 3,967 $ 5,791 $ 6,135 $ -- $ 40,096
Transfers between
geographic
locations............. 11,254 9,457 1,594 415 -- 1,406 (24,126) --
--------- --------- --------- --------- ----------- --------- ----------- -----------
Total revenues........ $ 14,225 $ 26,343 $ 5,940 $ 4,382 $ 5,791 $ 7,541 $ (24,126) $ 40,096
--------- --------- --------- --------- ----------- --------- ----------- -----------
--------- --------- --------- --------- ----------- --------- ----------- -----------
Net income (loss)..... $ 2,471 $ 2,595 $ (675) $ 312 $ 795 $ (51) $ (4,294) $ 1,153
--------- --------- --------- --------- ----------- --------- ----------- -----------
--------- --------- --------- --------- ----------- --------- ----------- -----------
</TABLE>
E-15
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1997
(INFORMATION AS AT AND FOR THE SIX-MONTH PERIOD ENDED DECEMBER 31, 1997 AND FOR
THE FIVE-MONTH PERIOD ENDED DECEMBER 31, 1996 IS UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
12. FINANCIAL INFORMATION BY GEOGRAPHIC AREA (CONTINUED)
<TABLE>
<CAPTION>
CANADA U.S. U.K. FRANCE GERMANY OTHER ELIMINATION CONSOLIDATED
--------- --------- --------- --------- ----------- --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Eleven-month period ended
June 30, 1997 --
Revenues................... $ 5,873 $ 42,135 $ 16,596 $ 10,299 $ 12,388 $ 14,632 $ -- $ 101,923
Transfers between
geographic locations..... 28,279 16,531 3,293 1,539 -- 5,483 (55,125) --
--------- --------- --------- --------- ----------- --------- ----------- ------------
Total revenues........... $ 34,152 $ 58,666 $ 19,889 $ 11,838 $ 12,388 $ 20,115 $ (55,125) $ 101,923
--------- --------- --------- --------- ----------- --------- ----------- ------------
--------- --------- --------- --------- ----------- --------- ----------- ------------
Net income (loss)........ $ 1,199 $ 708 $ (504) $ 841 $ 274 $ 482 $ (228) $ 2,772
--------- --------- --------- --------- ----------- --------- ----------- ------------
--------- --------- --------- --------- ----------- --------- ----------- ------------
Identifiable assets...... $ 148,152 $ 48,967 $ 21,763 $ 8,197 $ 6,108 $ 34,860 $(162,575) $ 105,472
--------- --------- --------- --------- ----------- --------- ----------- ------------
--------- --------- --------- --------- ----------- --------- ----------- ------------
</TABLE>
"Other" includes the revenues, net income (loss) and identifiable assets of
the Company's Asian subsidiaries, less significant European subsidiaries and
Barbados.
Export sales from Canada were $2,184, $1,221 and $3,709 for the six-month
period ended December 31, 1997, the five-month period ended December 31,
1996 and the eleven-month period ended June 30, 1997, respectively.
13. DEPENDENCE ON KEY SUPPLIER
The Company is dependent on SGI to manufacture and supply a large proportion
of the workstations and certain peripherals used in the Company's systems.
14. ACQUISITIONS
(a) DENIM SOFTWARE
On June 12, 1997, the Company, through its wholly-owned subsidiary
3380491 Canada Inc. ("Acquisition Sub"), acquired substantially all of
the assets and assumed certain liabilities of Denim Software L.L.C., a
Delaware limited liability company ("Denim") pursuant to the terms of an
Asset Purchase Agreement dated as of June 12, 1997 among Acquisition Sub,
Denim, Sam Khulusi, Frank Khulusi, Westco Denim Investments Group, Ltd.,
a California limited partnership, and Frank Khulusi Family Limited
Partnership, a California limited partnership. The purchased assets
consist primarily of Denim software products, including ILLUMINAIRE
paint, ILLUMINAIRE Composition and ILLUMINAIRE Studio and related
know-how and goodwill.
The aggregate purchase price for the assets was comprised of (i)
approximately $9,126 in cash, (ii) the assumption of certain enumerated
liabilities in an amount equal to no more than approximately $2,209 in
the aggregate, and (iii) the assumption of certain on-going obligations
under certain existing contracts of Denim. At closing, cash
consideration, of approximately $9,126 and certain liabilities, of
approximately $655, were paid. The cash used by the Company to fund the
acquisition was derived primarily from operations. The transaction has
been accounted for using the purchase method. Purchased in-process
research and development, acquired technology and goodwill amounting to
$9,800, $1,500 and $315, respectively have been recorded. The
amortization expense is $1,836 and $272 for the six-month period ended
December 31, 1997 and for the eleven-month period ended June 30, 1997,
respectively.
(b) D-VISION SYSTEMS
On July 15, 1997, the Company acquired all of the outstanding shares of
capital stock of D-Vision Systems, Inc. ("D-Vision"), an Illinois
corporation, pursuant to a Stock Purchase Agreement dated as of July 10,
1997 among the Company, D-Vision, the former stockholders of D-Vision
(the "Selling Stockholders") and certain other individuals (the "D-Vision
Acquisition"). As a result of the D-Vision Acquisition, the Company
acquired the D-Vision OnLINE and PRO software products for non-linear
video and digital media editing solutions including related know-how and
goodwill. The purchase price was paid in a combination of 555,000 newly
issued Discreet Logic common shares and approximately $10,750 in cash. In
addition, approximately $4,000 of the cash consideration is being held in
escrow until September 30, 1999, subject to (i) earlier release from
escrow of up to $1,900 on
E-16
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1997
(INFORMATION AS AT AND FOR THE SIX-MONTH PERIOD ENDED DECEMBER 31, 1997 AND FOR
THE FIVE-MONTH PERIOD ENDED DECEMBER 31, 1996 IS UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
14. ACQUISITIONS (CONTINUED)
September 30, 1998 and (ii) the resolution of any indemnification claims
made by the Company pursuant to the Stock Purchase Agreement. The cash
used by the Company to fund the acquisition was derived primarily from
cash flow from operations. The D-Vision Acquisition was accounted for as
a purchase. Purchased in-process research and development, acquired
technology and goodwill amounting to $21,000, $3,100 and $916,
respectively have been recorded. The amortization expense is $2,917 for
the six-month period ended December 31, 1997.
(c) LIGHTSCAPE TECHNOLOGIES INC.
On December 2, 1997, Discreet Logic entered into an Agreement and Plan of
Merger and Reorganization (the "Merger Agreement") with Lantern
Acquisition Corp., a Delaware corporation and wholly-owned subsidiary of
Discreet Logic ("Merger Sub"), and Lightscape Technologies, Inc., a
Delaware corporation ("Lightscape"). On December 30, 1997, pursuant to
the Merger Agreement, and upon the satisfaction of certain closing
conditions, Merger Sub merged (the "Merger") with and into Lightscape
with Lightscape as the surviving corporation and a wholly-owned
subsidiary of Discreet Logic. As a result of the Merger, Discreet Logic
acquired, among other products, the Lightscape TM product, a software
application which integrates radiosity and raytracing with physically
based lighting, including related know-how and goodwill. The aggregate
purchase price for Lightscape includes the assumption of approximately
$5,700 of net liabilities (of which approximately $3,400 was paid at the
closing), not including costs associated with the transaction, and up to
$6,800 in contingent consideration to be paid only if certain revenue
objectives are archived by Lightscape in calendar 1998 and 1999. The
acquisition has been accounted for as a purchase. Purchased in-process
research and development, acquired technology and goodwill in the amounts
of $5,800, $990 and $97, respectively, have been recorded.
15. PURCHASE OF LAND AND FACILITIES
In August 1995, the Company purchased land and an office building in London,
England for approximately L1,148 (or approximately $1,885 at December 31,
1997). Additionally, in December 1995, the Company purchased land and a
building in Montreal for CDN$1,730 (or approximately $1,210 at December 31,
1997). During fiscal 1996, the carrying value of the London and Montreal
buildings were written down to their estimated fair market values and these
buildings are classified as assets held for resale. In September 1997, the
Company sold the Montreal office building for a price not materially
different from its carrying value.
16. RESTRUCTURING
During the fiscal year ended July 31, 1996, the Company recorded a pre-tax
restructuring charge of $21,610 to cover the direct costs of restructuring
the Company's operations and to bring operating expenses in line with the
Company's current revenue level. The Company began implementation of its
restructuring plan in the fourth fiscal quarter of 1996 and had
substantially completed the implementation of the plan at the end of fiscal
1997.
The accrued restructuring expense of $3,335 and $4,272 as of December 31,
1997 and June 30, 1997, respectively, cover the remaining lease terminations
and related leasehold improvements, asset write downs, severance pay and
professional services expenses.
E-17
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1997
(INFORMATION AS AT AND FOR THE SIX-MONTH PERIOD ENDED DECEMBER 31, 1997 AND FOR
THE FIVE-MONTH PERIOD ENDED DECEMBER 31, 1996 IS UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
17. EARNINGS PER SHARE
The weighted average common shares outstanding and the net income used to
calculate the earnings per share were:
<TABLE>
<CAPTION>
ELEVEN-MONTH PERIOD
SIX-MONTH PERIOD ENDED FIVE-MONTH PERIOD ENDED ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996 JUNE 30, 1997
------------------------ ------------------------ ------------------------
COMMON COMMON COMMON
SHARES NET INCOME SHARES NET INCOME SHARES NET INCOME
--------- ------------- --------- ------------- --------- -------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C> <C> <C>
BASIC EARNINGS PER SHARE
Earnings per income statement............. 28,745,695 $ 8,238 27,852,370 $ 1,153 27,947,807 $ 2,772
--------- ------ --------- ------ --------- ------
--------- ------ --------- ------ --------- ------
Earnings per share........................ $ 0.29 $ 0.04 $ 0.10
------ ------ ------
------ ------ ------
FULLY DILUTED EARNINGS PER SHARE
Earnings per income statement............. 28,745,695 $ 8,238 27,852,370 $ 1,153 27,947,807 $ 2,772
Effect of assumed exercise of employee and
director stock options using a return of
3% (after income taxes)................. 2,467,562 274 300,197 5 1,167,210 83
--------- ------ --------- ------ --------- ------
Totals for calculating fully diluted
earnings per share...................... 31,213,257 $ 8,512 28,152,567 $ 1,158 29,115,017 $ 2,855
--------- ------ --------- ------ --------- ------
--------- ------ --------- ------ --------- ------
Fully diluted earnings per share.......... $ 0.27 $ 0.04 $ 0.10
------ ------ ------
------ ------ ------
</TABLE>
18. SUBSEQUENT EVENTS
(a) On March 4, 1998, the Company completed a private placement of 645,000
of its common shares with Intel Corporation for net proceeds to the
Company of approximately $13,545.
(b) On March 9, 1998 the Company agreed, subject to shareholders and
regulatory approvals, to merge with MGI Software Corp. (MGI). The merger
will be accomplished through a share exchange with each share of MGI to
be exchanged for 0.162 shares of Discreet shares. Outstanding options and
warrants to purchase MGI common shares will be converted at this exchange
ratio into options and warrants to acquire Discreet shares. The number of
common shares to be issued by Discreet pursuant to this arrangement is
4,577,981 for a consideration given by Discreet of approximately
$107,588. In connection with this transaction, MGI granted Discreet an
option exercisable under certain conditions, to purchase shares up to
approximately 20% of MGI's outstanding shares. The transaction will be
accounted for as a purchase under Canadian generally accepted accounting
principles (GAAP) and is expected to be accounted for as a pooling of
interests under U.S. GAAP. In the financial statements in Canadian GAAP,
the excess of the consideration given over the net tangible assets
acquired of $99,136 will be allocated to purchased in-process research
and development, acquired technology and goodwill.
E-18
<PAGE>
SCHEDULE F
DISCREET LOGIC INC.
CONSOLIDATED FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
DISCREET LOGIC INC. AND SUBSIDIARIES
Report of Arthur Andersen & Cie................................................................................ F-2
Consolidated Balance Sheets.................................................................................... F-3
Consolidated Statements of Shareholders' Equity................................................................ F-4
Consolidated Statements of Operations.......................................................................... F-5
Consolidated Statements of Cash Flows.......................................................................... F-6
Notes to Consolidated Financial Statements..................................................................... F-7
</TABLE>
F-1
<PAGE>
AUDITORS' REPORT
To the Shareholders of
Discreet Logic Inc.:
We have audited the consolidated balance sheets of Discreet Logic Inc. (a
Quebec company) and subsidiaries at July 31, 1995 and 1996 and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended July 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards in Canada, which are in substantial agreement with those in the United
States of America. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Discreet Logic Inc. and subsidiaries as at July 31, 1995 and 1996 and the
results of their operations and their cash flows for each of the three years in
the period ended July 31, 1996, in accordance with generally accepted accounting
principles in the United States of America.
Montreal, Canada (Signed) ARTHUR ANDERSEN & CIE
September 13, 1996 Chartered Accountants
F-2
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN U.S. DOLLARS)
<TABLE>
<CAPTION>
JULY 31,
---------------------------
1995 1996
------------ -------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................................................ $ 40,987,081 $ 21,658,051
Accounts receivable (less reserves for doubtful accounts of $431,000 and $3,649,000,
respectively).......................................................................... 15,019,113 16,073,788
Inventory --
Resale................................................................................. 6,361,375 11,555,525
Demonstration.......................................................................... 3,200,571 4,273,961
Income taxes receivable.................................................................. -- 3,191,291
Other current assets..................................................................... 1,751,536 3,640,143
------------ -------------
67,319,676 60,392,759
Property and equipment -- less accumulated depreciation and amortization................... 6,759,284 10,037,064
Deferred income taxes...................................................................... 2,218,123 4,721,578
Other assets............................................................................... 561,092 1,139,993
Assets held for resale..................................................................... -- 3,856,348
------------ -------------
$ 76,858,175 $ 80,147,742
------------ -------------
------------ -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable......................................................................... $ 15,534,679 $ 9,350,969
Accrued expenses......................................................................... 2,389,464 19,599,077
Deferred revenue......................................................................... 3,808,107 4,769,506
Customer deposits........................................................................ 810,807 2,618,061
Due to related parties................................................................... 101,313 25,535
Income taxes payable..................................................................... 2,578,994 --
Current portion of obligation under capital leases....................................... 249,694 --
------------ -------------
25,473,058 36,363,148
------------ -------------
Deferred income taxes...................................................................... 1,260,664 1,441,578
------------ -------------
Commitments and Contingencies (Notes 5, 12 and 17)
Shareholders' Equity:
Preferred shares -- no par value
Authorized -- unlimited number of shares
Issued and outstanding -- none......................................................... -- --
Common shares -- no par value
Authorized -- unlimited number of shares
Issued and outstanding -- 25,166,860 shares at July 31, 1995 and
27,699,426 shares at July 31, 1996................................................... 43,232,545 78,922,914
Retained earnings (deficit).............................................................. 8,257,782 (35,883,399)
Share subscriptions receivable........................................................... (1,645,000) --
Cumulative translation adjustment........................................................ 279,126 (696,499)
------------ -------------
Total shareholders' equity........................................................... 50,124,453 42,343,016
------------ -------------
$ 76,858,175 $ 80,147,742
------------ -------------
------------ -------------
</TABLE>
Approved on behalf of the Board of Directors:
<TABLE>
<S> <C>
(Signed) RICHARD J. SZALWINSKI (Signed) THOMAS CANTWELL
Director Director
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-3
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(AMOUNTS IN U.S. DOLLARS)
<TABLE>
<CAPTION>
RETAINED SHARE CUMULATIVE TOTAL
COMMON EARNINGS SUBSCRIPTIONS TRANSLATION SHAREHOLDERS'
SHARES AMOUNT (DEFICIT) RECEIVABLE ADJUSTMENT EQUITY
---------- ---------- ----------- ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, July 31, 1993............... 18,520,000 $ 547,910 $ 826 $ (89,730) $ (27,691) $ 431,315
Issuance of common shares.......... 3,200,000 148,148 -- (148,148) -- --
Collection of share subscriptions
receivable....................... -- -- -- 89,730 -- 89,730
Redemption of common shares........ (544,000) (187) (11,625) -- -- (11,812)
Net income......................... -- -- 483,486 -- -- 483,486
Change in cumulative translation
adjustment....................... -- -- -- -- (58,806) (58,806)
---------- ---------- ----------- ------------ ----------- -------------
Balance, July 31, 1994............... 21,176,000 695,871 472,687 (148,148) (86,497) 933,913
Issuance of common shares net of
issuance costs of $4,893,657 and
related tax effect of
$1,713,000....................... 4,250,788 40,906,450 -- -- -- 40,906,450
Issuance of common shares in
exchange for minority interest
(Note 2(a))...................... 18,000 44,659 -- -- -- 44,659
Exercise of common stock options... 1,172,072 1,652,694 -- (1,645,000) -- 7,694
Repurchase of common shares........ (1,450,000) (67,129) -- 67,129 -- --
Collection of share subscriptions
receivable....................... -- -- -- 81,019 -- 81,019
Net income......................... -- -- 7,785,095 -- -- 7,785,095
Change in cumulative translation
adjustment....................... -- -- -- -- 365,623 365,623
---------- ---------- ----------- ------------ ----------- -------------
Balance, July 31, 1995............... 25,166,860 43,232,545 8,257,782 (1,645,000) 279,126 50,124,453
Issuance of common shares net of
issuance costs of $1,988,202 and
related tax effect of $775,399... 970,920 28,157,527 -- -- -- 28,157,527
Exercise of common stock options... 1,244,918 1,230,734 -- -- -- 1,230,734
Issuance of shares through Employee
Stock Purchase Plan.............. 16,728 302,108 -- -- -- 302,108
Issuance of shares to COSS (Note
15(b))........................... 300,000 6,000,000 -- -- -- 6,000,000
Collection of share subscriptions
receivable....................... -- -- -- 1,645,000 -- 1,645,000
Net loss........................... -- -- (44,141,181) -- -- (44,141,181)
Change in cumulative translation
Adjustment....................... -- -- -- -- (975,625) (975,625)
---------- ---------- ----------- ------------ ----------- -------------
Balance, July 31, 1996............... 27,699,426 $78,922,914 $(35,883,399) $ -- $(696,499) $42,343,016
---------- ---------- ----------- ------------ ----------- -------------
---------- ---------- ----------- ------------ ----------- -------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-4
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN U.S. DOLLARS)
<TABLE>
<CAPTION>
YEARS ENDED JULY 31,
--------------------------------------------
1994 1995 1996
------------- ------------- --------------
<S> <C> <C> <C>
Total revenues........................................................... $ 15,391,636 $ 64,548,611 $ 83,997,447
Cost of revenues......................................................... 8,288,783 29,608,946 49,333,071
------------- ------------- --------------
Gross profit......................................................... 7,102,853 34,939,665 34,664,376
------------- ------------- --------------
Operating expenses:
Research and development, net of tax credits of $450,000, $545,000 and
$711,000, respectively............................................... 624,760 4,036,926 16,902,432
Sales and marketing.................................................... 2,785,148 12,588,110 26,088,163
General and administrative............................................. 1,383,362 4,854,261 10,581,670
Write-off of purchased research and development (Note 15).............. -- -- 8,500,000
Restructuring expense (Note 17)........................................ -- -- 15,000,000
Litigation and related settlement expenses (Note 5).................... 1,365,513 -- 2,506,203
------------- ------------- --------------
Total operating expenses............................................. 6,158,783 21,479,297 79,578,468
------------- ------------- --------------
Operating income (loss).............................................. 944,070 13,460,368 (44,914,092)
------------- ------------- --------------
Other income (expense):
Interest income........................................................ 14,948 218,976 2,258,705
Interest expense....................................................... (55,226) (222,103) (229,579)
Foreign currency exchange gain (loss).................................. (45,494) (167,224) 178,620
------------- ------------- --------------
Total other income (expense)......................................... (85,772) (170,351) 2,207,746
------------- ------------- --------------
Income (loss) before income taxes and minority interest................ 858,298 13,290,017 (42,706,346)
Provision for income taxes............................................... 343,159 5,490,197 1,434,835
------------- ------------- --------------
Net income (loss) before minority interest............................. 515,139 7,799,820 (44,141,181)
Minority interest........................................................ 31,653 14,725 --
------------- ------------- --------------
Net income (loss)...................................................... $ 483,486 $ 7,785,095 $ (44,141,181)
------------- ------------- --------------
------------- ------------- --------------
Net income (loss) per common and common equivalent share................. $ .02 $ .31 $ (1.64)
------------- ------------- --------------
------------- ------------- --------------
Weighted average common shares outstanding............................... 23,093,070 24,885,670 26,836,834
------------- ------------- --------------
------------- ------------- --------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-5
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN U.S. DOLLARS)
<TABLE>
<CAPTION>
YEARS ENDED JULY 31,
------------------------------------
1994 1995 1996
---------- ----------- -----------
<S> <C> <C> <C>
Operating activities:
Net income (loss)............................................................. $ 483,486 $ 7,785,095 $(44,141,181)
Adjustments to reconcile net income (loss) to cash provided by operating
activities --
Depreciation and amortization............................................... 242,755 1,674,858 6,276,139
Deferred income taxes....................................................... 102,046 652,512 (2,072,789)
Loss (gain) on sale of fixed assets......................................... (25,319) (7,080) 31,819
Write off of in process research and development............................ -- -- 8,500,000
Write off of assets for restructuring....................................... -- -- 5,510,237
Write off of investment in Essential Communications, Inc.................... -- -- 2,500,000
Increase in minority interest............................................... 31,653 14,725 --
Changes in assets and liabilities --
Accounts receivable....................................................... (3,743,276) (10,786,522) (1,100,199)
Inventory................................................................. (1,434,513) (7,692,451) (6,088,107)
Income taxes receivable................................................... (176,989) 523,924 (2,718,204)
Other current assets...................................................... (236,400) (1,326,134) (1,917,776)
Accounts payable.......................................................... 3,533,367 11,388,728 (6,183,710)
Accrued expenses.......................................................... 884,260 1,367,536 16,865,069
Deferred revenue.......................................................... 279,227 2,595,168 961,399
Income taxes payable...................................................... -- 2,553,153 (2,578,994)
Customer deposits......................................................... 732,750 (81,883) 1,807,254
Due to related parties.................................................... 261,200 (357,756) (75,778)
---------- ----------- -----------
Net cash provided by (used in) operating activities....................... 934,247 8,303,873 (24,424,821)
---------- ----------- -----------
Investing activities:
Purchase of property and equipment............................................ (306,476) (6,239,422) (15,870,636)
Proceeds from disposal of property and equipment.............................. 137,207 69,800 212,719
Increase in other assets...................................................... -- (584,794) (519,841)
Cash paid for purchase of Essential Communications, Inc....................... -- -- (2,500,000)
Cash paid for COSS/IMP acquisition and related costs.......................... -- -- (5,544,848)
---------- ----------- -----------
Net cash used in investing activities....................................... (169,269) (6,754,416) (24,222,606)
---------- ----------- -----------
Financing activities:
Proceeds from the issuance of common shares, net of issuance costs............ -- 39,193,450 27,382,128
Proceeds from the exercise of stock options................................... -- 7,694 1,230,734
Proceeds from the employee stock purchase plan................................ -- -- 302,108
Payment of capital lease obligations.......................................... (130,146) (963,500) (249,699)
Proceeds from subscriptions receivable........................................ 89,730 81,019 1,645,000
Redemption of common shares................................................... (11,812) -- --
---------- ----------- -----------
Net cash provided by (used in) financing activities......................... (52,228) 38,318,663 30,310,271
---------- ----------- -----------
Foreign exchange effect on cash................................................. (43,305) 292,516 (991,874)
---------- ----------- -----------
Increase (decrease) in cash and cash equivalents................................ 669,445 40,160,636 (19,329,030)
Cash and cash equivalents, beginning of year.................................... 157,000 826,445 40,987,081
---------- ----------- -----------
Cash and cash equivalents, end of year.......................................... $ 826,445 $40,987,081 $21,658,051
---------- ----------- -----------
---------- ----------- -----------
Supplemental disclosure of cash flow information:
Interest paid during the year................................................. $ 32,008 $ 203,038 $ 229,610
Income taxes paid during the year............................................. 18,649 974,569 8,823,579
Supplemental disclosure of noncash financing and investing activities:
Issuance of common shares in exchange for subscriptions receivable............ 148,148 1,645,000 --
Issuance of common shares to COSS............................................. -- -- 6,000,000
Property and equipment acquired under capital leases.......................... 930,411 416,671 --
Issuance of common shares in exchange for minority interest................... -- 44,659 --
Reduction of share subscriptions receivable................................... -- 67,129 --
Deferred tax asset recorded in connection with share issuance costs........... -- 1,713,000 775,399
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-6
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN U.S. DOLLARS)
1. OPERATIONS
Discreet Logic Inc. ("the Company") was incorporated under Part 1A of the
Quebec Companies Act on September 10, 1991. The Company and its subsidiaries
develop, assemble, market and support non-linear, on-line, digital systems
for creating, editing and compositing imagery and special visual effects for
film and video. The Company's systems are utilized by creative
professionals, for a variety of applications, including feature films,
television programs, commercials, music videos, interactive game production
and live broadcasting.
Discreet Logic sells its systems and other products through its direct sales
organization, as well as through distributors and resellers. The Company
markets and sells its systems directly in North America and in certain
European and Pacific Rim countries. Sales activities in North America are
conducted from the Company's Montreal headquarters, sales offices in Los
Angeles and New York and field representatives based in Boston, San
Francisco, Atlanta and Chicago. In fiscal 1996 the Company opened sales
offices in India, Hong Kong and Japan. The Company also markets its systems
through sales offices located in the United Kingdom, France, Germany,
Singapore and Brazil and through a network of distributors in 34 countries.
The success of the Company is subject to a number of risks and
uncertainties, including, without limitation, the risk of the Company's
historical dependence on its flame* and FLINT systems and related
maintenance and support for substantially all of the Company's revenue; the
Company's ability to successfully develop, introduce and gain customer
acceptance of existing and new or enhanced products; the need for the
continued development of the market for the Company's systems; the ability
of the Company to expand its current market to include additional
applications and develop new products for related markets; the presence of
competitors with greater financial, technical, manufacturing, marketing and
distribution resources; the risk that as the Company enters new markets, the
distribution channels, technical requirements and levels and basis of
competition may be different from those in the Company's current markets;
the risk that competitive pressures or other factors, including the
Company's ability to enter into new markets, may result in significant price
erosion of the Company's products; the risk of the Company's reliance on SGI
for the workstations included in the Company's systems including the impact
of the timing of the development and release of SGI products as well as
unforeseen difficulties associated with adapting the Company's products to
future SGI products; the Company's dependence on key management and
technical employees; the Company's reliance principally on unregistered
copyrights and trade secrets to protect its intellectual property; the risk
that the Company derives a significant portion of its revenues from foreign
sales; the risk that the Company will not be able to implement successfully
its restructuring plan, will need to take on further restructurings or will
not be profitable in the future; the risk that the Company will not be
successful in its defense of the two class action lawsuits to which it has
been named a defendant; the risk of quarterly fluctuations in the Company's
operating results; market price fluctuations due to quarter-to-quarter
variations in the Company's operating results, announcements of
technological innovations or new products by the Company or its competitors
and the historical fluctuations in market prices of technology companies
generally; the risk that the Company's direct sales efforts may compete with
those of its indirect channels; and other risks detailed from time to time
in the Company's filings with the Securities and Exchange Commission of the
United States.
The Company believes that with its currrent level of working capital
together with funds generated from operations, it has adequate sources of
cash to meet its operational and capital expenditure requirements through
fiscal 1997.
2. SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements reflect the application
of the following significant accounting policies, as described below and
elsewhere in the notes to Consolidated Financial Statements. These
Consolidated Financial Statements are prepared in accordance with generally
accepted accounting principles in the United States of America, and are
presented in United States dollars ("U.S. dollars").
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the consolidated financial statements, and the reported amounts of
revenues and expenses during the reporting periods. Actual results could
differ from these estimates.
(a) PRINCIPLES OF CONSOLIDATION AND MINORITY INTEREST
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All subsidiaries are wholly owned as of July 31,
1996. Discreet Logic (UK) Limited was a 75% owned subsidiary until
February 28, 1995, at which time, the Company purchased the 25% minority
interest in exchange for 18,000 common shares. All significant
intercompany accounts and transactions have been eliminated upon
consolidation.
F-7
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN U.S. DOLLARS) (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(b) REVENUE RECOGNITION
The Company recognizes revenue from software licenses, and the related
hardware and peripherals, upon shipment of the products. The Company
recognizes revenue from post contract customer support and other related
services ratably, as the obligations are fulfilled, or when the related
services are performed. Post contract customer support, training,
installation, systems integration and rental services, are performed
primarily under separately priced arrangements under which the Company
has recorded revenues of $1,000,000, $4,770,000 and $11,713,000 for the
years ended July 31, 1994, 1995 and 1996, respectively. In cases where
the Company has delivered hardware and/or software to customers and has
insignificant or noncritical vendor obligations related to these
deliveries, the revenue attributable to such obligations has been
deferred until such obligations have been fulfilled.
(c) NET INCOME (LOSS) PER COMMON SHARE
Net income (loss) per common share is computed by dividing net income
(loss) by the weighted average number of common and common equivalent
shares outstanding during the year, computed in accordance with the
treasury stock method. Net loss per common share is computed by dividing
net loss by the weighted average number of common shares outstanding
during the year. Pursuant to the requirements of the Securities and
Exchange Commission, common shares issued by the Company during the 12
months immediately preceding the initial public offering (the 12-month
period subsequent to June 1, 1994), plus options granted during the same
period, have been included in the calculation of weighted average number
of common shares using the treasury stock method at the initial public
offering price of $10.50 per share.
(d) RESEARCH AND DEVELOPMENT EXPENSES
The Company charges to operations research and development costs as
incurred and presents such expenses net of income tax credits from the
Canadian federal and Quebec provincial governments (see Note 7). Software
development costs are considered for capitalization when technological
feasibility is established in accordance with Statement of Financial
Accounting Standards (SFAS) No. 86, ACCOUNTING FOR THE COSTS OF COMPUTER
SOFTWARE TO BE SOLD, LEASED OR OTHERWISE MARKETED. The Company sells
software in a market that is subject to rapid technological change, new
product introductions and changing customer needs. Accordingly, the
Company has not capitalized software development costs due to its
inability to estimate the useful life of software under development.
(e) TRANSLATION OF FOREIGN CURRENCIES
The accounts of the Company are translated in accordance with SFAS No.
52, FOREIGN CURRENCY TRANSLATION. The Company's management has elected to
present these consolidated financial statements in U.S. dollars. The
financial statements of the Company and its subsidiaries are translated
from their functional currency, the Canadian dollar, into the reporting
currency, the U.S. dollar, utilizing the current rate method.
Accordingly, assets and liabilities are translated at exchange rates in
effect at the end of the year, and revenues and expenses are translated
at the weighted average exchange rate during the year. All cumulative
translation gains or losses from the translation into the Company's
reporting currency are included as a separate component of shareholders'
equity in the consolidated balance sheets.
The Company remeasures the financial statements of its foreign
subsidiaries and other foreign currency transactions into Canadian
dollars as follows: monetary assets and liabilities are translated at
exchange rates in effect at year-end, and nonmonetary items are
translated at historical exchange rates; revenues and expenses are
translated at the average rate during the year, except for depreciation
and amortization, which are translated at the same rates as the related
assets. Exchange gains and losses arising from transactions denominated
in foreign currencies are included in current operations. Foreign
currency translation gains (losses) from the remeasurement into the
Canadian dollar included in other income (expense) in the accompanying
consolidated statements of operations were $(21,650) and $4,968 for the
years ended July 31, 1994 and 1995, respectively. Beginning August 1,
1995, the Company changed the functional currency of its foreign
subsidiaries from the Canadian dollar to their respective local
currencies. Accordingly, cumulative translation gain (losses) are
included as a separate component of shareholders' equity in the
consolidated balance sheets. The impact on the consolidated financial
statements of the change of functional currency of the Company's foreign
subsidiaries was not significant. Foreign currency transaction gains
(losses) included in other income (expense) in the accompanying
consolidated statements of operations were, $(23,844), $162,256, and
$178,620 for the years ended July 31, 1994, 1995, and 1996, respectively.
(f) CONCENTRATION OF CREDIT RISK
During 1996, the Company entered into a Maximum Liability Agreement with
a leasing company. The agreement provides that the Company is
contingently liable up to a maximum percentage of the remaining principal
payments outstanding related to purchase
F-8
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN U.S. DOLLARS) (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
of the Company's products by customers financed by the said leasing
company. The maximum liability is contingent on certain factors as
defined in the agreement. As at July 31, 1996, the maximum contingent
liability is $830,000. The Company accrued the entire amount of the
contingent liability. The expense was charged to general and
administrative expenses.
The Company has no other significant off-balance sheet concentration of
credit risk such as foreign exchange contracts, option contracts or other
foreign hedging arrangements. The Company maintains the majority of cash
balances with three financial institutions and its accounts receivable
credit risk is not concentrated within any geographic area. There were no
accounts receivable from a single customer which exceeded 10 percent of
total accounts receivable as of July 31, 1996.
(g) POSTEMPLOYMENT AND POSTRETIREMENT BENEFITS
The Company does not provide postemployment and postretirement benefits.
(h) CASH EQUIVALENTS
Cash equivalents are carried at cost, which approximates market value.
Cash equivalents are short-term, highly liquid investments with original
maturities of less than three months. Cash equivalents consist of
commercial paper and money market mutual funds at July 31, 1995 and 1996.
The Company applied SFAS No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN
DEBT AND EQUITY SECURITIES.
(i) INVENTORY
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.
(j) PROPERTY AND EQUIPMENT
The Company provides for depreciation and amortization using the
straight-line and declining-balance methods over the estimated useful
lives of the assets as follows:
<TABLE>
<CAPTION>
JULY 31,
-----------------------
ASSET CLASSIFICATION ESTIMATED USEFUL LIFE 1995 1996
- -------------------------------------------------- ---------------------------------- ----------- ----------
<S> <C> <C> <C>
Computer equipment and software................... 2-3 Years $5,487,403 $14,095,730
Furniture, fixtures and equipment under capital
leases.......................................... 3-5 Years 459,673 --
Leasehold improvements............................ Shorter of term of lease or useful 1,483,109 2,485,751
life
Furniture and fixtures............................ 5 Years 905,981 1,677,067
----------- ----------
8,336,166 18,258,548
Less -- Accumulated depreciation and
amortization.................................... (1,576,882) (8,221,484)
----------- ----------
$6,759,284 $10,037,064
----------- ----------
----------- ----------
</TABLE>
3. OTHER CURRENT ASSETS
Other current assets consist of the following:
<TABLE>
<CAPTION>
JULY 31,
------------------------
1995 1996
----------- -----------
<S> <C> <C>
Prepaid expenses.......................................................... $1,156,520 $2,206,248
Sales tax receivable...................................................... 487,210 578,781
Other receivable.......................................................... 107,806 855,114
----------- -----------
$1,751,536 $3,640,143
----------- -----------
----------- -----------
</TABLE>
F-9
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
4. ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
JULY 31,
-----------------------
1995 1996
----------- ----------
<S> <C> <C>
Payroll and payroll related............................................... $ 853,966 $2,768,461
Professional fees......................................................... 561,055 739,412
Commissions............................................................... 454,175 1,967,175
Sales tax and VAT payable................................................. -- 946,917
Accrued restructuring expenses............................................ -- 8,634,484
Maximum Liability accrual................................................. -- 830,000
Accrued litigation fees................................................... -- 2,506,203
Other..................................................................... 520,268 1,206,425
----------- ----------
$2,389,464 $19,599,077
----------- ----------
----------- ----------
</TABLE>
5. LITIGATION AND RELATED SETTLEMENT EXPENSES
(a) SECURITIES LITIGATION
On May 29, 1996, a lawsuit entitled SANDRA ESNER AND JERRY KRIM, ON
BEHALF OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED, VS. [ ... ]
DISCREET LOGIC INC., ET AL., case No. 978584, was filed in the Superior
Court of the State of California, City and County of San Francisco. Named
as defendants are the Company, certain of the Company's former and
existing directors, officers, and affiliates, and certain underwriters
and financial analysts. The plaintiffs purport to represent a class of
all persons who purchased the Company's common stock between September
13, 1995, and May 1, 1996. The complaint alleges violations of California
law through material misrepresentations and omissions, among other
things. The Company believes the allegations in the complaint are without
merit and intends to defend the lawsuit vigorously.
On June 13, 1996, a lawsuit entitled BRUCE FRIEDBERG, ON BEHALF OF
HIMSELF AND ALL OTHERS SIMILARLY SITUATED, VS. DISCREET LOGIC INC., ET
AL., civ. No. 96-11232-EFH, was filed in the United States District
Court, District of Massachusetts. Named as defendants are the Company and
certain of the Company's former and existing directors and officers. The
plaintiff purports to represent a class of all persons who purchased the
Company's common stock between November 14, 1995, and February 13, 1996.
On October 11, 1996, the plaintiff filed an amended complaint which
asserts substantially the same factual allegations as the first complaint
and proposes the identical class period. The complaint alleges violations
of the United States Federal Securities law through material
misrepresentations and omissions. The Company believes the allegations in
the amended complaint are without merit and intends to defend the lawsuit
vigorously.
Although the Company denies all material allegations of these complaints
and intends to vigorously defend against claims brought against it, the
ultimate outcome, including amount of possible loss, if any, of
litigation cannot be determined at this time. No provision for any
liability that may result from this litigation has been taken. However,
the Company has accrued $2,506,000 as estimated legal fees to defend
against these lawsuits. There can be no assurance that the ultimate
outcome of these matters will not have a material adverse effect on the
Company's business and results of operations.
(b) SOFTIMAGE INC. LITIGATION
The Company was involved in litigation with SOFTIMAGE, Inc.
("Softimage"), a company that distributed the Company's products in 1993.
The litigation between the Company and Softimage was based on a dispute
over the ownership of the proprietary rights to a specific software
product, flame*, as well as upon the termination by the Company, in 1993,
of a distributorship agreement with Softimage. The litigation concerning
the termination of the distribution agreement with Softimage was decided
by arbitration in August 1994, and in September 1994, the Company and
Softimage reached a settlement whereby the Company maintained the
exclusive rights to flame*. The Company was required to make certain
payments to Softimage under the arbitration and the settlement
agreements. These payments, in addition to the related legal and other
settlement expenses, are included in litigation and related settlement
expenses in the accompanying consolidated statements of operations.
In July 1992, the Company entered into an assignment agreement with Gary
Tregaskis ("Tregaskis"), a shareholder of the Company, for the flame*
software. The Company did not record amounts payable to Tregaskis under
this agreement due to the litigation with Softimage concerning the
ownership of the flame* software. On February 25, 1994, the Company and
Tregaskis entered into an employment agreement, which replaced all
preceding agreements. In connection with the employment agreement,
Tregaskis assigned all rights, title and interest in the flame* software,
and the Company agreed to pay Tregaskis a fixed amount plus an amount
that was contingent upon the outcome of the litigation with Softimage.
The Company ultimately agreed to pay Tregaskis
F-10
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
5. LITIGATION AND RELATED SETTLEMENT EXPENSES (CONTINUED)
$312,500, which is included in litigation and related settlement expenses
for the year ended July 31, 1994. At July 31, 1996, a balance of $25,535
($101,313 at July 31, 1995) was due to Tregaskis and is included in due
to related parties.
6. DEMAND LINE OF CREDIT AND LEASING FACILITIES
The Company has a revolving demand line of credit with a bank under which it
can borrow up to CDN$3,600,00 (approximately $2,619,000 at July 31, 1996).
Advances under the line are based on 75-90% of qualified accounts receivable
balances and 60% of Canadian federal and provincial research and development
grants. The line accrues interest monthly at prime (6.25% at July 31, 1996)
plus 1%. Additionally, the Company has a CDN$600,000 (approximately $436,000
at July 31, 1996) demand leasing facility. The line and leasing facilities
are secured by essentially all assets of the Company. As additional
security, the Company assigned to the bank its insurance on all the
Company's assets, its insurance on the lives of its key executives and
Canadian federal and provincial research and development tax credits
receivable. The Company is required to maintain certain financial ratios,
including minimum levels of working capital, debt service coverage and
equity to asset ratios. At July 31, 1996, there were no amounts outstanding
under the line of credit or the leasing facilities. The Company is in breach
of certain covenants and does not plan to obtain a waiver; therefore these
credit facilities are not available.
7. CANADIAN FEDERAL AND PROVINCIAL INCOME TAX CREDITS
The Company is entitled to research and development incentives in the form
of income tax credits from the Canadian federal government ("Federal") and
from the Province of Quebec ("Provincial"). Federal income tax credits are
received on qualified Canadian research and development expenditures and
equipment purchases. Provincial income tax credits are received on qualified
research and development salaries in the Province of Quebec. In fiscal 1994,
Federal income tax credits were earned at the rate of 35% of the first
$2,000,000 of qualified expenditures and 20% on the excess for certain
qualified Canadian corporations and at the rate of 20% for all other
corporations. In fiscal 1994, Provincial income tax credits were earned at
the rate of 40% of qualified salaries for certain Canadian corporations and
at the rate of 20% for all other corporations. Income tax credits reduce
income taxes currently payable and to the extent these credits exceed income
taxes currently payable, these tax credits may be received in cash from the
Canadian federal government and the Province of Quebec, subject to various
limitations for Federal tax credits. Beginning in fiscal 1995, the Federal
and Provincial income tax credits were reduced to 20% of qualified research
and development expenditures. Additionally, the Federal credit may be
limited to a credit against income taxes payable.
The Company recorded $450,000, $545,000 and $711,000 of income tax credits
as a reduction of research and development expenses for the years ended July
31, 1994, 1995 and 1996, respectively. These income tax credits represent
credits earned based on qualifying research and development expenditures. In
addition, the Company recorded $310,000, $690,000 and $513,000 of income tax
credits as a reduction in the carrying value of property and equipment for
the years ended July 31, 1994, 1995 and 1996, respectively. These income tax
credits represent credits earned based on qualifying property and equipment
purchases.
8. SHAREHOLDERS' EQUITY
(a) INITIAL PUBLIC OFFERING
In July 1995, the Company closed its initial public offering of 4,189,248
Common Shares at $10.50 per share, resulting in proceeds of approximately
$40,803,000 net of issuance costs and their related tax effects.
(b) AMENDED ARTICLES OF INCORPORATION
On October 16, 1995, the Company effected a 2-to-1 share split of its
Common Shares with the additional shares delivered on November 6, 1995 to
holders of record on October 16, 1995. All Common Shares have been
adjusted retroactively to give effect to the split.
On May 15, 1995, the Company amended its Articles of Incorporation to
effect a 2-to-1 split of its Common Shares, to combine and redesignate
the Company's Class B through Class G shares into Common Shares and to
create a class of Preferred Shares. All Common Shares have been adjusted
retroactively to give effect to the split.
On July 14, 1994, the Company amended the characteristics of its capital
shares, which included converting its Class A shares into Common Shares.
On that date, the Company effected a split of its Common Shares on a
40-to-1 basis. All Common Shares have been adjusted retroactively to give
effect to the split.
F-11
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
8. SHAREHOLDERS' EQUITY (CONTINUED)
(c) SECONDARY OFFERING
In December 1995, the Company completed a secondary offering of 970,920
Common Shares at $30.25 per share, resulting in proceeds of approximately
$28,158,000 net of issuance costs and their related tax effects.
(d) PREFERRED SHARES
The Board of Directors is authorized to issue Preferred Shares, in one or
more series, and to fix the rights, dividend rates, conversion rights,
voting rights, terms of redemption (including sinking fund provisions),
redemption price or prices, and the number of shares constituting any
series or the designations of such series, without further vote or action
by the shareholders.
(e) SHARE SUBSCRIPTIONS RECEIVABLE
During 1994, certain shareholders issued non-interest bearing notes to
the Company in exchange for Common Shares of the Company. The $148,148
share subscriptions receivable at July 31, 1994 represents 10-year
non-interest bearing notes expiring March 9, 2004 from both the then and
current Chairman of the Board of Directors and the former president of
the Company. These amounts were either reduced through the shares being
repurchased (see note 8(f)) or repaid in fiscal 1995. On November 11,
1994, the former President and Chief Executive Officer of the Company
issued to the Company a $1,645,000 note in connection with the exercise
of nonqualified stock options which is included in share subscriptions
receivable at July 31, 1995. During the 1996 fiscal year the note was
repaid in full together with interest in the amount of $134,000.
(f) REPURCHASED SHARES
On March 27, 1995, the Company entered into an agreement with a former
president of the Company whereby he returned 1,450,000 Common Shares of
the Company in exchange for a $67,000 reduction in his outstanding share
subscription. This transaction was reflected as a reduction in common
shares and share subscription receivable in the accompanying consolidated
statement of shareholders' equity.
(g) DIVIDENDS
The Company has never declared or paid cash dividends and does not
anticipate paying any cash dividends on its capital stock in the
foreseeable future. In the event cash dividends are declared or paid, the
Company anticipates that they would be declared and paid in U.S. dollars.
Part 1A of the Quebec Companies Act prohibits the Company from paying
dividends that would prevent it from discharging its liabilities when due
or that would bring the book value of its assets to an amount less than
the sum of its liabilities and its issued and paid-up share capital
account. At July 31, 1996, the Company could not distribute any
dividends.
9. STOCK OPTION AND STOCK PURCHASE PLANS
The Company accounts for its stock issuance plans in accordance with
Accounting Principles Board Opinion No. 25 "ACCOUNTING FOR STOCK ISSUED TO
EMPLOYEES". Statement of Financial Accounting Standards No. 123 ("SFAS
123"), ACCOUNTING FOR STOCK-BASED COMPENSATION, became effective for
financial statements covering periods beginning after December 15, 1995.
This statement establishes financial accounting and reporting standards
based on a fair value concept for stock-based employee compensation plans.
This statement requires an employer that continues to apply the accounting
provisions of APB 25 to disclose pro forma amounts reflecting the difference
between compensation costs, including tax effects that would have been
recognized in the income statement, if the fair value based method had been
used. The Company expects to adopt only the disclosure requirements of the
statement.
(a) RESTRICTED STOCK AND STOCK OPTION PLAN
On June 14, 1994, the Company's Board of Directors approved the
establishment of the 1994 Restricted Stock and Stock Option Plan (the
"Discreet Stock Option Plan") for the Company's officers, employees,
consultants and directors. Under the Discreet Stock Option Plan, the
Compensation Committee of the Board of Directors (the "Compensation
Committee") may grant stock options for a maximum of 5,000,000 Common
Shares. Under the terms of the Discreet Stock Option Plan, the purchase
price, which approximates fair market value, and vesting schedule
applicable to each option granted is determined by the Compensation
Committee.
F-12
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
9. STOCK OPTION AND STOCK PURCHASE PLANS (CONTINUED)
(b) 1995 NONEMPLOYEE DIRECTOR STOCK OPTION PLAN
On March 27, 1995, the Company's Board of Directors adopted, and in April
1995, the shareholders approved, the 1995 Nonemployee Director Stock
Option Plan (the "Director Plan"). Under the Director Plan, the
Compensation Committee may grant options to purchase up to 200,000 Common
Shares to nonemployee directors of the Company. The Director Plan
authorizes the grant (a) to each person who becomes a member of the Board
of Directors and who is not an employee, officer or direct and indirect
owner of 5% or more of the Common Shares of the Company (a "Non-Employee
Director"), on the date such person is first elected to the Board of
Directors without further action by the Compensation Committee, of an
option to purchase 20,000 Common Shares and (b) to each person receiving
an option pursuant to clause (a) who is a Non-Employee Director on the
fifth anniversary of the date such person was first elected to the Board
of Directors, during the term of the Director Plan, of an option to
purchase 15,000 Common Shares, provided that such person has continuously
served as a Non-Employee Director during such 5-year period. The exercise
price will be the fair market value at the date of grant and the options
will expire 10 years from the date of grant. All options vest in three
equal annual installments. As of July 31, 1996, 60,000 options were
granted at fair market value under the Director Plan.
(c) 1995 EMPLOYEE STOCK PURCHASE PLAN
On March 27, 1995, the Company's Board of Directors adopted, and in April
1995, the shareholders approved, the 1995 Employee Stock Purchase Plan,
whereby the Company has reserved and may issue to employees up to an
aggregate of 300,000 Common Shares in semiannual offerings over a ten
year period. Common Shares are sold at 85% of fair market value. As of
July 31, 1996, 16,728 shares had been issued under the plan.
(d) NON-QUALIFIED STOCK OPTION OUTSIDE THE PLAN
On November 4, 1994, the Company granted, outside the Discreet Stock
Option Plan, a nonqualified stock option for the purchase of 1,012,308
Common Shares, at a price of $1.63 per share, which approximated fair
market value at date of grant, to the former President and Chief
Executive Officer of the Company. This option was exercised on November
4, 1994 through the issuance of a $1,645,000 note (see Note 8(e)).
The following is a summary of all stock option activity:
<TABLE>
<CAPTION>
NUMBER OF PRICE PER
OPTIONS SHARE
----------- -----------
<S> <C> <C>
Outstanding, July 31, 1993................................................. -- --
Options granted.......................................................... 1,245,080 $ .05-$ .70
Options exercised........................................................ -- --
Options terminated....................................................... -- --
----------- -----------
Outstanding, July 31, 1994................................................. 1,245,080 $ .05-$ .70
Options granted.......................................................... 3,389,260 $ .05- 20.69
Options exercised........................................................ (1,172,072) $ .05- 1.63
Options terminated....................................................... (58,528) $ .05- 1.63
----------- -----------
Outstanding, July 31, 1995................................................. 3,403,740 $ .05-$20.69
Options granted.......................................................... 973,000 $5.75- 28.50
Options exercised........................................................ (1,244,918) $ .05- 6.38
Options terminated....................................................... (387,176) $ .05- 24.50
----------- -----------
Outstanding, July 31, 1996................................................. 2,744,646 $ .05-$28.50
----------- -----------
----------- -----------
Exercisable, July 31, 1996................................................. 513,714 $ .05-$28.50
----------- -----------
----------- -----------
</TABLE>
10. RELATED PARTY TRANSACTIONS
(a) AMOUNTS DUE TO TECHNICAL COMPUTER GRAPHICS, INC. ("TCG")
TCG is a corporation owned by a director and shareholder of the Company
and provides management services and leases certain of its office space
to the Company. The Company believes these transactions were on the same
basis that could have been negotiated with unrelated parties. Management
fees and rent expense paid to TCG were $35,000, $59,000 and $0 for the
years ended July 31, 1994, 1995 and 1996, respectively. At July 31, 1995
and 1996, no amounts were due to TCG. During fiscal 1996, the Company had
sales of $49,000 to TCG. At July 31, 1996, the full amount of the sale
had been collected.
F-13
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
10. RELATED PARTY TRANSACTIONS (CONTINUED)
(b) BOXER SYSTEMS LIMITED ("BOXER")
Boxer is a wholly owned subsidiary of a former minority shareholder of
Discreet Logic (UK) Limited. The Company paid management fees of $83,000
to Boxer for the year ended July 31, 1994. Additionally, Boxer sold the
Company inventory at cost plus a 10% handling fee. The Company paid
$48,000 in handling fees in the year ended July 31, 1994. No such fees
were incurred in the years ended July 31, 1995 and 1996. At July 31, 1995
and 1996, no amounts were due to Boxer.
(c) BEHAVIOUR ENTERTAINMENT INC. ("BEHAVIOUR")
The Company has recorded during fiscal 1996 revenue of $121,000 from
Behaviour, which is a company owned by the Company's Chairman and Chief
Executive Officer and other directors of the Company. At July 31, 1996,
the Company had a trade receivable of $113,000 from Behaviour.
(d) OTHER RELATED PARTY TRANSACTIONS
The Company has recorded revenue of $2,304,000 during fiscal 1996, from a
company with which the Company's Chairman and Chief Executive Officer is
affiliated. At July 31, 1996, the Company had a trade accounts receivable
of $836,000 from such company. The balance is to be collected in six
monthly installments of $139,000.
The Company has recorded revenue of $1,138,000 during fiscal 1996, from a
company with which a member of the Company's board of directors is
affiliated. At July 31, 1996, the full amount of the sale had been
collected.
11. INCOME TAXES
The Company applies the provisions of SFAS No. 109, ACCOUNTING FOR INCOME
TAXES. Under the provisions of SFAS No. 109, the Company recognizes a
current tax liability or asset for current taxes payable or refundable and a
deferred tax liability or asset for the estimated future tax effects of
temporary differences between the carrying value of assets and liabilities
for financial reporting and their tax basis and carryforwards to the extent
they are realizable.
The components of the deferred tax assets and the deferred tax liabilities
are as follows:
<TABLE>
<CAPTION>
JULY 31,
-----------------------
1995 1996
----------- ----------
<S> <C> <C>
Deferred tax assets --
Foreign tax loss carryforwards.......................................... $ -- $6,850,000
Restructuring costs..................................................... -- 1,400,000
Initial and secondary public offering issuance costs.................... 1,713,000 1,740,378
Other temporary differences............................................. 505,123 1,581,200
----------- ----------
2,218,123 11,571,578
Less: Valuation allowance............................................... -- 6,850,000
----------- ----------
$2,218,123 $4,721,578
----------- ----------
----------- ----------
Deferred tax liabilities --
Difference between book and tax basis of capital assets................. $ 935,715 $1,121,514
Federal research and development tax credits............................ 324,949 320,064
----------- ----------
$1,260,664 $1,441,578
----------- ----------
----------- ----------
</TABLE>
The Company provides deferred taxes for research and development tax credits
earned in the current year, which are included in taxable income in the
subsequent year. In accordance with Canadian tax laws, stock issuance costs
are deductible over a five year period.
F-14
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
11. INCOME TAXES (CONTINUED)
Income (loss) before income taxes and minority interest for the entities
incorporated in the following jurisdictions:
<TABLE>
<CAPTION>
YEARS ENDED JULY 31,
------------------------------------
1994 1995 1996
----------- ---------- -----------
<S> <C> <C> <C>
Canada....................................................... $ 493,164 $10,755,706 $(2,470,805)
United States................................................ 227,406 3,359,166 (12,587,746)
United Kingdom............................................... 137,728 (350,429) (5,191,695)
European and Other........................................... -- (474,426) (22,456,100)
----------- ---------- -----------
$ 858,298 $13,290,017 $(42,706,346)
----------- ---------- -----------
----------- ---------- -----------
</TABLE>
The income tax provision is composed of the following:
<TABLE>
<CAPTION>
YEARS ENDED JULY 31,
-------------------------------------
1994 1995 1996
----------- ----------- -----------
<S> <C> <C> <C>
Current --
Federal.................................................... $ 209,339 $2,381,427 $2,060,380
Provincial................................................. 3,808 665,254 375,087
Foreign.................................................... 29,780 1,791,004 1,072,157
----------- ----------- -----------
242,927 4,837,685 3,507,624
----------- ----------- -----------
Deferred --
Federal.................................................... 11,288 647,247 (1,373,684)
Provincial................................................. 26,996 268,656 (228,379)
Foreign.................................................... 61,948 (263,391) (470,726)
----------- ----------- -----------
100,232 652,512 (2,072,789)
----------- ----------- -----------
Total provision.............................................. $ 343,159 $5,490,197 $1,434,835
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The reconciliation between the Canadian federal statutory income tax rate
and the effective tax rate is as follows:
<TABLE>
<CAPTION>
YEARS ENDED JULY 31,
-----------------------------------------------
1994 1995 1996
--------------- --------------- -------------
<S> <C> <C> <C>
Provision (benefit) at the Canadian federal statutory rate... 38.0% 38.0% (38.0)%
Foreign taxes................................................ 16.7 3.3 17.2
effect of not utilizing foreign subsidiaries' tax losses..... -- 0.9 16.0
effect of permanent differences.............................. -- -- 3.0
Provincial taxes, net of federal tax abatements.............. (3.0) (1.0) 0.2
Canadian federal incentives for manufacturers and small
business................................................... (2.8) (2.8) 0.2
Utilization of net operating losses.......................... (6.1) -- --
Other items.................................................. (2.8) 2.9 4.8
--- --- -----
Tax provision................................................ 40.0% 41.3% 3.4%
--- --- -----
--- --- -----
</TABLE>
The Company has $27,460,000 of cumulative foreign net operating loss
carryforwards which may be available to reduce future income tax liabilities
in those jurisdictions. The loss carryforwards will expire beginning July
31, 2001.
The Company has recorded a valuation allowance against the tax benefit of
these net operating loss carryforwards because the tax benefits do not meet
the recognition criteria set forth in SFAS 109 because their future
realizability is uncertain.
These net operating loss carryforwards are subject to review and adjustment
by the respective tax authorities and may be limited in certain cases upon a
significant ownership change of the corporation, as defined.
F-15
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
12. COMMITMENTS AND CONTINGENCIES
(a) LEASE COMMITMENTS
The Company has both operating and capital lease commitments for certain
facilities and equipment which expire through February 2003. The
following schedule outlines the future minimum rental payments under
these leases at July 31, 1996:
<TABLE>
<CAPTION>
OPERATING
LEASES
---------
<S> <C>
Year ended July 31,
1997.................................................................. $2,055,388
1998.................................................................. 1,647,307
1999.................................................................. 892,230
2000.................................................................. 730,732
2001 and thereafter................................................... 1,267,205
---------
Total minimum lease payments............................................ $6,592,862
---------
---------
</TABLE>
The above commitments include leases for locations which the Company
plans to close under the restructuring plan (see Note 17).
Rental expenses related to the operating leases were approximately
$312,000, $917,000 and $1,348,000, for the years ended July 31, 1994,
1995 and 1996 respectively.
(b) LETTERS OF GUARANTEE
The Company has provided letters of guarantee in the amount of $485,178
as of July 31, 1996.
13. FINANCIAL INFORMATION BY GEOGRAPHIC AREA
The Company operates in one industry segment primarily digital image
processing solution systems for creating, editing, and compositing special
visual effects for film and video, including training and other services
incident to these products.
Revenues by geographic destination and as a percentage of total revenues are
as follows:
<TABLE>
<CAPTION>
YEARS ENDED JULY 31,
----------------------------------
GEOGRAPHIC AREA BY DESTINATION 1994 1995 1996
- ------------------------------------------------------------- ---------- ---------- ----------
<S> <C> <C> <C>
North America................................................ $11,343,635 $35,515,336 $36,286,073
Europe....................................................... 2,816,670 20,706,850 35,774,418
Pacific Rim.................................................. 969,673 6,414,711 8,717,015
Other........................................................ 261,658 1,911,714 3,219,941
---------- ---------- ----------
$15,391,636 $64,548,611 $83,997,447
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED JULY 31,
-------------------------------------------
GEOGRAPHIC AREA BY DESTINATION 1994 1995 1996
- ------------------------------------------------------------- ------------- ------------- -------------
<S> <C> <C> <C>
North America................................................ 73.7% 55.0% 43.2%
Europe....................................................... 18.3 32.1 42.6
Pacific Rim.................................................. 6.3 9.9 10.4
Other........................................................ 1.7 3.0 3.8
----- ----- -----
100.0% 100.0% 100.0%
----- ----- -----
----- ----- -----
</TABLE>
F-16
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
13. FINANCIAL INFORMATION BY GEOGRAPHIC AREA (CONTINUED)
Revenues, net income and identifiable assets for the Company's Canadian,
U.S., U.K., Germany and European and other operations are as follows:
Intercompany transfers between geographic areas are at prices that
approximate arm's length transactions. Expenses incurred in one geographic
area that benefit other areas have been allocated based upon services
utilized.
<TABLE>
<CAPTION>
OTHER
EUROPEAN
COUNTRIES
CANADIAN U.S. U.K. GERMANY AND OTHER ELIMINATIONS CONSOLIDATED
------------ ------------ ----------- ----------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
1994 --
Revenues.................. $ 3,300,131 $ 10,703,296 $ 1,388,209 $ -- $ -- $ -- $15,391,636
Transfers between
geographic locations.... 2,505,781 -- -- -- -- (2,505,781) --
------------ ------------ ----------- ----------- ------------ ------------- -------------
Total revenues.......... $ 5,805,912 $ 10,703,296 $ 1,388,209 $ -- $ -- $ (2,505,781) $15,391,636
------------ ------------ ----------- ----------- ------------ ------------- -------------
------------ ------------ ----------- ----------- ------------ ------------- -------------
Net income.............. $ 241,733 $ 170,535 $ 71,218 $ -- $ -- $ -- $ 483,486
------------ ------------ ----------- ----------- ------------ ------------- -------------
------------ ------------ ----------- ----------- ------------ ------------- -------------
Identifiable assets..... $ 4,658,111 $ 4,436,186 $ 1,288,718 $ -- $ -- $ (952,180) $ 9,430,835
------------ ------------ ----------- ----------- ------------ ------------- -------------
------------ ------------ ----------- ----------- ------------ ------------- -------------
1995 --
Revenues.................. $ 12,878,575 $ 31,794,924 $10,089,329 $ 3,109,867 $ 6,675,916 $ -- $64,548,611
Transfers between
geographic locations.... 11,747,606 15,902,851 $ -- $ -- $ -- (27,650,457) --
------------ ------------ ----------- ----------- ------------ ------------- -------------
Total revenues.......... $ 24,626,181 $ 47,697,775 $10,089,329 $ 3,109,867 $ 6,675,916 $ (27,650,457) $64,548,611
------------ ------------ ----------- ----------- ------------ ------------- -------------
------------ ------------ ----------- ----------- ------------ ------------- -------------
Net income (loss)....... $ 6,778,399 $ 4,167,891 $ (296,320) $ (17,849) $ (629,786) $ (2,217,240) $ 7,785,095
------------ ------------ ----------- ----------- ------------ ------------- -------------
------------ ------------ ----------- ----------- ------------ ------------- -------------
Identifiable assets..... $ 58,693,038 $ 20,818,430 $ 9,205,168 $ 2,756,008 $ 4,895,738 $ (19,510,207) $76,858,175
------------ ------------ ----------- ----------- ------------ ------------- -------------
------------ ------------ ----------- ----------- ------------ ------------- -------------
1996 --
Revenues.................. $ 8,339,345 $ 33,090,335 $17,309,369 $12,307,428 $ 12,950,970 $ -- $83,997,447
Transfers between
geographic locations.... 20,211,614 29,090,504 -- -- 9,007,939 (58,310,057) --
------------ ------------ ----------- ----------- ------------ ------------- -------------
Total revenues.......... $ 28,550,959 $ 62,180,839 $17,309,369 $12,307,428 $ 21,958,909 $ (58,310,057) $83,997,447
------------ ------------ ----------- ----------- ------------ ------------- -------------
------------ ------------ ----------- ----------- ------------ ------------- -------------
Net income (loss)....... $ (1,398,871) $(11,532,447) $(5,210,577) $ (797,282) $(21,937,763) $ (3,264,240) $(44,141,181)
------------ ------------ ----------- ----------- ------------ ------------- -------------
------------ ------------ ----------- ----------- ------------ ------------- -------------
Identifiable assets..... $103,117,776 $ 48,995,740 $20,411,397 $ 5,937,355 $ 27,620,429 $(125,934,955) $80,147,742
------------ ------------ ----------- ----------- ------------ ------------- -------------
------------ ------------ ----------- ----------- ------------ ------------- -------------
</TABLE>
Export sales from Canada were $2,695,632, $10,601,744 and $5,788,925 for the
years ended July 31, 1994, 1995 and 1996, respectively. The Barbados and
Asian operations are included in Other European countries and other.
14. DEPENDENCE ON KEY SUPPLIER
The Company is dependent on Silicon Graphics, Inc. ("SGI") to manufacture
and supply all workstations and certain peripherals used in the Company's
systems. The Company derived 45.0%, 38.6% and 34.2% of total revenues in the
years ended July 31, 1994, 1995 and 1996, respectively, from sales of SGI
workstations and peripherals.
15. ACQUISITIONS
(a) BRUGHETTI CORPORATION
On May 26, 1995, the Company acquired substantially all the technology
and other assets of Brughetti Corporation ("Brughetti"), a Canadian
corporation. The purchase price was CDN$1,000,000 (or approximately
$741,000) in cash of which CDN$600,000 (or approximately $441,000) was
paid upon closing of the acquisition and CDN$400,000 (or approximately
$300,000) was paid in July 1995. In addition, the Company has agreed to
pay up to an additional $5,500,000 as contingent purchase price payable
in cash or securities of the Company, at the sole option of the Company.
The contingent purchase price is payable in three annual installments,
beginning October 1996, and is based upon a percentage of the amount by
which revenues derived from future sales of products and technologies
purchased from Brughetti exceed certain minimum annual revenues. In the
event that the revenues,
F-17
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
15. ACQUISITIONS (CONTINUED)
as defined, exceed certain minimum annual revenue levels in fiscal 1996,
1997 and 1998, the contingent consideration payable would be up to
$1,500,000, $2,000,000 and $2,000,000 for fiscal 1996, 1997 and 1998,
respectively. If the minimum annual revenue levels for any fiscal year
are not reached, no payments are due for that year, provided, however,
that the second and third payments are subject to upward adjustment in
the event that the initial revenue thresholds are not met but revenue
thresholds related to the subsequent fiscal years are exceeded. In no
event, however, will the contingent consideration payable exceed an
aggregate of $5,500,000. The Company did not meet the minimum revenue
levels for fiscal 1996 and no additional payment is currently due. The
acquisition was accounted for as a purchase and accordingly the initial
purchase price and acquisition costs were allocated to the assets
acquired which consisted of approximately $102,000 of accounts
receivable, $105,000 of property and equipment and $534,000 of acquired
technology. In addition, in accordance with APB No. 16, additional
consideration paid upon the achievement of the performance criteria, if
any, will be recorded as additional purchase price at such time,
allocated to acquired technology and amortized over the remaining
estimated useful life.
Under the restructuring plan, the Company has discontinued the
development of the Brughetti products. Accordingly, the unamortized value
of the acquired technology was written off.
(b) COSS/IMP
On October 24, 1995, the Company acquired all of the outstanding shares
of Computer-und Serviceverwaltungs AG, located in Innsbruck, Austria
("COSS") and certain assets of IMP Innovative Medientechnik-und
Planungs-GmbH, located in Geltendorf/ Kaltenberg, Germany ("IMP") related
to the research, development, manufacturing, marketing, sale,
distribution or procurement of real-time broadcast animation products,
including software. The purchase price for the shares of COSS was
$3,000,000 in cash plus 300,000 Common Shares of the Company. In
addition, the Company agreed to pay an additional $500,000 in cash as
contingent purchase price in the event COSS received orders for and
licensed a certain number of VAPOUR systems by April 1996, as defined.
The purchase price for the IMP assets was $2,000,000 in cash. During
fiscal 1996, the Company paid the contingent purchase price, which was
accounted for as an additional purchase price and allocated to goodwill.
The acquisition was accounted for as a purchase and accordingly the
purchase price and acquisition costs were allocated to the assets
acquired which consisted of approximately $8,500,000 of in process
research and development and charged to operations in the first quarter
of fiscal 1996, and approximately $3,200,000 was allocated to intangible
assets, which include goodwill and acquired technology, and is being
amortized on a straight-line basis over their estimated lives of 5 years.
These allocations represent the fair values determined by an independent
appraisal. The appraisal incorporated proven valuation procedures and
techniques in determining the fair value of each intangible asset. The
amount allocated to in process research and development relates to
projects that had not yet reached technological feasibility and that,
until completion of the development, had no alternative use. These
projects required substantial high risk development and testing by the
Company prior to reaching technological feasibility.
Under the restructuring plan, the Company has transitioned the technology
and the related research and development operations from Innsbruck,
Austria to Montreal, Canada. Accordingly, the unamortized balance of
goodwill of approximately $1.8 million was charged to restructuring
expense.
The following unaudited pro forma information presents the consolidated
results of operations for the year ended July 31, 1995 as if the
acquisitions of Brughetti and COSS/IMP had occurred on August 1, 1994
after giving effect to certain adjustments, including depreciation,
amortization of acquired assets and in process research and development
charges. The pro forma information does not reflect additional cash
consideration, if any which may be paid upon the occurrence of certain
performance criteria. This pro forma information has been prepared for
comparative purposes only and does not purport to be indicative of what
would have occurred had the acquisitions been made on August 1, 1994 or
of results that may occur in the future.
<TABLE>
<CAPTION>
YEAR ENDED
BRUGHETTI CORPORATION AND COSS/IMP JULY 31,
UNAUDITED PROFORMA INFORMATION 1995
- ---------------------------------------------------------------------------------- ------------
<S> <C>
Total Revenues.................................................................... $67,651,835
Net Loss.......................................................................... $(1,419,835)
Net Loss per common share......................................................... $ (0.06)
</TABLE>
(c) ESSENTIAL COMMUNICATIONS CORPORATION
On April 15, 1996, The Company purchased newly issued Series B
convertible, voting, preferred shares of a privately held company,
Essential Communications Corporation, representing approximately 20% of
the voting shares. The $2,500,000 investment has been
F-18
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
15. ACQUISITIONS (CONTINUED)
charged to operations in fiscal 1996 as research and development expense
due to the uncertainty regarding the realizability of the investment in
the preferred shares. Pro forma presentation has not been included as it
is not deemed to be meaningful or material.
16. PURCHASE OF LAND AND FACILITIES
In August 1995, the Company purchased land and an office building in London,
England for approximately L1,148,000 (or approximately $1,788,000).
Additionally, in September 1995, the Company entered into a purchase and
sale agreement to purchase land and a building in Montreal for CDN$1,730,000
(or approximately $1,250,000). During fiscal 1996, the carrying value of the
London and Montreal buildings were written down to their estimated fair
market values and these buildings are classified as assets held for resale.
17. RESTRUCTURING
In the fourth quarter of 1996, the Company recorded a pre-tax restructuring
charge of $15 million to cover the direct costs of restructuring the
Company's operations and to bring operating expenses in line with the
Company's current revenue level. The focus of the Company's restructuring
plan is to solidify its senior management team, reduce operating expenses
through workforce reductions and office closings, consolidate research and
development activities in Montreal, the discontinuance of certain product
lines, and restructure its sales force to emphasize indirect sales channels.
The Company began implementation of its restructuring plan in the fourth
fiscal quarter of 1996 and expects implementation to continue throughout
fiscal 1997. The major aspects of the restructuring plan are discussed
below. There can be no assurance that management will be successful in
implementing the restructuring plan or that the Company will not take on
further restructurings or be profitable in the future. Furthermore, the
implementation of the restructuring plan may cause diversion of management's
time and resources and may result in other unforeseen disruptions and
unexpected expenses.
The restructuring entails the closing and moving of several offices in North
America and Europe. It also includes the termination of approximately 110
positions across all departments and around the world. Of the 110 positions
to be terminated, 65 were terminated during the fourth quarter of 1996 at a
severance cost of $807,000 of which $582,000 had been paid as at July 31,
1996. The remaining termination and related benefits will be substantially
completed by the end of the first quarter of fiscal 1997.
The components of the restructuring charge are as follows:
<TABLE>
<S> <C>
Asset Write Down....................................................................... $6,190,000
Lease Terminations and Leasehold Improvements Reserve.................................. 4,600,000
Severance.............................................................................. 2,800,000
Professional Services and Other........................................................ 1,410,000
----------
$15,000,000
----------
----------
</TABLE>
The primary component of the asset write down is an amount of $2.2 million
for goodwill and acquired technology. The other components of the write down
are primarily fixed assets which have no future use.
18. DIFFERENCES BETWEEN U.S. AND CANADIAN GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES (GAAP)
These consolidated financial statements have been prepared in accordance
with U.S. GAAP which conform, in all material respects, with Canadian GAAP
except as follows:
(a) Under Canadian GAAP, the amount allocated to purchased in-process
research and development as part of the acquisition of COSS/IMP referred
to in note 15(b) would not have been charged to operations in the first
quarter of 1996. Rather, the amount would have been capitalized to other
assets and it would have been amortized using the straight-line method
over its estimated life of 3 years. Following the adoption of the
restructuring plan referred to in note 17, the unamortized purchased
in-process research and development would have been written off in the
fourth quarter of 1996 since, as a result of the plan, the Company
decided to indefinitely postpone further development of the in-process
research and development acquired.
The above difference would not have required adjustments to reconcile the
balance sheet as at July 31, 1996 to the Canadian GAAP format.
F-19
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
18. DIFFERENCES BETWEEN U.S. AND CANADIAN GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES (GAAP) (CONTINUED)
The following is a condensed income statement as of July 31, 1996 reconciled
to the Canadian GAAP format including the difference above.
<TABLE>
<CAPTION>
PER U.S. GAAP ADJUSTMENT (A) PER CANADIAN GAAP
-------------- -------------- -------------------
<S> <C> <C> <C>
Total revenues................................................. $ 83,997,447 $ -- $ 83,997,447
Cost of revenues............................................... 49,333,071 -- 49,333,071
Gross profit................................................. 34,664,376 -- 34,664,376
Operating expenses:
Research and development..................................... 16,902,432 1,890,000 18,792,432
Sales and marketing.......................................... 26,088,163 -- 26,088,163
General and administrative................................... 10,581,670 -- 10,581,670
Write-off of purchased research and development.............. 8,500,000 (8,500,000) --
Restructuring expense........................................ 15,000,000 6,610,000 21,610,000
Litigation and related settlement expenses................... 2,506,203 -- 2,506,203
-------------- -------------- -------------------
Total operating expenses................................... 79,578,468 -- 79,578,468
-------------- -------------- -------------------
Operating loss............................................. (44,914,092) -- (44,914,092)
-------------- -------------- -------------------
Other income (expense):
Interest income.............................................. 2,258,705 -- 2,258,705
Interest expense............................................. (229,579) -- (229,579)
Foreign currency exchange gain............................... 178,620 -- 178,620
-------------- -------------- -------------------
Total other income (expense)............................... 2,207,746 -- 2,207,746
-------------- -------------- -------------------
Loss before income taxes..................................... (42,706,346) -- (42,706,346)
Provision for income taxes..................................... 1,434,835 -- 1,434,835
-------------- -------------- -------------------
Net loss..................................................... $(44,141,181) -- $ (44,141,181)
-------------- -------------- -------------------
-------------- -------------- -------------------
Net loss per common and common equivalent share................ $ (1.64) -- $ (1.64)
-------------- -------------- -------------------
-------------- -------------- -------------------
Weighted average common shares outstanding..................... 26,836,834 -- 26,836,834
-------------- -------------- -------------------
-------------- -------------- -------------------
</TABLE>
For the years ending July 31, 1995 and 1994, there are no material
differences between the financial statements prepared in accordance with
U.S. GAAP and those prepared in Canadian GAAP.
F-20
<PAGE>
SCHEDULE G
DISCREET LOGIC INC. AND SUBSIDIARIES
PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
INDEX TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Report of Arthur Andersen & Cie.................................................................................. G-2
Pro forma Consolidated Balance Sheet............................................................................. G-3
Pro forma Consolidated Statement of Operations................................................................... G-4
Notes to the Pro forma Consolidated Balance Sheet and Pro forma Consolidated Statement of Operations............. G-5
</TABLE>
G-1
<PAGE>
SCHEDULE G
DISCREET LOGIC INC. AND SUBSIDIARIES
PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
COMPILATION REPORT
To the Directors of
Discreet Logic Inc.:
We have reviewed, as to compilation only, the accompanying unaudited pro
forma consolidated balance sheet of Discreet Logic Inc. as at June 30, 1997 and
the unaudited pro forma consolidated statement of operations for the
eleven-month period then ended. These unaudited pro forma consolidated financial
statements have been prepared solely for inclusion in this circular. In our
opinion, these unaudited pro forma consolidated financial statements have been
properly compiled to give effect to the proposed transaction and the assumptions
described in the notes thereto.
(Signed) ARTHUR ANDERSEN & CIE
Montreal, Canada General Partnership
April 8, 1998 Chartered Accountants
G-2
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
PRO FORMA CONSOLIDATED BALANCE SHEET
(UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL
-----------------------
DISCREET
LOGIC MGI PRO FORMA
JUNE 30, JANUARY 31, ADJUSTMENTS PRO FORMA
1997 1998 (NOTE 3) CONSOLIDATED
--------- ----------- ------------- ------------
<S> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents....................... $ 31,668 $ 1,205 $ 32,873
Notes receivable................................ -- 7,428 7,428
Accounts receivable............................. 26,893 3,322 30,215
Inventory....................................... 13,921 375 14,296
Income taxes receivable......................... 448 -- 448
Other current assets............................ 3,889 397 4,286
--------- ----------- ------------
76,819 12,727 89,546
Property and equipment -- less accumulated
depreciation and amortization................... 7,728 1,022 8,750
Deferred income taxes............................. 3,489 -- 3,489
Other assets...................................... 12,188 -- 99,136(a) 111,324
Assets held for resale............................ 5,248 -- 5,248
--------- ----------- ------------
$ 105,472 $ 13,749 $ 218,357
--------- ----------- ------------
--------- ----------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................................ $ 23,687 $ 2,297 25,984
Accrued expenses................................ 20,399 -- 3,000(b) 23,399
Deferred revenue................................ 8,103 -- 8,103
Income taxes payable............................ 4,734 -- 4,734
Customer deposits............................... 1,360 -- 1,360
--------- ----------- ------------
58,283 2,297 63,580
--------- ----------- ------------
Deferred income taxes............................. 713 -- 713
--------- ----------- ------------
SHAREHOLDERS' EQUITY
Common shares..................................... 80,402 21,997 85,591(a) 187,990
Deficit........................................... (33,112) (10,545) 10,545(a)(b) (33,112)
Cumulative translation adjustment................. (814) -- (814)
--------- ----------- ------------
Total shareholders' equity...................... 46,476 11,452 154,064
--------- ----------- ------------
$ 105,472 $ 13,749 $ 218,357
--------- ----------- ------------
--------- ----------- ------------
</TABLE>
Approved on behalf of the Board of Directors:
<TABLE>
<S> <C>
(Signed) RICHARD J. SZALWINSKI (Signed) THOMAS CANTWELL
Director Director
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED PRO FORMA
CONSOLIDATED FINANCIAL STATEMENTS.
G-3
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL
---------------------------
DISCREET
LOGIC MGI
FOR THE FOR THE
ELEVEN-MONTH YEAR
PERIOD ENDED ENDED PRO FORMA
JUNE 30, JANUARY 31, ADJUSTMENTS PRO FORMA
1997 1998 (NOTE 3) CONSOLIDATED
-------------- ----------- ----------- -------------
<S> <C> <C> <C> <C>
Total revenues........................................... $ 101,923 $ 9,170 $ 111,093
Cost of revenues......................................... 47,571 1,827 49,398
-------------- ----------- -------------
Gross profit........................................... 54,352 7,343 61,695
-------------- ----------- -------------
Operating expenses:
Research and development, net of tax credits........... 9,980 3,477 29,668(c) 43,125
Sales and marketing.................................... 23,206 8,046 31,252
General and administrative............................. 6,396 739 7,135
Litigation and settlement expenses..................... 6,500 -- 6,500
-------------- ----------- -------------
Total operating expenses............................... 46,082 12,262 88,012
-------------- ----------- -------------
Operating income (loss)................................ 8,270 (4,919) (26,317)
-------------- ----------- -------------
OTHER INCOME (EXPENSE)
Interest income........................................ 1,234 144 1,378
Interest expense....................................... (55) -- (55)
Foreign currency exchange loss......................... (188) -- (188)
-------------- ----------- -------------
Total other income................................... 991 144 1,135
-------------- ----------- -------------
Income (loss) before provision for income taxes........ 9,261 (4,775) (25,182)
Provision for income taxes............................... 6,489 -- 6,489
-------------- ----------- -------------
Net income (loss)...................................... $ 2,772 $ (4,775) $ (31,671)
-------------- ----------- -------------
-------------- ----------- -------------
Earnings (loss) per share................................ $ 0.10 $ (0.99)
-------------- -------------
-------------- -------------
Weighted average common shares outstanding............... 27,947,807 31,832,115
-------------- -------------
-------------- -------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED PRO FORMA
CONSOLIDATED FINANCIAL STATEMENTS.
G-4
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO THE UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
AND UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
AS AT AND FOR THE ELEVEN-MONTH PERIOD ENDED JUNE 30, 1997
(UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
1. BASIS OF PRESENTATION
The unaudited pro forma consolidated financial statements of Discreet Logic
Inc. ("Discreet") are provided to give effect to the Arrangement which will
be accomplished, subject to shareholders and regulatory approvals, through a
share exchange with each share of MGI Software Inc. ("MGI") to be exchanged
for 0.162 share of Discreet shares. Outstanding options and warrants to
purchase MGI common shares will be converted at the same exchange ratio into
options and warrants to acquire Discreet shares.
The pro forma information is based on the historical consolidated financial
statements of Discreet and MGI giving effect to the acquisition using the
purchase method of accounting in accordance with Canadian GAAP. Discreet
intends to account for the acquisition using the pooling of interests method
of accounting in its U.S. GAAP consolidated financial statements.
The unaudited pro forma consolidated balance sheet as at June 30, 1997 and
unaudited pro forma consolidated statement of operations for the
eleven-month period ended June 30, 1997 have been prepared using the
following information:
(a) audited consolidated financial statements of Discreet for the
eleven-month period ended June 30, 1997, which are included in this
circular;
(b) audited financial statements of MGI for the fiscal year ended January
31, 1998 which are included in this circular. MGI financial information
has been translated to U.S. dollars using the closing rate of 1.456. No
translation gains or losses have been recorded in the financial
statements;
(c) such other supplementary information as was considered necessary to
reflect the proposed transaction in these unaudited pro forma
consolidated financial statements.
The unaudited pro forma consolidated financial statements of Discreet should
be read in conjunction with the consolidated financial statements, including
notes thereto, of Discreet and MGI.
The unaudited pro forma consolidated financial statements are not intended
to reflect the results of operations or the financial position that would
have actually resulted had the transaction been effected on the date
indicated or the results which may be obtained in the future.
Certain of the financial statement items of MGI have been reclassified to
conform to the presentation format used by Discreet.
2. PRO FORMA ASSUMPTIONS
The unaudited pro forma consolidated balance sheet presents the combined
financial position of Discreet as at June 30, 1997 and MGI as at January 31,
1998, assuming the acquisition had been completed as of the date of the
balance sheet. The pro forma consolidated statement of operations presents
the combined results of operations for the eleven-month period ended June
30, 1997 for Discreet and for the fiscal year ended January 31, 1998 for
MGI, assuming that the acquisition had been completed at the beginning of
the eleven-month period.
The common shares issued by Discreet pursuant to this agreement is based on
the following:
<TABLE>
<S> <C>
Number of common shares outstanding of MGI, including all options and warrants.......... 28,259,144
Conversion ratio per the Arrangement.................................................... 0.162
---------
Number of common shares to be issued by Discreet........................................ 4,577,981
---------
---------
Market value of Discreet common shares.................................................. $ 25.06
---------
Equivalent market value of MGI shares including all options and warrants................ $ 114,724
Less cash to be received of converted options and warrants.............................. 7,136
---------
Consideration given by Discreet for MGI shares.......................................... $ 107,588
---------
---------
</TABLE>
The number of common shares outstanding of MGI, including all options and
warrants, as described above, has been established based on MGI management
representations in the Arrangement dated March 9, 1998.
The market value of Discreet common shares represents the closing market
value as of March 9, 1998, the date of the Arrangement and of the public
announcement.
G-5
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO THE UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
AND UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS (CONTINUED)
AS AT AND FOR THE ELEVEN-MONTH PERIOD ENDED JUNE 30, 1997
(UNAUDITED)
(AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
2. PRO FORMA ASSUMPTIONS (CONTINUED)
The cash to be received by Discreet upon exercise of the options and
warrants is based on the following:
<TABLE>
<S> <C>
MGI stock option plan
3,084,175 MGI common shares at a weighted average exercise price of $1.21 (CDN$1.76).... $ 3,732
Broker Special Warrants
175,000 warrants at an exercise price of $3.61 (CDN$5.25)............................... 632
Intel warrants
1,022,757 warrants at an exercise price of $2.71 (CDN$3.95)............................. 2,772
---------
Total cash to be received upon exercise of the options and warrants....................... $ 7,136
---------
---------
</TABLE>
The purchase price of the MGI shares has been determined and allocated as
follows:
<TABLE>
<S> <C>
Consideration given by Discreet for the MGI shares........................................ $ 107,588
Transaction costs......................................................................... 3,000
---------
110,588
Net tangible assets acquired.............................................................. 11,452
---------
Excess of the consideration given over net tangible assets acquired....................... $ 99,136
---------
---------
Allocation of the excess:
Purchased in-process research and development........................................... $ 67,500
Acquired technology..................................................................... 5,100
Goodwill................................................................................ 26,536
---------
$ 99,136
---------
---------
</TABLE>
3. PRO FORMA ADJUSTMENTS
The pro forma adjustments contained in these unaudited pro forma
consolidated financial statements are based on estimates and assumptions by
management of Discreet based on available information. The following
adjustments have been made to reflect the proposed transaction:
(a) ALLOCATION OF THE PURCHASE PRICE
To reflect the share exchange pursuant to the Arrangement as discussed in
Note 2.
(b) TRANSACTION COSTS
The transaction costs estimated at $3,000 such as legal fees, accounting
fees, broker fees and printing costs, have been included in the purchase
price and included in the accrued expenses in the unaudited pro forma
consolidated financial statements.
(c) PRO FORMA ADJUSTMENT TO THE UNAUDITED PRO FORMA CONSOLIDATED STATEMENT
OF OPERATIONS
The amortization of the intangibles has been accounted for in the
unaudited pro forma consolidated financial statements based on the
purchase price allocation as discussed in Note 2. The intangibles will be
amortized using the straight-line method over the following periods:
<TABLE>
<S> <C>
Purchased in-process research and development.......................................... 3 years
Acquired technology.................................................................... 5 years
Goodwill............................................................................... 3 years
</TABLE>
4. EARNINGS (LOSS) PER SHARE
Earnings (loss) per share reflects the issuance of approximately 3,884,308
common shares arising from the Arrangement (excluding the options and the
warrants) at the beginning of the eleven-month period combined with the
average number of common shares of Discreet outstanding during the period.
G-6
<PAGE>
SCHEDULE H
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------------
FORM 10-Q
(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended December 31, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the transition period from to
COMMISSION FILE NUMBER 0-26100
---------------------
DISCREET LOGIC INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
QUEBEC 98-0150790
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification Number)
</TABLE>
10 DUKE STREET
MONTREAL, QUEBEC, CANADA H3C 2L7
(Address of principal executive offices) (Zip code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (514) 393-1616
Indicate by check mark whether registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
28,880,561 shares of the registrant's Common Shares, without par value, were
outstanding as of February 11, 1998.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 1997
CONTENTS
<TABLE>
<CAPTION>
ITEM NUMBER PAGE
- ------------ -----
<S> <C> <C>
PART I: FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Balance Sheets..................................................................................... 3
Statements of Operations........................................................................... 4
Statements of Cash Flows........................................................................... 5
Notes to Condensed Consolidated Financial Statements............................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................................................. 9
Certain Factors That May Affect Future Results..................................................... 15
PART II: OTHER INFORMATION
Item 1. Legal Proceedings.................................................................................. 16
Item 4. Submissions of Matters to a Vote of Security Holders............................................... 17
Item 6. Exhibits and Reports on Form 8-K................................................................... 18
Signatures..................................................................................................... 19
</TABLE>
H-2
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(ALL AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT FOR SHARE DATA)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1997
---------- ------------
<S> <C> <C>
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................................................... $ 31,668 $ 12,649
Accounts receivable (less reserves for doubtful accounts)................................... 26,893 29,559
Inventory--
Resale.................................................................................... 10,867 9,725
Demonstration............................................................................. 3,054 4,073
Income taxes receivable..................................................................... 448 --
Other current assets........................................................................ 3,889 4,291
---------- ------------
76,819 60,297
Property and equipment--less accumulated depreciation and amortization........................ 7,728 9,583
Deferred income taxes......................................................................... 3,489 2,467
Other assets.................................................................................. 2,660 7,344
Assets held for resale........................................................................ 5,248 4,241
---------- ------------
$ 95,944 $ 83,932
---------- ------------
---------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses....................................................... $ 44,086 $ 36,824
Deferred revenue............................................................................ 8,103 5,740
Income taxes payable........................................................................ 4,734 5,707
Customer deposits........................................................................... 1,359 426
---------- ------------
58,282 48,697
---------- ------------
Deferred income taxes....................................................................... 713 2,268
---------- ------------
Shareholders' Equity:
Preferred shares--no par value
Authorized--unlimited number of shares
Issued and outstanding--none
Common shares--no par value
Authorized--unlimited number of shares
Issued and outstanding--28,117,415 shares at June 30, 1997 and 28,840,493 at December 31,
1997.................................................................................... 80,402 92,128
Accumulated deficit......................................................................... (42,639) (56,951)
Cumulative translation adjustment........................................................... (814) (2,210)
---------- ------------
Total shareholders' equity.............................................................. 36,949 32,967
---------- ------------
$ 95,944 $ 83,932
---------- ------------
---------- ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
H-3
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(ALL AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT FOR PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
TWO THREE FIVE SIX
MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1996 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Total revenues............................................... $ 16,833 $ 37,268 $ 40,096 $ 75,673
Cost of revenues............................................. 8,003 13,548 20,290 30,827
------------ ------------ ------------ ------------
Gross profit............................................... 8,830 23,720 19,806 44,846
------------ ------------ ------------ ------------
Operating expenses:
Research and development (net of tax credits).............. 1,575 3,901 4,253 7,413
Sales and marketing........................................ 4,610 8,407 10,627 15,840
General and administrative................................. 1,189 2,012 2,705 3,896
Charge for purchased research and development.............. -- 5,800 -- 26,800
------------ ------------ ------------ ------------
Total operating expenses................................. 7,374 20,120 17,585 53,949
------------ ------------ ------------ ------------
Operating income (loss).................................. 1,456 3,600 2,221 (9,103)
Other income (expense), net.................................. 1,819 287 894 663
------------ ------------ ------------ ------------
Income (loss) before income taxes.......................... 3,275 3,887 3,115 (8,440)
Provision for income taxes................................... 1,310 3,097 1,962 5,872
------------ ------------ ------------ ------------
Net income (loss).......................................... $ 1,965 $ 790 $ 1,153 $ (14,312)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Earnings (Loss) Per Share:
Basic...................................................... $ 0.07 $ 0.03 $ 0.04 $ (0.50)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Diluted.................................................... $ 0.07 $ 0.03 $ 0.04 $ (0.50)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Weighted average common shares outstanding:
Basic...................................................... 27,931 28,833 27,852 28,746
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Diluted.................................................... 28,444 30,597 28,412 28,746
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
H-4
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(ALL AMOUNTS IN THOUSANDS OF U.S. DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
FIVE MONTHS SIX MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31,
1996 1997
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)........................................................................ $ 1,153 $ (14,312)
Adjustments to reconcile net loss to cash provided by (used in) operating activities--
Depreciation and amortization.......................................................... 2,597 3,996
Deferred income taxes.................................................................. (463) 2,577
Write-off of in-process research and development....................................... -- 26,800
Write-off of assets for restructuring.................................................. -- 109
Compensation expense related to stock options.......................................... -- 300
Changes in assets and liabilities--
Settlement of class action litigations............................................... -- (10,800)
Accounts receivable.................................................................. 2,614 (1,783)
Inventory............................................................................ 9,089 935
Income taxes receivable.............................................................. 2,907 448
Other current assets................................................................. (527) (255)
Insurance proceeds related to class action litigation................................ -- 3,459
Accounts payable and accrued expenses................................................ (2,415) (13,347)
Deferred revenue..................................................................... 3,294 (2,363)
Income taxes payable................................................................. -- 973
Customer deposits.................................................................... (934) (933)
Due to related parties............................................................... (25) --
------------- -------------
Net cash provided by (used in) operating activities.................................... 17,290 (4,196)
------------- -------------
Cash flows from investing activities:
Purchase of property and equipment....................................................... (3,084) (4,350)
Proceeds on disposal of assets held for resale........................................... -- 818
Cash paid for D-Vision acquisition and related costs..................................... -- (10,342)
------------- -------------
Net cash used in investing activities.................................................. (3,084) (13,874)
------------- -------------
Cash flows from financing activities:
Proceeds from option exercises........................................................... 640 560
Proceeds from employee stock purchase plan............................................... 200 217
------------- -------------
Net cash provided by financing activities.............................................. 840 777
------------- -------------
Foreign exchange effect on cash.......................................................... (437) (1,726)
------------- -------------
(Decrease) increase in cash and cash equivalents......................................... 14,609 (19,019)
Cash and cash equivalents, beginning of period........................................... 21,658 31,668
------------- -------------
Cash and cash equivalents, end of period................................................. $ 36,267 $ 12,649
------------- -------------
------------- -------------
Supplemental disclosure of cash flow information:
Interest paid during the period.......................................................... $ 14 $ 46
------------- -------------
Income taxes paid during the period...................................................... $ 622 $ 2,293
------------- -------------
In connection with the acquisition of Lightscape in December 1997, the following non-cash
transaction occurred:
Fair value of assets acquired............................................................ $ -- $ 7,615
Liabilities assumed...................................................................... -- (7,615)
------------- -------------
Cash paid for acquisition, net of cash acquired............................................ $ -- $ --
------------- -------------
------------- -------------
In connection with the acquisition of D-Vision in July 1997, the following
non-cash transaction occurred:
Fair value of assets acquired............................................................ $ -- $ 27,210
Liabilities assumed...................................................................... -- (5,811)
Cash acquired............................................................................ -- (408)
Issuance of 555,000 shares of Common Stock............................................... -- (10,649)
------------- -------------
Cash paid for acquisition, net of cash acquired............................................ $ -- $ (10,342)
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
H-5
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared by Discreet Logic Inc. ("Discreet Logic" or the "Company")
pursuant to the rules and regulations of the Securities and Exchange
Commission regarding interim financial reporting. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements and should be read
in conjunction with the consolidated financial statements and notes thereto
for the year ended June 30, 1997. The accompanying condensed consolidated
financial statements reflect all adjustments (consisting solely of normal,
recurring adjustments) which are, in the opinion of management, necessary
for a fair presentation of results for the interim periods presented. The
results of operations for the three and six month periods ended December 31,
1997 are not necessarily indicative of the results to be expected for any
other interim period or for the full fiscal year.
(2) CHANGE OF FISCAL YEAR
On January 9, 1997, the Board of Directors of the Company approved the
change of the Company's fiscal year end from July 31 to June 30. This change
was effective beginning with the Company's second fiscal quarter of 1997.
The condensed consolidated financial statements are presented for the three
and six month periods ended December 31, 1997 and the two and five month
periods ended December 31, 1996. The Company prepares consolidated financial
statements, re-measures accounts in foreign currencies to reflect changes in
exchange rates, and examines and adjusts certain reserve accounts at the end
of each quarter. Therefore, it is not practicable to recast prior quarterly
results to reflect the new fiscal period. Consequently, the results for the
three and six month periods ended December 31, 1997 are not directly
comparable to the results of the two and five month periods ended December
31, 1996.
(3) LITIGATION AND RELATED SETTLEMENT EXPENSES
On May 29, 1996, a lawsuit entitled SANDRA ESNER AND JERRY KRIM, ON BEHALF
OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED, vs. [ ] DISCREET LOGIC
INC., ET AL., case No. 978584, was filed in the Superior Court of the State
of California, City and County of San Francisco. Named as defendants are the
Company, certain of the Company's former and existing directors, officers,
and affiliates, and certain underwriters and financial analysts. The
plaintiffs purport to represent a class of all persons who purchased the
Company's common stock between September 13, 1995, and May 1, 1996. The
complaint alleges violations of California law through material
misrepresentations and omissions, among other things. The Company believes
that the allegations in the complaint are without merit and has defended the
lawsuit vigorously.
On June 13, 1996, a lawsuit entitled BRUCE FRIEDBERG, ON BEHALF OF HIMSELF
AND ALL OTHERS SIMILARLY SITUATED, vs. DISCREET LOGIC INC., ET AL., Civ. No.
96-11232-EFH, was filed in the United States District Court, District of
Massachusetts. Named as defendants are the Company and certain of the
Company's former and existing directors and officers. The plaintiff purports
to represent a class of all persons who purchased the Company's common stock
between November 14, 1995, and February 13, 1996. On October 11, 1996, the
plaintiff filed an amended complaint which asserts substantially the same
factual allegations as the first complaint and proposes the identical class
period. The complaint alleges violations of the United States Federal
Securities law through material misrepresentations and omissions. The
Company believes that the allegations in the complaint are without merit and
has defended the lawsuit vigorously.
On April 29, 1997, a lawsuit entitled ANTON PAPARELLA, SANDRA ESNER AND
GEOFFREY L. SHERWOOD, ON BEHALF OF THEMSELVES AND ALL OTHERS SIMILARLY
SITUATED vs. DISCREET LOGIC INC., ET AL., case No. C-97-1570, was filed in
the United States District Court, Northern District of California. Named as
defendants are the Company and certain of Company's former and existing
officers, directors and affiliates, and certain underwriters. The complaint
asserts, in all material respects, the same factual allegations and proposes
the same class period as the above-described California state court
complaint filed in May 1996, except asserts claims under federal securities
law instead of state law. The Company believes that the allegations in the
California federal complaint are without merit and has defended the lawsuit
vigorously.
On or about November 25, 1997, a settlement of all three shareholder class
actions received final court approval. Under the $10,800,000 settlement, the
Company contributed approximately $7,400,000 from its own funds, with the
remainder provided by insurance.
In the year ended July 31, 1996, the Company had provided a $2,506,000
litigation reserve for legal costs associated with defending the class
action lawsuits. During the eleven month period ended June 30, 1997, the
Company recorded a provision of $6,500,000 to accrue the additional
estimated settlement costs to be borne by the Company.
(4) RELATED PARTY TRANSACTIONS
In the three month period ended December 31, 1997, the Company recorded
revenues from sales made to Behaviour Entertainment Inc. ("Behaviour"), a
company owned by the Company's Chairman and Chief Executive Officer, in the
amount of $309,000. The Company also purchased marketing services, in the
amount of $250,000, from Behaviour.
H-6
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(5) EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 128, EARNINGS PER
SHARE. The new standard simplifies the computation of earnings per share
(EPS) and increases comparability to international standards. Under SFAS No.
128, primary EPS is replaced by Basic EPS, which excludes dilution and is
computed by dividing income available to common shareholders by the weighted
average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common
stock. The Company is required to disclose both basic and diluted EPS. All
prior period EPS data have been restated to conform to SFAS No. 128.
The following tables present a reconciliation of Basic EPS to Diluted EPS as
required by SFAS No. 128:
<TABLE>
<CAPTION>
TWO MONTHS ENDED THREE MONTHS ENDED
DECEMBER 31, 1996 DECEMBER 31, 1997
--------------------- ---------------------
INCOME SHARES EPS INCOME SHARES EPS
------ ------ ----- ------ ------ -----
<S> <C> <C> <C> <C> <C> <C>
BASIC EPS
Income available to common shareholders....... $1,965 27,931 $0.07 $ 790 28,833 $0.03
----- -----
----- -----
EFFECT OF DILUTIVE SECURITIES
Impact of exercise of stock options under
treasury stock method....................... -- 513 -- 1,764
------ ------ ------ ------
DILUTED EPS
Income available to common shareholders and
assumed exercises........................... $1,965 28,444 $0.07 $ 790 30,597 $0.03
------ ------ ----- ------ ------ -----
------ ------ ----- ------ ------ -----
</TABLE>
Options to purchase 199 and 474 shares of common stock were outstanding
during the two month period ended December 31, 1996, and the three month
period ended December 31, 1997, respectively, but were not included in the
computation of diluted EPS because the options' exercise price was greater
than the average market price of the common shares
<TABLE>
<CAPTION>
FIVE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, 1996 DECEMBER 31, 1997
--------------------- ------------------------
INCOME SHARES EPS INCOME SHARES EPS
------ ------ ----- -------- ------ ------
<S> <C> <C> <C> <C> <C> <C>
BASIC EPS
Income available to common shareholders....... $1,153 27,852 $0.04 $(14,312) 28,746 $(0.50)
------
------
EFFECT OF DILUTIVE SECURITIES
Impact of exercise of stock options under
treasury stock method....................... -- 560 -- --
------ ------ -------- ------
DILUTED EPS
Income available to common shareholders and
assumed exercises........................... $1,153 28,412 $0.04 $(14,312) 28,746 $(0.50)
-------- ------
-------- ------
</TABLE>
Options to purchase 297 and 349 shares of common stock were outstanding
during the five month period ended December 31, 1996, and the six month
period ended December 31, 1997, respectively, but were not included in the
computation of diluted EPS because the options' exercise price was greater
than the average market price of the common shares
(6) REVENUE RECOGNITION
In November 1997, the AICPA issued Statement of Position (SOP) 97-2,
SOFTWARE REVENUE RECOGNITION. This statement is effective for all
transactions entered into in fiscal years beginning after December 15, 1997,
however, early adoption is permitted. SOP 97-2 establishes standards for
recognizing revenues related to software products and related services. The
Company intends to implement SOP 97-2 in its consolidated financial
statements for the third quarter of fiscal 1998. The Company does not
anticipate that the implementation of this statement will have a material
impact on the consolidated financial statements.
(7) ACQUISITION OF LIGHTSCAPE TECHNOLOGIES, INC.
On December 2, 1997, Discreet Logic entered into an Agreement and Plan of
Merger and Reorganization (the "Merger Agreement") with Lantern Acquisition
Corp., a Delaware corporation and wholly-owned subsidiary of Discreet Logic
("Merger Sub"), and Lightscape Technologies, Inc., a Delaware corporation
("Lightscape"). On December 30, 1997, pursuant to the Merger Agreement, and
upon the satisfaction of certain closing conditions, Merger Sub merged (the
"Merger") with and into Lightscape with Lightscape as the surviving
corporation and a wholly-owned subsidiary of Discreet Logic. As a result of
the Merger, Discreet Logic acquired, among other products, the Lightscape TM
product, a software application which integrates radiosity and raytracing
with physically based lighting,
H-7
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(7) ACQUISITION OF LIGHTSCAPE TECHNOLOGIES, INC. (CONTINUED)
including related know-how and goodwill. The aggregate purchase price for
Lightscape includes the assumption of approximately $5,700,000 of net
liabilities (of which approximately $3,400,000 was paid at the closing), not
including costs associated with the transaction, and up to $6,800,000 in
contingent consideration to be paid only if certain revenue objectives are
achieved by Lightscape in calendar 1998 and 1999. The acquisition has been
accounted for as a purchase. A substantial portion of the purchase price and
transaction costs was allocated to purchased in-process research and
development for which Discreet Logic incurred a one-time charge against
earnings in the amount of $5,800,000 ($0.19 per share on a diluted basis),
based on an independent appraisal, in the quarter ended December 31, 1997
and approximately $1,087,000 was allocated to intangible assets, which
include goodwill and acquired technology, and is being amortized on a
straight-line basis over their estimated useful lives of three to five
years. The terms of the transaction were the result of arms'-length
negotiations between the representatives of Discreet Logic and Lightscape.
The following presents, on an unaudited basis, certain items on the
Company's result of operations, for the five month period ended December 31,
1996, and six month period ended December 31, 1997, as though the acquisition
and related transactions discussed above had occurred at the beginning of those
periods:
<TABLE>
<CAPTION>
FIVE MONTHS SIX MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31,
1996 1997
------------- -------------
<S> <C> <C>
Net sales.................................................................................. $ 40,457 $ 76,392
Operating loss............................................................................. $ (15) $ (10,569)
Net loss................................................................................... $ (1,977) $ (16,448)
EPS........................................................................................ $ (0.07) $ (0.57)
</TABLE>
H-8
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Discreet Logic Inc. ("Discreet Logic" or the "Company") develops, assembles,
markets and supports non-linear, digital systems and software for creating,
editing and compositing imagery and special effects for film, video, and HDTV.
The Company's systems and software are utilized by creative professionals for a
variety of applications, including feature films, television programs,
commercials, music videos, interactive game production and live broadcasting.
RECENT DEVELOPMENTS
LITIGATION SETTLEMENT
On May 29, 1996, June 13, 1996 and April 29, 1997 certain of the Company's
shareholders filed class action lawsuits alleging violations of federal
securities laws and other claims against the Company and certain of its officers
and directors, among others. The three lawsuits were filed in the Superior Court
of the State of California, the United States District Court, District of
Massachusetts and the United States District Court, Northern District of
California, respectively. On or about November 25, 1997, a settlement of all
three shareholder class actions received final court approval. Under the
$10,800,000 settlement, the Company contributed approximately $7,400,000 from
its own funds, with the remainder provided by insurance.
RECENT ACQUISITIONS
On December 2, 1997, Discreet Logic entered into an Agreement and Plan of
Merger and Reorganization (the "Merger Agreement") with Lantern Acquisition
Corp., a Delaware corporation and wholly-owned subsidiary of Discreet Logic
("Merger Sub"), and Lightscape Technologies, Inc., a Delaware corporation
("Lightscape"). On December 30, 1997, pursuant to the Merger Agreement, and upon
the satisfaction of certain closing conditions, Merger Sub merged (the "Merger")
with and into Lightscape with Lightscape as the surviving corporation and a
wholly-owned subsidiary of Discreet Logic. As a result of the Merger, Discreet
Logic acquired, among other products, the Lightscape TM product, a software
application which integrates radiosity and raytracing with physically based
lighting, including related know-how and goodwill. The aggregate purchase price
for Lightscape includes the assumption of approximately $5,700,000 of net
liabilities (of which approximately $3,400,000 was paid at the closing), not
including costs associated with the transaction, and up to $6,800,000 in
contingent consideration to be paid only if certain revenue objectives are
achieved by Lightscape in calendar 1998 and 1999. The acquisition has been
accounted for as a purchase. A substantial portion of the purchase price and
transaction costs was allocated to purchased in-process research and development
for which Discreet Logic incurred a one-time charge against earnings in the
amount of $5,800,000 ($0.19 per share on a diluted basis), based on an
independent appraisal, in the quarter ended December 31, 1997 and approximately
$1,087,000 was allocated to intangible assets, which include goodwill and
acquired technology, and is being amortized on a straight-line basis over their
estimated useful lives of three to five years. The terms of the transaction were
the result of arms'-length negotiations between the representatives of Discreet
Logic and Lightscape.
On July 15, 1997, the Company acquired all of the outstanding shares of
capital stock of D-Vision Systems, Inc. ("D-Vision"), an Illinois corporation,
pursuant to a Stock Purchase Agreement dated as of July 10, 1997, among the
Company, D-Vision, the former stockholders of D-Vision (the "Selling
Stockholders") and certain other individuals (the "D-Vision Acquisition"). As a
result of the D-Vision Acquisition, the Company acquired the D-Vision OnLINE
(subsequently renamed D-VISION) and PRO software products for non-linear video
and digital media editing solutions including related know-how and goodwill. The
purchase price was paid in a combination of 555,000 newly issued Discreet Logic
common shares and approximately $10,750,000 in cash. In addition, approximately
$4,000,000 of the cash consideration is being held in escrow until September 30,
1999, subject to (i) earlier release from escrow of up to $1,900,000 on
September 30, 1998 and (ii) the resolution of any indemnification claims made by
the Company pursuant to the Stock Purchase Agreement. The cash used by the
H-9
<PAGE>
Company to fund the acquisition was derived primarily from cash flow from
operations. The D-Vision Acquisition was accounted for as a purchase. A
substantial portion of the purchase price, net liabilities of D-Vision and
transaction costs was allocated to purchased in-process research and development
for which the Company incurred a one-time charge against earnings in the amount
of $21,000,000 ($0.73 per share), based on an independent appraisal, in the
quarter ended September 30, 1997. The terms of the transaction and the
consideration received by the D-Vision stockholders were the result of
arms-length negotiations between the representatives of the Company and
D-Vision. D-Vision develops Microsoft Windows NT-based non-linear, digital
editing solutions.
RESTRUCTURING
During the fiscal year ended July 31, 1996, excluding a restructuring charge
of $15,000,000 and its related tax effects, the Company incurred a net loss of
approximately $31,000,000 on revenues of approximately $83,997,000. In response
to the financial results and other developments facing the business, the Company
developed a restructuring plan during the fourth fiscal quarter of 1996. While
the Company began implementation of its restructuring plan in the fourth fiscal
quarter of 1996 and had substantially completed the implementation of the plan
at the end of fiscal 1997, the Company still has approximately $3,335,000 in
restructuring reserves primarily for the estimated cost of terminating leases,
resolving outstanding severance issues, and the legal and taxation winding down
of several subsidiaries.
CHANGE OF FISCAL YEAR
On January 9, 1997, the Board of Directors of the Company approved the
change of the Company's fiscal year end from July 31 to June 30. This change was
effective beginning with the Company's second fiscal quarter of 1997. The
condensed consolidated financial statements are presented for the three and six
month period ended December 31, 1997 and the two and five month periods ended
December 31, 1996. The Company prepares consolidated financial statements,
remeasures accounts in foreign currencies to reflect changes in exchange rates
and examines and adjusts certain reserve accounts at the end of each quarter.
Therefore, it is not practicable to recast the prior fiscal period's results to
reflect the new fiscal period. Consequently, the results for the three and six
month periods ended December 31, 1997 are not directly comparable to the results
of the two and five month periods ended December 31, 1996.
H-10
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth the percentages of total revenues represented
by certain line items in the statements of operations:
<TABLE>
<CAPTION>
TWO MONTHS THREE MONTHS FIVE MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1996 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Total revenues.................................... 100% 100% 100% 100%
Cost of revenues.................................. 48 36 51 41
--- --- --- ---
Gross profit.................................... 52 64 49 59
--- --- --- ---
Operating expenses:
Research and development........................ 9 10 10 10
Sales and marketing............................. 27 23 26 21
General and administrative...................... 7 5 7 5
Charge for purchased research and development... -- 16 -- 35
--- --- --- ---
Total operating expenses...................... 43 54 43 71
--- --- --- ---
Operating income (loss)......................... 9 10 6 (12)
Other income (expense), net....................... 11 -- 2 1
--- --- --- ---
Income (loss) before income taxes............... 20 10 8 (11)
Provision for income taxes........................ 8 8 5 8
--- --- --- ---
Net income (loss)............................... 12% 2% 3% (19)%
--- --- --- ---
--- --- --- ---
</TABLE>
THREE MONTHS ENDED DECEMBER 31, 1997 AND TWO MONTHS ENDED DECEMBER 31, 1996 AND
SIX MONTHS ENDED DECEMBER 31, 1997 AND FIVE MONTHS ENDED DECEMBER 31, 1996
As discussed above, it is not practicable to recast prior quarterly results
to reflect new fiscal periodic reporting resulting from the Company's previously
announced change in fiscal year end. Therefore, the results for the three and
six month periods ended December 31, 1997 are not directly comparable to the
results of the two and five month periods ended December 31, 1996.
TOTAL REVENUES. The Company's revenues consist of product revenues
(including licensing of its software, sales of the Company's proprietary
hardware, and resale of third party hardware) and, to a lesser extent, revenues
from maintenance and other services (including consulting and training). For all
periods presented, the Company has recognized revenue in accordance with
Statement of Position 91-1, entitled "Software Revenue Recognition," issued by
the American Institute of Certified Public Accountants. In accordance with this
statement, in cases where the Company has delivered hardware and/or software to
customers and has insignificant or noncritical vendor obligations related to
these deliveries, the revenue attributable to such obligations has been deferred
until such obligations have been fulfilled. Beginning with its third quarter of
fiscal 1998, the Company intends to implement SOP 97-2 (See Note 6 of Notes to
Condensed Consolidated Financial Statements).
Total revenues were $37,268,000 and $16,833,000 for the three month period
ended December 31, 1997, and the two month period ended December 31, 1996,
respectively, and $75,673,000 and $40,096,000 for the six month period ended
December 31, 1997, and the five month period ended December 31, 1996,
respectively. The increase in total revenues in both the three and six month
periods ended December 31, 1997, when compared to the two and five month periods
ended December 31, 1996, respectively, was primarily due to the additional month
in the fiscal 1998 periods, and an increase in worldwide revenues generated by
the Company's Special Effects and Editing (including initial commercial
shipments of SMOKE, the Company's non-linear digital editing tool introduced in
the second quarter of fiscal 1998) product lines. These increases were partially
offset by a decrease in revenues, in the six month period ended December 31,
1997, from the Company's Broadcast Production product line, as compared to the
five month period ended December 31, 1996.
H-11
<PAGE>
Revenues from customers outside of North America were $21,702,000 (58% of
total revenues) and $10,255,000 (61% of total revenues) for the three month
period ended December 31, 1997, and the two month period ended December 31,
1996, respectively, and $39,965,000 (53% of total revenues) and $21,779,000 (54%
of total revenues) for the six month period ended December 31, 1997, and the
five month period ended December 31, 1996, respectively. Revenues from customers
outside North America increased in both the three and six months ended December
31, 1997 when compared to the two and five months ended December 31, 1996,
respectively, due to the additional month in the fiscal 1998 periods, and the
increased penetration of the Company's products in the Asian and European
markets. The Company expects that revenues from customers outside of North
America will continue to account for a substantial portion of its revenues and
should, as a percentage of total revenues, remain approximately the same as
current levels.
COST OF REVENUES. Cost of revenues consists primarily of the cost of
hardware sold (mainly workstations manufactured by Silicon Graphics, Inc.
("SGI")), cost of hardware service contracts, cost of integration and hardware
assembly, cost of service personnel and the facilities, computing, benefits and
other administrative costs allocated to such personnel and the provision for
inventory reserves. Cost of revenues was $13,548,000 (36% of total revenues) and
$8,003,000 (48% of total revenues) for the three month period ended December 31,
1997, and the two month period ended December 31, 1996, respectively, and
$30,827,000 (41% of total revenues) and $20,290,000 (51% of total revenues) for
the six month period ended December 31, 1997, and the five month period ended
December 31, 1996, respectively. The decrease in cost of revenues, as a
percentage of total revenues, in both the three and six months ended December
31, 1997 when compared to the two and five months ended December 31, 1996,
respectively, was primarily due to: (1) an increase in sales to the Company's
indirect channel partners, whose purchases from Discreet Logic are predominantly
software only and software and storage media bundles since these indirect
channel partners are themselves hardware resellers; (2) porting certain of the
Company's software products to recently available, lower priced workstations,
resulting in a lower cost to the Company for the hardware component of system
sales; and (3) the increased penetration of the Company's products in the Asian
market where customers typically purchase from the Company only software or
software and storage media bundles. The decrease in cost of revenues, as a
percentage of total revenues, in the six months ended December 31, 1997 when
compared to the five months ended December 31, 1996 is also attributable to
lower margins realized on systems sold in the three month period ended October
31, 1996 under an aggressive sales program, including product discounts,
designed to reduce the inventory on hand at the end of the fourth fiscal quarter
of 1996. The Company expects that cost of revenues, as a percentage of total
revenues, should increase from its current level. However, cost of revenues
remains difficult to predict and is subject to fluctuations due to a number of
factors including product and product configuration mix and the proportion of
direct and indirect sales.
RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of the cost of research and development personnel and the facilities,
depreciation on research and development equipment, amortization of acquired
technologies, computing, benefits and other administrative costs allocated to
such personnel, and consulting fees. Expenditures for research and development,
after deducting Canadian federal and provincial tax credits, were $3,901,000
(10% of total revenues) and $1,575,000 (9% of total revenues) for the three
month period ended December 31, 1997, and the two month period ended December
31, 1996, respectively, and $7,413,000 (10% of total revenues) and $4,253,000
(10% of total revenues) for the six month period ended December 31, 1997, and
the five month period ended December 31, 1996, respectively. The increase in
research and development expenses in both the three and six months ended
December 31, 1997 when compared to the two and five months ended December 31,
1996, respectively, was primarily due to: (1) the additional month in both of
the fiscal 1998 periods; (2) an increase in the number of software engineers
(including the engineers joining the Company as a result of the Denim and
D-Vision Acquisitions) to develop and enhance the Company's existing products
and to develop new products; (3) an increase in depreciation charges on the
additional research and development equipment required for the additional
personnel; and (4) an increase in the amortization of acquired technologies.
Research and development costs are expensed as incurred. Software development
costs are considered for capitalization once technical feasibility has been
established. The Company has not capitalized any software development costs to
date. Certain research and development expenditures are incurred substantially
in advance of related revenue and in some cases do not generate revenues. The
Company expects that research and development expenses will increase from
current
H-12
<PAGE>
levels. Should revenues increase, the Company expects that research and
development expenses, as a percentage of total revenues, should remain
approximately the same as their current levels.
SALES AND MARKETING. Sales and marketing expenses consist primarily of
salaries, commissions and related benefits, facilities and administrative costs
allocated to the Company's sales and marketing personnel, tradeshow expenses,
and dealer commissions. Sales and marketing expenses were $8,407,000 (23% of
total revenues) and $4,610,000 (27% of total revenues) for the three month
period ended December 31, 1997, and the two month period ended December 31,
1996, respectively, and $15,840,000 (21% of total revenues) and $10,627,000 (26%
of total revenues) for the six month period ended December 31, 1997, and the
five month period ended December 31, 1996, respectively. The increase in sales
and marketing expenses, in both the three and six months ended December 31, 1997
when compared to the two and five months ended December 31, 1996, respectively,
is explained by the additional month in the fiscal 1998 periods, the continued
expansion of the Company's direct and indirect sales organization, including the
operating costs of domestic sales offices and foreign subsidiaries, and an
increase in tradeshow activities. The decrease in sales and marketing expenses,
as a percentage of total revenues, in both the three and six months ended
December 31, 1997 when compared to the two and five months ended December 31,
1996, respectively, is explained in part by the growth of sales to the indirect
channel partners which require a reduced level of expenditures than direct sales
to end-users. The Company expects that sales and marketing expenses will
increase from their current levels. Should revenues increase, the Company
expects that sales and marketing expenses, as a percentage of total revenues,
should remain approximately the same as their current levels.
GENERAL AND ADMINISTRATIVE. General and administrative expenses include the
costs of finance and accounting, human resources, facilities, corporate
information systems, legal and other administrative functions of the Company and
reserves for doubtful accounts receivable. General and administrative expenses
were $2,012,000 (5% of total revenues) and $1,189,000 (7% of total revenues) for
the three month period ended December 31, 1997, and the two month period ended
December 31, 1996, respectively, and $3,896,000 (5% of total revenues) and
$2,705,000 (7% of total revenues) for the six month period ended December 31,
1997, and the five month period ended December 31, 1996, respectively. The
increase in general and administrative expenses in both the three and six months
ended December 31, 1997 when compared to the two and five months ended December
31, 1996, respectively, is explained by the additional month in the later
periods being compared, and by an increase in personnel. The Company expects
that general and administrative expenses will increase from their current
levels. Should revenues increase, the Company expects that general and
administrative expenses, as a percentage of total revenues, should remain
approximately the same as their current levels.
CHARGE FOR PURCHASED RESEARCH AND DEVELOPMENT. In connection with the
Lightscape Acquisition, the Company expensed $5,800,000 (16% of total revenues)
of in-process research and development in the three month period ended December
31, 1997. In connection with the D-Vision Acquisition, the Company expensed
$21,000,000 of in-process research and development in the three month period
ended September 30, 1997.
OTHER INCOME (EXPENSE). Other Income (Expense) primarily consists of
foreign currency gains and losses and interest income and expense. Foreign
currency translation gains were $179,000 for the three month period ended
December 31, 1997 compared to $1,539,000 for the two month period ended December
31, 1996. Foreign currency translation gains were $308,000 for the six month
period ended December 31, 1997 compared to $458,000 for the five month period
ended December 31, 1996. These gains and losses are primarily the result of the
Company and each subsidiary translating intercompany balances denominated in a
currency other than its own functional currency. These balances are remeasured
into the functional currency of each company every reporting period. This
remeasurement results in either unrealized gains or losses depending on the
exchange rate fluctuation between the functional currency of each company and
the currency in which the monetary asset or liability is denominated.
PROVISION FOR INCOME TAXES. The Company's provision for income taxes was
$3,097,000 and $1,310,000 for the three month period ended December 31, 1997,
and the two month period ended December 31, 1996, respectively, and $5,872,000
and $1,962,000 for the six month period ended December 31, 1997, and the five
month period ended December 31, 1996, respectively. The provision for all
periods is based upon the Canadian
H-13
<PAGE>
federal statutory rate of 38% and reflects the impact of various tax credits and
foreign taxes. The tax provision for the three and six month periods ended
December 31, 1997 differed from the statutory rate primarily as a result of the
Company recording charges for acquired in-process research and development for
which no benefit was recorded due to the uncertainty of realizing any future tax
benefit associated with these charges offset by the realization of the benefit
for some prior year tax losses for which no benefit was previously recorded. The
tax provision for the five month period ended December 31, 1996 differed from
the statutory rate primarily as a result of the Company not recording a benefit
related to losses where the realization of the benefit was uncertain. The
Company has foreign net operating loss carry forwards which may be available to
reduce future income tax liabilities.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date primarily through cash flow
from operations, borrowings under its demand line of credit, capital leases, the
private and public sales of equity securities, and the receipt of research and
development tax credits from the Canadian federal government and the Province of
Quebec. As of December 31, 1997, the Company had cash of approximately
$12,649,000. In August 1997, the Company amended its revolving demand line of
credit with a bank under which the Company may borrow up to CDN$7,000,000 (or
approximately $4,885,000 at December 31, 1997). Advances under the line accrue
interest monthly at the Canadian prime rate (6.0% at December 31, 1997) plus
0.25%. Additionally, the Company has a CDN$600,000 (approximately $419,000 at
December 31, 1997) demand leasing facility, and a CDN$600,000 (approximately
$419,000 at December 31, 1997) demand research and development tax credit
facility. Advances under these facilities accrue interest monthly at the
Canadian prime rate (6.0% at December 31, 1997) plus 1%. The line and facilities
are secured by essentially all of the Company's North American assets. As
additional security, the Company has assigned to the bank its insurance on these
assets. The Company is required to maintain certain financial ratios, including
minimum levels of working capital, debt service coverage and equity to assets
ratios. As of December 31, 1997, no amounts were outstanding under the demand
line of credit, the demand leasing, or the demand research and development tax
credit facilities.
The Company's operating activities used cash of $4,196,000 and provided cash
of $17,290,000 for the six month period ended December 31, 1997 and the five
month period ended December 31, 1996, respectively. The principal uses of cash
for the six months ended December 31, 1997 were the disbursement of funds used
to settle the class action litigations and the decrease in accounts payable and
accrued expenses resulting from the Company paying many of the liabilities
assumed in connection with the D-Vision and Lightscape acquisitions. These uses
of cash were offset primarily by cash provided by net income before non-cash
charges, including the charges for purchased in-process research and
development, and the receipt of insurance proceeds related to the settlement of
the class action litigations. Net cash provided by operations in the five month
period ended December 31, 1996 was composed primarily of net income before
non-cash charges and decreases in accounts receivable and inventory.
The Company's investing activities used cash of $13,874,000 in the six month
period ended December 31, 1997 primarily for the acquisition of D-Vision
Systems, Inc. and the purchase of research and development equipment and related
software. During the six month period ended December 31, 1997, the Company
received proceeds from the sale of its Montreal land and office building which
were previously included on the balance sheet as assets held for resale. The
proceeds of sale were not materially different from the carrying value of these
assets. The Company's investing activities used cash of $3,084,000 in the five
month period ended December 31, 1996, primarily for renovations to the office
building in London, England and the purchase of computer equipment and software
used in the operations of the Company's business, primarily in the research and
development area.
Financing activities provided cash of $777,000 and $840,000 in the six month
period ended December 31, 1997 and five month period ended December 31, 1996,
respectively, from proceeds from common stock option exercises and the issuance
of shares under the Employee Stock Purchase Plan.
As of December 31, 1997, the Company did not have any material commitments
for capital expenditures.
The Company's ability to meet its future liquidity requirements is dependent
upon its ability to operate profitably, or in the absence thereof, to obtain
additional financing. The Company underwent a restructuring
H-14
<PAGE>
intended to decrease operating expenses, however, there can be no assurance that
the Company will not have to take further restructurings or be profitable in the
future. Should the Company need to secure additional financing to meet its
future liquidity requirements, there can be no assurance that the Company will
be able to secure such financing, or that such financing, if available, will be
on terms favorable to the Company. Subject to the factors discussed below in
Certain Factors That May Affect Future Results, the Company believes that, with
its current levels of working capital together with funds generated from
operations, it has adequate sources of cash to meet its operations and capital
expenditure requirements through calendar 1998.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
Information provided by the Company from time to time including statements
in this Form 10-Q which are not historical facts, are so-called forward-looking
statements, and are made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995 and releases of the Securities and
Exchange Commission. In particular, statements contained in the "Management's
Discussion and Analysis of Financial Condition and Results of Operations" which
are not historical facts (including, but not limited to, statements regarding
the Company's anticipated cost of revenues, statements regarding the anticipated
adequacy of cash to meet operations, statements concerning anticipated expense
levels and such expenses as a percentage of revenues, statements about the
anticipated portion of revenues from customers outside North America, and the
implementation of the restructuring plan) may constitute forward-looking
statements. The Company's actual future results may differ significantly from
those stated in any forward-looking statements. Factors that may cause such
differences include, but are not limited to, the factors discussed below, other
risks discussed in this section and elsewhere in this Form 10-Q, and the other
risks discussed in the Company's Annual Report on Form 10-K for the fiscal year
ended June 30, 1997, as well as, from time to time, in the Company's other
filings with the Securities and Exchange Commission.
The Company's future results are subject to substantial risks and
uncertainties. The Company's future financial performance will depend in part on
the successful development, introduction and customer acceptance of its existing
and new or enhanced products. In addition, in order for the Company to achieve
sustained growth, the market for the Company's systems and software must
continue to develop and the Company must expand this market to include
additional applications within the film and video industries and develop or
acquire new products for use in related markets. There can be no assurance that
the Company will be successful in marketing its existing or any new or enhanced
products. In addition, as the Company enters new markets, distribution channels,
technical requirements and levels and bases of competition may be different from
those in the Company's current markets and there can be no assurance that the
Company will be able to compete favorably. The markets in which the Company
competes are characterized by intense competition and many of the Company's
current and prospective competitors have significantly greater financial,
technical, manufacturing and marketing resources than the Company. These
companies may introduce additional products that are competitive with those of
the Company, and there can be no assurance that the Company's products would
compete effectively with such products. Furthermore, competitive pressures or
other factors, including the Company's entry into new markets, may result in
significant price erosion that could have a material adverse effect on the
Company's business and results of operations. The Company has recently completed
the purchase of certain products and technology through acquisitions. There can
be no assurance that the products and technologies acquired from these companies
will be successful or will achieve market acceptance, or that the Company will
not incur disruptions and unexpected expenses in integrating the operations of
the acquired businesses with those of the Company.
The Company's FLAME, FLINT, INFERNO, FIRE, VAPOUR and FROST systems
currently include workstations manufactured by SGI. There are significant risks
associated with this reliance on SGI and the Company may be impacted by the
timing of the development and release of products by SGI, as was the case during
fiscal 1996. In addition, there may be unforeseen difficulties associated with
adapting the Company's products to future SGI products. The Company derives a
significant portion of its total revenues from foreign sales. Foreign sales are
subject to significant risks, including unexpected legal, tax and exchange rate
changes (including the recent currency volatility in Asia) and other barriers.
In addition, foreign customers may have longer payment cycles and the protection
of intellectual property in foreign countries may be more difficult to enforce.
The Company currently relies principally on unregistered copyrights and trade
secrets to protect its
H-15
<PAGE>
intellectual property. Any invalidation of the Company's intellectual property
rights or lengthy and expensive defense of those rights could have a material
adverse effect on the Company. The Company received a letter from Avid
Technology, Inc. ("Avid") stating its belief that certain of the Company's
recently acquired D-Vision products practice inventions claimed in a patent on a
media editing system. The Company has responded to Avid's letter stating the
Company's belief that the Company is not infringing any valid claim of Avid's
patent. To the Company's knowledge, Avid has not initiated any suit, action or
other proceeding alleging any infringement by the Company of such patent. The
Company currently markets its systems through its direct sales organization and
through distributors. This marketing strategy may result in distribution channel
conflicts as the Company's direct sales efforts may compete with those of its
indirect channels. The Company currently relies on SGI as the sole source for
video input/output cards used in the Company's systems. The Company's D-VISION
(formerly named OnLINE) software requires a videographic card manufactured
solely by Truevision, Inc. An interruption in the supply or increase in the
price of either one of these components could have a material adverse effect on
the Company's business and results of operations. To date, the Company has
depended to a significant extent upon a number of key management and technical
employees and the Company's ability to manage its operations will require it to
continue to recruit and retain senior management personnel and to motivate and
effectively manage its employee base. The loss of the services of one or more of
these key employees could have a material adverse effect on the Company's
business and results of operations. There can be no assurance that these factors
will not have a material adverse effect on the Company's future international
sales and consequently, on the Company's business and results of operations.
The market price of the Company's common shares could be subject to
significant fluctuations in response to quarter-to-quarter variations in the
Company's operating results, announcements of technological innovations or new
products by the Company, its competitors or suppliers and other events or
factors. In addition, the stock market in recent years has experienced extreme
price and volume fluctuations that have particularly affected the market prices
of many technology companies and that have often been unrelated or
disproportionate to the operational performance of these companies. These
fluctuations, as well as general economic and market conditions, may materially
and adversely affect the market price of the Company's common shares.
The Company believes that its operating results could vary significantly
from quarter to quarter. A limited number of systems sales may account for a
substantial percentage of the Company's quarterly revenue because of the high
average sales price of such systems and the timing of purchase orders.
Historically, the Company has generally experienced greater revenues during the
period following the completion of the annual conference of the National
Association of Broadcasters ("NAB"), which is typically held in April. The
Company's expense levels are based, in part, on its expectations of future
revenues. Therefore, if revenue levels are below expectations, particularly
following NAB, the Company's operating results are likely to be adversely
affected as was the case for the three month periods ended April 30, 1996 and
July 31, 1996. In addition, the timing of revenue is influenced by a number of
other factors, including: the timing of individual orders and shipments, other
industry trade shows, competition, seasonal customer buying patterns, changes to
customer buying patterns in response to platform changes and changes in product
development and sales and marketing expenditures. Because the Company's
operating expenses are based on anticipated revenue levels and a high percentage
of the Company's expenses are relatively fixed in the short term, variations in
the timing of recognition of revenue could cause significant fluctuations in
operating results from quarter to quarter and may result in unanticipated
quarterly earnings shortfalls or losses. There can be no assurance that the
Company will be successful in maintaining or improving its profitability or
avoiding losses in any future period. The Company believes that
quarter-to-quarter comparisons of its financial results are not necessarily
meaningful and should not be relied upon as an indication of future performance.
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On May 29, 1996, a lawsuit entitled SANDRA ESNER AND JERRY KRIM, ON BEHALF
OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED, VS. [ . ]DISCREET LOGIC INC.,
ET AL., case No. 978584, was filed in the Superior Court of the State of
California, City and County of San Francisco. Named as defendants are the
Company, certain of the Company's former and existing directors, officers, and
affiliates, and certain underwriters and financial analysts. The plaintiffs
purport to represent a class of all persons who purchased the Company's common
stock between
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<PAGE>
September 13, 1995, and May 1, 1996. The complaint alleges violations of
California law through material misrepresentations and omissions, among other
things. The Company believes that the allegations in the complaint are without
merit and has defended the lawsuit vigorously.
On June 13, 1996, a lawsuit entitled BRUCE FRIEDBERG, ON BEHALF OF HIMSELF
AND ALL OTHERS SIMILARLY SITUATED, VS. DISCREET LOGIC INC., ET AL., Civ. No.
96-11232-EFH, was filed in the United States District Court, District of
Massachusetts. Named as defendants are the Company and certain of the Company's
former and existing directors and officers. The plaintiff purports to represent
a class of all persons who purchased the Company's common stock between November
14, 1995, and February 13, 1996. On October 11, 1996, the plaintiff filed an
amended complaint which asserts substantially the same factual allegations as
the first complaint and proposes the identical class period. The complaint
alleges violations of the United States Federal Securities law through material
misrepresentations and omissions. The Company believes that the allegations in
the complaint are without merit and has defended the lawsuit vigorously.
On April 29, 1997, a lawsuit entitled ANTON PAPARELLA, SANDRA ESNER AND
GEOFFREY L. SHERWOOD, ON BEHALF OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED
VS. DISCREET LOGIC INC., ET AL., case No. C-97-1570, was filed in the United
States District Court, Northern District of California. Named as defendants are
the Company and certain of Company's former and existing officers, directors and
affiliates, and certain underwriters. The complaint asserts, in all material
respects, the same factual allegations and proposes the same class period as the
above-described California state court complaint filed in May 1996, except
asserts claims under federal securities law instead of state law. The Company
believes that the allegations in the California federal complaint are without
merit and has defended the lawsuit vigorously.
On or about November 25, 1997, a settlement of all three shareholder class
actions received final court approval. Under the $10,800,000 settlement, the
Company contributed approximately $7,400,000 from its own funds, with the
remainder provided by insurance.
In the year ended July 31, 1996, the Company had provided a $2,506,000
litigation reserve for legal costs associated with defending the class action
lawsuits. During the eleven month period ended June 30, 1997, the Company
recorded a provision of $6,500,000 to accrue the additional estimated settlement
costs to be borne by the Company.
ITEMS 2-3. NOT APPLICABLE.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the Annual Meeting of Shareholders held on November 20, 1997 pursuant to
the Notice of Annual Meeting of Shareholders dated October 24, 1997.
1. The proposal to elect the following nominees as directors, to serve for a
two-year term or until their successors are elected and qualified, was approved.
Vote results as follows:
<TABLE>
<CAPTION>
CLASS OF VOTES
NOMINEE DIRECTOR VOTES FOR WITHHELD ABSTAINED
- -------------------------------------------------- -------- ---------- -------- ---------
<S> <C> <C> <C> <C>
Richard Szalwinski................................ I 24,164,903 18,264 0
Thomas Cantwell................................... I 24,164,303 18,864 0
Pierre Desjardins................................. I 24,164,753 18,414 0
</TABLE>
At the Annual Meeting of Shareholders held on January 9, 1997, Messrs. Brian
P. Drummond, Perry M. Simon and Gary G. Tregaskis were elected to Class II of
the Company's Board of Directors to hold office until the Annual Meeting of
Shareholders for fiscal 1998 and until their successors have been duly elected
and qualified.
2. The proposal to approve an amendment to the Company's 1994 Amended and
Restated Restricted Stock and Stock Option Plan to reserve an additional
2,000,000 shares of common stock for issuance thereunder was approved. Vote
results as follows: 14,641,810 shares in favor; 7,814,761 shares against, with
8,090 shares abstaining; and 1,718,506 counted as 'non-votes'.
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<PAGE>
3. The proposal to appoint Arthur Andersen & Cie as independent accountants
for the Company for fiscal 1998 and to authorize the Board of Directors to fix
their remuneration was approved. Vote results as follows: 24,169,287 shares in
favor; 7,640 shares against, with 6,240 shares abstaining.
There were no other matters submitted to a vote of the Company's
shareholders during the second quarter of the fiscal year covered by this report
through the solicitation of proxies or otherwise.
ITEM 5. NOT APPLICABLE.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION OF EXHIBIT
- ----------------------------------------------------------- -----------------------------------------------------------
<S> <C>
Exhibit 10.1............................................... Employment Agreement, dated August 29, 1997, by and between
the Company and Richard Szalwinski.
Exhibit 10.2............................................... Lease Agreement for 10 Duke Street, Montreal, dated July 4,
1997, by and between TGR Zone Corporation and Discreet
Logic Inc.
Exhibit 27.1............................................... Financial Data Schedule
</TABLE>
(B) REPORTS ON FORM 8-K.
A Current Report on Form 8-K dated December 30, 1997 was filed on January
14, 1998. The Current Report on Form 8-K was filed pursuant to Item 2 of Form
8-K (Acquisition or Disposition of Assets) announcing the completion of the
merger of Lantern Acquisition Corp. ("Merger Sub"), a Delaware corporation and
wholly-owned subsidiary of Discreet Logic with and into Lightscape Technologies,
Inc. ("Lightscape"), a Delaware corporation, with Lightscape the surviving
corporation and a wholly-owned subsidiary of Discreet Logic, pursuant to the
Agreement and Plan of Merger and Reorganization dated as of December 2, 1997 by
and among Discreet Logic, Merger Sub and Lightscape.
H-18
<PAGE>
DISCREET LOGIC INC.
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.
DISCREET LOGIC INC.
By: /s/ FRANCOIS PLAMONDON
------------------------------------------
Francois Plamondon
VICE PRESIDENT, CHIEF FINANCIAL
OFFICER, TREASURER AND SECRETARY
February 13, 1998
H-19
<PAGE>
SCHEDULE I
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
(MARK ONE)
/ / ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE FISCAL YEAR ENDED:
OR
/X/ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
[NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM AUGUST 1, 1996 TO JUNE 30, 1997
COMMISSION FILE NUMBER: 0-26100
------------------------
DISCREET LOGIC INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
QUEBEC
(State or other jurisdiction of incorporation or 98-0150790
organization) (I.R.S. Employer Identification No.)
</TABLE>
10 DUKE STREET
MONTREAL, QUEBEC, CANADA H3C 2L7
(Address of principal executive offices)(Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (514) 393-1616
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON SHARES, WITHOUT PAR VALUE
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in part III of this Form 10-K or any amendment to this
Form 10-K. /X/
The aggregate market value of the voting stock held by nonaffiliates of the
registrant as of September 22, 1997 (based on the closing price as quoted by
Nasdaq National Market as of such date) was $423,896,850. As of September 22,
1997, 28,817,128 of the registrant's common shares were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the Annual
Meeting of Stockholders to be held on November 19, 1997 to be filed pursuant to
Regulation 14A are incorporated by reference into Part III of this Form 10-K.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART I
ITEM 1. BUSINESS
OVERVIEW AND RECENT DEVELOPMENTS
THE COMPANY
Discreet Logic Inc. ("Discreet Logic" or the "Company") develops, assembles,
markets and supports non-linear, digital systems and software for creating,
editing and compositing imagery and special effects for film, video, and HDTV.
The Company's systems and software are utilized by creative professionals for a
variety of applications, including feature films, television programs,
commercials, music videos, interactive game production and live broadcasting.
Discreet Logic's systems have played key roles in the creation of special visual
effects for recent films such as FORREST GUMP, INDEPENDENCE DAY, THE FIFTH
ELEMENT, BATMAN & ROBIN, CONTACT and AIR FORCE ONE; television programs and
special events such as ABC's "WORLD NEWS TONIGHT WITH PETER JENNINGS" and the
1996 U.S. Presidential elections on ABC and CBS; music videos by artists
including U2, REM, Rolling Stones and The Beatles; and commercials for clients
such as Nike, Pepsi, AT&T and McDonald's.
The Company believes that creative professionals in the film and video
industries require systems and software that can integrate and simplify their
work, enabling them to devote more time to creative activities and less time to
technical tasks. Discreet Logic has traditionally offered turnkey systems
comprised of the Company's proprietary software utilizing workstations
manufactured by Silicon Graphics, Inc. ("SGI"), scaleable disk arrays and other
peripherals. Through two recent acquisitions, the Company now offers editing
software which runs on the Microsoft Windows NT operating system and special
effects software which runs on the Microsoft Windows NT and Apple Macintosh
operating systems. The Company's systems and software provide digital solutions
for creative professionals to input, create, manipulate, store and output images
in an integrated production environment. The Company's systems can be linked to
enable users to collaborate and manage data more efficiently. In addition, by
utilizing general purpose workstation technology, the Company's systems and
software integrate more easily with third party software systems and devices.
Discreet Logic's systems and software are focused towards three markets:
special effects, editing and broadcast production. The Company's systems include
its FLAME, FLINT, INFERNO, FIRE, VAPOUR and FROST systems. The Company's FLAME
system is used to create, edit and composite special visual effects in an
on-line, real-time environment, providing instant feedback to the creative
professional. The Company's FLINT system contains virtually the same special
visual effects features as FLAME, but because of platform limitations runs in a
non-real-time environment. The Company's INFERNO system is an on-line, real-time
digital system providing all of the features of FLAME with film tools, increased
film resolution and color control for digital film work. The Company's FLAME,
FLINT and INFERNO systems run on SGI platforms, are resolution independent and
allow users to work on uncompressed images from a variety of media sources in
the full range of resolutions necessary for film and video (including HDTV). The
Company's FIRE system runs on an SGI platform and is an uncompressed, on-line,
non-linear digital video editing system with special effects capabilities.
Commercial shipments of FIRE systems, including software and hardware, began in
October 1996. In the broadcast production market, the Company offers its VAPOUR
system, an SGI-based, integrated graphics system, which is used to create
computer generated locales, also known as virtual sets, for news, sports and
entertainment programming, and FROST, a set of modeling, animation and rendering
tools for the creation and manipulation of 3D environments for broadcast
companies. The Company sells its systems and software worldwide through a direct
sales force as well as through distributors. The Company's software-only
products include its recently acquired ILLUMINAIRE product line and OnLINE
product, and when sold through the Company's indirect sales channel, the
Company's FLINT software. The Company's ILLUMINAIRE product line consists of
Microsoft Windows NT and Apple Macintosh-based paint and compositing software
for producing effects, interactive content and graphics design. The Company's
OnLINE product is a non-linear video and digital media editing software product
that runs on the Microsoft Windows NT operating system.
Discreet Logic's strategy is to maintain and enhance its position as a
leading provider of digital systems by continuing to develop, integrate and
support complete systems that include applications, networking and
communications software, workstations, disk arrays and other peripherals. In
addition, Discreet Logic is pursuing a strategy to develop the business of
selling software across Apple Macintosh, Microsoft Windows NT
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and UNIX operating systems, in addition to its existing fully integrated
real-time turnkey systems solutions. The Company seeks to further expand the
range of creative professionals served by the Company and, by leveraging its
technology base, customer relationships and existing reputation, extend its
product line to include other aspects of the content creation process.
RECENT DEVELOPMENTS
RECENT ACQUISITIONS
DENIM SOFTWARE, L.L.C. ACQUISITION. On June 12, 1997, the Company, through
its wholly-owned subsidiary 3380491 Canada Inc. ("Acquisition Sub"), acquired
substantially all of the assets and assumed certain liabilities of Denim
Software L.L.C., a Delaware limited liability company ("Denim"), pursuant to the
terms of an Asset Purchase Agreement dated as of June 12, 1997, among
Acquisition Sub, Denim, Sam Khulusi, Frank Khulusi, Westco Denim Investments
Group, Ltd., a California limited partnership, and Frank Khulusi Family Limited
Partnership, a California limited partnership (the "Denim Acquisition"). The
purchased assets consisted primarily of Denim software products, including
ILLUMINAIRE Paint, ILLUMINAIRE Composition and ILLUMINAIRE Studio, and related
know-how and goodwill. The aggregate purchase price for the assets was comprised
of (i) approximately $9,126,000 in cash, (ii) the assumption of certain
enumerated liabilities in an amount equal to no more than approximately
$2,209,000 in the aggregate, and (iii) the assumption of certain on-going
obligations under certain existing contracts of Denim. At closing, cash
consideration, of approximately $9,126,000, and certain liabilities, of
approximately $655,000, were paid. The cash used by the Company to fund the
acquisition was derived primarily from cash flow from operations. The
transaction was accounted for as a purchase. The Company incurred a one-time
charge of $9,800,000, or $0.35 per share, for in-process research and
development, purchased and expensed in its fourth fiscal quarter ended June 30,
1997, based on an independent appraisal. The terms of the transaction and the
consideration received by Denim were the result of arms-length negotiations
between the representatives of Discreet Logic and Denim. Denim developed Apple
Macintosh and Microsoft Windows NT-based paint and compositing software for
producing effects, interactive content and graphics design.
D-VISION SYSTEMS, INC. ACQUISITION. On July 15, 1997, the Company acquired
all of the outstanding shares of capital stock of D-Vision Systems, Inc.
("D-Vision"), an Illinois corporation, pursuant to a Stock Purchase Agreement
dated as of July 10, 1997, among the Company, D-Vision, the former stockholders
of D-Vision (the "Selling Stockholders") and certain other individuals (the
"D-Vision Acquisition"). As a result of the D-Vision Acquisition, the Company
acquired the D-Vision OnLINE and PRO software products for non-linear video and
digital media editing solutions including related know-how and goodwill. The
purchase price was paid in a combination of 555,000 newly issued Discreet Logic
common shares and approximately $10,750,000 in cash. In addition, approximately
$4,000,000 of the cash consideration is being held in escrow until September 30,
1999, subject to (i) earlier release from escrow of up to $1,900,000 on
September 30, 1998 and (ii) the resolution of any indemnification claims made by
the Company pursuant to the Stock Purchase Agreement. The cash used by the
Company to fund the acquisition was derived primarily from cash flow from
operations. The D-Vision Acquisition was accounted for as a purchase. A
substantial portion of the purchase price, net liabilities of D-Vision and
transaction costs was allocated to purchased in-process research and development
for which the Company expects to incur a one-time charge against earnings in the
range of $20,000,000 to $21,000,000, or $0.70 to $0.73 per share, in the quarter
ending September 30, 1997, based on an independent appraisal. The terms of the
transaction and the consideration received by the D-Vision stockholders were the
result of arms-length negotiations between the representatives of Discreet Logic
and D-Vision. D-Vision develops Microsoft Windows NT-based non-linear editing
solutions.
DISCREET LOGIC SYSTEMS
Discreet Logic offers turnkey systems comprised of the Company's proprietary
software utilizing workstations manufactured by SGI, scaleable disk arrays and
other peripherals. The Company's systems provide the speed and operational
flexibility demanded by the professional film and video industries. The
Company's systems can be linked to enable users to collaborate and manage data
more efficiently.
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The Company's systems are designed to be intuitive and easy to use. The
systems use a consistent interface through which operations are controlled via
on-screen menus (which users can organize to fit their preferences) and a
pressure-sensitive stylus. The Company's systems include a SPARKS developers
kit, which allows customers to integrate their own proprietary software or third
party software into the Company's systems' environments. The Company's systems
also offer comprehensive image input/output ("I/O") functions, allowing image or
object data to be captured and exchanged between workstations in a studio
environment in a variety of formats. For sites with multiple systems, work
generated on other platforms can be imported and placed directly onto the
Company's systems' local disk array for integration into the current production.
In addition, Discreet Logic's image files can be transferred among local disk
arrays. For example, if a user prepares a production on a FLINT system, the user
can transfer video or film data to the FLAME or INFERNO systems or video data to
the FIRE system, for finishing with the client. The flexible systems
architecture can result in different system configurations and enables clients
to differentiate themselves from their competitors by allowing them to customize
their systems.
SPECIAL EFFECTS SYSTEMS
FLAME
FLAME is an on-line, resolution-independent, non-linear, uncompressed
digital system. The system is used by creative professionals to create, edit and
composite special visual effects in an on-line, real-time environment. Easily
integrated into a suite environment and possessing the power and features
necessary to serve as the core of a fully digital suite, FLAME is designed to
allow the operator to create desired effects with near instantaneous feedback.
A complete FLAME system includes the FLAME software, an SGI Onyx2
workstation, a STONE disk array and various I/O devices. The Company expects to
commence commercial shipments of FLAME on the SGI Octane workstation during the
fourth calendar quarter of 1997, at which time it plans to discontinue offering
FLAME software for the SGI Onyx2. As of September 1, 1997, the North American
list price for a basic four-processor FLAME system was approximately $480,000
and the software-only list price was $185,000. The Company began full commercial
shipments of FLAME in January 1993. As of September 1, 1997, the Company had
sold more than 350 FLAME licenses worldwide.
INFERNO
INFERNO is an on-line, non-linear, resolution-independent, uncompressed
digital system providing all the features of FLAME with film tools, and
increased image resolution and color control for digital film work. INFERNO
provides up to 12 bits color depth per channel along with high image resolution.
The system also features tools for grain management, wire and scratch removal
and color calibration.
A complete INFERNO system includes the INFERNO software, an SGI Onyx2
workstation, a STONE disk array and various I/O devices. As of September 1,
1997, the North American list price for a basic four-processor INFERNO system
was approximately $705,000 and the software-only list price was $235,000. The
Company began full commercial shipments of INFERNO in October 1995. As of
September 1, 1997, the Company had sold more than 90 INFERNO licenses worldwide.
FLINT
FLINT, like FLAME and INFERNO, is a resolution-independent, non-linear,
uncompressed digital system used by creative professionals to create, edit and
composite special visual effects, but because of platform limitations, runs in a
non-real-time environment. The FLINT system incorporates virtually all of
FLAME's feature set. The primary difference in the two systems is the speed of
interactivity, processing and I/O. The FLINT system also can be used in
conjunction with any of the Company's other systems. For example, effects can be
created on a FLINT system and made available to the FLAME system for real-time
client selection, approval and alteration.
A complete FLINT system includes the FLINT software, an SGI Indigo2 or O2
workstation, a disk array and various I/O devices. As of September 1, 1997, the
North American list price for a basic FLINT system on the
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O2 workstation was approximately $65,000 and the software-only list price for
the O2 workstation was approximately $22,000. The Company began full commercial
shipments of FLINT in December 1993. As of September 1, 1997, the Company had
sold more than 575 FLINT licenses worldwide.
FLINT RT
FLINT RT is a bundled solution that offers FLINT's visual effects technology
in conjunction with a real-time video and audio acquisition, storage and
playback hardware subsystem, PEBBLES. PEBBLES is an I/O subsystem that provides
the SGI Indigo2 or O2 workstation with real-time video I/O and thus relieves the
central processing unit of this task.
A complete FLINT RT system includes the FLINT RT software, an SGI Indigo2 or
O2 workstation, and a PEBBLES unit. As of September 1, 1997, the North American
list price for a basic FLINT RT system was approximately $100,000 and the
software bundle (including PEBBLES) list price was approximately $75,000. The
Company began full commercial shipments of FLINT RT in December 1996. As of
September 1, 1997, the Company had sold more than 70 FLINT RT licenses
worldwide. When FLAME becomes available on the Octane workstation, the Company
believes that demand for FLINT RT may decrease.
EDITING SYSTEMS
FIRE
FIRE is an uncompressed, on-line, non-linear, digital video editing system
with special effects capabilities. FIRE includes a sophisticated toolset and a
gestural, picture-based editing interface, which the Company believes
specifically address the new and expanding requirements needed for on-line
finishing.
A complete FIRE system includes the FIRE software, an SGI Onyx2 workstation,
a STONE disk array and various I/O devices. As of September 1, 1997, the North
American list price for a basic four-processor FIRE system was approximately
$550,000 and the software-only list price was $185,000. The Company commenced
full commercial shipments of FIRE in October 1996 and expects to release an
HDTV-compatible FIRE system during the first half of calendar 1998. As of
September 1, 1997, the Company had sold more than 75 FIRE licenses worldwide.
SMOKE
SMOKE, like FIRE, is an uncompressed, on-line, non-linear, digital video
editing system with limited special effects capabilities. SMOKE uses the same
gestural, picture-based editing interface as FIRE. The primary difference in the
two systems is FIRE's greater speed of interactivity and processing as well as
greater special effects capabilities than those of SMOKE. However, SMOKE's
special effects capabilities are modular; effects modules may be purchased
separately by the customer to augment the special effects capabilities of the
baseline SMOKE system. The Company expects to commence commercial shipments of
SMOKE during the fourth quarter of calendar 1997.
A complete SMOKE system includes the SMOKE software, an SGI Octane
workstation, a STONE disk array and various I/O devices. As of September 1,
1997, the North American list price for a basic SMOKE system was $304,000 and
the software-only list price was approximately $175,000.
BROADCAST PRODUCTION SYSTEMS
The Company offers VAPOUR, a computer-based, integrated graphics system
which is used to create computer generated locales, also known as virtual sets,
for news, sports and entertainment programming, and FROST, a computer-based set
of modeling, animation and rendering tools for the creation and manipulation of
3D graphics for broadcast. VAPOUR and FROST are designed to operate on the SGI
Onyx2 workstation and allow the user to work completely in real-time or through
a combination of real-time and post-produced components. As of September 1,
1997, the North American list prices for basic VAPOUR and FROST systems were
approximately $323,000 and $459,000, respectively, and the software-only list
prices for VAPOUR and FROST were $175,000 and $115,000, respectively.
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STORAGE AND NETWORKING SOLUTIONS
The Company offers STONE, a disk-based storage system for use with its video
and high-performance film applications, which is targeted at the production,
post-production and broadcast markets. STONE is designed to allow real-time
playback of uncompressed video frames in any order, efficiently store any mix of
resolutions and ensure image integrity by remaining operational in the event of
disk or power supply failure. The Company commenced full commercial shipments of
STONE in April 1995. As of September 1, 1997, the North American list price for
a basic STONE disk array offering 36 minutes of storage was approximately
$62,000.
The Company offers WIRE, a high-performance transport system for digital
film and video for use with multiple STONE disk arrays. WIRE builds on the
Company's disk technology and is designed, if the network provides sufficient
bandwidth, to provide real-time CCIR-601 instant access to images located on a
disk anywhere within a post-production facility. WIRE can be configured as a
centralized or distributed network, or both. The Company began commercial
shipments of WIRE in the fourth quarter of fiscal 1997. As of September 1, 1997,
the North American list price for WIRE was $10,000.
SYSTEM COMPONENTS
THE WORKSTATION
FLAME, INFERNO, FIRE, VAPOUR and FROST run on SGI Onyx2 workstations,
typically configured with four or eight processors, SMOKE runs on the SGI Octane
workstation and FLINT runs on the SGI Indigo2 Impact and O2 workstations. The
Company expects to commence commercial shipments of FLAME on the SGI Octane
workstation during the fourth calendar quarter of 1997, at which time it plans
to discontinue offering FLAME software for the SGI Onyx2. The SGI hardware
platforms are scaleable and upgradeable (within the same machine) to fit the
price and performance criteria of the customer. Each system can be connected to
other Discreet Logic systems and to numerous third party software, systems and
devices.
DISK ARRAYS
A disk array is comprised of a number of disks working cooperatively to
handle high speed data flows. FLAME, INFERNO, FIRE, SMOKE, VAPOUR and FROST must
be used with the Company's STONE disk arrays, which can be configured to deliver
up to 12 hours of video or one hour of film. A typical FLINT disk array
configuration can record and play up to nine minutes of video or one minute of
film.
I/O
Third party video tape recorders can be controlled with FLAME, INFERNO,
FLINT, FLINT RT, FIRE and SMOKE's stylus and tablet. FLAME, INFERNO, FIRE and
SMOKE interface to component digital video devices using the SGI DIVO board.
FLAME, INFERNO, FIRE and SMOKE can record and play back component digital video
in real time directly to and from its disk array. I/O edits can be implemented
sequentially using the EDL capabilities of the FLAME, INFERNO, FIRE and SMOKE
systems. Other third party devices, such as film scanners and recorders, can
also be used with Discreet Logic systems for HDTV and film transfers.
FLAME, FLINT, FLINT RT and INFERNO can record and playback two audio tracks
synchronized with an image effect. FIRE and SMOKE offer four tracks.
DISCREET LOGIC SOFTWARE
Through two recent acquisitions, the Company now offers software-only
solutions which run on the Windows NT and the Apple Macintosh operating systems.
These acquisitions are part of the Company's strategy to expand the range of
creative professionals served by the Company and to extend its product line to
include other aspects of the content creation process, specifically off-line
special effects creation and off-line editing.
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SPECIAL EFFECTS SOFTWARE
ILLUMINAIRE
ILLUMINAIRE Paint is an Apple Macintosh and Microsoft Windows NT-based paint
software and ILLUMINAIRE Composition is an Apple Macintosh and Microsoft Windows
NT-based compositing software for effects, interactive content and graphic
design creation. ILLUMINAIRE Paint and ILLUMINAIRE Composition are also sold
together as ILLUMINAIRE Studio. Both Paint and Composition are resolution-
independent, feature a configurable interactive interface, and provide for
automatic key-framing of all operations. The Company acquired the ILLUMINAIRE
product line as part of the Company's acquisition of substantially all of the
assets of Denim on June 12, 1997. As of September 1, 1997, the North American
list prices for ILLUMINAIRE Paint, Composition, and Studio were $1,995, $1,995
and $3,495, respectively.
EDITING SOFTWARE
ONLINE
OnLINE is a non-linear, compressed editing software solution which runs on
the Microsoft Windows NT operating system. OnLINE is offered in two versions:
OnLINE RT for real-time effects and keying, and OnLINE XT for basic editing and
compositing. The Company acquired OnLINE as part of the D-Vision Acquisition. As
of September 1, 1997, the North American list price for OnLINE was $9,995.
CUSTOMERS
The Company's systems and related software are sold primarily to film and
video production, post-production and broadcast companies. The Company's
software-only products are sold in these markets as well as to institutional
customers and professional consumers. As of September 1, 1997, the Company had
an installed base of more than 350 FLAME, 575 FLINT, 70 FLINT RT, 90 INFERNO and
75 FIRE licenses worldwide.
No customer accounted for 10% or more of the Company's total revenues in
fiscal 1995, 1996 or 1997.
MARKETING AND SALES
MARKETING STRATEGY. To date, the Company has marketed its systems and
software primarily to production and post-production companies in the film and
video industries. The Company's principal marketing strategy has been to create
awareness of its systems and software through appearances at major international
computer graphics and broadcasting tradeshows, such as National Association of
Broadcasters ("NAB"), ACM SIGGRAPH (U.S.), International Broadcasters Convention
("IBC") (Europe), INTERBEE (Japan) and Montreaux (Europe). The Company has
supported this marketing strategy with direct-mail advertising and
advertisements in trade publications. In addition, the Company believes that the
high quality of computer images generated using its products results in
significant industry awareness. With permission from its customers, the Company
creates promotional materials utilizing content created using the Company's
products.
The Company is marketing its newly acquired software-only products primarily
through direct mail advertising, advertising in trade publications, seminars and
roadshows, as well as at both international and local tradeshows. In addition,
the Company provides cooperative advertising funding to a number of its
distributors who locally advertise the Company's software-only products. As the
Company broadens the markets for its products, the Company intends to expand its
marketing efforts accordingly.
DIRECT SALES AND DISTRIBUTION. Discreet Logic sells its systems and
software through its direct sales organization, as well as through distributors
and resellers. Sales activities in North America are conducted from the
Company's Montreal headquarters, sales offices in Los Angeles, Chicago and New
York and field representatives based in Boston, San Francisco, and Atlanta. The
Company also markets its systems and software through sales offices located in
the United Kingdom, Spain, France, Germany, Japan, Singapore, India, Hong Kong
and Brazil. The Company's headquarters and each of its sales offices have sales
and demonstration capabilities. As of September 1, 1997, the Company employed 32
direct sales people and 26 demonstration artists worldwide.
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Historically, the Company has used distributors and resellers to sell FLINT
in geographic areas generally not served by the Company's direct sales
organization. In addition, many of these distributors also market the Company's
other systems for which the distributors or resellers will receive a finder's
fee if the customer purchases the system from the Company. Substantially all of
the Company's distributors now sell the Company's software-only products,
ILLUMINAIRE and OnLINE, as well as FLINT. In the United States, the Company
maintains a direct sales presence in its primary markets including New York,
Chicago and Los Angeles. Elsewhere in the United States, the Company typically
sells its systems and software through its distribution network which is managed
by the Company's sales representatives. Outside of the United States, the
Company maintains a direct sales presence in its primary markets, including
London, Paris, Munich, Singapore and Tokyo. In other areas outside of the United
States, the Company typically sells its systems and software through its
distribution network which is managed by the Company's sales representatives.
Generally, customers purchasing the Company's system software and peripherals
from the distributors will also purchase the SGI workstation hardware from the
distributors. The Company provides software and systems integration training to
its distributors. The Company continued its strategy of increasing its
distributor relationships throughout fiscal 1997 and greatly increased the
number of its distributors through the Denim and D-Vision Acquisitions in the
fourth quarter of fiscal 1997 and first quarter of fiscal 1998, respectively.
The Company currently has distribution relationships with over 300 distributors
and resellers in over 60 countries. This compares with 48 distributors and
resellers in 34 countries in fiscal 1996. The Company's strategy of marketing
its systems and software directly to customers and indirectly through
distributors may result in distribution channel conflicts as the Company's
direct sales efforts may compete with those of its indirect channels.
INTERNATIONAL REVENUES. For fiscal 1995, 1996 and 1997, revenues from
customers outside North America accounted for approximately 45%, 57% and 57%,
respectively, of the Company's total revenues. The Company expects that revenues
from customers outside North America will continue to account for a substantial
portion of its revenues.
RESELLER ARRANGEMENTS. The Company is a master value added reseller ("VAR")
of SGI workstations. There are significant risks associated with this reliance
on SGI and the Company may be impacted by the timing of the development and
release of products by SGI, as was the case during fiscal 1996. In addition, the
Company has faced and may in the future face unforeseen difficulties associated
with adapting the Company's products to future SGI products. In May 1994,
Discreet Logic entered into a Value-Added Reseller Agreement with SGI. The
agreement grants to the Company a non-exclusive right to purchase and license
certain hardware products from SGI, including the SGI Onyx2, Octane, Indigo2 and
O2 workstations for remarketing by the Company in the United States. Although
the agreement contains no minimum purchase requirements, the volume of systems
purchased from SGI affects the percentage discount received by the Company. The
agreement is subject to annual renewal in May of each year and may be terminated
by SGI for cause. The agreement with SGI has been extended through October 1997
and the Company has no reason to believe that SGI will not renew such agreement.
The Company also acts as a reseller and systems integrator of certain peripheral
devices used in the Company's systems, including audio and video I/O cards and
electronic tablets. The Company receives discounts for the purchase price of
these products.
BACKLOG. The Company has no significant backlog and does not believe that
its backlog at any particular point in time is indicative of future sales
levels.
SYSTEMS INTEGRATION, SERVICE AND SUPPORT
The Company provides its customers with a variety of systems integration,
support and training services including on-site and telephone support, and
in-house and on-site training in the use of the Company's products. These
services are generally provided under separately priced arrangements with the
Company's customers. In some markets, these services are provided by the
Company's distributors who are compensated for such services directly by the
customer. The Company maintains a staff of persons dedicated to training its
distributors in the performance of these services. The Company believes that its
focus on customer service provides it with important information about the
evolving needs of its customers. The Company derived revenues of approximately
$4,770,000, $11,713,000 and $13,606,000 from these services in fiscal 1995, 1996
and 1997, respectively.
I-8
<PAGE>
The Company supports its customers in North and South America from the
Company's Montreal office and through its distributors. Customers in Europe and
the Pacific Rim are supported from the offices of the Company's European
subsidiaries and by distributors. As of September 1, 1997, the Company employed
a total of 77 persons worldwide in its customer support organization.
RESEARCH AND DEVELOPMENT
The Company's research and product development efforts are focused on the
continued enhancement of the FLAME, FLINT, INFERNO, FIRE, VAPOUR and FROST
systems, the ILLUMINAIRE and OnLINE software and the development of new
products. Discreet Logic employs a modular development approach which it
believes allows it to bring innovative technology to market more rapidly than
traditional analog or proprietary hardware-based digital solutions and enables
it to take advantage of advances in general purpose workstation technology as
they become available. The Company intends to continue to enhance and upgrade
these products on a regular basis.
In fiscal 1995, 1996 and 1997, excluding purchased in-process research and
development, the Company spent approximately $4,037,000, $16,902,000 and
$9,708,000 (net of tax credits), respectively, on research and development,
representing 6%, 20% and 10%, respectively, of total revenues. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations." The Company's research and development staff
consisted of 92 persons as of September 1, 1997.
The markets for the Company's systems and software are characterized by
evolving industry standards, changing technologies and frequent new product
introductions. The Company believes that its future success will depend in part
on its ability to enhance its existing systems and software and to develop and
introduce new products and features which meet changing customer requirements
and emerging industry standards on a timely basis. In addition, as a master VAR
of SGI workstations, the Company obtains certain advance access to SGI
technology which facilitates its efforts to develop compatible systems and to
modify and improve existing products. If the Company were unable to obtain such
advance access, it could have an adverse impact on the Company's business and
results of operations.
PROPRIETARY RIGHTS
The Company's success is dependent upon its proprietary technology. Although
the Company currently has one patent and has 74 patent applications on its
technology, it relies principally on unregistered copyrights and trade secrets
to protect its intellectual property. The Company generally seeks to enter into
confidentiality agreements with its employees and license agreements with its
distributors and to limit access to and distribution of its systems, software,
documentation and other proprietary information. Until fiscal 1996,
substantially all of the Company's systems were sold without written license
agreements. There can be no assurance that the Company will not be involved in
litigation with respect thereto or that the outcome of any such litigation might
not be more unfavorable to the Company as a result of such omissions. Any such
litigation could have a material adverse effect on the Company's business and
results of operations. The Company licenses its ILLUMINAIRE and OnLINE products
under "shrink-wrap" licenses (i.e., licenses included as part of the product
packaging). Shrink-wrap licenses are not negotiated with or signed by individual
licensees, and purport to take effect upon the opening of the product package.
Certain provisions of such licenses, including provisions protecting against
unauthorized use, copying, transfer and disclosure of the licensed program, may
be unenforceable under the laws of many jurisdictions. The Company uses both
software and hardware keys with respect to its systems and software but
otherwise does not copy-protect its systems and software. It may be possible for
unauthorized third parties to copy the Company's products or to reverse engineer
or obtain and use information that the Company regards as proprietary. There can
be no assurance that the Company's competitors will not independently develop
technologies that are substantially equivalent or superior to the Company's
technologies. In addition, the laws of certain countries in which the Company's
products are or may be distributed do not protect the Company's products and
intellectual property rights to the same extent as the laws of Canada or the
United States. As the number of software products in the industry increases and
the functionality of these products further overlaps, the Company believes that
software products generally may increasingly become the subject of claims that
such software products infringe the rights of others.
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<PAGE>
Significant and protracted litigation may be necessary to protect the
Company's intellectual property rights, to determine the scope of the
proprietary rights of others or to defend against claims of infringement. The
Company is not currently involved in any litigation with respect to intellectual
property rights; however, there can be no assurance that third-party claims
alleging infringements will not be asserted against the Company in the future.
For example, the Company recently received a letter from Avid Technology, Inc.
("Avid") stating its belief that certain of the Company's recently acquired
D-Vision products practice inventions claimed in a patent on a media editing
system. The Company is currently investigating the assertions of Avid's letter.
To the Company's knowledge, Avid has not initiated any suit, action, or other
proceeding alleging any infringement by the Company of such patent. If
infringement is alleged by Avid, or any other holder of protected intellectual
property rights, the Company could be required to discontinue the use of certain
software code or processes, to cease the manufacture, use and sale of infringing
products, to incur significant litigation costs and expenses, to develop
non-infringing technology or to obtain licenses to use the allegedly infringed
technology. There can be no assurance that the Company would be able to develop
alternative technologies or to obtain such licenses or, if a license were
obtainable, that the terms would be commercially reasonable or acceptable to the
Company. Moreover, there may be pending or issued patents that extend to the
Company's products, which, together with the growing use of patents to protect
technology, increase the risk that third parties may assert infringement claims
against the Company in the future. There can be no assurance that a court to
which any infringement claims are submitted would not find that the Company's
products infringe any third party's intellectual property rights. Further, such
litigation, regardless of its outcome, could result in substantial costs to and
diversion of efforts by the Company. Litigation may also be necessary to enforce
the Company's intellectual property rights. Any infringement claim or other
litigation against or by the Company could have a material adverse effect on the
Company's business and results of operations.
MANUFACTURING AND SUPPLIERS
The Company has historically relied on third-party vendors to manufacture
and supply all of the hardware components used in the Company's systems.
Manufacturing at the Company consists of assembly (including disk array
assembly), testing and value added systems integration. The Company's
manufacturing staff consisted of 11 persons as of September 1, 1997.
The Company's FLAME, FLINT, FLINT RT, INFERNO, FIRE, VAPOUR and FROST
systems currently include workstations manufactured by SGI. There are
significant risks associated with this reliance on SGI and the Company may be
impacted by the timing of the development and release of products by SGI, as was
the case during fiscal 1996. In addition, there may be unforeseen difficulties
associated with adapting the Company's products to future SGI products. The
Company is an authorized master VAR of workstations manufactured by SGI. The
Company's agreement with SGI is subject to annual renewal in May of each year
and termination by SGI for cause. The agreement with SGI has been extended
through October 1997 and the Company has no reason to believe that SGI will not
renew such agreement. In addition, although the Company has no reason to believe
that it will be unable to obtain sufficient quantities of SGI workstations on a
timely basis or that its status as a master VAR will be changed, there can be no
assurance that the Company will continue to be able to procure such workstations
in sufficient quantities on a timely basis or that SGI will continue to
recognize the Company as a master VAR. The success of the Company also depends,
in part, on the continued market acceptance of SGI workstations, in general, and
by the professional film and video industries, in particular. Although the
Company intends to continue to evaluate new hardware platforms and may adapt its
products as technological advances and market demands dictate, and although the
Company has now entered the market for content creation software which runs on
the Apple Macintosh and Windows NT operating systems, the Company believes that
it will continue to derive substantially all of its revenue for the foreseeable
future from the sale and maintenance of systems designed to include SGI
workstations. As a result, financial, market and other developments adversely
affecting SGI or the sales of workstations, the introduction or acquisition by
SGI of products which are competitive with those of the Company, or the
unanticipated timing or pricing of SGI products that could cause customers to
defer the decision to buy or determine not to buy the Company's then available
products or systems, could have an adverse effect upon the Company's business
and results of operations. As a master VAR, the Company also obtains certain
advance access to SGI technology in order to develop compatible systems and to
modify and improve existing products. If the Company were unable to obtain such
advance access, it could have an adverse impact on the Company's business and
results of operations.
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<PAGE>
The Company is dependent on SGI as the Company's sole source for video I/O
cards used in the Company's systems. The Company also purchases electronic
tablets manufactured by Wacom Technology Corporation and believes that, while
alternative suppliers are available, there can be no assurance that alternative
electronic tablets would be functionally equivalent or be available on a timely
basis or on similar terms. The Company generally purchases sole source or other
components pursuant to purchase orders placed from time to time in the ordinary
course of business and has no written agreements or guaranteed supply
arrangements with its sole source suppliers. The Company has experienced quality
control problems and supply shortages for sole source components in the past and
there can be no assurance that the Company will not experience significant
quality control problems or supply shortages for these components in the future.
The Company does not maintain an extensive inventory of these components, and an
interruption in supply could have a material adverse effect on the Company's
business and results of operations. Because of the Company's reliance on these
vendors, the Company may also be subject to increases in component costs which
could adversely affect the Company's business and results of operations.
The Company's OnLINE product requires, and can only be used with, a Targa
videographic card manufactured by Truevision, Inc., which distributors
customarily purchase and resell to end users as part of a turnkey system. The
Company believes that while alternative suppliers are available, it would take a
significant amount of time to integrate any such replacement cards with the
Company's OnLINE product. There can be no assurance that alternative cards would
be functionally equivalent or be available to distributors or users on a timely
basis or at a similar price. An interruption in the supply or an increase in
price of these cards to OnLINE software users could have a material adverse
effect on the Company's business and results of operations.
COMPETITION
The market in which the Company competes is characterized by intense
competition. In the real-time segment of the special effects market, the
Company's FLAME system competes with Quantel Limited's ("Quantel") Henry. In
certain applications in the non-real-time segment of the market, the Company's
FLINT system competes with Avid's Illusion. The Company's INFERNO system
competes with Quantel's Domino and Eastman Kodak Company's ("Kodak") Cineon. The
Company's FIRE system competes with Quantel's Editbox and Sony Corporation's
("Sony") range of proprietary editing equipment. In addition, the Company
expects that the products gained from the Denim and D-Vision acquisitions will
compete with Adobe Systems Incorporated's ("Adobe") special effects products and
Avid's and Media 100 Inc.'s ("Media 100") range of editing products. Many of the
Company's current and prospective competitors, including Quantel, Avid, Kodak,
Sony, Adobe and Media 100 have significantly greater financial, technical,
manufacturing and marketing resources than the Company. Moreover, these
companies may introduce additional products that are competitive with those of
the Company, and there can be no assurance that the Company's products would
compete effectively with such products. In addition, as personal computers
become more powerful, software suppliers may be able to introduce products for
personal computers that would be competitive with the Company's products in
terms of price and performance for professional users.
The Company believes that its ability to compete depends on elements both
within and outside its control, including the success and timing of new product
development and introduction by the Company and its competitors, product
performance and price, distribution and customer support. There can be no
assurance that the Company will be able to compete successfully with respect to
these factors. Although the Company believes that it has certain technological
and other advantages over its competitors, maintaining such advantages will
require continued investment by the Company in research and development, sales
and marketing and customer service and support. There can be no assurance that
the Company will have sufficient resources to make such investments or that the
Company will be able to make the technological advances necessary to maintain
such competitive advantages. In addition, as the Company enters new markets,
distribution channels, technical requirements and levels and bases of
competition may be different than those in the Company's current markets and
there can be no assurance that the Company will be able to compete favorably.
Furthermore, competitive pressures or other factors, including the Company's
entry into new markets, may result in significant price erosion that could have
a material adverse effect on the Company's business and results of operations.
I-11
<PAGE>
EMPLOYEES
As of September 1, 1997, the Company had 350 full-time employees. Of such
employees, 92 were employed in research and development, 81 in sales, 20 in
marketing, 77 in customer support, 11 in manufacturing and 69 in administration
and finance. The Company believes that its future success will depend in large
part upon its ability to attract and retain highly skilled technical, management
and sales and marketing personnel. Moreover, because the development and
marketing of the Company's systems and software requires knowledge of film and
video production and post-production, key technical personnel must be proficient
in a number of disciplines. Competition for such technical personnel is intense,
and the failure of the Company to hire and retain talented technical personnel
or the loss of one or more key employees could have an adverse effect on the
Company's business and results of operations. The Company's employees are not
represented by a labor union, and the Company considers its employee relations
to be good.
ITEM 2. PROPERTIES
In July 1997, the Company agreed to rent space for its new headquarters in
Montreal from TGR Zone Corporation ("TGR Zone"), a company indirectly owned by
Discreet Logic's Chairman and Chief Executive Officer. As part of this
agreement, TGR Zone will assume the Company's lease commitment at its previous
Montreal location. The agreement provides that the Company will lease
approximately 55,000 square feet of space at approximately CDN$13.00 (or
approximately $9.44 at June 30, 1997) per square foot per annum subject to
normal escalation clauses. The proposed lease is set to expire in June 2007. The
Company will only sign the proposed lease when the Company is satisfied with the
assignment of its previous lease. If this assignment is not negotiated with the
previous landlord and TGR Zone in a manner acceptable to the Company, the
Company has the right to modify the terms of its agreement with TGR Zone. The
proposed lease for the current building and the assignment of the lease for the
previous building are expected to be executed in the second fiscal quarter of
1998. As of June 30, 1997, the Company leased sales offices, research and
development facilities and/or warehouse space in the United States, Brazil,
France, the United Kingdom, Spain, Germany, Singapore, India, Hong Kong and
Japan, pursuant to leases which expire from January 1998 through February 2003.
The Company's current aggregate annual rental expense for these additional
facilities is approximately $1,230,000.
In August 1995, the Company purchased an approximately 10,000 square foot
office building in London, England for use as a sales facility for approximately
L1,148,000 (or approximately $1,788,000 at June 30, 1997). Subsequently, in
December 1995, the Company purchased an approximately 50,000 square foot office
building in Montreal, Quebec for CDN$1,730,000 (or approximately $1,250,000 at
June 30, 1997). The carrying values of the Montreal building and the London
building were written down to their estimated fair market values and the
buildings were classified as assets held for sale. In September 1997, the
Company entered into an agreement to sell the Montreal office building for a
price not materially different from its carrying value.
ITEM 3. LEGAL PROCEEDINGS
On May 29, 1996, a lawsuit entitled SANDRA ESNER AND JERRY KRIM, ON BEHALF
OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED, VS. [ . . . ] DISCREET LOGIC
INC., ET AL., Case No. 978584, was filed in the Superior Court of the State of
California, City and County of San Francisco. Named as defendants are the
Company, certain of the Company's former and existing directors, officers, and
affiliates, and certain underwriters and financial analysts. The plaintiffs
purport to represent a class of all persons who purchased the Company's common
stock between September 13, 1995, and May 1, 1996. The complaint alleges
violations of California law through material misrepresentations and omissions,
among other things. The Company believes the allegations in the complaint are
without merit and has defended the lawsuit vigorously.
On June 13, 1996, a lawsuit entitled BRUCE FRIEDBERG, ON BEHALF OF HIMSELF
AND ALL OTHERS SIMILARLY SITUATED, VS. DISCREET LOGIC INC., ET AL., Civ. No.
96-11232-EFH, was filed in the United States District Court, District of
Massachusetts. Named as defendants are the Company and certain of the Company's
former and existing directors and officers. The plaintiff purports to represent
a class of all persons who purchased the Company's common stock between November
14, 1995, and February 13, 1996. On October 11, 1996, the plaintiff filed an
amended complaint which asserts substantially the same factual allegations as
the first complaint and proposes the identical class period. The complaint
alleges violations of United States Federal Securities law through
I-12
<PAGE>
material misrepresentations and omissions. The Company believes the allegations
in the complaint are without merit and has defended the lawsuit vigorously.
On April 29, 1997, a lawsuit entitled ANTON PAPARELLA, SANDRA ESNER AND
GEOFFREY L. SHERWOOD, ON BEHALF OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED
VS. DISCREET LOGIC INC., ET AL., case No. C-97-1570, was filed in the United
States District Court, Northern District of California. Named as defendants are
the Company and certain of the Company's former and existing officers, directors
and affiliates, and certain underwriters. The complaint asserts, in all material
respects, the same factual allegations and proposes the same class period as the
above-described California state court complaint filed in May 1996, except
asserts claims under federal securities law instead of state law. The Company
believes the allegations in the California federal complaint are without merit
and has defended the lawsuit vigorously.
On August 12, 1997, the Company announced that it had reached an
agreement-in-principle to settle all three of the shareholder class action
litigations. The proposed $10.8 million settlement will require Discreet Logic
to contribute approximately $7.4 million from its own funds, with the remainder
provided by insurance. The settlement is subject to the signing of a definitive
settlement agreement and to final court approval of the proposed settlement.
There can be no assurance that the settlement will be consummated and that the
Company will not have to continue its defense of the lawsuits. Should the
proposed settlement not be consummated or finally approved for any reason, the
Company intends to defend the lawsuits vigorously.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the fiscal year ended
June 30, 1997 to a vote of security holders of the Company, through the
solicitation of proxies or otherwise.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Shares are traded on the Nasdaq National Market under
the symbol "DSLGF." Public trading of the common shares commenced on June 30,
1995. Prior to that time, there was no public market for the Company's Common
Shares. The following table sets forth the high and low sales prices for the
Common Shares as reported by Nasdaq for the periods indicated:
<TABLE>
<CAPTION>
HIGH LOW
------- -------
<S> <C> <C> <C> <C>
Fiscal 1996:
First quarter................................. $29 $19
Second quarter................................ $32 1/4 $17 3/4
Third quarter................................. $28 1/4 $ 9 3/4
Fourth quarter................................ $10 1/4 $ 3 7/8
Fiscal 1997:
First quarter................................. $8 5/8 $ 3 1/2
Second quarter................................ $9 1/8 $ 5 3/4
Third quarter................................. $9 1/2 $ 5 3/4
Fourth quarter................................ $18 1/8 $ 5 5/8
Fiscal 1998:
First quarter (through September 22, 1997).... $28 7/8 $16
</TABLE>
On September 22, 1997, the last reported sale price of the common shares on
the Nasdaq National Market was $25 per share. As of September 22, 1997, there
were approximately 160 holders of record of the common shares and the Company
believes that as of such date there were approximately 3,100 beneficial owners
of the common shares, based upon information provided by the Company's transfer
agent.
The Company has never declared or paid cash dividends and does not
anticipate paying any cash dividends on its capital stock in the foreseeable
future. In the event cash dividends are declared or paid, the Company
anticipates that they would be declared and paid in U.S. dollars. Part 1A of the
Quebec Companies Act prohibits the Company from paying dividends that would
prevent it from discharging its liabilities when due or that would
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<PAGE>
bring the book value of its assets to an amount less than the sum of its
liabilities and its issued and paid-up share capital account. At June 30, 1997,
the Company could not distribute any dividends.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data should be read in conjunction with,
and are qualified in their entirety by, the Company's consolidated financial
statements, related notes and other financial information included herein. On
January 9, 1997, the Board of Directors of the Company approved the change of
the Company's fiscal year end from July 31 to June 30. This change was effective
beginning with the Company's second fiscal quarter of 1997. The selected
consolidated financial data for fiscal 1997 are presented for the eleven month
period ended June 30, 1997. The results for the eleven month period ended June
30, 1997 are not directly comparable with those for the twelve month period
ended July 31, 1996, and the current eleven month period's results are not
necessarily indicative of the results that could be expected for a full twelve
month period.
<TABLE>
<CAPTION>
ELEVEN
MONTHS
YEAR ENDED JULY 31 ENDED
------------------------------------------ JUNE 30,
1993 1994 1995 1996 1997
-------- -------- -------- --------- ---------
<S> <C> <C> <C> <C> <C>
(in thousands, except per share data)
STATEMENT OF OPERATIONS DATA:
Total revenues........................ $ 2,609 $ 15,392 $ 64,549 $ 83,997 $ 101,924
Cost of revenues...................... 674 8,289 29,609 49,333 47,571
-------- -------- -------- --------- ---------
Gross profit...................... 1,935 7,103 34,940 34,664 54,353
-------- -------- -------- --------- ---------
Operating expenses:
Research and development(1)(2)...... 281 625 4,037 16,902 9,708
Sales and marketing................. 1,059 2,785 12,588 26,088 23,206
General and administrative(3)....... 500 1,383 4,855 10,582 6,396
Write-off of purchased research and
development(4)..................... -- -- -- 8,500 9,800
Restructuring expense(5)............ -- -- -- 15,000 --
Litigation and related settlement
expense(6)(7)..................... 152 1,366 -- 2,506 6,500
-------- -------- -------- --------- ---------
Total operating expenses.......... 1,992 6,159 21,480 79,578 55,610
-------- -------- -------- --------- ---------
Operating income (loss)........... (57) 944 13,460 (44,914) (1,257)
Total other income (expense)............ (44) (86) (170) 2,208 990
-------- -------- -------- --------- ---------
Income (loss) before income taxes and
minority interest..................... (101) 858 13,290 (42,706) (267)
Provision for income taxes.............. 12 343 5,490 1,435 6,489
-------- -------- -------- --------- ---------
Net income (loss) before minority
interest.............................. (113) 515 7,800 (44,141) $ (6,756)
-------- -------- -------- --------- ---------
Minority interest....................... -- 32 15 -- --
-------- -------- -------- --------- ---------
Net income (loss)................. $ (113) $ 483 $ 7,785 $ (44,141) $ (6,756)
-------- -------- -------- --------- ---------
Net income (loss) per common share...... $ (.01) $ .02 $ .31 $ (1.64) $ (0.24)
-------- -------- -------- --------- ---------
Weighted average common shares
outstanding........................... 20,954 23,094 24,886 26,837 27,948
-------- -------- -------- --------- ---------
</TABLE>
<TABLE>
<CAPTION>
JULY 31,
------------------------------- JUNE 30,
1994 1995 1996 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
(in thousands)
BALANCE SHEET DATA:
Cash and cash equivalents................................................... $ 826 $ 40,987 $ 21,658 $ 31,668
Working capital (deficit)................................................... (382) 41,847 24,030 18,537
Total assets................................................................ 9,431 76,858 80,148 95,944
Total shareholders' equity.................................................. 934 50,124 42,343 36,949
</TABLE>
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<PAGE>
- ------------
(1) Research and development expenses are net of Canadian federal and provincial
tax credits of $314,000, $450,000, $545,000, $711,000, and $696,000 for the
years ended July 31, 1993, 1994, 1995, 1996, and the eleven months ended
June 30, 1997 respectively. See Note 7 of Notes to the Company's
consolidated financial statements.
(2) In the third fiscal quarter of 1996, the Company charged to operations
$2,500,000 as research and development expense related to its investment in
Series B convertible, voting, preferred shares of Essential Communications
due to the uncertainty regarding the realizability of the investment in the
preferred shares.
(3) In Fiscal 1996, the Company provided approximately $3,300,000 in reserves
for potentially doubtful accounts receivable, and provided $830,000 to
reflect certain recourse provisions in and other risks associated with
certain third party financing arrangements. See Note 2(g) of Notes to the
Company's consolidated financial statements. In addition, in the third
quarter of fiscal 1996, the Company reduced the carrying value of a building
purchased in Montreal by CDN$500,000 (approximately $365,000) to reflect the
amount expected to be realized upon its sale.
(4) As part of the Company's acquisition of all of the outstanding shares of
Computer-und Serviceverwaltungs AG ("COSS") and certain assets of IMP
Innovative Medientechnik-und Planungs-GmbH ("IMP") in October 1995, the
Company charged to operations $8,500,000 of in-process research and
development. As part of the Company's acquisition of substantially all of
the assets of Denim Software L.L.C., the Company charged to operations
$9,800,000 of in-process research and development.
(5) In the fourth quarter of fiscal 1996, the Company recorded a pre-tax
restructuring charge of $15,000,000. See Note 17 of Notes to the Company's
consolidated financial statements.
(6) The results of operations for fiscal 1993 and 1994 include charges of
$152,000 and $1,366,000, respectively, for litigation and related settlement
expenses in connection with the Company's litigation and arbitration with
Softimage.
(7) The results of operations for fiscal 1996 includes a charge of $2,506,000 to
operations for legal costs associated with defending the class action
lawsuits. In fiscal 1997, an additional charge of $6,500,000 was recorded to
accrue the anticipated costs of settling all three lawsuits under the
agreement-in-principle. See Note 5 of Notes to Company's consolidated
financial statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the consolidated
financial statements and Notes thereto included elsewhere herein.
The success of the Company is subject to a number of risks and
uncertainties, including, without limitation, the Company's ability to
successfully develop, introduce and gain customer acceptance of existing and new
or enhanced products; the need for the continued development of the market for
the Company's systems; the ability of the Company to expand its current market
to include additional applications and develop new products for related markets;
the risk that as the Company enters new markets, the distribution channels,
technical requirements and levels and basis of competition may be different from
those in the Company's current markets; the presence of competitors with greater
financial, technical, manufacturing, marketing and distribution resources; the
risk that the products and technologies acquired by the Company through
acquisitions will not be successful, achieve market acceptance or be
successfully integrated with the Company's existing products and business; the
risk of quarterly fluctuations in the Company's operating results; the risk of
the Company's reliance on SGI for the workstations included in the Company's
systems including the impact of the timing of the development and release of SGI
products as well as unforeseen difficulties associated with adapting the
Company's products to future SGI products; the risk that the Company derives a
significant portion of its revenues from foreign sales; the Company's reliance
principally on unregistered copyrights and trade secrets to protect its
intellectual property; the risk that the Company's direct sales efforts may
compete with those of its indirect channels; the risk of the Company's reliance
on SGI as the sole source for video input/output cards used in the Company's
systems and the risk resulting from the requirement of the Company's OnLINE
software for a videographic card manufactured solely by Truevision, Inc.; the
Company's dependence on key management and technical employees; market price
fluctuations due to quarter-to-quarter variations in the Company's operating
results, announcements of technological innovations or new products by the
Company or its competitors and the historical fluctuations in market prices of
technology companies generally; the risk that the litigation settlement
agreement-in-principle will not be consummated and that the Company will not be
successful in its continued defense of the three class action lawsuits; and
other risks detailed from time to time in the Company's filings with the
Commission, including this Form 10-K.
Information provided by the Company from time to time including statements
in this Form 10-K which are not historical facts, are so-called forward-looking
statements, and are made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995 and releases of the Securities and
Exchange Commission. In particular, statements contained in the "Management's
Discussion and Analysis of Financial
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<PAGE>
Condition and Results of Operations" which are not historical facts (including,
but not limited to, statements regarding the Company's anticipated cost of
revenues, statements regarding the adequacy of cash to meet operations,
statements concerning anticipated expense levels and such expenses as a
percentage of revenues, statements about the portion of revenues from customers
outside North America, and the implementation of the restructuring plan),
"Business -- Overview and Recent Developments," "-- Other Products and Products
Under Development," "-- Marketing and Sales," "-- Proprietary Rights,"
"-- Manufacturers and Suppliers,"
"-- Competition," "-- Employees" and "Legal Proceedings" which are not
historical facts may constitute forward-looking statements. The Company's actual
future results may differ significantly from those stated in any forward-looking
statements. Factors that may cause such differences include, but are not limited
to, the factors discussed immediately above and below under the heading
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Certain Factors That May Affect Future Results," and elsewhere in
this Form 10-K, as well as from time to time in the Company's other filings with
Securities and Exchange Commission, including without limitation the Company's
Annual Report on Form 10-K for the fiscal year ended July 31, 1996.
OVERVIEW
GENERAL
The Company's revenues consist of product revenues (including licensing of
its software, sales of the Company's proprietary hardware, and resale of third
party hardware) and revenues from maintenance and other services (including
consulting and training). For all periods presented, the Company has recognized
revenue in accordance with Statement of Position 91-1, entitled "Software
Revenue Recognition," issued by the American Institute of Certified Public
Accountants. In accordance with this statement, in cases where the Company has
delivered hardware and/or software to customers and has insignificant or
noncritical vendor obligations related to these deliveries, the revenue
attributable to such obligations has been deferred until such obligations have
been fulfilled.
LITIGATION SETTLEMENT AGREEMENT-IN-PRINCIPLE
On May 29, 1996, June 13, 1996 and April 29, 1997 certain of the Company's
shareholders filed class action lawsuits alleging violations of federal
securities laws and other claims against the Company and certain of its officers
and directors, among others. The three lawsuits were filed in the Superior Court
of the State of California, the United States District Court, District of
Massachusetts and the United States District Court, Northern District of
California, respectively. On August 12, 1997 the Company announced that it had
reached an agreement-in-principle to settle all three of the shareholder class
action litigations. The proposed $10.8 million settlement will require Discreet
Logic to contribute approximately $7.4 million from its own funds, with the
remainder provided by insurance. The settlement is subject to the signing of a
definitive settlement agreement and to final court approval of the proposed
settlement. There can be no assurance that the settlement will be consummated
and that the Company will not have to continue its defense of the lawsuits.
Should the proposed settlement not be consummated or finally approved for any
reason, the Company intends to defend the lawsuits vigorously.
RECENT ACQUISITIONS
On June 12, 1997, the Company, through its wholly-owned subsidiary 3380491
Canada Inc. ("Acquisition Sub"), acquired substantially all of the assets and
assumed certain liabilities of Denim pursuant to the terms of an Asset Purchase
Agreement dated as of June 12, 1997, among Acquisition Sub, Denim, Sam Khulusi,
Frank Khulusi, Westco Denim Investments Group, Ltd., a California limited
partnership, and Frank Khulusi Family Limited Partnership, a California limited
partnership. The purchased assets consisted primarily of Denim software
products, including ILLUMINAIRE Paint, ILLUMINAIRE Composition and ILLUMINAIRE
Studio and related know-how and goodwill. The aggregate purchase price for the
assets was comprised of (i) approximately $9,126,000 in cash, (ii) the
assumption of certain enumerated liabilities in an amount equal to no more than
approximately $2,209,000 in the aggregate, and (iii) the assumption of certain
on-going obligations under certain existing contracts of Denim. At closing, cash
consideration, of approximately $9,126,000, and certain liabilities, of
approximately $655,000 were paid. The cash used by the Company to fund the
acquisition
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<PAGE>
was derived primarily from cash flow from operations. The transaction was
accounted for as a purchase. The Company incurred a one-time charge of
$9,800,000, or $0.35 per share for in-process research and development,
purchased and expensed in its fourth fiscal quarter ended June 30, 1997 based on
an independent appraisal. The terms of the transaction and the consideration
received by Denim were the result of arms-length negotiations between the
representatives of Discreet Logic and Denim. Denim developed Apple Macintosh and
Microsoft Windows NT-based paint and compositing software for producing effects,
interactive content and graphics design.
On July 15, 1997, the Company acquired all of the outstanding shares of
capital stock of D-Vision pursuant to a Stock Purchase Agreement dated as of
July 10, 1997, among the Company, D-Vision, the former stockholders of D-Vision
the Selling Stockholders and certain other individuals. As a result of the
D-Vision Acquisition, the Company acquired the D-Vision OnLINE and PRO software
products for non-linear video and digital media editing solutions including
related know-how and goodwill. The purchase price was paid in a combination of
555,000 newly issued Discreet Logic common shares and approximately $10,750,000
in cash. In addition, approximately $4,000,000 of the cash consideration is
being held in escrow until September 30, 1999, subject to (i) earlier release
from escrow of up to $1,900,000 on September 30, 1998 and (ii) the resolution of
any indemnification claims made by the Company pursuant to the Stock Purchase
Agreement. The D-Vision Acquisition was accounted for as a purchase. The cash
used by the Company to fund the acquisition was derived primarily from cash flow
from operations. A substantial portion of the purchase price, net liabilities of
D-Vision and transaction costs was allocated to purchased in-process research
and development for which the Company expects to incur a one-time charge against
earnings in the range of $20,000,000 to $21,000,000 ($0.70 to $0.73 per share),
in the quarter ending September 30, 1997, based on an independent appraisal. The
terms of the transaction and the consideration received by the D-Vision
stockholders were the result of arms-length negotiations between the
representatives of Discreet Logic and D-Vision. D-Vision develops Microsoft
Windows NT-based non-linear, digital editing solutions.
RESTRUCTURING
During the fiscal year ended July 31, 1996, excluding a restructuring charge
of $15,000,000 and its related tax effects, the Company incurred a net loss of
approximately $31,000,000 on revenues of approximately $83,997,000. During the
second half of fiscal 1996, the Company identified a number of difficulties and
developments facing its business, including, (1) softening of market demand in
its core high end visual effects market segment, (2) delays by the Company in
introducing new products aimed at new market segments, (3) inventory build-up in
anticipation of continued high sales in its core market segment and high growth
in its new market segments, (4) expense and headcount build-up in anticipation
of continued high sales in its core market segment and high growth in new market
segments, (5) the disruption caused by platform changes by the Company's key
supplier, and (6) greater use of third party financing by customers. In
addition, during the second half of fiscal 1996, several of the Company's senior
executives resigned to pursue other opportunities.
In response to the financial results and other developments facing the
business, the Company developed a restructuring plan during the fourth fiscal
quarter of 1996. The focus of the Company's restructuring plan was to solidify
its senior management team; reduce operating expenses through a 28% reduction of
its workforce and the closure of its Cambridge, Massachusetts, Connecticut,
London and Innsbruck offices; consolidate software research and development
activities in Montreal; discontinue the AIR, PURE, SLICE and DIPLOMAT product
lines; and restructure its sales force to emphasize indirect sales channels.
While the Company began implementation of its restructuring plan in the fourth
fiscal quarter of 1996 and had substantially completed the implementation of the
plan at the end of fiscal 1997, the Company still has approximately $4,272,000
in restructuring reserves primarily for the estimated cost of terminating
leases, resolving outstanding severance issues, and the legal and taxation
winding down of several subsidiaries.
CHANGE IN FISCAL YEAR
On January 9, 1997, the Board of Directors of the Company approved the
change of the Company's fiscal year end from July 31 to June 30. This change was
effective beginning with the Company's second fiscal quarter of 1997. The
consolidated financial statements are presented for the eleven month period
ended June 30, 1997 and the twelve month periods ended July 31, 1996 and 1995.
The Company prepares consolidated financial
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<PAGE>
statements, remeasures accounts in foreign currencies to reflect changes in
exchange rates and examines and adjusts certain reserve accounts at the end of
each quarter. Therefore, it is not practicable to recast the prior fiscal year's
results to reflect the current eleven month fiscal period. Consequently, the
results for the eleven month period ended June 30, 1997 are not directly
comparable with those for the twelve month periods ending July 31, 1996 and 1995
and the current eleven month period's results are not necessarily indicative of
results for a full fiscal year.
RESULTS OF OPERATIONS
The following table sets forth the percentages of total revenues represented
by certain line items in the statement of operations:
<TABLE>
<CAPTION>
ELEVEN
YEAR MONTHS
ENDED JULY 31, ENDED
------------------- JUNE 30,
1995 1996 1997
-------- -------- ------------
<S> <C> <C> <C>
Total revenues.................................... 100% 100% 100%
Cost of revenues.................................. 46 59 47
--- --- ---
Gross profit.................................... 54 41 53
--- --- ---
Operating expenses:
Research and development........................ 6 20 10
Sales and marketing............................. 19 31 23
General and administrative...................... 8 13 6
Write-off of purchased research and
development................................... -- 10 10
Restructuring expense........................... -- 18 --
Litigation and related settlement expense....... -- 3 6
--- --- ---
Total operating expenses...................... 33 95 55
--- --- ---
Operating income (loss)....................... 21 (54) (2)
Other income (expense)............................ 0 3 1
--- --- ---
Income (loss) before income taxes and minority
interest........................................ 21 (51) (1)
Provision for income taxes........................ 9 2 6
--- --- ---
Net income (loss) before minority interest........ 12 (53) (7)
Minority interest................................. 0 -- --
--- --- ---
Net income (loss)............................... 12% (53)% (7)%
--- --- ---
</TABLE>
FISCAL YEARS ENDED JUNE 30, 1997 AND JULY 31, 1996
TOTAL REVENUES. Total revenues were $101,924,000 for the eleven month
period ended June 30, 1997 and $83,997,000 for the year ended July 31, 1996.
Despite the fact that fiscal 1997 was an eleven month period, total revenues
increased in fiscal 1997 over total revenues for fiscal 1996 due to new product
offerings during the year, namely FIRE and FLINT RT, as well as wider acceptance
of the Company's premier resolution-independent effects system, INFERNO, and a
growing installed base. Revenues from FLAME systems, including software and
hardware, were $26,159,000 (26% of total revenues) and $44,745,000 (53% of total
revenues) for the eleven month period ended June 30, 1997 and the twelve month
period ended July 31, 1996, respectively. The decline in FLAME revenues, both in
amount and as a percentage of total revenues, was primarily a result of an
aggressive program in the three months ended October 31, 1996 which included
significant discounting designed to reduce inventory on hand at the end of
fiscal 1996, and the wider acceptance of the Company's premier resolution-
independent effects system, INFERNO, which began to ship commercially in October
1995. Revenues from INFERNO systems, including software and hardware, were
$16,161,000 (16% of total revenues) and $8,887,000 (11% of total revenues) for
the eleven month period ended June 30, 1997 and the twelve month period ended
July 31, 1996, respectively. The decline in FLAME revenues was also offset by an
increase in FLINT revenues due to the initial commercial shipment of FLINT RT.
Revenues from FLINT (including FLINT RT) systems,
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<PAGE>
including software and hardware, were $17,263,000 (17% of total revenues) and
$14,068,000 (17% of total revenues) for the eleven month period ended June 30,
1997 and the twelve month period ended July 31, 1996, respectively. Revenues
from FIRE systems, including software and hardware, were $26,482,000 (26% of
total revenues) during the eleven month period ended June 30, 1997, the first
period it was commercially available. Revenues from VAPOUR and FROST systems,
including software and hardware, were $2,253,000 (2% of total revenues) and
$4,784,000 (6% of total revenues) for the eleven month period ended June 30,
1997 and the twelve month period ended July 31, 1996, respectively. Due to the
high average sales price, the timing of purchase orders and the lengthy sales
cycle of VAPOUR and FROST systems, a limited number of sales of these systems
could account for a significant amount of revenues. The decline in VAPOUR and
FROST revenues is attributable to the fact that the 1996 revenues include the
sale of several large systems.
Software-only revenues were $7,495,000 (7% of total revenues) and $4,564,000
(5% of total revenues) for the eleven month period ended June 30, 1997 and the
twelve month period ended July 31, 1996, respectively. Hardware-only revenues,
consisting primarily of the sale of disk arrays and other peripherals, were
$6,639,000 (7% of total revenues) and $4,938,000 (6% of total revenues) for the
eleven month period ended June 30, 1997 and the twelve month period ended July
31, 1996, respectively. System revenues, which include software and hardware,
were $74,183,000 (73% of total revenues) and $63,183,000 (75% of total revenues)
for the eleven month period ended June 30, 1997 and the twelve month period
ended July 31, 1996, respectively. The fluctuations in software-only,
hardware-only and system revenues are primarily due to the high average sales
price of the Company's products, such that a limited number of sales can account
for a substantial portion of total revenues. The increase in software-only
revenues as a percentage of total revenues resulted from more revenues in fiscal
1997 being derived from the Company's indirect sales channel which primarily
purchases only software from the Company.
Maintenance revenues were $9,728,000 (10% of total revenues) and $6,483,000
(8% of total revenues) for the eleven month period ended June 30, 1997 and the
twelve month period ended July 31, 1996, respectively. Maintenance revenues
increased due to the increased installed base of the Company's FLAME, INFERNO
and FLINT systems as well as the development of an installed base for the
Company's FIRE systems. Other revenues were $3,878,000 (4% of total revenues)
and $4,829,000 (6% of total revenues) for the eleven month period ended June 30,
1997 and the twelve month period ended July 31, 1996, respectively. Other
revenues for all periods consisted primarily of rentals, systems integration,
and training services provided to customers. Other revenues decreased in the
eleven month period ended June 30, 1997 as compared to the twelve month period
ended July 31, 1996, due to the decrease in rentals of the Company's FLAME
systems.
Revenues from customers outside of North America were $58,171,000 (57% of
total revenues) and $47,711,000 (57% of total revenues) for the eleven month
period ended June 30, 1997 and the twelve month period ended July 31, 1996,
respectively. The Company is continuing to develop its direct and indirect
distribution channels in North America, Asia and Europe. The Company expects
that revenues from customers outside of North America will continue to account
for a substantial portion of its revenues and, as a percentage of total
revenues, remain approximately the same.
COST OF REVENUES. Cost of revenues consists primarily of the cost of
hardware sold (mainly workstations manufactured by Silicon Graphics Inc.
("SGI")), cost of hardware service contracts, cost of integration and hardware
assembly, cost of service personnel and the facilities, computing, benefits and
other administrative costs allocated to such personnel and the provision for
inventory reserves. Cost of revenues was $47,571,000 (47% of total revenues) and
$49,333,000 (59% of total revenues) for the eleven month period ended June 30,
1997 and the twelve month period ended July 31, 1996, respectively. The decrease
in cost of revenues as a percentage of total revenues was a result of the
following factors: (1) the Company's growing penetration into the Asian market
where customers typically purchase only software or software and storage media
bundles, (2) the SGI workstation component of cost of revenues declined as the
Company's installed base purchased additional software and storage media to add
on to existing workstations, and (3) provisions to write inventories down to
their net realizable values were lower for the eleven month period ended June
30, 1997 as compared to the twelve month period ended July 31, 1996. The Company
believes that cost of revenues, as a percentage of total revenues, will remain
approximately the same.
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<PAGE>
RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of the cost of research and development personnel and the facilities,
depreciation on research and development equipment, amortization of acquired
technologies, computing, benefits and other administrative costs allocated to
such personnel. Expenditures for research and development, after deducting
Canadian federal and provincial tax credits, were $9,708,000 (10% of total
revenues) and $16,902,000 (20% of total revenues) for the eleven month period
ended June 30, 1997 and the twelve month period ended July 31, 1996,
respectively. The decrease in research and development expenses, after deducting
tax credits, was a result of the following factors: (1) the provision, in the
amount of $2,500,000, recorded during the quarter ended April 30, 1996, to
reflect the uncertainty regarding the realizability of the Company's investment
in the preferred shares of Essential Communications Corporation and (2) the
implementation of the Company's restructuring plan which included the reduction
of personnel, closure of certain research and development offices, and
consolidation of software research and development in its Montreal headquarters
during the fourth fiscal quarter of 1996 and the eleven month period ended June
30, 1997. See Note 15 and 17 to Notes to the Company's consolidated financial
statements. These decreases were partially offset by general salary increases.
Research and development costs are expensed as incurred. Software development
costs are considered for capitalization once technical feasibility has been
established. The Company has not capitalized any software development costs to
date. See Note 2(e) of Notes to the Company's consolidated financial statements.
Certain research and development expenditures are incurred substantially in
advance of related revenue and in some cases do not generate revenues. The
Company expects that research and development expenses will increase from their
current levels. However, should revenues increase, the Company believes that
research and development expenses should remain approximately the same as a
percentage of total revenues.
The Company is entitled to research and development incentives in the form
of income tax credits from the Canadian federal government and from the Province
of Quebec. These income tax credits are earned based upon qualified Canadian
research and development salaries and other qualified research and development
expenditures. The Company also earns income tax credits from the Canadian
federal government based upon qualified research and development equipment
purchases and has recorded such credits as a reduction of the carrying value of
the equipment when such credits are realized. See Note 7 of Notes to the
Company's consolidated financial statements.
SALES AND MARKETING. Sales and marketing expenses consist primarily of
salaries, commissions and related benefits, facilities and administrative costs
allocated to the Company's sales and marketing personnel, tradeshow expenses and
dealer commissions. Sales and marketing expenses were $23,206,000 (23% of total
revenues) and $26,088,000 (31% of total revenues) for the eleven month period
ended June 30, 1997 and the twelve month period ended July 31, 1996,
respectively. The decrease in sales and marketing expenses resulted primarily
from the implementation of the Company's restructuring plan, which included a
reduction of personnel and the closure of the Florida sales office and the
relocation of the New York demonstration center during the fourth fiscal quarter
of 1996. These decreases were partially offset by the continued expansion of the
Company's direct and indirect sales organization, including the operating costs
of domestic sales offices and foreign subsidiaries. The Company expects that
sales and marketing expenses will increase from their current levels. However,
should revenues increase, the Company believes that sales and marketing
expenses, as a percentage of total revenues, should decrease.
GENERAL AND ADMINISTRATIVE. General and administrative expenses include the
costs of finance, accounting, human resources, facilities, corporate information
systems, legal and other administrative functions of the Company and reserves
for doubtful accounts receivable. General and administrative expenses were
$6,396,000 (6% of total revenues) and $10,582,000 (13% of total revenues) for
the eleven month period ended June 30, 1997 and the twelve month period ended
July 31, 1996, respectively. The decrease in general and administrative expenses
resulted primarily from the implementation of the Company's restructuring plan
which included a reduction of administrative personnel as well as the closure of
administrative offices in Cambridge, Massachusetts. Additionally, in fiscal
1996, the Company provided approximately $3,300,000 in reserves for potentially
uncollectible accounts receivable and provided $830,000 to reflect certain
recourse provisions associated with third party financing arrangements, and
reduced the carrying value of a building purchased in Montreal by CDN$500,000
(approximately $365,000) to reflect the value expected to be realized upon sale.
The Company expects that general and administrative expenses should increase
from their current levels. However,
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<PAGE>
should revenues increase the Company expects that general and administrative
expenses, as a percentage of total revenues, should remain approximately the
same.
CHARGE FOR PURCHASED RESEARCH AND DEVELOPMENT. In connection with the
acquisition of substantially all of the assets of Denim Software L.L.C., the
Company expensed $9,800,000 (10% of total revenues) of in-process research and
development during the eleven month period ended June 30, 1997. During fiscal
1996, in connection with the COSS/IMP acquisition, the Company expensed
$8,500,000 (10% of total revenues) of in-process research and development. See
Note 15 of Notes to the Company's consolidated financial statements.
RESTRUCTURING EXPENSE. In the fourth quarter of fiscal 1996, the Company
recorded a restructuring expense of $15,000,000 (18% of total fiscal 1996
revenues). The focus of the Company's restructuring plan was to solidify its
senior management team, reduce operating expenses through workforce reductions
and office closings, consolidate software research and development activities in
Montreal, discontinue certain product lines, and restructure its sales force to
emphasize indirect sales channels. While the Company began implementation of its
restructuring plan in the fourth fiscal quarter of 1996 and had substantially
completed the implementation of the plan at the end of fiscal 1997, the Company
still has $4,272,000 in restructuring reserves primarily for the estimated cost
of terminating leases, resolving outstanding severance issues, and the legal and
taxation winding down of several subsidiaries. See Note 17 to Notes of the
Company's consolidated financial statements.
LITIGATION AND SETTLEMENT. In August of 1997, the Company announced an
agreement-in-principle to settle all three of the class action shareholder
lawsuits outstanding against it for $10,800,000. In the fiscal year ended July
31, 1996, the Company had provided a $2,506,000 (3% of total revenues)
litigation reserve for legal costs associated with defending the class action
lawsuits. During the eleven month period ended June 30, 1997, the Company
recorded a provision of $6,500,000 (6% of total revenues) to accrue the
additional estimated settlement costs to be borne by the Company, should the
agreement-in-principle be consummated. See Note 5 of Notes to the Company's
consolidated financial statements.
OTHER INCOME (EXPENSE). Other Income (Expense) consists primarily of
foreign currency gains and losses and interest income and expense. Foreign
currency translation losses were $188,000 during the eleven month period ended
June 30, 1997 compared to gains of $179,000 during the year ended July 31, 1996.
These gains and losses are primarily the result of the Company and each
subsidiary translating intercompany balances denominated in a currency other
than its own functional currency. These balances are remeasured into the
functional currency of each company every reporting period. This remeasurement
results in either unrealized gains or losses depending on the exchange rate
fluctuation between the functional currency of each company and the currency in
which the monetary asset or liability is denominated.
PROVISION FOR INCOME TAXES. The Company's provision for income taxes was
approximately $6,489,000 and $1,435,000 for the eleven month period ended June
30, 1997 and the twelve month period ended July 31, 1996, respectively. The
provision for all periods was based on the Canadian federal statutory rate of
38% and reflects the impact of various tax credits and foreign taxes. The tax
provision for these periods resulted from taxable earnings in jurisdictions
where the Company did not have available tax loss carryforwards partially offset
by the realization of the benefit for some prior year tax losses for which no
benefit was previously recorded. In both fiscal years, the Company recorded
charges for acquired in-process research and development for which no benefit
was recorded due to the uncertainty of realizing any future tax benefit
associated with these charges. In addition, in fiscal 1997, the Company recorded
a provision for estimated litigation settlement costs for which no tax benefit
was recorded because of the uncertainty of realizing any tax benefit associated
with this charge. See Note 11 of Notes to the Company's consolidated financial
statements. As of June 30, 1997, the Company had available approximately
$15,150,000 of cumulative foreign net operating loss carryforwards which may be
available to reduce future income tax liabilities.
FISCAL YEARS ENDED JULY 31, 1996 AND JULY 31, 1995
TOTAL REVENUES. Total revenues were $83,997,000 in fiscal 1996, an increase
of 30% from $64,549,000 in fiscal 1995. Despite this increase, total revenues in
fiscal 1996 were significantly below management's expectations, resulting in an
operating loss of $44,914,000 in fiscal 1996 compared to operating income of
$13,460,000 in fiscal 1995. The revenue shortfall was due primarily to softening
of demand in the high end visual
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<PAGE>
effects market segment, delays by the Company in introducing new products aimed
at new market segments, as well as the announcement by SGI of a new Onyx
workstation approximately two weeks prior to January 31, 1996 which caused the
Company to offer substantial discounts and other favorable terms regarding its
then current inventory of SGI workstations. Revenues in fiscal 1996 were also
affected by a decline of 14% in sales of FLAME systems, from $52,147,000 in
fiscal 1995 to $44,745,000 in fiscal 1996. The decline in FLAME sales was offset
by a 93% increase in sales of FLINT systems, including software and hardware,
from $7,303,000 in fiscal 1995 to $14,068,000 in fiscal 1996. This continued
growth in FLINT sales is primarily a result of the release of the Indigo2 Impact
by SGI, the Company's related release of the upgraded FLINT software, and
continued market penetration. Although FLINT sales increased during fiscal 1996,
FLINT revenues were less than management's expectations, primarily due to the
unavailability of SGI Indigo2 Impact texture memory to the Company's
distributors which caused customers to delay purchasing FLINT. In addition,
revenues increased in fiscal 1996 as a result of sales of INFERNO, VAPOUR, and
FROST systems and software, which were not sold in fiscal 1995. Full commercial
shipments of INFERNO systems began in October 1995 (including the recognition in
October 1995 of approximately $800,000 of previously deferred revenue of INFERNO
software). The VAPOUR and FROST technology was purchased in the October 1995
acquisition of COSS/IMP. Hardware revenues, consisting primarily of the resale
of SGI workstations and assembly and sale of disk arrays and other peripherals,
constituted 55% and 62% of total revenues fiscal 1996 and 1995, respectively, of
which 34% and 39% of total revenues, respectively, were attributable to SGI
hardware. This decrease was primarily due to a higher percentage of revenues
during fiscal 1996 derived from software-only sales, the recognition of the
previously deferred INFERNO software revenue as noted above, and the increase in
support and other revenues as a percentage of total revenues in fiscal 1996 as
discussed below.
Maintenance revenues were $6,483,000 (8% of total revenues) in fiscal 1996,
an increase of 178% from $2,330,000 (4% of total revenue) in fiscal 1995.
Maintenance revenues increased due to the increased installed base of the
Company's FLAME and FLINT systems in fiscal 1996. Other revenues were $4,829,000
(6% of total revenues) in fiscal 1996, an increase of 98% from $2,440,000 (4% of
total revenue) for the same period in fiscal 1995. Other revenues for all
periods consisted primarily of rentals, systems integration, and training
services provided to customers. This increase was attributable to increased
sales and rentals of the Company's systems in fiscal 1996.
Revenues from customers outside of North America were $47,711,000 in fiscal
1996, an increase of 64% from $29,033,000 in fiscal 1995, and accounted for
approximately 57% of total revenues in fiscal 1996, compared with approximately
45% in fiscal 1995. During fiscal 1995 and fiscal 1996, the Company expanded its
direct sales force and distribution channels in Europe and the Pacific Rim at a
greater rate than in North America which resulted in revenues from customers
outside of North America increasing at a higher rate than revenues from
customers inside North America.
COST OF REVENUES. Cost of revenues was $49,333,000 in fiscal 1996, as
compared to $29,609,000 in fiscal 1995, an increase of 67%. Cost of revenues was
59% and 46% of total revenues for fiscal 1996 and 1995, respectively. The
increase as a percentage of total revenues was due to fixed costs in cost of
revenues being a larger percentage of revenues in fiscal 1996 due to the
Company's increased support, integration and manufacturing activities in
anticipation of higher revenues as well as increased discounting of the selling
price of the Company's products in fiscal 1996 due to competitive pressures. In
addition, 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. Without the
inventory reserves, cost of revenues in fiscal 1996 would have been 52% of total
revenues.
RESEARCH AND DEVELOPMENT. Expenditures for research and development, after
deducting Canadian federal and provincial tax credits, were $16,902,000 in
fiscal 1996, an increase of 319% from $4,037,000 in fiscal 1995. Research and
development expenses, after deducting tax credits, were 20% and 6% of total
revenues for fiscal 1996 and 1995, respectively. Canadian federal and provincial
tax credits were $711,000 and $545,000 for fiscal 1996 and 1995, respectively.
The increases in expenditures for both periods were due primarily to the hiring
of additional software engineers to develop and enhance the Company's existing
products and to develop new products, as well as an increase in depreciation due
to additional purchases of development equipment required for the additional
personnel. In connection with the investment in Essential Communications
Corporation, the
I-22
<PAGE>
Company charged $2,500,000 of research and development expense in its third
fiscal quarter of 1996 due to the uncertainty regarding the realizability of the
investment in the preferred shares. Without the write-off, research and
development expenses in fiscal 1996 would have been 17% of total revenues. See
Note 15 to Notes to the Company's consolidated financial statements.
SALES AND MARKETING. Sales and marketing expenses were $26,088,000 in
fiscal 1996, an increase of 107% from $12,588,000 in fiscal 1995. Sales and
marketing expenses as a percentage of total revenues were 31% and 19% for fiscal
1996 and 1995, respectively. These increases resulted primarily from the
continued expansion of the Company's direct sales organization, including the
opening of domestic sales offices and foreign subsidiaries, the payment of sales
commissions on increasing sales volumes and increased presence at major
tradeshows.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were
$10,582,000 in fiscal 1996, an increase of 118% from $4,855,000 in fiscal 1995.
General and administrative expenses as a percentage of total revenues were 13%
and 8% for fiscal 1996 and 1995, respectively. These increases resulted from
hiring several senior executive officers, as well as additional finance,
accounting and administrative personnel. The increase also reflected general
salary increases, increased occupancy expenses as the Company hired additional
staff and increased professional fees and insurance premiums associated with the
growth of the Company's infrastructure. In addition, the Company provided
approximately $3,300,000 in reserves for potentially doubtful accounts
receivable in fiscal 1996, and provided $830,000 to reflect certain recourse
provisions in and other risks associated with certain third party financing
arrangements implemented in the third and fourth fiscal 1996 quarters. Also, in
its third quarter of fiscal 1996, the Company reduced the carrying value of a
building purchased in Montreal by CDN$500,000 (approximately $365,000) to
reflect the amount expected to be realized upon sale.
CHARGE FOR PURCHASED RESEARCH AND DEVELOPMENT. In connection with the
COSS/IMP acquisition, the Company expensed $8,500,000 of in-process research and
development. This write-off represented approximately 10% of total revenues for
fiscal 1996. See Note 15 of Notes to the Company's consolidated financial
statements.
RESTRUCTURING EXPENSE. In the fourth quarter of fiscal 1996, the Company
recorded a restructuring expense of $15,000,000, representing approximately 18%
of total revenues for the fiscal 1996. The focus of the Company's restructuring
plan is to solidify its senior management team, reduce operating expenses
through workforce reductions and office closings, consolidate research and
development activities in Montreal, the discontinuance of certain product lines,
and restructure its sales force to emphasize indirect sales channels. The
Company began implementation of its restructuring plan in the fourth fiscal
quarter of 1996. See Note 17 to Notes of the Company's consolidated financial
statements.
LITIGATION. In the three months ended July 31, 1996, the Company provided a
$2,506,000 litigation reserve for legal costs associated with defending the
class action lawsuits. See Note 5 of Notes to the Company's consolidated
financial statements.
OTHER INCOME (EXPENSE). Other Income (Expense) primarily consists of
foreign currency gains and losses and interest income.
PROVISION FOR INCOME TAXES. The Company's provision for income taxes for
fiscal 1996 was $1,435,000 compared to $5,490,000 for fiscal 1995. The
provision/benefit for all periods was based on the Canadian federal statutory
rate of 38% and reflects the impact of various tax credits, the effect of not
utilizing foreign subsidiaries' tax losses and the effect of the foreign taxes.
As of July 31, 1996, the Company had $27,460,000 of foreign net cumulative
operating loss carryforwards which may be available to reduce further income tax
liabilities in those jurisdictions. The tax benefits of those tax carryforwards
have not been recognized due to the uncertainty of realizing the future tax
benefit. See Note 11 of Notes to the Company's consolidated financial
statements.
I-23
<PAGE>
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain quarterly financial data for each of
the eight most recent quarters in the period ended June 30, 1997, together with
such data as a percentage of total revenues. The quarterly information presented
is unaudited. In the opinion of management, the unaudited quarterly information
has been prepared on the same basis as the annual audited consolidated financial
statements and includes all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the information for the
periods presented. Operating results for any quarter are not necessarily
indicative of results for any future period.
<TABLE>
<CAPTION>
QUARTER ENDED TWO MONTHS QUARTER ENDED
-------------------------------------------------------------- ENDED --------------------
OCTOBER 31, JANUARY 31, APRIL 30, JULY 31, OCTOBER 31, DECEMBER 31, MARCH 31, JUNE 30,
1995 1996 1996 1996 1996 1996 1997 1997
----------- ----------- --------- -------- ----------- ------------ --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(in thousands)
Total revenues................ $ 25,044 $ 25,225 $ 14,677 $ 19,052 $ 23,263 $ 16,833 $ 27,044 $ 34,784
Cost of revenues.............. 10,564 13,752 12,008 13,009 12,287 8,003 11,255 16,026
----------- ----------- --------- -------- ----------- ------------ --------- ---------
Gross profit.................. 14,480 11,473 2,669 6,043 10,976 8,830 15,789 18,758
----------- ----------- --------- -------- ----------- ------------ --------- ---------
Operating expenses:
Research and development...... 2,371 3,522 6,567 4,442 2,678 1,575 2,746 2,709
Sales and marketing........... 5,433 6,153 7,224 7,278 6,017 4,610 6,534 6,045
General and administrative.... 1,542 2,022 4,016 3,002 1,516 1,189 1,842 1,849
Write-off of purchased
research and development.... 8,500 -- -- -- -- 9,800
----
Restructuring expense......... -- -- -- 15,000 -- -- -- --
Litigation and Related
Settlement Expenses......... -- -- -- 2,506 -- 6,500
----
----------- ----------- --------- -------- ------------ --------- ---------
-----------
Total operating expenses...... 17,846 11,697 17,807 (32,228) 10,211 7,374 11,122 26,903
----------- ----------- --------- -------- ----------- ------------ --------- ---------
Operating income (loss)....... (3,366) (224) (15,138) (26,185) 765 1,456 4,667 (8,145)
Total other income
(expense)................... 275 1,495 (1,334) 1,771 (925) 1,819 46 51
----------- ----------- --------- -------- ----------- ------------ --------- ---------
Income (loss) before income
taxes....................... (3,091) 1,271 (16,472) (24,414) (160) 3,275 4,713 (8,094)
Provision (benefit) for income
taxes....................... 2,117 496 (1,363) 186 652 1,310 1,674 2,853
----------- ----------- --------- -------- ----------- ------------ --------- ---------
Net income (loss)............. $ (5,208) $ 775 $(15,109) $(24,600) $ (812) $ 1,965 $ 3,039 $(10,947)
----------- ----------- --------- -------- ----------- ------------ --------- ---------
----------- ----------- --------- -------- ----------- ------------ --------- ---------
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED TWO MONTHS QUARTER ENDED
-------------------------------------------------------------- ENDED --------------------
OCTOBER 31, JANUARY 31, APRIL 30, JULY 31, OCTOBER 31, DECEMBER 31, MARCH 31, JUNE 30,
1995 1996 1996 1996 1996 1996 1997 1997
----------- ----------- --------- -------- ----------- ------------ --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total revenues................ 100% 100% 100% 100% 100% 100% 100% 100%
Cost of revenues.............. 42 55 82 68 53 48 42 46
--- --- --- --- --- --- --- ---
Gross profit.............. 58 45 18 32 47 52 58 54
--- --- --- --- --- --- --- ---
Operating expenses:
Research and development.... 9 14 45 23 12 9 10 8
Sales and marketing......... 22 24 49 38 26 27 24 17
General and
administrative............ 6 8 27 16 6 7 7 5
Write-off of purchased
research and
development............... 34 -- -- -- -- -- -- 28
--- --- --- --- --- --- --- ---
Restructuring expense....... -- -- -- 79 -- -- -- --
Litigation and Related
Settlement Expenses....... -- -- -- 13 -- -- -- 19
--- --- --- --- --- --- --- ---
Total operating
expenses................ 71 46 121 169 44 43 41 77
--- --- --- --- --- --- --- ---
Operating income (loss)... (13) (1) (103) (137) 3 9 17 (23)
Total other income
(expense)................... 1 6 (9) 9 (4) 11 -- --
--- --- --- --- --- --- --- ---
Income (loss) before income
taxes....................... (12) 5 (112) (128) (1) 20 17 23
Provision (benefit) for income
taxes....................... 9 2 (9) 1 3 8 6 8
--- --- --- --- --- --- --- ---
Net income (loss)......... (21)% 3% (103)% (129)% (4)% 12% 11% (31)%
--- --- --- --- --- --- --- ---
--- --- --- --- --- --- --- ---
</TABLE>
The Company's revenues and operating results are subject to quarterly and
other fluctuations. A limited number of systems sales may account for a
substantial percentage of the Company's quarterly revenue due to of the high
average sales price of such systems and the timing of purchase orders.
Historically, the Company has
I-24
<PAGE>
generally experienced greater revenues during the period following the
completion of NAB, which is typically held in April. The Company's expense
levels are based, in part, on its expectations of future revenues. Therefore, if
revenue levels are below expectations, particularly following NAB, the Company's
operating results are likely to be adversely affected, as was the case for the
three month periods ended April 30, 1996 and July 31, 1996. In addition, the
timing of revenue is influenced by a number of other factors, including: the
timing of individual orders and shipments, other industry trade shows,
competition, seasonal customer buying patterns, changes in customer buying
patterns in response to platform changes and changes in product development and
sales and marketing expenditures. Because the Company's operating expenses are
based on anticipated revenue levels and a high percentage of the Company's
expenses are relatively fixed in the short term, variations in the timing of
recognition of revenue could cause significant fluctuations in operating results
from quarter to quarter and may result in unanticipated quarterly earnings
shortfalls or losses. There can be no assurance that the Company will be
successful in maintaining or improving its profitability or avoiding losses in
any future period. The Company believes that quarter-to-quarter comparisons of
its financial results are not necessarily meaningful and should not be relied
upon as an indication of future performance.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date primarily through cash flow
from operations (including deferred revenue and customer deposits), borrowings
under its demand line of credit, capital leases, the private and public sales of
equity securities, and the receipt of research and development tax credits from
the Canadian federal government and the Province of Quebec. As of June 30, 1997,
the Company had cash of approximately $31,668,000. Subsequent to year end, the
Company amended its revolving demand line of credit with a bank under which the
Company may borrow up to CDN$7,000,000 (approximately $5,085,000 at June 30,
1997). Advances under the line accrue interest monthly at the Canadian prime
rate (4.75% at June 30, 1997) plus 0.25%. Additionally, the Company has a
CDN$600,000 (approximately $436,000 at June 30, 1997) demand leasing facility,
and a CDN$600,000 (approximately $436,000 at June 30, 1997) demand research and
development tax credit facility. Advances under these facilities accrue interest
monthly at the Canadian prime rate (4.75% at June 30, 1997) plus 1%. The line
and facilities are secured by essentially all of the Company's North American
assets. As additional security, the Company assigned to the bank its insurance
on these assets. The Company is required to maintain certain financial ratios,
including minimum levels of working capital, debt service coverage and equity to
assets ratios. As of June 30, 1997, there were no amounts outstanding under the
line of credit or the demand leasing and demand research and development tax
credit facilities.
The Company's operating activities, including research and development tax
credits, provided cash of $26,012,000, used cash of $24,425,000, and provided
cash of $8,304,000 in the eleven month period ended June 30, 1997, and the
fiscal years ended July 31, 1996 and 1995, respectively. The principal sources
of cash in the eleven month period ended June 30, 1997 were cash generated from
operations, the decreases in inventory and in income taxes receivable, and the
increases in accounts payable and accruals, deferred revenues and income taxes
payable, offset by an increase in accounts receivable, when compared to the
fiscal year ended July 31, 1996. Accounts receivable increased during fiscal
1997 as a result of the Company experiencing a greater level of sales and the
timing of those sales being closer to the end of the fourth fiscal quarter as
compared to the fourth fiscal quarter of 1996. Inventory decreased during fiscal
1997, as a result of an aggressive sales program during the three month period
ended October 31, 1996, including system discounting, designed to reduce the
inventory on hand at the end of fiscal 1996 as well as close monitoring of
inventory throughout the eleven month period ended June 30, 1997. Accounts
payable increased due to the increased level of hardware purchases required at
the end of the fourth quarter of fiscal 1997 to meet the quarter's revenue
demands. Accrued liabilities increased due to the provision recorded to accrue
the estimated additional costs of settling the three class action lawsuits
brought against the Company, should the agreement-in-principle to settle be
consummated. This increase was partially offset by a decrease in the accrued
restructuring expenses.
The Company's investing activities used cash of $17,867,000, $24,223,000,
and $6,754,000 in the eleven month period ended June 30, 1997, and the fiscal
years ended July 31, 1996, and 1995, respectively. The principal uses of cash in
fiscal 1997 were the acquisition of Denim Software L.L.C. (approximately
$9,126,000) and the purchase of computer equipment and software, general office
equipment, leasehold improvements and furniture and fixtures used in the
operation of the Company's business. In fiscal 1996, the principal uses of cash
were the
I-25
<PAGE>
acquisition of COSS/IMP (approximately $5,545,000), the purchase of the
preferred shares of Essential Communications Corporation ($2,500,000), the
purchase of land and an office building in London, England for L1,148,000 (or
approximately $1,788,000), the purchase of land and an office building in
Montreal, Quebec for CDN$1,730,000 (or approximately $1,250,000) and the
purchase of computer equipment and software, general office equipment, leasehold
improvements, and furniture and fixtures used in the operation of the Company's
business. The principal uses of cash in fiscal 1995 were the purchase of
computer equipment and software, general office equipment, leasehold
improvements, and furniture and fixtures used in the operation of the Company's
business.
Financing activities provided cash of $1,479,000, $30,310,000 and
$38,319,000 during the eleven months ended June 30, 1997, and the fiscal years
ended July 31, 1996 and 1995, respectively. In the fiscal year ended June 30,
1997, cash was provided from common stock option exercises and the issuance of
shares under the Employee Stock Purchase Plan. In fiscal 1996, cash was provided
primarily from proceeds from the issuance of approximately 971,000 common shares
in a secondary public offering which was completed in December 1995, proceeds
from the repayment of subscriptions receivable, and proceeds from common stock
option exercises less payment of capital lease obligations. In fiscal 1995, cash
provided by financing activities was primarily from the receipt of the net
proceeds of the Company's initial public offering.
The Company incurred $6,265,000, $15,871,000 and $6,239,000 of capital
expenditures during the eleven month period ended June 30, 1997, and the fiscal
years ended July 31, 1996 and 1995, respectively, consisting primarily of
computer equipment, software and general office equipment and leasehold
improvements. In the fiscal year ended July 31, 1996, the Company purchased an
office building and related land in London, England. The Company incurred
L1,034,000 (or approximately $1,663,000), and L715,000 (or approximately
$1,114,000) in capital expenditures during the fiscal years ended June 30, 1997
and July 31, 1996, respectively, for the refitting of the London property. In
fiscal 1996, the Company also purchased an office building in Montreal, Quebec.
The carrying values of the Montreal building and the London building were
written down to their estimated fair market values and the buildings were
classified as assets held for sale. In September 1997, the Company entered into
an agreement to sell the Montreal office building for a price not materially
different from its carrying value.
As of June 30, 1997, the Company did not have any material commitments for
capital expenditures. However, in July 1997, the Company entered into an
agreement to acquire all of the outstanding common stock of D-Vision. This
agreement resulted in a cash disbursement of approximately $10,750,000 in July
1997. In August 1997, the Company entered into an agreement-in-principle to
settle the three outstanding class action lawsuits against it. This
agreement-in-principle, should it be consummated, would require the Company to
disburse approximately $7,400,000 from its own funds.
The Company's ability to meet its future liquidity requirements is dependent
upon its ability to operate profitably, or in the absence thereof, to obtain
additional financings. The Company underwent a restructuring intended to
decrease operating expenses, however there can be no assurance that the Company
will not have to take further restructurings or be profitable in the future.
Should the Company need to secure additional financing to meet its future
liquidity requirements, there can be no assurance that the Company will be able
to secure such financing, or that such financing, if available, will be on terms
favorable to the Company. Subject to the factors discussed below in Certain
Factors That May Affect Future Results, the Company believes that, with its
current levels of working capital together with funds generated from operations,
it has adequate sources of cash to meet its operations and capital expenditure
requirements through fiscal 1998.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
Information provided by the Company from time to time including statements
in this Form 10-K which are not historical facts, are so-called forward-looking
statements, and are made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995 and releases of the Securities and
Exchange Commission. In particular, statements contained in the "Management's
Discussion and Analysis of Financial Condition and Results of Operations" which
are not historical facts (including, but not limited to, statements regarding
the Company's anticipated cost of revenues, statements regarding the adequacy of
cash to meet operations, statements concerning anticipated expense levels and
such expenses as a percentage of revenues, statements about the portion of
revenues from customers outside North America, and the implementation of the
I-26
<PAGE>
restructuring plan), "Business--Overview and Recent Developments," "--Other
Products and Products Under Development," "--Marketing and Sales,"
"--Proprietary Rights," "--Manufacturers and Suppliers," "-- Competition,"
"--Employees" and "Legal Proceedings" which are not historical facts may
constitute forward-looking statements. The Company's actual future results may
differ significantly from those stated in any forward-looking statements.
Factors that may cause such differences include, but are not limited to, the
factors discussed below, and the other risks discussed in this section and
elsewhere in this Form 10-K, as well as from time to time in the Company's other
filings with Securities and Exchange Commission, including without limitation
the Company's Annual Report on Form 10-K for the fiscal year ended July 31,
1996.
The Company's future results are subject to substantial risks and
uncertainties. The Company's future financial performance will depend in part on
the successful development, introduction and customer acceptance of its existing
and new or enhanced products. In addition, in order for the Company to achieve
sustained growth, the market for the Company's systems and software must
continue to develop and the Company must expand this market to include
additional applications within the film and video industries and develop new
products for use in related markets. There can be no assurance that the Company
will be successful in marketing its existing or any new or enhanced products. In
addition, as the Company enters new markets, distribution channels, technical
requirements and levels and basis of competition may be different from those in
the Company's current markets and there can be no assurance that the Company
will be able to compete favorably. The market in which the Company competes is
characterized by intense competition and many of the Company's current and
prospective competitors have significantly greater financial, technical,
manufacturing and marketing resources than the Company. These companies may
introduce additional products that are competitive with those of the Company,
and there can be no assurance that the Company's products would compete
effectively with such products. Furthermore, competitive pressures or other
factors, including the Company's entry into new markets, may result in
significant price erosion that could have a material adverse effect on the
Company's business and results of operations. The Company has recently completed
the purchase of certain products and technology through two acquisitions. There
can be no assurance that the products and technologies acquired from these
companies will be successful or will achieve market acceptance, or that the
Company will not incur disruptions and unexpected expenses in integrating the
operations of the two acquired businesses with those of the Company.
The Company's FLAME, FLINT, INFERNO, FIRE, VAPOUR and FROST systems
currently include workstations manufactured by SGI. There are significant risks
associated with this reliance on SGI and the Company may be impacted by the
timing of the development and release of products by SGI, as was the case during
fiscal 1996. In addition there may be unforeseen difficulties associated with
adapting the Company's products to future SGI products. The Company derives a
significant portion of its total revenues from foreign sales. Foreign sales are
subject to significant risks, including unexpected legal, tax and exchange rate
changes and other barriers. In addition, foreign customers may have longer
payment cycles and the protection of intellectual property in foreign countries
may be more difficult to enforce. The Company relies principally on unregistered
copyrights and trade secrets to protect its intellectual property. Any
invalidation of the Company's intellectual property rights or lengthy and
expensive defense of those rights could have a material adverse effect on the
Company. The Company currently markets its systems through its direct sales
organization and through distributors. This marketing strategy may result in
distribution channel conflicts as Company's direct sales efforts may compete
with those of its indirect channels. The Company relies on SGI as the sole
source for video input/ output cards used in the Company's systems. The
Company's OnLINE software requires a videographic card manufactured solely by
Truevision. An interruption in the supply or increase in the price of either one
of these components could have a material adverse effect on the Company's
business and results of operations. To date, the Company has depended to a
significant extent upon a number of key management and technical employees and
the Company's ability to manage its operations will require it to continue to
recruit and retain senior management personnel and to motivate and effectively
manage its employee base. The loss of the services of one or more of these key
employees could have a material adverse effect on the Company's business and
results of operations. There can be no assurance that these factors will not
have a material adverse effect on the Company's future international sales and
consequently, on the Company's business and results of operations.
On May 29, 1996, June 13, 1996 and April 29, 1997 certain of the Company's
shareholders filed class action lawsuits alleging violations of federal
securities laws and other claims against the Company and certain of its
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<PAGE>
officers and directors. The three lawsuits were filed in the Superior Court of
the State of California, the United States District Court, District of
Massachusetts and the United States District Court, Northern District of
California, respectively. On August 12, 1997 the Company announced that it had
reached an agreement-in-principle to settle all of the shareholder class action
lawsuits. The proposed $10.8 million settlement will require Discreet Logic to
contribute approximately $7.4 million from its own funds, with the remainder
provided by insurance. The settlement is subject to the signing of a definitive
settlement agreement and to final court approval of the proposed settlement.
There can be no assurance that the settlement will be consummated and that the
Company will not have to continue its defense of the lawsuits. Should the
proposed settlement not be consummated or finally approved for any reason, the
Company intends to defend the lawsuits vigorously.
The market price of the Company's common shares could be subject to
significant fluctuations in response to quarter-to-quarter variations in the
Company's operating results, announcements of technological innovations or new
products by the Company, its competitors or suppliers and other events or
factors. In addition, the stock market in recent years has experienced extreme
price and volume fluctuations that have particularly affected the market prices
of many technology companies and that have often been unrelated or
disproportionate to the operational performance of these companies. These
fluctuations, as well as general economic and market conditions, may materially
and adversely affect the market price of the Company's common shares.
ITEM 8. FINANCIAL STATEMENTS AND SCHEDULES
The Company's Financial Statements and Schedules, together with the
auditors' reports thereon, appear at pages F-1 through F-26 and S-1 through S-2,
respectively, of this Form 10-K.
ITEM 9. DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
Information concerning the directors of the Registrant is hereby
incorporated by reference from the information contained under the heading
"Election of Directors" in the Registrant's definitive proxy statement of the
Registrant's 1997 Annual Meeting of Stockholders which will be filed with the
Commission within 120 days after the close of the fiscal year (the "Definitive
Proxy Statement").
Certain information concerning directors and executive officers of the
Registrant is hereby incorporated by reference to the information contained
under the heading "Occupations of Directors and Executive Officers" in the
Registrant's Definitive Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is hereby incorporated by
reference to the information contained under the heading "Compensation and Other
Information Concerning Directors and Officers" in the Definitive Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners and
management is hereby incorporated by reference to the information contained
under the heading "Management and Principal Holders of Voting Securities" in the
Definitive Proxy Statement.
I-28
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions is
hereby incorporated by reference to the information contained under the heading
"Certain Relationships and Related Transactions" in the Definitive Proxy
Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES AND REPORTS ON FORM 8-K
(A)(1) INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The following Consolidated Financial Statements of the Registrant are filed
as part of this report:
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
DISCREET LOGIC INC. AND SUBSIDIARIES
Report of Arthur Andersen & Cie................................................................................ F-2
Consolidated Balance Sheets.................................................................................... F-3
Consolidated Statements of Operations.......................................................................... F-4
Consolidated Statements of Shareholders' Equity................................................................ F-5
Consolidated Statements of Cash Flows.......................................................................... F-6
Notes to Consolidated Financial Statements..................................................................... F-7
</TABLE>
(A)(2) INDEX TO FINANCIAL STATEMENT SCHEDULES
The following Financial Statement Schedules of the Registrant are filed as
part of this report:
<TABLE>
<S> <C>
Report of Arthur Andersen & Cie.......................................................... S-1
Schedule II--Valuation and Qualifying Accounts........................................... S-2
</TABLE>
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the
accompanying Consolidated Financial Statements or notes thereto.
(A)(3) INDEX TO EXHIBITS
See attached Index to Exhibits on pages X-1 through X-3 of this Form 10-K.
(B) REPORTS ON FORM 8-K
A Current Report on Form 8-K dated June 12, 1997 was filed on June 27, 1997.
The Current Report on Form 8-K was filed pursuant to Item 2 of Form 8-K
announcing the completion by Discreet Logic, through its wholly owned subsidiary
3380491 Canada Inc. ("Acquisition Sub"), of the acquisition of substantially all
of the assets and the assumption of certain liabilities of Denim Software L.L.C.
pursuant to the terms of an Asset Purchase Agreement dated as of June 12, 1997
among Acquisition Sub, Denim Software L.L.C., Sam Khulusi, Frank Khulusi, Westco
Denim Investments Group, Ltd. and Frank Khulusi Family limited partnership.
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<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
<TABLE>
<S> <C> <C>
DISCREET LOGIC INC.
By: /s/ RICHARD J. SZALWINSKI
------------------------------------------
Richard J. Szalwinski
DATE: SEPTEMBER 29, 1997 PRESIDENT AND CHIEF EXECUTIVE OFFICER
</TABLE>
POWER OF ATTORNEY AND SIGNATURES
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Richard J. Szalwinski and Francois Plamondon,
jointly and severally, his attorney-in-fact, each with the power of
substitution, for him in any and all capacities, to sign any amendments to this
Report on Form 10-K and to file same, with exhibits thereto and other documents
in connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
President, Chief Executive
/s/ RICHARD J. SZALWINSKI Officer, Chairman of the
- ------------------------------ Board of Directors September 29, 1997
Richard J. Szalwinski (Principal Executive
Officer)
Senior Vice President,
/s/ FRANCOIS PLAMONDON Chief Financial Officer,
- ------------------------------ Treasurer and Secretary September 29, 1997
Francois Plamondon (Principal Financial and
Accounting Officer)
/s/ THOMAS CANTWELL
- ------------------------------ Director and Authorized September 29, 1997
Thomas Cantwell U.S. Representative
/s/ GARY G. TREGASKIS
- ------------------------------ Director September 29, 1997
Gary G. Tregaskis
/s/ BRIAN P. DRUMMOND
- ------------------------------ Director September 29, 1997
Brian P. Drummond
/s/ PERRY M. SIMON
- ------------------------------ Director September 29, 1997
Perry M. Simon
/s/ PIERRE DESJARDINS
- ------------------------------ Director September 29, 1997
Pierre Desjardins
I-30
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C> <C>
DISCREET LOGIC INC. AND SUBSIDIARIES
Report of Arthur Andersen & Cie........................ F-2
Consolidated Balance Sheets............................ F-3
Consolidated Statements of Operations.................. F-4
Consolidated Statements of Shareholders' Equity........ F-5
Consolidated Statements of Cash Flows.................. F-6
Notes to Consolidated Financial Statements............. F-7
</TABLE>
REPORT OF INDEPENDENT CHARTERED ACCOUNTANTS
To Discreet Logic Inc.:
We have audited the accompanying consolidated balance sheets of Discreet Logic
Inc. (a Quebec corporation) and subsidiaries at July 31, 1996 and June 30, 1997
and the related consolidated statements of operations, shareholders' equity and
cash flows for each of the two years in the period ended July 31, 1996 and the
eleven month period ended June 30, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards in Canada, which are in substantial agreement with those in the United
States of America. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Discreet Logic Inc. and subsidiaries as at July 31, 1996 and June 30, 1997 and
the results of their operations and their cash flows for each of the two years
in the period ended July 31, 1996, and the eleven month period ended June 30,
1997, in accordance with generally accepted accounting principles in the United
States of America.
ARTHUR ANDERSEN & CIE
Chartered Accountants
Montreal, Canada
August 12, 1997
I-31
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN U.S. DOLLARS)
<TABLE>
<CAPTION>
JULY 31, JUNE 30,
1996 1997
------------- -------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents.............................................................. $ 21,658,051 $ 31,668,128
Accounts receivable (less reserves for uncollectible accounts of $3,649,000 and
$3,487,000, respectively)............................................................ 16,073,788 26,893,405
Inventory--
Resale............................................................................... 11,555,525 10,867,176
Demonstration........................................................................ 4,273,961 3,053,752
Income taxes receivable................................................................ 3,191,291 448,059
Other current assets................................................................... 3,640,143 3,888,689
------------- -------------
60,392,759 76,819,209
Property and equipment--less accumulated depreciation and amortization................... 10,037,064 7,728,248
Deferred income taxes.................................................................... 4,721,578 3,489,537
Other assets............................................................................. 1,139,993 2,659,964
Assets held for resale................................................................... 3,856,348 5,247,741
------------- -------------
$ 80,147,742 $ 95,944,699
------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable....................................................................... $ 9,350,969 $ 23,687,070
Accrued expenses....................................................................... 19,599,077 20,398,720
Deferred revenue....................................................................... 4,769,506 8,103,294
Customer deposits...................................................................... 2,618,061 1,359,619
Due to related parties................................................................. 25,535 --
Income taxes payable................................................................... -- 4,734,484
------------- -------------
36,363,148 58,283,187
------------- -------------
Deferred income taxes.................................................................... 1,441,578 713,236
------------- -------------
Commitments and Contingencies (Notes 5, 12, and 15)
Shareholders' Equity:
Preferred shares--no par value
Authorized--unlimited number of shares
Issued and outstanding--none
Common shares--no par value
Authorized--unlimited number of shares
Issued and outstanding--27,699,426 shares at July 31, 1996 and 28,117,415shares at June
30, 1997............................................................................. 78,922,914 80,401,669
Retained deficit......................................................................... (35,883,399) (42,639,374)
Cumulative translation adjustment........................................................ (696,499) (814,019)
------------- -------------
Total shareholders' equity......................................................... 42,343,016 36,948,276
------------- -------------
$ 80,147,742 $ 95,944,699
------------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
I-32
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN U.S. DOLLARS)
<TABLE>
<CAPTION>
YEARS ENDED JULY 31, ELEVEN MONTHS
----------------------------- ENDED
1995 1996 JUNE 30, 1997
------------- -------------- --------------
<S> <C> <C> <C>
Total revenues.......................................................... $ 64,548,611 $ 83,997,447 $ 101,923,931
Cost of revenues........................................................ 29,608,946 49,333,071 47,571,342
------------- -------------- --------------
Gross profit.................................................... 34,939,665 34,664,376 54,352,589
------------- -------------- --------------
Operating expenses:
Research and development, net of tax credits of $545,000, $711,000
and $696,000, respectively........................................ 4,036,926 16,902,432 9,707,890
Sales and marketing................................................. 12,588,110 26,088,163 23,206,070
General and administrative.......................................... 4,854,261 10,581,670 6,396,024
Write-off of purchased research and development (Note 15)........... -- 8,500,000 9,800,000
Restructuring expense (Note 17)..................................... -- 15,000,000 --
Litigation and related settlement expenses (Note 5)................. -- 2,506,203 6,500,000
------------- -------------- --------------
Total operating expenses........................................ 21,479,297 79,578,468 55,609,984
------------- -------------- --------------
Operating income (loss)......................................... 13,460,368 (44,914,092) (1,257,395)
------------- -------------- --------------
Other income (expense):
Interest income..................................................... 218,976 2,258,705 1,233,924
Interest expense.................................................... (222,103) (229,579) (55,318)
Foreign currency exchange gain (loss)............................... (167,224) 178,620 (187,843)
------------- -------------- --------------
Total other income (expense).................................... (170,351) 2,207,746 990,763
------------- -------------- --------------
Income (loss) before income taxes and minority interest............. 13,290,017 (42,706,346) (266,632)
Provision for income taxes.......................................... 5,490,197 1,434,835 6,489,343
------------- -------------- --------------
Net income (loss) before minority interest.......................... 7,799,820 (44,141,181) (6,755,975)
Minority interest................................................... 14,725 -- --
------------- -------------- --------------
Net income (loss)................................................... $ 7,785,095 $ (44,141,181) $ (6,755,975)
------------- -------------- --------------
Net income (loss) per common and common equivalent share............ $ 0.31 $ (1.64) $ (0.24)
------------- -------------- --------------
Weighted average common shares outstanding.......................... 24,885,670 26,836,834 27,947,807
------------- -------------- --------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
I-33
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(amounts in U.S. Dollars)
<TABLE>
<CAPTION>
RETAINED SHARE CUMULATIVE TOTAL
COMMON EARNINGS SUBSCRIPTIONS TRANSLATION SHAREHOLDERS'
SHARES AMOUNT (DEFICIT) RECEIVABLE ADJUSTMENT EQUITY
------------ ------------- -------------- ------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
Balance, July 31, 1994................ 21,176,000 $ 695,871 $ 472,687 $ (148,148) $ (86,497) $ 933,913
Issuance of common shares net of
issuance costs of $4,893,657 and
related tax effect of
$1,713,000........................ 4,250,788 40,906,450 -- -- -- 40,906,450
Issuance of common shares in
exchange for minority interest
(Note 2(b))....................... 18,000 44,659 -- -- -- 44,659
Exercise of common stock options.... 1,172,072 1,652,694 -- (1,645,000) -- 7,694
Repurchase of common shares......... (1,450,000) (67,129) -- 67,129 -- --
Collection of share subscriptions
receivable........................ -- -- -- 81,019 -- 81,019
Net income.......................... -- -- 7,785,095 -- -- 7,785,095
Change in cumulative translation
adjustment........................ -- -- -- -- 365,623 365,623
------------ ------------- -------------- ------------- ----------- --------------
Balance, July 31, 1995................ 25,166,860 43,232,545 8,257,782 (1,645,000) 279,126 50,124,453
Issuance of common shares net of
issuance costs of $1,988,202 and
related tax effect of $775,399.... 970,920 28,157,527 -- -- -- 28,157,527
Exercise of common stock options.... 1,244,918 1,230,734 -- -- -- 1,230,734
Issuance of shares through Employee
Stock Purchase Plan............... 16,728 302,108 -- -- -- 302,108
Issuance of shares to COSS (Note
15(b))............................ 300,000 6,000,000 -- -- -- 6,000,000
Collection of share subscriptions
receivable........................ -- -- -- 1,645,000 -- 1,645,000
Net loss............................ -- -- (44,141,181) -- -- (44,141,181)
Change in cumulative translation
adjustment........................ -- -- -- -- (975,625) (975,625)
------------ ------------- -------------- ------------- ----------- --------------
Balance, July 31, 1996................ 27,699,426 78,922,914 (35,883,399) -- (696,499) 42,343,016
Exercise of common stock options.... 321,577 1,128,256 -- -- -- 1,128,256
Issuance of shares through Employee
Stock Purchase Plan............... 96,412 350,499 -- -- -- 350,499
Net loss............................ -- -- (6,755,975) -- -- (6,755,975)
Change in cumulative translation
adjustment........................ -- -- -- -- (117,520) (117,520)
------------ ------------- -------------- ------------- ----------- --------------
Balance, June 30, 1997................ 28,117,415 $ 80,401,669 $ (42,639,374) $ -- $ (814,019) $ 36,948,276
------------ ------------- -------------- ------------- ----------- --------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
I-34
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN U.S. DOLLARS)
<TABLE>
<CAPTION>
ELEVEN
MONTHS
YEARS ENDED JULY 31, ENDED
------------------------ JUNE 30,
1995 1996 1997
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)............................................................ $ 7,785,095 $(44,141,181) $(6,755,975)
Adjustments to reconcile net income (loss) to cash provided by operating
activities--
Depreciation and amortization.............................................. 1,674,858 6,276,139 5,882,575
Deferred income taxes...................................................... 652,512 (2,072,789) 503,699
Increase in minority interest.............................................. 14,725 -- --
Loss (gain) on sale of fixed assets........................................ (7,080) 31,819 --
Write-off of purchased research & development.............................. -- 8,500,000 9,800,000
Write-off of assets for restructuring...................................... -- 5,510,237 --
Write-off of investment in Essential Communications Corporation............ -- 2,500,000 --
Changes in assets and liabilities--
Accounts receivable...................................................... (10,786,522) (1,100,199) (10,819,617)
Inventory................................................................ (7,692,451) (6,088,107) 2,986,146
Income taxes receivable.................................................. 523,924 (2,718,204) 2,743,232
Other current assets..................................................... (1,326,134) (1,917,776) (248,546)
Accounts payable......................................................... 11,388,728 (6,183,710) 14,336,101
Accrued expenses......................................................... 1,367,536 16,865,069 799,643
Deferred revenue......................................................... 2,595,168 961,399 3,333,788
Income taxes payable..................................................... 2,553,153 (2,578,994) 4,734,484
Customer deposits........................................................ (81,883) 1,807,254 (1,258,442)
Due to related parties................................................... (357,756) (75,778) (25,535)
----------- ----------- -----------
Net cash provided by (used in) operating activities........................ 8,303,873 (24,424,821) 26,011,553
----------- ----------- -----------
Cash flows from investing activities:
Purchase of property and equipment........................................... (6,239,422) (15,870,636) (6,265,405)
Proceeds from disposal of property and equipment............................. 69,800 212,719 4,885
Increase in other assets..................................................... (584,794) (519,841) (2,480,908)
Cash paid for Denim acquisition and related costs............................ -- -- (9,125,611)
Cash paid for COSS/IMP acquisition and related costs......................... -- (5,544,848) --
Cash paid for investment in Essential Communications Corporation............. -- (2,500,000) --
----------- ----------- -----------
Net cash used in investing activities...................................... (6,754,416) (24,222,606) (17,867,039)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common shares, net of issuance costs............... 39,193,450 27,382,128 --
Proceeds from the exercise of stock options.................................. 7,694 1,230,734 1,128,256
Proceeds from the employee stock purchase plan............................... -- 302,108 350,499
Payment of capital lease obligations......................................... (963,500) (249,699) --
Proceeds from subscriptions receivable....................................... 81,019 1,645,000 --
----------- ----------- -----------
Net cash provided by financing activities.................................. 38,318,663 30,310,271 1,478,755
----------- ----------- -----------
Foreign exchange effect on cash................................................ 292,516 (991,874) 386,808
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents............................... 40,160,636 (19,329,030) 10,010,077
Cash and cash equivalents, beginning of year................................... 826,445 40,987,081 21,658,051
----------- ----------- -----------
Cash and cash equivalents, end of year......................................... $40,987,081 $21,658,051 $31,668,128
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosure of cash flow information:
Interest paid during the year................................................ $ 203,038 $ 229,610 $ 16,579
Income taxes paid during the year............................................ 974,569 8,823,579 1,141,487
Supplemental disclosure of non-cash financing and investing activities:
Issuance of common shares in exchange for subscriptions receivable........... 1,645,000 -- --
Issuance of common shares to COSS............................................ -- 6,000,000 --
Property and equipment acquired under capital leases......................... 416,671 -- --
Issuance of common shares in exchange for minority interest.................. 44,659 -- --
Reduction of share subscriptions receivable.................................. 67,129 -- --
Deferred tax asset recorded in connection with share issuance costs.......... 1,713,000 775,399 --
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
I-35
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS IN U.S. DOLLARS)
(1) OPERATIONS
Discreet Logic Inc. ("the Company") was incorporated under Part 1A of the
Quebec Companies Act on September 10, 1991. The Company and its subsidiaries
develop, assemble, market and support non-linear, digital systems and
software for creating, editing and compositing imagery and special effects
for film, video and HDTV. The Company's systems and software are utilized by
creative professionals, for a variety of applications, including feature
films, television programs, commercials, music videos, interactive game
production and live broadcasting.
The Company sells its systems and other products through its direct sales
organization, as well as through distributors and resellers. The Company
markets and sells its systems directly in North America and in certain
European and Pacific Rim countries. Sales activities in North America are
conducted from the Company's Montreal headquarters, sales offices in Los
Angeles, New York and Chicago and field representatives based in Boston, San
Francisco and Atlanta. In fiscal 1996, the Company opened sales offices in
India, Hong Kong and Japan. The Company also markets its systems through
sales offices located in the United Kingdom, France, Germany, Singapore and
Brazil and through a network of distributors in over 60 countries.
The success of the Company is subject to a number of risks and
uncertainties, including, without limitation, the Company's ability to
successfully develop, introduce and gain customer acceptance of existing and
new or enhanced products; the need for the continued development of the
market for the Company's systems; the ability of the Company to expand its
current market to include additional applications and develop new products
for related markets; the risk that as the Company enters new markets, the
distribution channels, technical requirements and levels and basis of
competition may be different from those in the Company's current markets;
the presence of competitors with greater financial, technical,
manufacturing, marketing and distribution resources; the risk that the
products and technologies acquired by the Company through acquisitions will
not be successful, achieve market acceptance or be successfully integrated
with the Company's existing products and business; the risk of quarterly
fluctuations in the Company's operating results; the risk of the Company's
reliance on SGI for the workstations included in the Company's systems
including the impact of the timing of the development and release of SGI
products as well as unforeseen difficulties associated with adapting the
Company's products to future SGI products; the risk that the Company derives
a significant portion of its revenues from foreign sales; the Company's
reliance principally on unregistered copyrights and trade secrets to protect
its intellectual property; the risk that the Company's direct sales efforts'
may compete with those of its indirect channels; the risk of the Company's
reliance on SGI as the sole source for video input/ output cards used in the
Company's systems and the risk resulting from the requirement of the
Company's OnLINE software for a videographic card manufactured solely by
Truevision, Inc.; the Company's dependence on key management and technical
employees; market price fluctuations due to quarter-to-quarter variations in
the Company's operating results, announcements of technological innovations
or new products by the Company or its competitors and the historical
fluctuations in market prices of technology companies generally; the risk
that the litigation settlement agreement-in-principle will not be
consummated and that the Company will not be successful in its continued
defense of the three class action lawsuits; and other risks detailed from
time to time in the Company's filings with the Commission, including this
Form 10-K.
The Company believes that with its current level of working capital together
with funds generated from operations, it has adequate sources of cash to
meet its operational and capital expenditure requirements through fiscal
1998.
(2) SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements reflect the application
of the following significant accounting policies, as described below and
elsewhere in the notes to consolidated financial statements. These
consolidated financial statements are prepared in accordance with generally
accepted accounting principles in the United States of America, and are
presented in United States dollars ("U.S. Dollars").
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the consolidated financial statements, and the reported amounts of
revenues and expenses during the reporting periods. Actual results may
differ from these estimates.
(A) CHANGE OF FISCAL YEAR
On January 9, 1997, the Board of Directors of the Company approved the
change of the Company's fiscal year end from July 31 to June 30. This change
was effective beginning with the Company's second fiscal quarter of 1997.
The consolidated financial statements are presented for the eleven month
period ended June 30, 1997 and the twelve month periods ended July 31, 1996
and 1995. The Company prepares consolidated financial statements, remeasures
accounts in foreign currencies to reflect changes in exchange rates, and
examines and adjusts certain reserve accounts at the end of each quarter.
Therefore, it is not practicable to recast the prior fiscal year's results
to reflect the current eleven month fiscal period. Consequently, the results
for the eleven month period ended June 30,
I-36
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
(2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
1997 are not directly comparable with those for the twelve month period
ended July 31, 1996, and the current eleven month period's results are not
necessarily indicative of the results that could be expected for a full
twelve month period.
(B) PRINCIPLES OF CONSOLIDATION AND MINORITY INTEREST
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All subsidiaries are wholly owned as of June 30, 1997.
Discreet Logic (UK) Limited was a 75% owned subsidiary until February 28,
1995, at which time, the Company purchased the 25% minority interest in
exchange for 18,000 common shares. All significant intercompany accounts and
transactions have been eliminated upon consolidation.
(C) REVENUE RECOGNITION
The Company recognizes revenue from software licenses, and the related
hardware and peripherals, upon shipment of the products. The Company
recognizes revenue from post contract customer support and other related
services ratably, as the obligations are fulfilled, or when the related
services are performed. Post contract customer support, training,
installation, systems integration and rental services, are performed
primarily under separately priced arrangements under which the Company has
recorded revenues of $4,770,000, and $11,713,000, for the years ended July
31, 1995 and 1996, respectively, and $13,606,000 for the eleven month period
ended June 30, 1997. In cases where the Company has delivered hardware
and/or software to customers and has insignificant or noncritical vendor
obligations related to these deliveries, the revenue attributable to such
obligations has been deferred until such obligations have been fulfilled.
(D) NET INCOME (LOSS) PER COMMON SHARE
Net income per common share is computed by dividing net income by the
weighted average number of common and common equivalent shares outstanding
during the year, computed in accordance with the treasury stock method. Net
loss per common share is computed by dividing net loss by the weighted
average number of common shares outstanding during the year. Pursuant to the
requirements of the Securities and Exchange Commission, common shares issued
by the Company during the 12 months immediately preceding the initial public
offering (the twelve-month period subsequent to June 1, 1994), plus options
granted during the same period, have been included in the calculation of
weighted average number of common shares using the treasury stock method at
the initial public offering price of $10.50 per share.
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 128, EARNINGS PER
SHARE. The new standard simplifies the computation of earnings per share
(EPS) and increases comparability to international standards. Under SFAS No.
128, primary EPS is replaced by "Basic" EPS, which excludes dilution and is
computed by dividing income available to common shareholders by the weighted
average number of common shares outstanding for the period. "Diluted" EPS,
which is computed similarly to fully diluted EPS, reflects the potential
dilution that could occur if securities or other contracts to issue common
stock were exercised or converted into common stock. The Company will be
required to disclose both basic and diluted EPS.
The Company is required to adopt the new standard in its year-end 1998
consolidated financial statements. All prior-period EPS information
(including interim EPS) is required to be restated at that time. Early
adoption is not permitted. Pro forma EPS, under SFAS No. 128, have not been
presented as they do not differ materially from the EPS presented in the
consolidated statements of operations.
(E) RESEARCH AND DEVELOPMENT EXPENSES
The Company charges to operations research and development costs as incurred
and presents such expenses net of income tax credits from the Canadian
federal and Quebec provincial governments (see Note 7). Software development
costs are considered for capitalization when technological feasibility is
established in accordance with Statement of Financial Accounting Standards
(SFAS) No. 86, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE TO BE SOLD,
LEASED OR OTHERWISE MARKETED. The Company sells software in a market that is
subject to rapid technological change, new product introductions and
changing customer needs. Accordingly, the Company has not capitalized
software development costs due to its inability to estimate the useful life
of software under development.
(F) TRANSLATION OF FOREIGN CURRENCIES
The accounts of the Company are translated in accordance with SFAS No. 52,
FOREIGN CURRENCY TRANSLATION. The Company's management has elected to
present these consolidated financial statements in U.S. dollars. The
financial statements of the Company and its subsidiaries are translated from
their functional currency into the reporting currency, the U.S. dollar,
utilizing the current rate method. Accordingly, assets and liabilities are
translated at exchange rates in effect at the end of the year, and revenues
and expenses are translated at the weighted average exchange rate during the
year. All cumulative translation gains or losses from the translation into
the Company's reporting currency are included as a separate component of
shareholders' equity in the consolidated balance sheets.
I-37
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
(2) SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Prior to August 1995, the Company remeasured the financial statements of its
foreign subsidiaries and other foreign currency transactions into Canadian
dollars as follows: monetary assets and liabilities are translated at
exchange rates in effect at year-end, and nonmonetary items are translated
at historical exchange rates; revenues and expenses are translated at the
average rate during the year, except for depreciation and amortization,
which are translated at the same rates as the related assets. Exchange gains
and losses arising from transactions denominated in foreign currencies are
included in current operations. Foreign currency translation gains (losses)
from the remeasurement into the Canadian dollar included in other income
(expense) in the accompanying consolidated statements of operations were
$4,968 for the year ended July 31, 1995.
Beginning August 1, 1995, the Company changed the functional currency of its
foreign subsidiaries from the Canadian dollar to their respective local
currencies. Accordingly, cumulative translation gain (losses) are included
as a separate component of shareholders' equity in the consolidated balance
sheets. The impact on the consolidated financial statements of the change of
functional currency of the Company's foreign subsidiaries was not
significant. Foreign currency transaction gains (losses) included in other
income (expense) in the accompanying consolidated statements of operations
were $162,256, $178,620, and $(187,843) for the years ended July 31, 1995,
and 1996, and the eleven month period ended June 30, 1997, respectively.
(G) CONCENTRATION OF CREDIT RISK
During fiscal 1997, the Company amended and restated its Maximum Liability
Agreement with a leasing company. The agreement provides that the Company is
contingently liable up to a maximum percentage of the remaining principal
payments outstanding related to the purchase of the Company's products by
customers financed by said leasing company. The maximum liability is
contingent on certain factors as defined in the agreement. As at June 30,
1997, the Company has accrued $619,000 the maximum amount of the contingent
liability as a charge to general and administrative expenses.
The Company has no other significant off-balance sheet concentration of
credit risk such as foreign exchange contracts, option contracts or other
foreign currency hedging arrangements. The Company maintains the majority of
cash balances with three financial institutions and its accounts receivable
credit risk is not concentrated within any geographic area. There were no
accounts receivable from a single customer which exceeded 10 percent of
total accounts receivable as of June 30, 1997.
(H) POSTEMPLOYMENT AND POSTRETIREMENT BENEFITS
The Company does not provide postemployment and postretirement benefits.
(I) CASH EQUIVALENTS
Cash equivalents are carried at cost, which approximates market value. Cash
equivalents are short-term, highly liquid investments with original
maturities of less than three months. Cash equivalents consist of commercial
paper and money market mutual funds at July 31, 1996 and June 30, 1997. The
Company applied SFAS No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND
EQUITY SECURITIES.
(J) INVENTORY
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.
(K) PROPERTY AND EQUIPMENT
The Company provides for depreciation and amortization using the
straight-line and declining-balance methods over the estimated useful lives
of the assets as follows:
<TABLE>
<CAPTION>
ESTIMATED JULY 31, JUNE 30,
ASSET CLASSIFICATION USEFUL LIFE 1996 1997
- -------------------------------------------- -------------------------------------------- ---------- ----------
<S> <C> <C> <C>
Computer equipment, video equipment and
software.................................. 2-5 Years $14,095,730 $14,375,443
Leasehold improvements...................... Shorter of term of lease or useful life 2,485,751 1,222,478
Furniture and fixtures...................... 5 Years 1,677,067 1,797,891
---------- ----------
18,258,548 17,395,812
Less--Accumulated depreciation and
amortization.............................. (8,221,484) (9,667,564)
---------- ----------
$10,037,064 $7,728,248
---------- ----------
---------- ----------
</TABLE>
I-38
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
(3) OTHER CURRENT ASSETS
Other current assets consist of the following:
<TABLE>
<CAPTION>
JULY 31, JUNE 30,
1996 1997
--------- ---------
<S> <C> <C>
Prepaid expenses............................................................................ $2,206,248 $2,919,782
Sales tax receivable........................................................................ 578,781 787,515
Other receivables........................................................................... 855,114 181,392
--------- ---------
$3,640,143 $3,888,689
--------- ---------
--------- ---------
</TABLE>
(4) ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
JULY 31, JUNE 30,
1996 1997
---------- ----------
<S> <C> <C>
Payroll and payroll related............................................................... $2,768,461 $2,838,873
Professional fees......................................................................... 739,412 733,680
Commissions............................................................................... 1,967,175 2,187,178
Sales tax and VAT payable................................................................. 946,917 679,052
Accrued restructuring expenses............................................................ 8,634,484 4,272,438
Maximum liability accrual................................................................. 830,000 619,000
Accrued litigation and settlement expenses................................................ 2,506,203 8,186,969
Other..................................................................................... 1,206,425 881,530
---------- ----------
$19,599,077 $20,398,720
---------- ----------
---------- ----------
</TABLE>
(5) LITIGATION AND RELATED SETTLEMENT EXPENSES
(A) SECURITIES LITIGATION
On May 29, 1996, a lawsuit entitled SANDRA ESNER AND JERRY KRIM, ON BEHALF
OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED, VS. [. . .] DISCREET LOGIC
INC., ET AL., case No. 978584, was filed in the Superior Court of the State
of California, City and County of San Francisco. Named as defendants are the
Company, certain of the Company's former and existing directors, officers,
and affiliates, and certain underwriters and financial analysts. The
plaintiffs purport to represent a class of all persons who purchased the
Company's common stock between September 13, 1995, and May 1, 1996. The
complaint alleges violations of California law through material
misrepresentations and omissions, among other things. The Company believes
that the allegations in the complaint are without merit and has defended the
lawsuit vigorously.
On June 13, 1996, a lawsuit entitled BRUCE FRIEDBERG, ON BEHALF OF HIMSELF
AND ALL OTHERS SIMILARLY SITUATED, VS. DISCREET LOGIC INC., ET AL., Civ. No.
96-11232-EFH, was filed in the United States District Court, District of
Massachusetts. Named as defendants are the Company and certain of the
Company's former and existing directors and officers. The plaintiff purports
to represent a class of all persons who purchased the Company's common stock
between November 14, 1995, and February 13, 1996. On October 11, 1996, the
plaintiff filed an amended complaint which asserts substantially the same
factual allegations as the first complaint and proposes the identical class
period. The complaint alleges violations of the United States Federal
Securities law through material misrepresentations and omissions. The
Company believes that the allegations in the complaint are without merit and
has defended the lawsuit vigorously.
On April 29, 1997, a lawsuit entitled ANTON PAPARELLA, SANDRA ESNER AND
GEOFFREY L. SHERWOOD, ON BEHALF OF THEMSELVES AND ALL OTHERS SIMILARLY
SITUATED VS. DISCREET LOGIC INC., ET AL., case No. C-97-1570, was filed in
the United States District Court, Northern District of California. Named as
defendants are the Company and certain of Company's former and existing
officers, directors and affiliates, and certain underwriters. The complaint
asserts, in all material respects, the same factual allegations and proposes
the same class period as the above-described California state court
complaint filed in May 1996, except asserts claims under federal securities
law instead of state law. The Company believes that the allegations in the
California federal complaint are without merit and has defended the lawsuit
vigorously.
On August 12, 1997 the Company announced that it had reached an
agreement-in-principle to settle all three of the shareholder class action
litigations. The proposed $10,800,000 settlement would require the Company
to contribute approximately $7,400,000 from its own funds, with the
remainder provided by insurance. The settlement is subject to the signing of
a definitive settlement agreement and
I-39
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
(5) LITIGATION AND RELATED SETTLEMENT EXPENSES (CONTINUED)
to final court approval of the proposed settlement. There can be no
assurance that the settlement will be consummated and that the Company will
not have to continue its defense of the lawsuits. Should the proposed
settlement not be consummated or finally approved for any reason, the
Company intends to defend the lawsuits vigorously.
In the year ended July 31, 1996, the Company had provided a $2,506,000
litigation reserve for legal costs associated with defending the class
action lawsuits. During the eleven month period ended June 30, 1997, the
Company recorded a provision of $6,500,000 to accrue the additional
estimated settlement costs to be borne by the Company, should the
agreement-in-principle be consummated. At June 30, 1997, accrued expenses
included a reserve of $8,186,969 for these estimated settlement costs.
(6) DEMAND LINE OF CREDIT, LEASING AND TAX CREDIT FACILITIES
Subsequent to year end, the Company amended its revolving demand line of
credit and leasing facility with its bank. The new agreement provides for a
revolving demand line of credit under which it can borrow up to
CDN$7,000,000 (approximately $5,085,000 at June 30, 1997). Advances under
the line accrue interest monthly at the Canadian prime rate (4.75% at June
30, 1997) plus 0.25%. Additionally, the agreement provides for a CDN$600,000
(approximately $436,000 at June 30, 1997) demand leasing facility, and a
CDN$600,000 (approximately $436,000 at June 30, 1997) demand research and
development tax credit facility. Advances under these facilities accrue
monthly at the Canadian prime rate (4.75% at June 30, 1997) plus 1%. The
line and facilities are secured by essentially all of the Company's North
American assets. As additional security, the Company assigned to the bank
its insurance on these assets, and Canadian federal and provincial research
and development tax credits receivable. The Company is required to maintain
certain financial ratios, including minimum levels of working capital, debt
service coverage and equity to asset ratios.
(7) CANADIAN FEDERAL AND PROVINCIAL INCOME TAX CREDITS
The Company is entitled to research and development incentives in the form
of income tax credits from the Canadian federal government ("Federal") and
from the Province of Quebec ("Provincial"). Federal income tax credits are
received on qualified Canadian research and development expenditures and
equipment purchases. Provincial income tax credits are received on qualified
research and development salaries in the Province of Quebec. The Federal and
Provincial income tax credits are earned at 20% of qualified research and
development expenditures. Additionally, the Federal credit may be limited to
a credit against income taxes payable.
The Company recorded $545,000, $711,000 and $696,000 of income tax credits
as a reduction of research and development expenses for the years ended July
31, 1995 and 1996, and the eleven month period ended June 30, 1997,
respectively. These income tax credits represent credits earned based on
qualifying research and development expenditures. In addition, the Company
recorded, $690,000, $513,000 and $196,000 of income tax credits as a
reduction in the carrying value of property and equipment for the years
ended July 31, 1995 and 1996 and the eleven month period ended June 30,
1997, respectively. These income tax credits represent credits earned based
on qualifying property and equipment purchases.
(8) SHAREHOLDERS' EQUITY
(A) INITIAL PUBLIC OFFERING
In July 1995, the Company closed its initial public offering of 4,189,248
common shares at $10.50 per share, resulting in proceeds of approximately
$40,803,000 net of issuance costs and their related tax effects.
(B) AMENDED ARTICLES OF INCORPORATION
On October 16, 1995, the Company effected a 2-to-1 share split of its common
shares with the additional shares delivered on November 6, 1995 to holders
of record on October 16, 1995. All common shares have been adjusted
retroactively to give effect to the split.
On May 15, 1995, the Company amended its Articles of Incorporation to effect
a 2-to-1 split of its common shares, to combine and redesignate the
Company's Class B through Class G shares into common shares and to create a
class of preferred shares. All common shares have been adjusted
retroactively to give effect to the split.
On July 14, 1994, the Company amended the characteristics of its capital
shares, which included converting its Class A shares into common shares. On
that date, the Company effected a split of its common shares on a 40-to-1
basis. All common shares have been adjusted retroactively to give effect to
the split.
I-40
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
(8) SHAREHOLDERS' EQUITY (CONTINUED)
(C) SECONDARY OFFERING
In December 1995, the Company completed a secondary offering of 970,920
common shares at $30.25 per share, resulting in proceeds of approximately
$28,158,000 net of issuance costs and their related tax effects.
(D) PREFERRED SHARES
The Board of Directors is authorized to issue preferred shares, in one or
more series, and to fix the rights, dividend rates, conversion rights,
voting rights, terms of redemption (including sinking fund provisions),
redemption price or prices, and the number of shares constituting any series
or the designations of such series, without further vote or action by the
shareholders.
(E) SHARE SUBSCRIPTIONS RECEIVABLE
In fiscal 1995, a share subscriptions receivable, in the amount of $148,148,
from the then and current Chairman of the Board of Directors and the former
president of the Company was reduced through the shares being repurchased
(see note 8(f)) or repaid. On November 11, 1994, the former President and
Chief Executive Officer of the Company issued to the Company a $1,645,000
note in connection with the exercise of nonqualified stock options which is
included in share subscriptions receivable at July 31, 1995. During the 1996
fiscal year, the note was repaid in full together with interest in the
amount of $134,000.
(F) REPURCHASED SHARES
On March 27, 1995, the Company entered into an agreement with a former
President of the Company whereby he returned 1,450,000 common shares of the
Company in exchange for a $67,000 reduction in his outstanding share
subscription. This transaction was reflected as a reduction in common shares
and share subscription receivable in the accompanying consolidated
statements of shareholders' equity.
(G) DIVIDENDS
The Company has never declared or paid cash dividends and does not
anticipate paying any cash dividends on its capital stock in the foreseeable
future. In the event cash dividends are declared or paid, the Company
anticipates that they would be declared and paid in U.S. dollars. Part 1A of
the Quebec Companies Act prohibits the Company from paying dividends that
would prevent it from discharging its liabilities when due or that would
bring the book value of its assets to an amount less than the sum of its
liabilities and its issued and paid-up share capital account. At June 30,
1997, the Company could not distribute any dividends.
(H) CAPITAL STRUCTURE
In February 1997, the FASB also issued SFAS No. 129, Disclosure of
Information About Capital Structure. This statement is effective for
financial statements for periods ended after December 15, 1997. SFAS No. 129
establishes standards for disclosing information about an entity's capital
structure. The Company does not anticipate that the implementation of this
statement will have a material impact on the consolidated financial
statements.
(9) STOCK OPTION AND STOCK PURCHASE PLANS
The Company applies the Accounting Principles Board (APB) Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, in accounting for its stock-based
compensation plans. During the year, the Company has adopted only the
disclosure requirements of Statement of Financial Accounting Standards No.
123 (SFAS 123), ACCOUNTING FOR STOCK-BASED COMPENSATION. SFAS No. 123
establishes financial accounting and reporting standards based on a fair
value concept for stock-based employee compensation plans. This statement
requires an employer that continues to apply the accounting provisions of
APB 25 to disclose pro forma amounts reflecting the difference between
compensation costs, including tax effects, that would have been recognized
in the income statement, if the fair value based method had been used.
The table below presents pro forma net income (loss) and EPS, had
compensation cost for the Company's stock-based employee compensation plans
been determined using the provisions of SFAS No. 123. Pro forma information
has not been presented for fiscal
I-41
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
(9) STOCK OPTION AND STOCK PURCHASE PLANS (CONTINUED)
1995 because the fair value based method of accounting has not been applied
to options granted prior to August 1, 1995 and there were no offerings under
the 1995 Employee Stock Purchase Plan prior to August 1, 1995.
<TABLE>
<CAPTION>
1996 1997
----------- ----------
<S> <C> <C> <C>
Net income (loss).......................................................... As Reported $(44,141,181) $(6,755,975)
Pro forma $(46,118,158) $(8,414,957)
Net income (loss) per share................................................ As Reported $ (1.64) $ (0.24)
Pro forma $ (1.72) $ (0.30)
</TABLE>
Because the fair value based method of accounting has not been applied to
options granted prior to August 1, 1995, the resulting pro forma
compensation cost may not be representative of that to be expected in future
years.
(A) RESTRICTED STOCK AND STOCK OPTION PLAN
On June 14, 1994, the Company's Board of Directors approved the
establishment of the 1994 Restricted Stock and Stock Option Plan (the "1994
Plan") for the Company's officers, employees, consultants and directors.
Under the 1994 Plan, the Compensation Committee of the Board of Directors
(the "Compensation Committee") may grant stock options for a maximum of
5,000,000 common shares. Under the terms of the 1994 Plan, the purchase
price, which approximates fair market value, and vesting schedule applicable
to each option grant is determined by the Compensation Committee.
On August 12, 1996, the Company's Board of Directors authorized the
repricing of 106,600 stock options previously granted under the 1994 Plan.
The repricing provided for the exercise price of the 106,600 options to be
reduced to $6.375 per share, representing the fair value per common shares
on the date of repricing. Prior to the repricing, such options had exercise
prices ranging from $19.25 to $28.50 per share. In exchange for the repriced
options, the 159,900 stock options remaining from these grants were
forfeited.
(B) 1995 NONEMPLOYEE DIRECTOR STOCK OPTION PLAN
On March 27, 1995, the Company's Board of Directors adopted, and in April
1995, the shareholders approved, the 1995 Nonemployee Director Stock Option
Plan (the "Director Plan"). Under the Director Plan, the Compensation
Committee may grant options to purchase up to 200,000 common shares to
nonemployee directors of the Company. The Director Plan authorizes the grant
(a) to each person who becomes a member of the Board of Directors and who is
not an employee, officer or direct and indirect owner of 5% or more of the
common shares of the Company (a "Non-Employee Director"), on the date such
person is first elected to the Board of Directors without further action by
the Compensation Committee, of an option to purchase 20,000 common shares
and (b) to each person receiving an option pursuant to clause (a) who is a
Non-Employee Director on the fifth anniversary of the date such person was
first elected to the Board of Directors, during the term of the Director
Plan, of an option to purchase 15,000 common shares, provided that such
person has continuously served as a Non-Employee Director during such 5-year
period. The exercise price will be the fair market value at the date of
grant and the options will expire 10 years from the date of grant. All
options vest in three equal annual installments, with the first vesting on
the date of grant. As of June 30, 1997, 60,000 options were granted and
outstanding at fair market value under the Director Plan.
(C) 1995 EMPLOYEE STOCK PURCHASE PLAN
On March 27, 1995, the Company's Board of Directors adopted, and in April
1995, the shareholders approved, the 1995 Employee Stock Purchase Plan,
whereby the Company has reserved and may issue to employees up to an
aggregate of 300,000 common shares in semiannual offerings over a ten year
period. Common shares are sold at 85% of fair market value. As of June 30,
1997, 113,140 shares had been issued under the plan.
(D) NON-QUALIFIED STOCK OPTION OUTSIDE THE PLAN
On November 4, 1994, the Company granted, outside the 1994 Plan, a
nonqualified stock option for the purchase of 1,012,308 common shares, at a
price of $1.63 per share, which approximated fair market value at date of
grant, to the former President and Chief Executive Officer of the Company.
This option was exercised on November 4, 1994 through the issuance of a
$1,645,000 note (see Note 8(e)).
(E) 1997 SPECIAL LIMITED NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN
On February 10, 1997, the Company's Board of Directors adopted the 1997
Special Limited Non-Employee Director Stock Option Plan (the "1997 Plan").
Under the 1997 Plan, options to purchase 10,000 of the Company's common
shares were granted to each of two of the Company's non-employee directors
at the Fair Market Value (as defined in the 1997 Plan) of the shares on the
date of the grant, February 10, 1997. The total number of common shares
originally available for grant under the 1997 Plan was 20,000. The options
I-42
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
(9) STOCK OPTION AND STOCK PURCHASE PLANS (CONTINUED)
granted pursuant to the 1997 Plan expire 10 years from the date of grant and
vest in three equal annual installments. As of June 30, 1997, 20,000 options
were granted and outstanding under the 1997 Plan.
(F) STOCK OPTION ACTIVITY
The following is a summary of all stock option activity:
<TABLE>
<CAPTION>
1995 1996 1997
---------------------- ---------------------- ----------------------
<S> <C> <C> <C> <C> <C> <C>
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- ----------- --------- ----------- --------- -----------
Beginning Outstanding........................... 1,245,080 $ 0.09 3,403,740 $ 2.97 2,744,646 $ 7.77
Options Granted................................. 3,389,260 3.33 973,000 16.53 1,689,638 5.41
Options Exercised............................... (1,172,072) 1.15 (1,244,918) 1.27 (321,577) 3.51
Options Canceled................................ (58,528) 1.01 (387,176) 10.67 (1,606,794) 9.63
--------- --------- ---------
Ending Outstanding.............................. 3,403,740 2.97 2,744,646 7.77 2,505,913 5.64
--------- --------- ---------
Exercisable..................................... 763,576 $ 0.73 513,714 $ 6.01 389,832 $ 4.71
--------- --------- ---------
Weighted Average Fair Value of Options Granted
During the Year............................... -- $ 10.43 $ 3.19
</TABLE>
The following table provides further detail on the options granted during
fiscal 1996 and 1997 in relation to their respective fair values as
calculated above:
<TABLE>
<CAPTION>
1996 1997
-------------------------- --------------------------
<S> <C> <C> <C> <C>
WEIGHTED WEIGHTED
AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
--------- --------------- --------- ---------------
Exercise price equal to fair value............................... 531,562 $ 13.17 1,487,238 $ 5.23
Exercise price greater than fair value........................... 45,000 23.72 147,400 6.48
Exercise price less than fair value.............................. 396,438 20.22 55,000 7.38
--------- ------ --------- -----
973,000 $ 16.53 1,689,638 $ 5.41
--------- ------ --------- -----
</TABLE>
The following table summarizes the options outstanding and exercisable as at
June 30, 1997:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
OPTIONS CONTRACTUAL AVERAGE NUMBER AVERAGE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- --------------------------------------------- ----------- --------------- --------------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
$0.05-$2.88.................................. 322,402 7.26 $ 1.29 240,878 $ 1.05
$4.50-$4.50.................................. 748,800 9.12 $ 4.50 -- $ --
$4.69-$5.50.................................. 304,000 9.06 $ 5.49 666 $ 4.63
$6.03-$6.38.................................. 897,911 9.26 $ 6.15 91,312 $ 6.38
$7.00-$25.00................................. 232,800 8.66 $ 13.59 56,976 $ 17.53
----------- -----------
$0.05-$25.00................................. 2,505,913 8.88 $ 5.64 389,832 $ 4.71
</TABLE>
The fair value of each graded vesting option grant is estimated on the date
of grant using the Black-Scholes option pricing model with the following
weighted average assumptions used for grants in both 1996 and 1997; risk
free interest rates between 5.6% and 6.3%; expected dividend yields of 0%;
expected term after vest date of approximately .52 years; and expected
volatility of 100%.
I-43
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
(10) RELATED PARTY TRANSACTIONS
(A) BEHAVIOUR ENTERTAINMENT INC. ("BEHAVIOUR")
The Company recorded revenue of $121,000 from Behaviour, a company owned by
the Company's Chairman and Chief Executive Officer, during the fiscal year
ended July 31, 1996. The Company had trade receivables of $113,000 from
Behaviour at July 31, 1996.
(B) OTHER RELATED PARTY TRANSACTIONS
The Company recorded revenue of $2,304,000 during fiscal 1996, from a
company with which the Company's Chairman and Chief Executive Officer is
affiliated. At July 31, 1996, the Company had a trade accounts receivable of
$836,000 from such company. The balance was collected in six monthly
installments of $139,000.
The Company has recorded revenue of $1,138,000 during fiscal 1996, from a
company with which a member of the Company's board of directors is
affiliated. At July 31, 1996, the full amount of the sale had been
collected.
In July 1997 the Company agreed to rent space for its new headquarters in
Montreal from TGR Zone Corporation ("TGR Zone"), a company indirectly owned
by Discreet Logic's Chairman and Chief Executive Officer. As part of this
agreement, TGR Zone will assume the Company's lease commitment at its
previous Montreal location. The agreement provides that the Company will
lease approximately 55,000 square feet of space at approximately CDN$13.00
(or approximately $9.44 at June 30, 1997) per square foot per annum subject
to normal escalation clauses. The proposed lease is set to expire in June
2007. The Company will only sign the proposed lease when the Company is
satisfied with the assignment of its previous lease. If this assignment is
not negotiated with the previous landlord and TGR Zone in a manner
acceptable to the Company, the Company has the right to modify the terms of
its agreement with TGR Zone. The proposed lease for the current building and
the assignment of the lease for the previous building are expected to be
executed in the second fiscal quarter of 1998. The commitments related to
this proposed lease are disclosed in Note 12.
(11) INCOME TAXES
The Company applies the provisions of SFAS No. 109, Accounting for Income
Taxes. Under the provisions of SFAS No. 109, the Company recognizes a
current tax liability or asset for current taxes payable or refundable and a
deferred tax liability or asset for the estimated future tax effects of
temporary differences between the carrying value of assets and liabilities
for financial reporting and their tax basis and carryforwards to the extent
they are realizable.
The components of the deferred tax assets and the deferred tax liabilities
are as follows:
<TABLE>
<CAPTION>
JULY 31, JUNE 30,
1996 1997
--------- ---------
<S> <C> <C>
Deferred tax assets --
Foreign tax loss carryforwards............................................................ $6,850,000 $5,150,000
Litigation and related settlement expenses................................................ -- 1,650,000
Restructuring expenses.................................................................... 1,400,000 1,400,000
Initial and secondary public offering issuance costs...................................... 1,740,378 1,254,730
Other temporary differences............................................................... 1,581,200 834,807
--------- ---------
11,571,578 10,289,537
Less: Valuation allowance................................................................. 6,850,000 6,800,000
--------- ---------
$4,721,578 $3,489,537
--------- ---------
--------- ---------
Deferred tax liabilities--
Difference between book and tax basis of property and equipment........................... $1,121,514 $ 544,745
Federal research and development tax credits.............................................. 320,064 168,491
--------- ---------
$1,441,578 $ 713,236
--------- ---------
--------- ---------
</TABLE>
The Company provides deferred taxes for research and development tax credits
earned in the current year, which are included in taxable income in the
subsequent year. In accordance with Canadian tax laws, stock issuance costs
are deductible over a five year period.
I-44
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
(11) INCOME TAXES (CONTINUED)
Income (loss) before income taxes and minority interest for the entities
incorporated in the following jurisdictions:
<TABLE>
<CAPTION>
YEARS ENDED
JULY 31, ELEVEN MONTHS
----------------------- ENDED JUNE 30,
1995 1996 1997
---------- ----------- --------------
<S> <C> <C> <C>
Canada................................................................... $10,755,706 $(2,470,805) $6,110,923
United States............................................................ 3,359,166 (12,587,746) 1,486,294
United Kingdom........................................................... (350,429) (5,191,695) (320,982)
European and Other....................................................... (474,426) (22,456,100) (7,542,867)
---------- ----------- --------------
$13,290,017 $(42,706,346) $ (266,632)
---------- ----------- --------------
---------- ----------- --------------
</TABLE>
The income tax provision is composed of the following:
<TABLE>
<CAPTION>
YEARS ENDED
JULY 31, ELEVEN MONTHS
--------------------- ENDED JUNE 30,
1995 1996 1997
--------- ---------- --------------
<S> <C> <C> <C>
Current --
Federal.................................................................. $2,381,427 $2,060,380 $ 3,641,996
Provincial............................................................... 665,254 375,087 930,323
Foreign.................................................................. 1,791,004 1,072,157 1,979,000
--------- ---------- --------------
4,837,685 3,507,624 6,551,319
--------- ---------- --------------
Deferred --
Federal.................................................................. 647,247 (1,373,684) 229,580
Provincial............................................................... 268,656 (228,379) 190,996
Foreign.................................................................. (263,391) (470,726) (482,552)
--------- ---------- --------------
652,512 (2,072,789) (61,976)
--------- ---------- --------------
Total provision........................................................ $5,490,197 $1,434,835 $ 6,489,343
--------- ---------- --------------
--------- ---------- --------------
</TABLE>
The reconciliation between the Canadian federal statutory income tax rate
and the effective tax rate is as follows:
<TABLE>
<CAPTION>
YEARS ENDED
JULY 31, ELEVEN MONTHS
---------------------- ENDED JUNE 30,
1995 1996 1997
----- --------- ---------------
<S> <C> <C> <C>
Provision (benefit) at the Canadian federal statutory rate............................ 38.0% (38.0)% (38.0)%
Foreign taxes......................................................................... 3.3 17.2 122.1
Effect of not utilizing foreign subsidiaries' tax losses.............................. 0.9 16.0 320.2
Effect of basis differences not benefited............................................. -- 3.0 2,323.1
Provincial taxes, net of federal tax abatements....................................... (1.0) 0.2 72.3
Canadian federal incentives for manufacturers and small business...................... (2.8) 0.2 0.0
Utilization of net operating loss carrybacks.......................................... -- -- (361.2)
Other items........................................................................... 2.9 4.8 (4.7)
--- --------- -------
Tax provision....................................................................... 41.3% 3.4% 2,433.8%
--- --------- -------
--- --------- -------
</TABLE>
The Company has $15,150,000 of cumulative foreign net operating loss
carryforwards which may be available to reduce future income tax liabilities
in those jurisdictions. The loss carryforwards will expire beginning June
30, 2001.
The Company has recorded a valuation allowance against certain deferred tax
assets including the tax benefit of certain foreign net operating loss
carryforwards as the tax benefits do not meet the recognition criteria set
forth in SFAS 109 due to the uncertainty of realizability.
These net operating loss carryforwards are subject to review and adjustment
by the respective tax authorities and may be limited in certain cases upon a
significant ownership change of the corporation, as defined.
I-45
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
(12) COMMITMENTS AND CONTINGENCIES
(A) LEASE COMMITMENTS
The Company has both operating and capital lease commitments for certain
facilities and equipment which expire, at various dates, through June 2007.
The following schedule outlines the future minimum rental payments under
these leases at June 30, 1997:
<TABLE>
<CAPTION>
OPERATING
YEAR ENDED JUNE 30, LEASES
- ------------------------------------------------------------------------------------------------------- ----------
<S> <C>
1998................................................................................................. $2,077,806
1999................................................................................................. 1,499,624
2000................................................................................................. 1,323,663
2001................................................................................................. 1,279,458
2002 and thereafter.................................................................................. 6,083,483
----------
Total minimum lease payments......................................................................... $12,264,034
----------
</TABLE>
The above commitments include leases for locations which the Company plans
to close under the restructuring plan (see Note 17).
Rental expenses related to the operating leases were approximately $917,000,
$1,348,000 and $1,600,000 for the years ended July 31, 1995 and 1996 and the
eleven month period ended June 30, 1997 respectively. Included in the
minimum lease payment commitment is approximately CDN $12,950,824
(approximately $9,407,478 at June 30, 1997) representing future payment due
to a related party from which the Company leases office space in Montreal.
(B) LETTERS OF GUARANTEE
The Company has provided letters of guarantee in the amount of $485,178 and
$328,753 as of July 31, 1996 and June 30, 1997, respectively.
(13) FINANCIAL INFORMATION BY GEOGRAPHIC AREA
The Company operates in one industry segment primarily digital image
processing solution systems for creating, editing and compositing special
visual effects for film and video, including training and other services
incidental to these products.
Revenues by geographic destination and as a percentage of total revenues are
as follows:
<TABLE>
<CAPTION>
YEARS ENDED JULY 31, ELEVEN MONTHS
GEOGRAPHIC AREA ---------------------- ENDED JUNE 30,
BY DESTINATION 1995 1996 1997
- -------------------------------------------------------------------------- ---------- ---------- --------------
<S> <C> <C> <C>
North America............................................................. $35,515,336 $36,286,073 $ 43,752,904
Europe.................................................................... 20,706,850 35,774,418 36,839,458
Pacific Rim............................................................... 6,414,711 8,717,015 15,396,131
Other..................................................................... 1,911,714 3,219,941 5,935,438
---------- ---------- --------------
$64,548,611 $83,997,447 $101,923,931
---------- ---------- --------------
---------- ---------- --------------
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED
JULY 31, ELEVEN MONTHS
GEOGRAPHIC AREA -------------------- ENDED JUNE 30,
BY DESTINATION 1995 1996 1997
- ------------------------------------------------------------------------------------- --------- --------- -----------------
<S> <C> <C> <C>
North America........................................................................ 55.0% 43.2% 42.9%
Europe............................................................................... 32.1 42.6 36.1
Pacific Rim.......................................................................... 9.9 10.4 15.2
Other................................................................................ 3.0 3.8 5.8
--------- --------- -----
100.0% 100.0% 100.0%
--------- --------- -----
--------- --------- -----
</TABLE>
I-46
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
(13) FINANCIAL INFORMATION BY GEOGRAPHIC AREA (CONTINUED)
Revenues, net income and identifiable assets for the Company's Canadian,
U.S., U.K., German, French and other operations are as follows:
Intercompany transfers between geographic areas are at prices that
approximate arm's length transactions. Expenses incurred in one geographic
area that benefit other areas have been allocated based upon services
utilized.
<TABLE>
<CAPTION>
CANADA U.S. U.K. FRANCE GERMANY OTHER ELIMINATIONS CONSOLIDATED
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1995 --
Revenues......... $12,878,575 $31,794,924 $10,089,329 $6,675,916 $3,109,867 $ -- $ -- $64,548,611
Transfers between
geographic
locations...... 11,747,606 15,902,851 -- -- -- -- (27,650,457) --
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
Total
revenues..... $24,626,181 $47,697,775 $10,089,329 $6,675,916 $3,109,867 $ -- $(27,650,457) $64,548,611
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
Net income
(loss)......... $ 6,778,399 $ 4,167,891 $ (296,320) $ (629,786) $ (17,849) $ -- $ (2,217,240) $7,785,095
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
Identifiable
assets......... $58,693,038 $20,818,430 $9,205,168 $2,687,565 $2,756,008 $ 2,208,173 $(19,510,207) $76,858,175
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
1996 --
Revenues......... $ 8,339,345 $33,090,335 $17,309,369 $7,696,297 $12,307,428 $ 5,254,673 $ 97 $83,997,447
Transfers between
geographic
locations...... 20,211,614 29,090,504 -- -- -- 9,007,939 (58,310,057) --
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
Total revenues... $28,550,959 $62,180,839 $17,309,369 $7,696,297 $12,307,428 $14,262,612 $(58,310,057) $83,997,447
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
Net income
(loss)......... $(1,398,871) $(11,532,447) $(5,210,577) $(2,409,595) $ (797,282) $(19,528,169) $ (3,264,240) ($44,141,181)
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
Identifiable
assets......... $103,117,776 $48,995,740 $20,411,397 $6,583,316 $5,937,355 $21,037,113 $(125,934,955) $80,147,742
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
1997 --
Revenues......... $ 5,872,359 $42,135,249 $16,596,218 $10,298,958 $12,388,084 $14,633,063 $ -- 1$01,923,931
Transfers between
geographic
locations........ 28,279,123 16,531,229 3,293,329 1,539,298 -- 5,483,484 (55,126,463) --
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
Total revenues... $34,151,482 $58,666,478 $19,889,547 $11,838,256 $12,388,084 $20,116,547 $(55,126,463) 1$01,923,931
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
Net income
(loss)......... $ 1,199,545 $ 707,540 $ (504,001) $ 841,043 $ 274,412 $(9,046,246) $ (228,268) $(6,755,975)
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
Identifiable
assets........... $148,151,830 $48,967,084 $21,762,860 $8,196,759 $6,107,907 $25,332,305 $(162,574,046) $95,944,699
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
----------- ----------- ---------- ---------- ---------- ----------- ------------ ------------
</TABLE>
"Other" includes the revenues, net income(loss) and identifiable assets of
the Company's Asian and less significant European subsidiaries.
Export sales from Canada were $10,601,744, $5,788,925, and $3,708,757 for
the fiscal years ended July 31, 1995 and 1996, and the eleven month period
ended June 30, 1997, respectively.
(14) DEPENDENCE ON KEY SUPPLIER
The Company is dependent on Silicon Graphics, Inc. ("SGI") to manufacture
and supply a large proportion of the workstations and certain peripherals
used in the Company's systems.
(15) ACQUISITIONS
(A) BRUGHETTI CORPORATION
On May 26, 1995, the Company acquired substantially all the technology and
other assets of Brughetti Corporation ("Brughetti"), a Canadian corporation.
The purchase price was CDN$1,000,000 (or approximately $741,000) in cash of
which CDN$600,000 (or approximately $441,000) was paid upon closing of the
acquisition and CDN$400,000 (or approximately $300,000) was paid in July
1995. In addition, the Company has agreed to pay up to an additional
$5,500,000 as a contingent purchase price payable in cash or securities
I-47
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
(15) ACQUISITIONS (CONTINUED)
of the Company, at the sole option of the Company. The contingent purchase
price is payable in three annual installments, beginning October 1996, and
is based upon a percentage of the amount by which revenues derived from
future sales of products and technologies purchased from Brughetti exceed
certain minimum annual revenues. In the event that the revenues, as defined,
exceed certain minimum annual revenue levels in fiscal 1996, 1997 and 1998,
the contingent consideration payable would be up to $1,500,000, $2,000,000
and $2,000,000 for fiscal 1996, 1997 and 1998, respectively. If the minimum
annual revenue levels for any fiscal year are not reached, no payments are
due for that year, provided, however, that the second and third payments are
subject to upward adjustment in the event that the initial revenue
thresholds are not met but revenue thresholds related to the subsequent
fiscal years are exceeded. In no event, however, will the contingent
consideration payable exceed an aggregate of $5,500,000. The Company did not
meet the minimum revenue levels for fiscal 1996 or the eleven month period
ended June 30, 1997 and no additional payment is currently due. The
acquisition was accounted for as a purchase and accordingly the initial
purchase price and acquisition costs were allocated to the assets acquired
which consisted of approximately $102,000 of accounts receivable, $105,000
of property and equipment and $534,000 of acquired technology. In addition,
in accordance with APB No. 16, additional consideration paid upon the
achievement of the performance criteria, if any, will be recorded as an
additional purchase price at such time, allocated to acquired technology and
amortized over the remaining estimated useful life.
Under the restructuring plan, the Company has discontinued the development
of the Brughetti products. Accordingly, the unamortized value of the
acquired technology was written off.
(B) COSS/IMP
On October 24, 1995, the Company acquired all of the outstanding shares of
Computer-und Serviceverwaltungs AG, located in Innsbruck, Austria ("COSS")
and certain assets of IMP Innovative Medientechnik-und Planungs-GmbH,
located in Geltendorf/ Kaltenberg, Germany ("IMP") related to the research,
development, manufacturing, marketing, sale, distribution or procurement of
real-time broadcast animation products, including software. The purchase
price for the shares of COSS was $3,000,000 in cash plus 300,000 common
shares of the Company. In addition, the Company agreed to pay an additional
$500,000 in cash as a contingent purchase price in the event COSS received
orders for and licensed a certain number of VAPOUR systems by April 1996, as
defined. The purchase price for the IMP assets was $2,000,000 in cash.
During fiscal 1996, the Company paid the contingent purchase price, which
was accounted for as an additional purchase price and allocated to goodwill.
The acquisition was accounted for as a purchase and accordingly the purchase
price and acquisition costs were allocated to the assets acquired which
consisted of approximately $8,500,000 of in process research and development
and charged to operations in the first quarter of fiscal 1996, and
approximately $3,200,000 was allocated to intangible assets, which include
goodwill and acquired technology, and is being amortized on a straight-line
basis over their estimated lives of 5 years. These allocations represent the
fair values determined by an independent appraisal. The appraisal
incorporated proven valuation procedures and techniques in determining the
fair value of each intangible asset. The amount allocated to in process
research and development relates to projects that had not yet reached
technological feasibility and that, until completion of the development, had
no alternative use. These projects required substantial high risk
development and testing by the Company prior to reaching technological
feasibility.
Under the restructuring plan, the Company has transitioned the technology
and the related research and development operations from Innsbruck, Austria
to Montreal, Canada. Accordingly, the unamortized balance of goodwill of
approximately $1.8 million was charged to restructuring expense.
(C) ESSENTIAL COMMUNICATIONS CORPORATION
On April 15, 1996, the Company purchased newly issued Series B convertible,
voting, preferred shares of a privately held company, Essential
Communications Corporation, representing approximately 20% of the voting
shares. The $2,500,000 investment has been charged to operations in fiscal
1996 as research and development expense due to the uncertainty regarding
the realizability of the investment in the preferred shares. Pro forma
presentation has not been included as it is not deemed to be meaningful or
material.
(D) DENIM SOFTWARE
On June 12, 1997, the Company, through its wholly-owned subsidiary 3380491
Canada Inc. ("Acquisition Sub"), acquired substantially all of the assets
and assumed certain liabilities of Denim Software L.L.C., a Delaware limited
liability company ("Denim"), pursuant to the terms of an Asset Purchase
Agreement dated as of June 12, 1997 among Acquisition Sub, Denim, Sam
Khulusi, Frank Khulusi, Westco Denim Investments Group, Ltd., a California
limited partnership, and Frank Khulusi Family Limited Partnership, a
California limited partnership. The purchased assets consist primarily of
Denim software products, including ILLUMINAIRE Paint, ILLUMINAIRE
Composition and ILLUMINAIRE Studio and related know-how and goodwill.
The aggregate purchase price for the assets was comprised of (i)
approximately $9,126,000 in cash, (ii) the assumption of certain enumerated
liabilities in an amount equal to no more than approximately $2,209,000 in
the aggregate, and (iii) the assumption of
I-48
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
(15) ACQUISITIONS (CONTINUED)
certain on-going obligations under certain existing contracts of Denim. At
closing, cash consideration, of approximately $9,126,000 and certain
liabilities, of approximately $655,000, were paid. The cash used by the
Company to fund the acquisition was derived primarily from operations. The
transaction has been accounted for using the purchase method. The Company
incurred a one-time charge of $9,800,000 based on an independent appraisal,
or $0.35 per share, for in-process research and development, purchased and
expensed in the eleven month period ended June 30, 1997. Goodwill, in the
amount of $315,000, has been recorded and is included in other assets in the
consolidated balance sheet.
(E) D-VISION SYSTEMS
On July 15, 1997, the Company acquired all of the outstanding shares of
capital stock of D-Vision Systems, Inc. ("D-Vision"), an Illinois
corporation, pursuant to a Stock Purchase Agreement dated as of July 10,
1997 among the Company, D-Vision, the former stockholders of D-Vision (the
"Selling Stockholders") and certain other individuals (the "D-Vision
Acquisition"). As a result of the D-Vision Acquisition, the Company acquired
the D-Vision OnLINE and PRO software products for non-linear video and
digital media editing solutions including related know-how and goodwill. The
purchase price was paid in a combination of 555,000 newly issued Discreet
Logic common shares and approximately $10,750,000 in cash. In addition,
approximately $4,000,000 of the cash consideration is being held in escrow
until September 30, 1999, subject to (i) earlier release from escrow of up
to $1,900,000 on September 30, 1998 and (ii) the resolution of any
indemnification claims made by the Company pursuant to the Stock Purchase
Agreement. The cash used by the Company to fund the acquisition was derived
primarily from cash flow from operations. The D-Vision Acquisition was
accounted for as a purchase. A substantial portion of the purchase price,
net liabilities of D-Vision and transaction costs was allocated to purchased
in-process research and development for which the Company expects to incur a
one-time charge against earnings in the range of $20,000,000 to $21,000,000,
or $0.70 to $0.73 per share, in the quarter ending September 30, 1997 based
on an independent appraisal.
The following presents, on an unaudited basis, certain items of the
Company's result of operations, for the eleven month period ended June 30,
1997, as though the acquisition and related transactions discussed above had
occurred on August 1, 1996:
<TABLE>
<S> <C>
Net sales......................................................... $106,326,000
Operating loss.................................................... $ 8,590,000
Net loss.......................................................... $13,619,000
</TABLE>
(16) PURCHASE OF LAND AND FACILITIES
In August 1995, the Company purchased land and an office building in London,
England for approximately L1,148,000 (or approximately $1,788,000 at June
30, 1997). Additionally, in December 1995, the Company purchased land and a
building in Montreal for CDN$1,730,000 (or approximately $1,250,000 at June
30, 1997). During fiscal 1996, the carrying value of the London and Montreal
buildings were written down to their estimated fair market values and these
buildings are classified as assets held for resale. In September 1997, the
Company entered into an agreement to sell the Montreal office building for a
price not materially different from its carrying value.
(17) RESTRUCTURING
During the fiscal year ended July 31, 1996, the Company recorded a pre-tax
restructuring charge of $15 million to cover the direct costs of
restructuring the Company's operations and to bring operating expenses in
line with the Company's current revenue level. The focus of the Company's
restructuring plan was to solidify its senior management team, reduce
operating expenses through workforce reductions and office closings,
consolidate research and development activities in Montreal, discontinue
certain product lines, and restructure its sales force to emphasize indirect
sales channels. The Company began implementation of its restructuring plan
in the fourth fiscal quarter of 1996 and had substantially completed the
implementation of the plan at the end of fiscal 1997. The major aspects of
the restructuring plan and remaining amounts in accrued liabilities are
discussed below. There can be no assurance that management will be
successful in implementing the restructuring plan or that the Company will
not take on further restructurings or be profitable in the future.
Furthermore, the implementation of the restructuring plan may cause
diversion of management's time and resources and may result in other
unforeseen disruptions and unexpected expenses.
The restructuring entailed the closing and moving of several offices in
North America and Europe. It also included the termination of approximately
110 positions across all departments and around the world.
I-49
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(AMOUNTS IN U.S. DOLLARS)
(17) RESTRUCTURING (CONTINUED)
The components of the restructuring charge are as follows:
<TABLE>
<S> <C>
Asset write down....................................................................................... $6,190,000
Lease terminations and leasehold improvements reserve.................................................. 4,600,000
Severance.............................................................................................. 2,800,000
Professional services and other........................................................................ 1,410,000
----------
$15,000,000
----------
----------
</TABLE>
The primary component of the asset write down is an amount of $2.2 million
for goodwill and acquired technology. The other components of the write down
are primarily fixed assets which have no future use.
The following reflects the remaining accrued restructuring expense as of
July 31, 1996 and June 30, 1997, by major component:
<TABLE>
<CAPTION>
JULY 31,
1996 JUNE 30, 1997
------------ -------------
<S> <C> <C>
Asset Write Down.................................................................. $1,769,000 $ 500,000
Lease Terminations and Leasehold Improvements Reserve............................. 3,528,000 2,663,000
Severance......................................................................... 2,218,000 450,000
Professional Services and Other................................................... 1,119,000 659,000
------------ -------------
$8,634,000 $ 4,272,000
------------ -------------
------------ -------------
</TABLE>
(18) CHANGE IN YEAR END COMPARATIVE RESULTS
Selected unaudited estimated results for the eleven month period ended June
30, 1996 were approximately as follows:
<TABLE>
<S> <C>
Revenues.............................................................................................. $73,000,000
Gross profit.......................................................................................... 31,176,000
Provision for income taxes............................................................................ 1,435,000
Net loss.............................................................................................. (43,310,000)
</TABLE>
I-50
<PAGE>
REPORT OF INDEPENDENT CHARTERED ACCOUNTANTS
ON SCHEDULE
To Discreet Logic Inc.:
We have audited in accordance with generally accepted auditing standards in
Canada, which are in substantial agreement with those in the United States of
America, the consolidated financial statements of Discreet Logic Inc. and
subsidiaries as of July 31, 1996 and June 30, 1997 and the two years in the
period ended July 31, 1996 and the eleven month period ended June 30, 1997
included in this 10-K. Our audits were made for the purpose of forming an
opinion on the basic financial statements taken as a whole. The schedule listed
in Item 16 is the responsibility of the Company's management and is presented
for the purposes of complying with the Securities and Exchange Commission's
rules and is not part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in the audits of the basic
financial statements and, in our opinion, fairly states in all material respects
the financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.
Montreal, Canada
August 12, 1997
ARTHUR ANDERSEN & CIE
Chartered Accountants
I-51
<PAGE>
SCHEDULE II
DISCREET LOGIC INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
DESCRIPTION OF PERIOD EXPENSES WRITE-OFFS PERIOD
- ---------------------------------------------------------------------- ---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS
July 31, 1995....................................................... 70,000 361,000 -- 431,000
July 31, 1996....................................................... 431,000 3,307,000 89,000 3,649,000
June 30, 1997....................................................... 3,649,000 -- 162,000 3,487,000
</TABLE>
I-52
<PAGE>
SCHEDULE J
SECTION 185 OF THE BUSINESS CORPORATIONS ACT (ONTARIO)
185. (1) RIGHTS OF DISSENTING SHAREHOLDERS. -- Subject to subsection (3) and to
section 186 and 248, if a corporation resolves to,
(a) amend its articles under section 168 to add, remove or change
restrictions on the issue, transfer or ownership of shares of a class
or series of the shares of the corporation;
(b) amend its articles under section 168 to add, remove or change any
restriction upon the business or businesses that the corporation may
carry on or upon the powers that the corporation may exercise;
(c) amalgamate with another corporation under section 175 and 176;
(d) be continued under the laws of another jurisdiction under section
181; or
(e) sell, lease or exchange all or substantially all its property under
subsection 184(3), a holder of shares of any class or series entitled
to vote on the resolution may dissent.
(2) IDEM. -- If a corporation resolves to amend its articles in a manner
referred to in subsection 170(1), a holder of shares of any class or
series entitled to vote on the amendment under section 168 or 170 may
dissent, except in respect of an amendment referred to in,
(a) clause 170(1)(a), (b) or (e) where the articles provide that the
holders of shares of such class or series are not entitled to
dissent; or
(b) subsection 170(5) or (6).
(3) EXCEPTION. -- A shareholder of a corporation incorporated before the
29th day of July, 1983 is not entitled to dissent under this section in
respect of an amendment of the articles of the corporation to the extent
that the amendment,
(a) amends the express terms of any provision of the articles of the
corporation to conform to the terms of the provision as deemed to be
amended by section 277; or
(b) deleted for the articles of the corporation all of the objects of the
corporation set out in its articles, provided that the deletion is
made by the 29th day of July, 1986.
(4) SHAREHOLDER'S RIGHT TO BE PAID FAIR VALUE. -- In addition to any other
right the shareholder may have, but subject to subsection (30), a
shareholder who complies with this section is entitled, when the action
approved by the resolution from which the shareholder dissents becomes
effective, to be paid by the corporation the fair value of the shares
held by the shareholder in respect of which the shareholder dissents,
determined as of the close of business on the day before the resolution
was adopted.
(5) NO PARTIAL DISSENT. -- A dissenting shareholder may only claim under
this section with respect to all the shares of a class held by the
dissenting shareholder on behalf of any one beneficial owner and
registered in the name of the dissenting shareholder.
(6) OBJECTION. -- A dissenting shareholder shall send to the corporation, at
or before any meeting of shareholders at which a resolution referred to
in subsection (1) or (2) is to be voted on, a written objection to the
resolution, unless the corporation did not give notice to the shareholder
of the purpose of the meeting or of the shareholder's right to dissent.
(7) IDEM. -- The execution or exercise of a proxy does not constitute a
written objection for purposes of subsection (6).
(8) NOTICE OF ADOPTION OF RESOLUTION. -- The corporation shall, within ten
days after the shareholders adopt the resolution, send to each
shareholder who has filed the objection referred to in subsection (6)
notice that the resolution has been adopted, but such notice is not
required to be sent to any shareholder who voted for the resolution or
who has withdrawn the objection.
J-1
<PAGE>
(9) IDEM. -- A notice sent under subsection (8) shall set out the rights of
the dissenting shareholder and the procedures to be followed to exercise
those rights.
(10) DEMAND FOR PAYMENT OF FAIR VALUE. -- A dissenting shareholder entitled
to receive notice under subsection (8) shall, within twenty days after
receiving such notice, or, if the shareholder does not receive such
notice, within twenty days after learning that the resolution has been
adopted, send to the corporation a written notice containing,
(a) the shareholder's name and address;
(b) the number and class of shares in respect of which the shareholder
dissents; and
(c) a demand for payment of the fair value of such shares.
(11) CERTIFICATES TO BE SENT IN. -- Not later than the thirtieth day after
the sending of a notice under subsection (10), a dissenting shareholder
shall send the certificates representing the shares in respect of which
the shareholder dissents to the corporation or its transfer agent.
(12) IDEM. -- A dissenting shareholder who fails to comply with subsections
(6), (10) and (11) has no right to make a claim under this section.
(13) ENDORSEMENT ON CERTIFICATE. -- A corporation or its transfer agent
shall endorse on any share certificate received under subsection (11) a
notice that the holder is a dissenting shareholder under this section and
shall return forthwith the share certificates to the dissenting
shareholder.
(14) RIGHTS OF DISSENTING SHAREHOLDER. -- On sending a notice under
subsection (10), a dissenting shareholder ceases to have any rights as a
shareholder other than the right to be paid the fair value of the shares
as determined under this section except where,
(a) the dissenting shareholder withdraws notice before the corporation
makes an offer under subsection (15);
(b) the corporation fails to make an offer in accordance with subsection
(15) and the dissenting shareholder withdraws notice; or
(c) the directors revoke a resolution to amend the articles under
subsection 168(3), terminate an amalgamation agreement under
subsection 176(5) or an application for continuance under subsection
181(5), or abandon a sale, lease or exchange under subsection 184(8),
in which case the dissenting shareholder's rights are reinstated as
of the date the dissenting shareholder sent the notice referred to in
subsection (10), and the dissenting shareholder is entitled, upon
presentation and surrender to the corporation or its transfer agent
of any certificate representing the shares that has been endorsed in
accordance with subsection (13), to be issued a new certificate
representing the same number of shares as the certificate so
presented, without payment of any fee.
(15) OFFER TO PAY. -- A corporation shall, not later than seven days after
the later of the day on which the action approved by the resolution is
effective or the day the corporation received the notice referred to in
subsection (10), send to each dissenting shareholder who has sent such
notice,
(a) a written offer to pay for the dissenting shareholder's shares in an
amount considered by the directors of the corporation to be the fair
value thereof, accompanied by a statement showing how the fair value
was determined; or
(b) if subsection (3) applies, a notification that it is unable lawfully
to pay dissenting shareholders for their shares.
(16) IDEM. -- Every offer made under subsection (15) for shares of the same
class or series shall be on the same terms.
(17) IDEM. -- Subject to subsection (30), a corporation shall pay for the
shares of a dissenting shareholder within ten days after an offer made
under subsection (15) has been accepted, but any such offer lapses
J-2
<PAGE>
if the corporation does not receive an acceptance thereof within thirty
days after the offer has been made.
(18) APPLICATION TO COURT TO FIX FAIR VALUE. -- Where a corporation fails to
make an offer under subsection (15) or if a dissenting shareholder fails
to accept an offer, the corporation may, within fifty days after the
action approved by the resolution is effective or within such further
period as the court may allow, apply to the court to fix a fair value for
the shares of any dissenting shareholder.
(19) IDEM. -- If a corporation fails to apply to the court under subsection
(18), a dissenting shareholder may apply to the court for the same
purpose within a further period of twenty days or within such further
period as the court may allow.
(20) IDEM. -- A dissenting shareholder is not required to give security for
costs in an application made under subsection (18) or (19).
(21) COSTS. -- If a corporation fails to comply with subsection (15), then
the costs of a shareholder application under subsection (19) are to be
borne by the corporation unless the court otherwise orders.
(22) NOTICE TO SHAREHOLDERS. -- Before making application to the court under
subsection (18) or not later than seven days after receiving notice of an
application to the court under subsection (19), as the case may be, a
corporation shall give notice to each dissenting shareholder who at the
date upon which the notice is given,
(a) has sent to the corporation the notice referred to in subsection
(10); and
(b) has not accepted an offer made by the corporation under subsection
(15), if such an offer was made, of the date, place and consequences
of the application and of the dissenting shareholder's right to
appear and be heard in person or by counsel, and a similar notice
shall be given to each dissenting shareholder who, after the date of
such first mentioned notice and before termination of the proceedings
commenced by the application, satisfied the condition set out in
clauses (a) and (b) within three days after the dissenting
shareholder satisfies such conditions.
(23) PARTIES JOINED. -- All dissenting shareholders who satisfy the
conditions set out in clauses (22)(a) and (b) shall be deemed to be
joined as parties to an application under subsection (18) or (19) on the
later of the date upon which the application is brought and the date upon
which they satisfy the conditions, and shall be bound by the decision
rendered by the court in the proceedings commenced by the application.
(24) IDEM. -- Upon an application to the court under subsection (18) or
(19), the court may determine whether any other person is a dissenting
shareholder who should be joined as a party, and the court shall fix a
fair value for the shares of all dissenting shareholders.
(25) APPRAISERS. -- The court may in its discretion appoint one or more
appraisers to assist the court to fix a fair value for the shares of the
dissenting shareholders.
(26) FINAL ORDER. -- The final order of the court in the proceedings
commenced by an application under subsection (18) or (19) shall be
rendered against the corporation and in favour of each dissenting
shareholder who, whether before or after the date of the order, complies
with the conditions set out in clauses (22)(a) and (b).
(27) INTEREST. -- The court may in its discretion allow a reasonable rate of
interest on the amount payable to each dissenting shareholder from the
date the action approved by the resolution is effective until the date of
payment.
(28) WHERE CORPORATION UNABLE TO PAY. -- Where subsection (30) applies, the
corporation shall, within ten days after the pronouncement of an order
under subsection (26), notify each dissenting shareholder that is unable
lawfully to pay dissenting shareholders for their shares.
J-3
<PAGE>
(29) IDEM. -- Where subsection (30) applies, a dissenting shareholder, by
written notice sent to the corporation within thirty days after receiving
a notice under subsection (29), may,
(a) withdraw a notice of dissent, in which case the corporation is deemed
to consent to the withdrawal and the shareholder's full rights are
reinstated; or
(b) retain a status as a claimant against the corporation, to be paid as
soon as the corporation is lawfully able to do so or, in a
liquidation, to be ranked subordinate to the rights of creditors of
the corporation but in priority to its shareholders.
(30) IDEM. -- A corporation shall not make a payment to a dissenting
shareholder under this section if there are reasonable grounds for
believing that,
(a) the corporation is or, after the payment, would be unable to pay its
liabilities as they become due; or
(b) the realizable value of the corporation's assets would thereby be
less than the aggregate of its liabilities.
(31) COURT ORDER. -- Upon application by a corporation that proposes to take
any of the action referred to in subsection (1) or (2), the court may, if
a satisfied that the proposed action is not in all the circumstances one
that should give rise to rights arising under subsection (4), by order
declare that those rights will not arise upon the taking of the proposed
action, and the order may be subject to compliance upon such terms and
conditions as the court thinks fit and, if the corporation is an offering
corporation, notice of any such application and a copy of any order made
by the court upon such application shall be served upon the Commission.
(32) COMMISSION MAY APPEAR. -- The Commission may appoint counsel to assist
the court upon the hearing of an application under subsection (31), if
the corporation is an offering corporation.
J-4
<PAGE>
SCHEDULE K
Court File No. 98-CL-002503
ONTARIO COURT (GENERAL DIVISION)
COMMERCIAL LIST
<TABLE>
<S> <C>
THE HONOURABLE THURSDAY, THE 9TH
MR. JUSTICE LEDERMAN DAY OF APRIL, 1998
</TABLE>
IN THE MATTER OF the BUSINESS CORPORATIONS ACT (Ontario),
R.S.O. 1990, c. B. 16, s. 182, as amended
AND IN THE MATTER OF a plan of arrangement of MGI SOFTWARE
CORP.
ORDER
THIS MOTION, made by the Applicant MGI Software Corp. ("MGI") for advice and
directions of the Court in connection with an arrangement under section 182 of
the BUSINESS CORPORATIONS ACT (Ontario), R.S.O. 1990, c. B. 16, as amended (the
"OBCA"), was heard this day at Toronto, Ontario.
ON READING the Affidavit of Oren Asher, sworn April 8, 1998, (the
"Affidavit") and the exhibits thereto, and on hearing the submissions of counsel
for MGI,
1. THIS COURT ORDERS that MGI call, hold and conduct a special meeting (the
"Special Meeting") of the holders of its common shares (the "Common Shares")
to, among other things, consider and, if deemed advisable, to pass, with or
without variation, a special resolution (the "Arrangement Resolution") to
approve an arrangement (the "Arrangement") substantially in the form set
forth in the Plan of Arrangement attached as Exhibit 1 to Schedule "B" of
Exhibit 3 to the Affidavit.
2. THIS COURT ORDERS that the Special Meeting shall be called, held and
conducted in accordance with the OBCA, and the articles and by-laws of MGI,
subject to what may be provided hereafter and subject to any further order
of this Honourable Court.
3. THIS COURT ORDERS that MGI is authorized to make such amendments, revisions
or supplements to the Plan of Arrangement as it may determine, and the Plan
of Arrangement as so amended, revised or supplemented shall be the Plan of
Arrangement submitted to the Special Meeting and the subject of the
Arrangement Resolution.
4. THIS COURT ORDERS that MGI, if it deems it advisable, is specifically
authorized to adjourn or postpone the Special Meeting on one or more
occasions, without the necessity of first convening the Special Meeting or
first obtaining any vote of Shareholders respecting the adjournment or
postponement.
5. THIS COURT ORDERS that (i) the Notice of Application herein, (ii) the Notice
of the Meeting and (iii) a Management Information Circular of MGI in
substantially the same form as contained in Exhibit 3 to the Affidavit with
such amendments thereto as counsel for MGI may advise are necessary or
desirable, provided that such amendments are not inconsistent with the terms
of this Order, shall be distributed to the holders of Common Shares by
mailing the same by prepaid ordinary mail to such persons in accordance with
the OBCA at least twenty-one (21) days prior to the date of the Special
Meeting, excluding the date of the mailing and the date of the Special
Meeting, and such mailing shall constitute good and sufficient service of
notice of the Application, the Special Meeting and hearing in respect of the
Application.
6. THIS COURT ORDERS that the accidental omission to give notice of the Special
Meeting, or the non-receipt of such notice, shall not invalidate any
resolution passed or proceedings taken at the Special Meeting.
7. THIS COURT ORDERS that MGI is authorized to use the form of Proxy, in
substantially the same form as Exhibit 6 to the Affidavit, subject to MGI's
ability to insert dates and other relevant information in the final form of
Proxy. MGI is authorized, at its expense, to solicit Proxies, directly and
through its officers,
K-1
<PAGE>
directors and employees, and through such agents or representatives as it
may retain for that purpose, and by mail or such other forms of personal or
electronic communication as it may determine.
8. THIS COURT ORDERS that votes shall be taken at the Special Meeting on the
basis of one (1) vote per common share of MGI. Subject to further Order of
this court, the vote required to pass the Arrangement Resolution shall be
the affirmative vote of not less than two-thirds of the votes cast (for this
purpose any spoiled votes, illegible votes, defective votes and abstentions
shall be deemed not to be votes cast) by the holders of Common Shares
present in person or represented by proxy at the meeting.
9. THIS COURT ORDERS that the only persons entitled to notice of or to attend
the Special Meeting shall be the holders of Common Shares as at the record
date for the Special Meeting, MGI's directors and auditors, and
representatives of Discreet and that the only persons entitled to be
represented and to vote at the Special Meeting shall be the holders of
record of Common Shares as at the record date for the Special Meeting
subject to the provisions of the OBCA with respect to persons who become
registered holders of shares after that date.
10. THIS COURT ORDERS that all holders of Common Shares shall be entitled to
exercise rights of dissent and appraisal, in accordance with and in
compliance with Section 185 of the OBCA, as amended, and the Plan of
Arrangement and to seek fair value for their Common Shares, provided they
provide MGI with written objection to the Arrangement at or before the
Special Meeting and otherwise comply with section 185 of the OBCA, as
amended, and the Plan of Arrangement.
11. THIS COURT ORDERS that upon approval by the holders of Common Shares of the
Arrangement in the manner set forth in this Order, MGI may apply to this
Honourable Court for approval of the Arrangement and that service of the
Notice of Application herein, in accordance with paragraph 5 of this Order,
shall constitute good and sufficient service of such Notice of Application
pursuant to this Order and no other form of service need be made and no
other material need be served on such persons in respect of these
proceedings, and such service shall be effective on the fifth day after the
Notice of Application is mailed.
12. THIS COURT ORDERS that the only persons entitled to notice of any further
proceedings herein, including any hearing to sanction and approve the Plan,
and to appear and to be heard thereon, shall be only: (a) the Applicant; (b)
solicitors for Discreet and the Discreet Subsidiary and (c) persons who have
filed an appearance herein in accordance with the RULES OF CIVIL PROCEDURE.
13. THIS COURT ORDERS that, to the extent of any inconsistency or discrepancy
with respect to the matters determined in this Order, between this Order and
the terms of any instrument creating or governing or collateral to the
common shares of the Company or to which the common shares of the Company
are collateral, or to the articles and/or by-laws of the Company, this Order
shall govern.
14. THIS COURT ORDERS that any notice of appearance served in response to the
Notice of Application shall be served on counsel for MGI at the following
address: Osler, Hoskin & Harcourt, P.O. Box 50, 1 First Canadian Place,
Toronto, Ontario, M5X 1B8, Attention: Laura K. Fric.
(Signed) Lederman, J.
K-2
<PAGE>
EXHIBIT 99.2
UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS
AS AT DECEMBER 31, 1997
The following unaudited pro forma combined condensed financial statements assume
a business combination between Discreet and MGI accounted for on a pooling of
interests basis and are based on the respective historical financial statements
and the notes thereto of Discreet, which are incorporated by reference, and MGI,
which are included herein. The pro forma combined condensed balance sheet
combines Discreet's December 31, 1997 unaudited consolidated balance sheet with
MGI's January 31, 1998 audited balance sheet. The pro forma statements of
operations combine Discreet's unaudited historical operating results for the
six-month period ended December 31, 1997 with MGI's unaudited historical
operating results for the six-month period ended January 31, 1998.
For purposes of the preparation of the unaudited pro forma combined condensed
financial statements, no adjustments have been made to reflect the arrangement
related costs or any additional integration costs that could result from
combining the operations of Discreet and MGI.
The pro forma combined condensed financial statements are presented for
illustrative purposes only and are not necessarily indicative of the operating
results or financial position that would have been achieved if the Arrangement
had been consummated as of the beginning of the periods presented, nor are they
necessarily indicative of the future operating results or financial position of
the combined company. The pro forma combined condensed financial statements do
not give effect to any cost savings which may result from the integration of
Discreet's and MGI's operations.
These pro forma combined condensed financial statements are based on and should
be read in conjunction with, the historical consolidated financial statements
and the related notes of Discreet, incorporated by reference, and the historical
financial statements and the related notes of MGI included herein.
<PAGE>
UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET
AS AT DECEMBER 31, 1997 FOR DISCREET AND JANUARY 31, 1998 FOR MGI
(all amounts in thousands of U.S. Dollars)
<TABLE>
<CAPTION>
ASSETS DISCREET MGI PRO FORMA
Logic Inc. SOFTWARE Combined
Corp.
-------- -------- --------
<S> <C> <C> <C>
CURRENT ASSETS:
CASH AND CASH EQUIVALENTS $ 12,649 $ 1,205 $ 13,854
NOTE RECEIVABLE - 7,429 7,429
ACCOUNTS RECEIVABLE (LESS reserves for doubtful accounts) 29,559 3,322 32,881
INVENTORY
RESALE 9,725 375 10,100
DEMONSTRATION 4,073 - 4,073
OTHER CURRENT ASSETS 4,291 397 4,688
-------- -------- --------
60,297 12,728 73,025
PROPERTY AND EQUIPMENT - LESS Accumulated depreciation and
amortization 9,583 960 10,543
DEFERRED INCOME TAXES 2,467 - 2,467
OTHER ASSETS 7,344 - 7,344
ASSETS HELD FOR RESALE 4,241 - 4,241
-------- -------- --------
$ 83,932 $ 13,688 $ 97,620
-------- -------- --------
-------- -------- --------
LIABILITIES AND
SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
ACCOUNTS PAYABLE AND ACCRUED EXPENSES $ 36,824 $ 2,298 $ 39,122
DEFERRED REVENUE 5,740 - 5,740
INCOME TAXES PAYABLE 5,707 - 5,707
CUSTOMER DEPOSITS 426 - 426
-------- -------- --------
48,697 2,298 50,995
-------- -------- --------
DEFERRED INCOME TAXES 2,268 - 2,268
-------- -------- --------
SHAREHOLDERS' EQUITY:
PREFERRED SHARES - - -
COMMON SHARES 92,128 23,860 115,988
WARRANTS - 403 403
ACCUMULATED DEFICIT (56,951) (12,257) (69,208)
CUMULATIVE TRANSLATION adjustment (2,210) (616) (2,826)
-------- -------- --------
TOTAL SHAREHOLDERS' EQUITY 32,967 11,390 44,357
-------- -------- --------
$ 83,932 $ 13,688 $ 97,620
-------- -------- --------
-------- -------- --------
</TABLE>
See accompanying Notes to Unaudited Pro Forma Combined Condensed Financial
Statements.
<PAGE>
UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENTS OF OPERATIONS
FOR THE SIX-MONTH PERIOD ENDED DECEMBER 31, 1997 FOR DISCREET
AND THE SIX-MONTH PERIOD ENDED JANUARY 31, 1998 FOR MGI
(ALL AMOUNTS IN THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DISCREET MGI PRO FORMA
Logic Inc. SOFTWARE Combined
Corp.
-------- -------- --------
<S> <C> <C> <C>
Total revenues $ 75,673 $ 5,561 $ 81,234
Cost of revenues 30,827 1,171 31,998
-------- -------- --------
Gross profit 44,846 4,390 49,236
-------- -------- --------
Operating expenses :
Research and development (net of tax credits) 7,413 2,133 9,546
Sales and marketing 15,840 4,914 20,754
General and administrative 3,896 420 4,316
Charge for purchased research and development 26,800 - 26,800
-------- -------- --------
Total operating expenses 53,949 7,467 61,416
-------- -------- --------
Operating loss (9,103) (3,077) (12,180)
-------- -------- --------
Other income, net 663 120 783
-------- -------- --------
Loss before income taxes (8,440) (2,957) (11,397)
Provision for income taxes 5,872 - 5,872
-------- -------- --------
Net loss $(14,312) $ (2,957) $(17,269)
-------- -------- --------
-------- -------- --------
Loss Per share: $(0.50) $ (0.14) $ (0.54)
-------- -------- --------
-------- -------- --------
Weighted average common shares outstanding 28,746 20,851 32,124
-------- -------- --------
-------- -------- --------
</TABLE>
See accompanying Notes to Unaudited Pro Forma Combined Condensed Financial
Statements.
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS
1. The unaudited pro forma combined condensed financial statements of
Discreet and MGI give retroactive effect to the Arrangement which
Discreet currently intends to account for as a pooling of interests and,
as a result, such statements are presented as if the combining companies
had been combined for the period presented.
2. The pro forma combined net income per share is based on the combined
weighted average number of Discreet Common Shares and MGI Common Shares
for each period. This is based on the Exchange Ratio of 0.162 Discreet
Common Shares for each MGI Common Share as described in the Arrangement
Agreement.
3. The unaudited pro forma combined condensed financial statements combine
Discreet's December 31, 1997 unaudited balance sheet with MGI's January 31,
1998 audited balance sheet. The pro forma statements of operations combine
Discreet's unaudited historical operating results for the six-month period
ended December 31, 1997 with MGI's unaudited historical operating results
for the six-month period ended January 31, 1998.
4. The unaudited pro forma combined condensed financial statements do not
include adjustments to conform the accounting policies of MGI to those
followed by Discreet. The nature and extent of such adjustments, if any,
will be based upon further analysis and are not expected to be material.
5. Discreet and MGI estimate they will incur Arrangement related costs of
approximately $3 million, including investment advisory fees, regulatory
filing costs, legal and accounting expenses, and other transaction costs.
In addition, it is expected that as a result of the Arrangement, the
combined company will incur consolidation and integration expenses which
are not currently reasonably estimable. All of these costs and expenses
and any tax benefit relating to these costs and expenses have not been
reflected as a pro forma adjustment in the pro forma combined condensed
financial statements as of December 31, 1997.
6. Certain financial statement balances of MGI have been reclassified to
conform with the Discreet financial statement presentation.
<PAGE>
EXHIBIT 99.3
------------
MGI Software Corp.
FINANCIAL STATEMENTS
(EXPRESSED IN THOUSANDS OF U.S.
DOLLARS IN ACCORDANCE WITH
GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES IN THE UNITED
STATES OF AMERICA)
January 31, 1998 and 1997
<PAGE>
March 19, 1998
AUDITORS' REPORT
To the Directors of
MGI Software Corp.
We have audited the balance sheets of MGI SOFTWARE CORP. as at January 31, 1998
and 1997 and the statements of operations and deficit, changes in shareholders'
equity and cash flows for the years ended January 31, 1998 and 1997. These
financial statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing standards
in the United States of America. Those standards require that we plan and
perform an audit to obtain reasonable assurance whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation.
In our opinion, these financial statements present fairly, in all material
respects, the financial position of the company as at January 31, 1998 and 1997
and the results of its operations and the changes in its shareholders' equity
and in its cash flows for the years ended January 31, 1998 and 1997 in
accordance with generally accepted accounting principles in the United States of
America.
/s/ Price Waterhouse
CHARTERED ACCOUNTANTS
<PAGE>
MGI SOFTWARE CORP.
BALANCE SHEETS
(EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
<TABLE>
<CAPTION>
JANUARY 31
1998 1997
------------------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash $ 1,205 $3,276
Note receivable (NOTE 4) 7,429 -
Accounts receivable (NOTE 5) 3,322 2,010
Prepaids and other assets 381 228
Inventories (NOTE 6) 375 218
Investment tax credits receivable 16 126
------------------------
12,728 5,858
CAPITAL ASSETS (NOTE 7) 960 609
------------------------
$13,688 $6,467
------------------------
------------------------
LIABILITIES
CURRENT LIABILITIES
Accounts payable and accrued liabilities (NOTE 8) $ 2,298 $1,715
Due to related party - 56
------------------------
2,298 1,771
SHAREHOLDERS' EQUITY
CAPITAL STOCK (NOTE 9) 23,860 9,969
WARRANTS (NOTE 9(a)) 403 1,978
DEFICIT (12,257) (7,322)
CUMULATIVE TRANSLATION ADJUSTMENT (616) 71
------------------------
11,390 4,696
------------------------
$13,688 $6,467
------------------------
------------------------
</TABLE>
2
<PAGE>
MGI SOFTWARE CORP.
STATEMENTS OF OPERATIONS AND DEFICIT
(EXPRESSED IN THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31
1998 1997
--------------------------
<S> <C> <C>
PRODUCT REVENUE $ 9,541 $ 3,792
COST OF SALES 1,905 983
--------------------------
7,636 2,809
EXPENSES
Marketing and selling 8,292 3,348
Research and development (NOTE 10) 3,406 2,415
Administration 718 840
Amortization of capital assets 304 141
Reorganization costs (NOTE 2) - 235
--------------------------
12,720 6,979
--------------------------
LOSS FROM OPERATIONS (5,084) (4,170)
INTEREST INCOME 149 91
--------------------------
LOSS FOR THE YEAR (4,935) (4,079)
DEFICIT, BEGINNING OF YEAR (7,322) (3,243)
--------------------------
DEFICIT, END OF YEAR $(12,257) $(7,322)
--------------------------
--------------------------
BASIC AND FULLY DILUTED LOSS PER SHARE $ (0.25) $ (0.27)
--------------------------
--------------------------
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING 19,958,968 15,355,052
--------------------------
--------------------------
</TABLE>
<PAGE>
MGI SOFTWARE CORP.
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
<TABLE>
<CAPTION>
COMMON SHARES WARRANTS
------------------------------- --------------------------
NUMBER AMOUNT NUMBER AMOUNT
------------------------------------------------------------
------------------------------------------------------------
<S> <C> <C> <C> <C>
BALANCE, JANUARY 31, 1996 13,110,768 $ 4,339 - $ -
Common shares issued (NOTE 9)
On conversion of debentures 650,000 525 - -
Upon exercise of purchase warrants for cash 650,000 716 - -
Purchase of computer software, licences
and rights 471,429 1,033 - -
On conversion of special warrants 2,744,000 3,149 - -
On exercise of employee stock options 75,000 55 - -
On reorganization (NOTE 2) 206,433 152 - -
Warrants
Issued for cash - - 2,744,000 3,149
Issued as broker compensation warrants - - 137,200 -
Issued for cash - - 1,200,000 1,978
Converted into common shares - - (2,744,000) (3,149)
Loss for the year - - - -
Cumulative translation adjustment - - - -
------------------------------------------------------------
BALANCE, JANUARY 31, 1997 17,907,630 9,969 1,337,200 1,978
Common shares issued (NOTE 9)
For cash upon private placement 1,022,757 1,582 1,022,757 403
On conversion of special warrants 4,700,000 11,918 - -
On exercise of broker compensation warrants 137,200 246 - -
On exercise of employee stock options 196,125 145 - -
Warrants (NOTE 9)
Issued for cash - - 3,500,000 9,940
Issued as broker compensation warrants - - 175,000 -
Converted into common shares - - (4,700,000) (11,918)
Converted into common shares - - (137,200) -
Loss for the year - - - -
Cumulative translation adjustment - - - -
------------------------------------------------------------
BALANCE, JANUARY 31, 1998 23,963,712 $23,860 1,197,757 $ 403
------------------------------------------------------------
------------------------------------------------------------
<PAGE>
CUMULATIVE
TRANSLATION
ADJUSTMENT DEFICIT TOTAL
------------------------------------------------------------
------------------------------------------------------------
BALANCE, JANUARY 31, 1996 $ 4 $ (3,243) $ 1,100
Common shares issued (NOTE 9)
On conversion of debentures - - 525
Upon exercise of purchase warrants for cash - - 716
Purchase of computer software, licences
and rights - - 1,033
On conversion of special warrants - - 3,149
On exercise of employee stock options - - 55
Reorganization costs (NOTE 2) - - 152
Warrants
Issued for cash - - 3,149
Issued as broker compensation warrants - - -
Issued for cash - - 1,978
Converted into common shares - - (3,149)
Loss for the year - (4,079) (4,079)
Cumulative translation adjustment 67 - 67
------------------------------------------------------------
BALANCE, JANUARY 31, 1997 71 (7,322) 4,696
Common shares issued (NOTE 9)
For cash upon private placement - - 1,985
On conversion of special warrants - - 11,918
On exercise of broker compensation warrants - 246
On exercise of employee stock options - - 145
Warrants (NOTE 9)
Issued for cash - - 9,940
Issued as broker compensation warrants - - -
Converted into common shares (11,918)
Converted into common shares - - -
Loss for the year - (4,935) (4,935)
Cumulative translation adjustment (687) - (687)
------------------------------------------------------------
BALANCE, JANUARY 31, 1998 $ (616) $(12,257) $ 11,390
------------------------------------------------------------
------------------------------------------------------------
</TABLE>
3
<PAGE>
MGI SOFTWARE CORP.
STATEMENTS OF CASH FLOWS
(EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31
1998 1997
----------------------
----------------------
<S> <C> <C>
CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES
Loss for the year $(4,935) $(4,079)
Items not affecting cash
Amortization of capital assets 304 141
Reorganization costs - 152
Acquisition of computer software included in research
and development expenses (NOTE 15) - 1,033
Net change in noncash working capital amounts
relating to operations (NOTE 11) (1,120) (675)
----------------------
(5,751) (3,428)
----------------------
FINANCING ACTIVITIES
Issue of common shares, net of issue costs 11,913 3,920
Issue of warrants, net of issue costs 403 1,978
Retirement of debentures - (576)
----------------------
12,316 5,322
----------------------
INVESTING ACTIVITIES
Purchase of capital assets (655) (627)
Increase in note receivable (7,429) -
----------------------
(8,084) (627)
----------------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (552) 198
----------------------
INCREASE (DECREASE) IN CASH DURING THE YEAR (2,071) 1,465
CASH, BEGINNING OF YEAR 3,276 1,811
----------------------
CASH, END OF YEAR $1,205 $3,276
----------------------
----------------------
CASH CONSISTS OF
Cash $1,205 $ 516
Short-term deposits - 2,760
----------------------
$1,205 $3,276
----------------------
----------------------
</TABLE>
4
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
1 NATURE OF OPERATIONS
MGI Software Corp. (the "company") was incorporated on September
22, 1995 under the laws of the Province of Ontario, Canada, to
develop, market and support multimedia products in the digital
photography, video editing, three-dimensional graphics and page
layout markets of the personal computer software industry. The
company's products are primarily directed toward retail consumers
but are also suitable for small businesses, companies and
governments. To date, the company's primary markets have been
Europe, United States and Asia Pacific.
2 REORGANIZATION
Effective April 30, 1996, MGI Software Corp. ("MGI"), a private
company, amalgamated with Globex Biotechnologies Inc. ("Globex"),
a public company whose shares were traded on the Canadian Dealer
Network, and continued operations under the name of MGI Software
Corp. The amalgamation was effected pursuant to the provisions of
the Ontario Business Corporations Act and involved the issuance
of shares of the amalgamated company to the former shareholders
as follows: (a) 1 common share of the amalgamated company for
each 15 shares of Globex; and (b) 1 common share of the
amalgamated company for each common share of the predecessor MGI.
The amalgamation resulted in the shareholders of the predecessor
MGI holding 98.4% of the common shares of the amalgamated
company. Accordingly, the transaction has been recorded in these
accounts using the principles of purchase accounting whereby
predecessor MGI is considered to have acquired Globex in exchange
for shares. Prior to the amalgamation, Globex was inactive and
without assets and accordingly the substance of the amalgamation
is a capital reorganization of MGI. The consideration of
$152,000, attributed to the 206,433 common shares issued to the
shareholders of Globex (Note 9), liabilities assumed of $42,000
and legal costs incurred in the amount of $41,000, was charged to
the statement of operations in the amount of $235,000.
3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
These financial statements have been prepared in U.S. dollars and
in accordance with the accounting principles generally accepted
in the United States of America. The principal accounting
policies of the company are summarized as follows:
REVENUE RECOGNITION
Revenue from the sale of products is recognized at the time of
shipment to the customer net of discounts and allowances for
estimated future returns. Revenue from product sales includes
sales to distributors and original equipment manufacturers.
Where the company ships software to customers and has
insignificant post customer support obligations, revenue is
recognized upon shipment net of accruals for related costs.
5
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS continued
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
INVENTORIES
Inventories are valued at the lower of cost and net realizable
value. Cost is determined on the weighted average cost basis.
CAPITAL ASSETS
Capital assets are recorded at the lower of cost, net of
accumulated amortization, and net recoverable amount.
Amortization charges are calculated on the following bases using
the following annual rates:
Furniture and equipment 20% declining balance
Computer equipment 30% declining balance
Leasehold improvements over the remaining lease term
Computer software straight-line over 3 years
RESEARCH AND DEVELOPMENT
The company charges to operations software research and
development costs as incurred net of income tax credits from the
Canadian federal and Ontario provincial governments.
GOVERNMENT ASSISTANCE
Government assistance is available to the company through the
Industrial Research Assistance Program ("IRAP") and income tax
investment credits. IRAP funds qualified research and development
activities on preapproved projects. IRAP assistance is recorded
as a reduction of research and development expenses in the year
in which it is claimed.
The company is entitled to research and development incentives in
the form of income tax credits from the Canadian federal
government ("federal") and from the Province of Ontario
("provincial"). Federal income tax credits are received on
qualified Canadian research and development expenditures and
equipment purchases. Provincial income tax credits are received
on qualified research and development salaries in the Province of
Ontario. The federal and provincial income tax credits are earned
at 20% of qualified research and development expenditures.
Additionally, the federal credit may be limited to a credit
against income taxes payable.
Income tax investment credits are recorded in the year of
research and development expenditure where it is more likely than
not that the credits will be realized.
FOREIGN CURRENCY TRANSLATION
Monetary assets and liabilities denominated in foreign currencies
are translated into the functional currency, Canadian dollars, at
the exchange rate prevailing at the balance sheet date.
Nonmonetary assets and liabilities and transactions are
translated at exchange rates prevailing at the respective
transaction dates. Exchange gains and losses are included in the
statement of operations and deficit.
For the purpose of conversion from Canadian dollars into U.S.
dollars, assets and liabilities are translated at exchange rates
in effect at the balance sheet date. Revenue and expenses are
translated at average rates of exchange during the year.
Translation gains and losses are deferred as a separate component
of shareholders' equity.
6
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS continued
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
USE OF ESTIMATES
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amount of
assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements, and the
reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
INCOME TAXES
Income taxes are accounted for under Statement of Financial
Accounting Standards No. 109 "Accounting for Income Taxes." Under
this method, deferred tax assets and liabilities are determined
based on differences between the financial reporting and income
tax bases of assets and liabilities and are measured using the
enacted tax rates and laws. Valuation allowances are established,
when necessary, to reduce deferred tax assets when realization is
less likely than not.
FINANCIAL INSTRUMENTS
Financial instruments are initially recorded at historical cost.
If subsequent circumstances indicate that a decline in the fair
value of a financial asset is other than temporary, the financial
asset is written down to its fair value. Unless otherwise
indicated, the fair values of financial instruments approximate
their recorded amounts.
The fair values of cash on deposit with commercial banks, note
receivable, accounts receivable, and accounts payable and accrued
liabilities approximate recorded amounts because of the short
period to receipt or payment of cash.
CASH AND CASH EQUIVALENTS
Cash includes short-term highly liquid investments that are
readily convertible into cash and are near maturity.
4 NOTE RECEIVABLE
On January 8, 1998, the company purchased a commercial note from
a corporation in the amount of $7,429,000. This note, bearing
interest at a rate of 4.41% per annum, was repaid on February 5,
1998.
5 ACCOUNTS RECEIVABLE
<TABLE>
<CAPTION>
1998 1997
----------------------
<S> <C> <C>
Accounts receivable - trade $3,239 $1,923
Employee receivables 6 4
Other receivables 219 107
Allowance for doubtful accounts (142) (24)
----------------------
$3,322 $2,010
----------------------
----------------------
</TABLE>
7
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS continued
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
6 INVENTORIES
<TABLE>
<CAPTION>
1998 1997
---------------
---------------
<S> <C> <C>
Raw materials $271 $ 99
Finished products 104 119
---------------
$375 $218
---------------
---------------
</TABLE>
7 CAPITAL ASSETS
<TABLE>
<CAPTION>
1998
--------------------------
ACCUMULATED
COST AMORTIZATION NET
---------------------------
---------------------------
<S> <C> <C> <C>
Furniture and equipment $ 354 $ 79 $275
Computer equipment 765 221 544
Leasehold improvements 179 46 133
Computer software 134 126 8
--------------------------
$ 814 $472 $960
--------------------------
--------------------------
</TABLE>
<TABLE>
<CAPTION>
1997
------------------------
ACCUMULATED
COST AMORTIZATION NET
------------------------
------------------------
<S> <C> <C> <C>
Furniture and equipment $191 $ 31 $160
Computer equipment 367 76 291
Leasehold improvements 151 13 138
Computer software 105 85 20
------------------------
$814 $205 $609
------------------------
------------------------
</TABLE>
8
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS continued
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
8 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
<TABLE>
<CAPTION>
1998 1997
----------------
----------------
<S> <C> <C>
Accounts payable - trade $1,115 $1,038
Accrued liabilities 421 395
Accrued marketing and advertising 510 161
Accrued - trade 128 -
Other payables 90 84
Vacation pay accrual 34 37
----------------
$2,298 $1,715
----------------
----------------
</TABLE>
9 CAPITAL STOCK
<TABLE>
<CAPTION>
1998 1997
----------------------
----------------------
<S> <C> <C>
Authorized
An unlimited number of common shares
An unlimited number of Class A voting special shares
Issued
23,963,712 (1997 - 17,907,630) common shares $23,860 $9,969
----------------------
----------------------
</TABLE>
The common share transactions are as follows:
<TABLE>
<CAPTION>
1998 1997
-------------------------- --------------------------
NUMBER NUMBER
OF SHARES AMOUNT OF SHARES AMOUNT
-------------------------------------------------------
-------------------------------------------------------
<S> <C> <C> <C> <C>
Issued, beginning of year 17,907,630 $ 9,969 13,110,768 $4,339
Issued during the year
For cash upon private
placement (A) 1,022,757 1,582 - -
On conversion of
debentures (B) - - 650,000 525
Upon exercise of purchase
warrants for cash (B) - - 650,000 716
On reorganization (NOTE 2) - - 206,433 152
Purchase of computer software,
licences and rights (NOTE 15) - - 471,429 1,033
On conversion of special
warrants (C) 4,700,000 11,918 2,744,000 3,149
On exercise of broker
compensation warrants (C) 137,200 246 - -
On exercise of employee stock
options 196,125 145 75,000 55
-------------------------------------------------------
23,963,712 $23,860 17,907,630 $9,969
-------------------------------------------------------
-------------------------------------------------------
</TABLE>
9
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS continued
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
(a) On September 30, 1997, the company issued 1,022,757 common
shares for cash of $1,582,000 pursuant to the terms of a
subscription agreement. In addition, the same number of
common share purchase warrants were issued for an aggregate
consideration of $403,000. Each warrant entitles the holder
to purchase one common share of the company, subject to
adjustment, at the lower of: (i) $2.91 per common share and
(ii) the higher of the then current market price of the
common shares of the company and $2.36 per common share.
These common share purchase warrants expire on September 30,
2000. As at the year-end, all purchase warrants remained
outstanding.
(b) On October 21, 1995, the company issued $1,101,000 aggregate
principal amount of debentures, payable on demand, bearing
interest at 5.7% per annum, payable quarterly, in arrears.
The debentures were convertible at any time at the option of
the holder into units on the basis of one unit for each
$0.81 principal amount of debentures. Each unit consisted of
one share and one-half of one common share purchase warrant.
On February 26, 1996, the company retired an aggregate
principal amount of $576,000 of the debentures for cash and
the issuance of an additional one-half of one warrant upon
the exercise of the conversion rights attached to the
debentures. The value of these warrants was nominal. On
April 30, 1996, the remaining debentures in the amount of
$525,000 were converted into an aggregate of 650,000 common
shares and 650,000 warrants. Each warrant was convertible
into one common share for cash of $0.81. On June 4, 1996,
200,000 warrants were exercised and on December 31, 1996 all
remaining warrants were exercised.
(c) On May 15, 1996, the company issued 2,744,000 special
warrants at $1.28 each for net proceeds of $3,149,000 (net
of issue costs of $377,000). On August 19, 1996, the special
warrants were converted into 2,744,000 common shares without
additional consideration. As additional compensation, the
company issued 137,200 broker special warrants. Each broker
special warrant was converted into an option to purchase one
common share at a price of $1.84 per share. The options were
exercised and converted into 137,200 common shares.
On January 16, 1997, the company issued 1,200,000 special
warrants at $1.84 each for net proceeds of $1,978,000 (net
of issue costs of $232,000). On February 25, 1997, the
special warrants were converted into 1,200,000 common shares
without additional consideration.
On September 29, 1997, the company issued 3,500,000 special
warrants at $3.05 each for net proceeds of $9,940,000 (net
of issue costs of $735,000). On December 8, 1997, the
special warrants were converted into 3,500,000 common shares
without additional consideration. As additional
compensation, the company issued 175,000 broker special
warrants. Each broker special warrant was converted into a
compensation option to purchase one common share at a price
of $3.77 per share, expiring on December 29, 1998. All
compensation options remained outstanding as at January 31,
1998.
10
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS continued
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
(d) The company has an incentive plan under which 3,821,526
options to purchase common shares have been authorized to be
granted to its directors, officers and employees at the
discretion of the Board of Directors. Each option under the
incentive plan allows for the purchase of one common share
and expires not later than ten years from the date granted.
The option exercise price is set at amounts not less than
the fair market value at the date of grant. The options are
subject to various vesting requirements as outlined in the
plan.
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
NUMBER EXERCISABLE PRICE
--------------------------------
--------------------------------
<S> <C> <C> <C>
Options
Balance, January 31, 1996 2,262,000 391,000 $0.73
Granted at $0.73 - $2.57 567,000 1.72
Excercised (75,000) 0.73
Cancelled (31,000) 0.85
---------
Balance, January 31, 1997 2,723,000 997,500 0.93
Granted at $0.73 to $2.57 1,020,800 2.05
Excercised (196,125) 0.75
Cancelled (472,000) 1.25
---------
Balance, January 31, 1998 3,075,675 1,259,375 $1.26
---------
---------
</TABLE>
The company accounts for its stock option plans under APB
Opinion No. 25, "Accounting for Stock Issued to Employees."
In 1997, the company adopted SFAS No. 123, "Accounting for
Stock-based Compensation," for disclosure purposes. Under
these provisions, no compensation expense has been
recognized in the results of operations for its stock option
plans.
<TABLE>
<CAPTION>
WEIGHTED WEIGHTED
AVERAGE WEIGHTED NUMBER AVERAGE
NUMBER EXERCISE AVERAGE EXERCISABLE EXERCISE
RANGE OF OUTSTANDING AT PRICE OF REMAINING AT PRICE OF
EXERCISE JANUARY 31 OUTSTANDING LIFE JANUARY 31 EXERCISABLE
PRICES 1998 OPTIONS (years) 1998 OPTIONS
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$0.73 1,849,250 $0.73 3.10 1,188,625 $0.73
$1.58 - $1.91 660,700 $1.73 4.30 24,500 $1.88
$2.04 - $2.99 565,725 $2.53 4.34 46,250 $2.20
</TABLE>
For disclosure purposes, the fair value of each stock option
granted is estimated on the date of grant using the
Black-Scholes option-pricing model with the following
weighted average assumptions used for stock options granted
in 1998: no annual dividends (1997 - none), expected
volatility of 60% (1997 - 65%), risk-free interest
11
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS continued
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
rate of 4.10% (1997 - 3.82%) and expected life of 5 years
(1997 - 5 years). The weighted-average fair value of the
stock options granted in 1998 was $1.33 (1997 - $1.31).
Under the above model, the total value of stock options
granted in 1998 was $668,000 (1997 - $165,000), which would
be amortized on a pro forma basis over the option vesting
period. Had the company determined compensation cost for
these plans in accordance with SFAS No. 123, the company's
pro forma loss and pro forma loss per share would have been
$5,049,000 and $0.25 in 1998 (1997 - $4,096,000 and $0.27).
The SFAS No. 123 method of accounting does not apply to
options granted prior to February 1, 1996, and accordingly,
the resulting pro forma compensation cost may not be
representative of that to be expected in future years.
(e) At January 31, the company had incurred share issue costs of
$1,344,000 (1997 - $609,000; 1996 - $Nil). When realized,
the tax benefit of these deductible costs will be recorded
as an expense in the statement of operations.
10 RESEARCH AND DEVELOPMENT
<TABLE>
<CAPTION>
1998 1997
---------------------
---------------------
<S> <C> <C>
Gross research and development expenses $3,563 $2,483
IRAP funding (157) -
Investment tax credits - (68)
---------------------
Research and development expenses, net $3,406 $2,415
---------------------
---------------------
</TABLE>
The IRAP funding received or receivable amounted to $157,000
(1997 - $Nil). At January 31, 1998, included in accounts
receivable were IRAP receivables of $20,000 (1997 - $Nil).
Investment tax credits are calculated at the rate of 20% for
qualifying research and development expenditures and can be
offset against future taxes payable within the tax carryforward
period of ten years.
12
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS continued
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
11 NET CHANGE IN NONCASH WORKING CAPITAL AMOUNTS RELATING TO OPERATIONS
<TABLE>
<CAPTION>
1998 1997
--------------------
--------------------
<S> <C> <C>
Accounts receivable $(1,388) $(1,701)
Prepaids and other assets (162) (228)
Inventories (166) (180)
Investment tax credits receivable 105 (71)
Accounts payable and accrued liabilities 550 1,451
Due to related party (59) 54
---------------------
$(1,120) $ (675)
---------------------
---------------------
</TABLE>
12 INCOME TAXES
The company's income tax provision has been determined as
follows:
<TABLE>
<CAPTION>
1998 1997
--------------------
--------------------
<S> <C> <C>
Loss for the year $ 4,935 $ 4,079
---------------------
Combined basic federal and provincial
income tax recovery at 44.62% 2,202 1,820
Provincial research and development
deduction 156 32
Tax benefit of losses not recognized in the
accounts, included in valuation allowance (2,358) (1,852)
--------------------
$ - $ -
--------------------
--------------------
</TABLE>
13
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS continued
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
At January 31, 1998, the company had incurred losses of
approximately $4,700,000 for income tax purposes the tax benefit
of which has not been included in these amounts. These losses
are available to be applied as a deduction against taxable income
earned in the future and expire as follows:
<TABLE>
<CAPTION>
PROVINCIAL FEDERAL
--------------------
--------------------
<S> <C> <C>
2002 $ 200 $ 100
2003 1,300 300
2004 4,400 1,500
2005 4,500 2,800
---------------------
$10,400 $4,700
---------------------
---------------------
</TABLE>
The provincial losses exceed federal losses principally due to
enhanced provincial scientific research and development
incentives.
In addition, the company has incurred costs for both purposes in
excess of amounts claimed for tax purposes amounting to
approximately $6,950,000, the tax benefit of which has not been
recorded in the accounts.
The company has federal investment tax credits available to
reduce future income taxes otherwise payable of $877,000 which
expire between 2005 and 2008. The benefit of these tax credits
has not been recorded.
Deferred tax assets are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
--------------------
--------------------
<S> <C> <C>
Deferred tax assets
Share issue costs $ 400 $ 200
Research expenses 1,400 400
Noncapital losses 2,100 900
Investment tax credits 500 100
Capital assets 1,200 1,400
Coupon and other provisions 100 -
--------------------
5,700 3,000
Valuation allowance (5,700) (3,000)
---------------------
Net deferred tax assets $ - $ -
---------------------
---------------------
</TABLE>
14
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS continued
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
The valuation allowance increased by $2,700,000 during 1998.
Realization of the future tax benefits related to the deferred
tax assets is dependent upon many factors including the
company's ability to generate taxable income within the loss
carryforward periods.
13 EXPORT SALES
The company's operations are located in Canada in one principal
industry segment, software development, across geographically
diverse markets.
<TABLE>
<CAPTION>
1998 1997
--------------------
--------------------
<S> <C> <C>
Revenue from customers by geographic area
Canada $ 179 $ 196
United States 5,957 2,317
Europe 2,729 922
Asia Pacific 676 357
--------------------
$9,541 $3,792
--------------------
--------------------
</TABLE>
14 FINANCIAL OBLIGATIONS
The company is obligated under operating leases for the rental of
facilities. Minimum future rental payments under the company's
current leases in effect as at January 31, 1998, which expire on
December 31, 2000, are approximately as follows:
1999 $58
2000 60
2001 55
Rent expense for the year ended January 31, 1998 was $90,200
(1997 - $41,000).
15 RELATED PARTY TRANSACTIONS
Research and development fees are paid to a company controlled by
a significant shareholder. The total fees paid in 1998 were
$108,900 (1997 - $6,600).
15
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS continued
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
Computer software acquired in fiscal 1997 from a company related
by virtue of common shareholdings, was as follows:
<TABLE>
<S> <C>
Cash payment $ 110,000
Issuance of 471,429 common shares recorded at fair value 1,033,000
----------
$1,143,000
----------
----------
The costs relating to the software acquired were charged to research and
development expense in the statement of operations during the year ended
January 31, 1997.
</TABLE>
16 CREDIT RISK EXPOSURES
Concentrations of credit risk on trade accounts receivable are
indicated in the following table by the percentage of the total
balance receivable by individual customers. At January 31, 1998,
three customers accounted for 76% (1997 - 54%) of total accounts
receivable, as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------------------------------
<S> <C> <C> <C>
First customer 50% 19% 67%
Second customer 14 18 -
Third customer 12 17 -
</TABLE>
17 FINANCIAL INSTRUMENTS
The carrying and fair values of financial instruments at January
31, 1998 are summarized as follows:
<TABLE>
<CAPTION>
ESTIMATED
CARRYING FAIR
AMOUNT VALUE
--------------------
<S> <C> <C>
Cash $1,205 $1,205
Note receivable 7,429 7,429
Accounts receivable 3,332 3,332
Accounts payable and accrued liabilities 2,298 2,298
</TABLE>
18 CONTINGENCY
The company has received correspondence alleging the company's
infringement of certain technology rights. Management believes
that the allegations are without merit and, however resolved,
will not have a material adverse effect on the company's
financial position. No amount has been provided in these
financial statements in respect of these allegations. Loss, if
any, sustained upon ultimate resolution will be accounted for
prospectively in the year of settlement in the statement of
operations.
16
<PAGE>
MGI SOFTWARE CORP.
NOTES TO FINANCIAL STATEMENTS continued
JANUARY 31, 1998 AND 1997
(TABULAR AMOUNTS EXPRESSED IN THOUSANDS OF U.S. DOLLARS)
19 SUBSEQUENT EVENT
On March 9, 1998, the company ("MGI") agreed, subject to
shareholder and regulatory approvals, to combine with Discreet
Logic ("Discreet"). Each share of MGI will be exchanged for 0.162
shares of Discreet shares. Outstanding options to purchase MGI
common shares will be converted at this exchange ratio into
options to acquire Discreet shares. In connection with the
transaction, MGI will grant Discreet an option, exercisable under
certain conditions, to purchase shares up to approximately 20% of
MGI's outstanding shares. Depending on the closing date of the
transaction, the time within which the losses and investment tax
credits expire will accelerate. In the event that the above
transaction is not consummated as anticipated, under certain
circumstances there could be substantial costs incurred by the
company.
17
