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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K/A
AMENDMENT NO. 1
(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
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DISCREET LOGIC INC.
(Exact name of registrant as specified in its charter)
Quebec 98-0150790
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10 Duke Street H3C 2L7
Montreal, Quebec, Canada
(Zip Code)
(Address of principal executive
offices)
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. [_]
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.
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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.
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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 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 $2,263,000, or $0.08 per share, as restated, for
in-process research and development, purchased and expensed in its fourth
fiscal quarter ended June 30, 1997, based on an 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 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 of approximately $5,269,000, or $0.18 per
share, as restated, in the quarter ending September 30, 1997, based on an
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.
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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.
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.
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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 Indigo/2/ 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 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 Indigo/2/ 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 Indigo/2/
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.
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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.
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 Indigo/2/ 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
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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.
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
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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.
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
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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, Indigo/2/ 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.
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, $14,402,000 and
$9,708,000 (net of tax credits), respectively, on research and development,
representing 6%, 17% 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
9
<PAGE>
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.
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
10
<PAGE>
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.
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
11
<PAGE>
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.
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.
12
<PAGE>
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 (Pounds)1,148,000 (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 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
13
<PAGE>
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>
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 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.
14
<PAGE>
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
------ ------- ------- -------- ----------
(in thousands, except per share
data) (Restated)
<S> <C> <C> <C> <C> <C>
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)... 281 625 4,037 14,402 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 6,501
Write-off of purchased
research and development(4).. -- -- -- 8,500 2,263
Write-down of investment(2)... -- -- -- 2,500 --
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 48,178
------ ------- ------- -------- --------
Operating income (loss)...... (57) 944 13,460 (44,914) 6,175
Total other income (expense).... (44) (86) (170) 2,208 990
------ ------- ------- -------- --------
Income (loss) before income
taxes and minority interest.... (101) 858 13,290 (42,706) 7,165
Provision for income taxes...... 12 343 5,490 1,435 6,489
------ ------- ------- -------- --------
Net income (loss) before
minority interest.............. (113) 515 7,800 (44,141) $ 676
------ ------- ------- -------- --------
Minority interest............... -- 32 15 -- --
------ ------- ------- -------- --------
Net income (loss)........... $ (113) $ 483 $ 7,785 $(44,141) $ 676
====== ======= ======= ======== ========
Net income (loss) per common
share.......................... $ (.01) $ .02 $ .31 $ (1.64) $ 0.02
====== ======= ======= ======== ========
Weighted average common shares
outstanding.................... 20,954 23,094 24,886 26,837 28,894
====== ======= ======= ======== ========
</TABLE>
<TABLE>
<CAPTION>
July 31,
----------------------- June 30,
1994 1995 1996 1997
------ ------- ------- ----------
(in thousands) (Restated)
<S> <C> <C> <C> <C>
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 80,148 103,377
Total shareholders' equity.................. 934 50,124 42,343 44,381
</TABLE>
15
<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
$2,263,000 as restated, 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.
16
<PAGE>
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.
Restatement of Financial Statements
In connection with the proposed merger of the Company and Autodesk, Inc., a
Form S-4 (registration no. 333-65075) was filed with The Securities and
Exchange Commission ("SEC"). Subsequent to the SEC's letter to the AICPA dated
September 9, 1998, regarding the SEC's views on in-process research and
development, the Company has increased the allocation of the purchase price to
"Goodwill" and has decreased the allocation to the "Write-off of purchased
research and development" for its acquisitions of Denim Software in fiscal
1997. The impact on the Company's previously reported financial information is
as follows:
The revised allocation of the aggregate purchase price is as follows:
<TABLE>
<CAPTION>
As reported As restated
----------- -----------
<S> <C> <C>
In-process research and development.................... $ 9,800,000 $ 2,263,000
Acquired technology.................................... 1,463,991 1,463,991
Goodwill............................................... 315,000 7,852,000
Fair value of tangible assets acquired................. 606,009 606,009
----------- -----------
$12,185,000 $12,185,000
=========== ===========
</TABLE>
The effect of these adjustments on previously reported consolidated
financial statements as of and for the eleven-month period ended June 30, 1997
is as follows:
<TABLE>
<CAPTION>
1997
------------------------
As Reported As Restated
----------- -----------
<S> <C> <C>
Other assets.......................................... $ 2,659,964 $10,092,283
Accumulated deficit................................... $42,639,374 $35,207,055
General and administrative expenses................... $ 6,396,024 $ 6,500,705
Write-off of purchased research and development....... $ 9,800,000 $ 2,263,000
Operating income (loss)............................... $(1,257,395) $ 6,174,924
Net income (loss)..................................... $(6,755,975) $ 676,344
Basic earnings (loss) per share....................... $ (0.24) $ 0.02
Diluted earnings (loss) per share..................... $ (0.24) $ 0.02
</TABLE>
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
17
<PAGE>
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 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,
18
<PAGE>
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 was derived primarily from cash flow from
operations. The transaction was accounted for as a purchase. The Company
incurred a one-time charge of $2,263,000, or $0.08 per share, as restated, for
in-process research and development, purchased and expensed in its fourth
fiscal quarter ended June 30, 1997 based on an 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 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 of approximately
$5,269,000 ($0.18 per share) as restated, in the quarter ending September 30,
1997, based on an 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.
Overview--The Acquisition of D-Vision Systems, Inc.
The nature of the efforts required to develop the acquired in-process
technology into commercially viable products principally relates to the
completion of all planning, designing and testing activities that are
necessary to establish that the products can be produced to meet their design
requirements, including functions, features and technical performance
requirements. Generally, if the R&D projects and technologies are not
completed as planned, they will neither satisfy the technical requirements of
a changing market nor be cost effective.
19
<PAGE>
As of the acquisition date, D-Vision Systems, Inc. ("D-Vision"), had
initiated research and development efforts related to the product features and
functionality that will reside in the advancement of its WindowsNT with other
operating systems to develop an advanced, cross-platform editing/effects
product capable of performing complete video editing functions for a broad
array of customers.
With respect to the acquired in-process technology, the calculations of
value were adjusted to reflect the value creation efforts of D-Vision prior to
the close of the acquisition. Following are, as of the acquisition date, the
estimated completion percentage, estimated technology life and projected
introduction date:
<TABLE>
<CAPTION>
Percent Technology Introduction
D-Vision In-Process Technology Completed Life Date
------------------------------ --------- ------------ ------------
<S> <C> <C> <C>
Next generation D-Vision technology...... 26% 4 to 5 years April 1999
</TABLE>
A brief description of the acquired in-process project is set forth below:
Next generation D-Vision technology
The substantial technological improvements under development at the time of
the acquisition included the introduction of advanced user interface concepts
and structures to the combined product that support both the editing and
effects paradigms and building advanced product features. Examples of the
advanced product features being built included: remote editing capabilities
with live interaction between remote users; a text or script-based interface
designed to allow the user to customize the application by typing common
statements or words; and text command interpretation that will read film or
program scripts and provide computer-generated "virtual" clips allowing users
to visualize a scene even before the first field shot begins.
Cost to Complete
Discreet anticipated incurring costs of approximately $2.6 million over the
24 months following the acquisition to complete the R & D projects.
Valuation analysis
Revenue
The value of the acquired in-process technology was computed using a
discounted cash flow analysis on the anticipated income stream of the related
product sales. The value assigned to purchased in-process technology was
determined by estimating the costs to develop the purchased in-process
technology into commercially viable products, estimating the resulting net
cash flows from the projects and discounting the net cash flows to their
present value. The revenue projection used to value the in-process research
and development was based on estimates of relevant market sizes and growth
factors, expected trends in technology and the nature and expected timing of
new product introductions by the Company and its competitors. Future revenue
estimates were generated from the next generation D-Vision product family.
Aggregate revenue for D-Vision products was estimated to be approximately $11
million for the period from January 1, 1997 to December 31, 1997, increasing
to approximately $48 million by 2002 (representing a compound annual growth
rate of 21%) and stabilizing at a 5 percent growth rate in 2002 and for the
remainder of the estimation period.
The estimated revenues for the in-process technologies assumed compound
annual growth rates of 45% in the four years following introduction, assuming
the successful completion and market acceptance of the major R&D programs. The
estimated revenues for the in-process projects were expected to peak within
five years of acquisition and then decline sharply as other new products and
technologies are expected to enter the market. Revenues for developed
technology were estimated for 1997 through 2002, and were expected to decline
gradually as new products are expected to enter the marketplace.
20
<PAGE>
Management's analysis also considered anticipated product release dates for
a next-generation version of the Company's D-Vision product scheduled for
release in April 1999, as well as the release date for a significantly
enhanced version of D-Vision's existing product currently scheduled for
release in April 1999. The overall technology life was estimated to be
approximately five years for both the Company's next generation D-Vision
product and the significantly enhanced version of its D-Vision's existing
product.
Operating Expenses
Operating expenses used in the valuation analysis of D-Vision included (i)
cost of sales, (ii) selling, general and administrative expenses, and (iii)
research and development expenses. Operating expenses were estimated based on
historical results and anticipated cost savings. Due to general economies of
scale, improved infrastructure, and greater management breadth, estimated
operating expense as a percentage of revenues were expected to decrease after
the acquisitions.
Cost of sales. Cost of sales, expressed as a percentage of revenue, for the
developed and in-process technologies identified in the valuation was
estimated to range from 10 to 45.2 percent for 1997 through 2002. The cost of
sales was forecast by management for 1997 and 1998. Cost of sales as a
percentage of revenue were stabilized for 2003 based on fiscal 2002 data.
Selling, General and Administrative. Selling, general and administrative
expenses, expressed as a percentage of revenue for the developed and in-
process technologies identified in the valuation, ranged from 52.2 percent in
1997 to 30.0 percent in 2002. Selling, general and administrative expenses
were forecast by management for 1997 through 2002. Thereafter, selling,
general and administrative expenses, expressed as a percentage of revenue,
were estimated to stabilize at 25.0 percent of revenue. Long-term margins were
expected to decline due to increased competitive pressures within the maturing
industry.
Research and Development. Research and development ("R&D") expenses consist
of the costs associated with activities undertaken to develop new software and
to correct errors or to keep products updated with current information. The
R&D expense was estimated to be 6.5 percent of revenues throughout the
forecast period.
Effective income tax rate. The effective income tax rate utilized in the
analysis of the in-process technology was 32 percent throughout the valuation
period. The 32 percent reflects the Company's estimated combined federal and
state statutory income tax rate, exclusive of nonrecurring charges, and its
estimated income tax rate, as provided by management, in future years.
Discount rate. The discount rate selected for developed and in-process
technology was 20 and 25 percent, respectively. In the selection of the
appropriate discount rate, consideration was given to the Weighted Average
Cost of Capital ("WACC"), which was determined, in part, by using the Capital
Asset Pricing Model (CAPM). The discount rate utilized for the in-process
technology was higher than Discreet's WACC due to the risk of realizing cash
flows from products that had yet to reach technological feasibility.
Allocation of value
The fair values of the assets acquired from D-Vision were allocated between:
Intellectual property--in-process research and development and developed
technology; and Other intangible assets--assembled work force and
goodwill/other intangibles. The results of the allocation of values between
the assets are as follows:
<TABLE>
<CAPTION>
Asset Fair Market Value
----- -----------------
(Restated)
<S> <C>
Intellectual Property:
In-Process Research and Development...................... $ 5,269,000
Acquired Technology...................................... $ 3,100,000
Other Intangible Assets:
Assembled Work Force..................................... $ 200,000
Goodwill/Other Intangibles............................... $16,448,000
</TABLE>
21
<PAGE>
Overview--The Acquisition of Denim Software LLC
The nature of the efforts required to develop the acquired in-process
technology into commercially viable products principally relates to the
completion of all planning, designing and testing activities that are
necessary to establish that the products can be produced to meet their design
requirements, including functions, features and technical performance
requirements. Generally, if the R&D project and technologies are not completed
as planned, they will neither satisfy the technical requirements of a changing
market nor be cost effective.
As of the acquisition date, Denim Software LLC ("Denim"), had initiated
research and development efforts related to the product features and
functionality that would reside in the advancement of its WindowsNT technology
with other operating systems to develop a revolutionary, cross-platform
editing/effects product capable of performing complete video special effects
functions for a broad array of customers. This next-generation product is
designed to deliver technology across all major platforms for digital video
systems and will enable the Company to provide a range of solutions designed
to meet the needs of all digital artists.
With respect to the acquired in-process technology, the calculations of
value were adjusted to reflect the value creation efforts of Denim prior to
the close of the acquisition. Following are, as of the acquisition date, the
estimated completion percentage, estimated technology life and projected
introduction date:
<TABLE>
<CAPTION>
Percent Technology Introduction
Denim In-Process Technology Completed Life Date
--------------------------- --------- ------------ ------------
<S> <C> <C> <C>
Next-generation Denim technology......... 24% 4 to 5 years April 1999
</TABLE>
A brief description of the acquired in-process project is set forth below:
Next generation Denim technology
The substantial technological improvements under development at the time of
the acquisition included providing new advanced editing capabilities and
developing productivity tools, such as machine control, media management and
video card support. This will involve reconstructing the internal architecture
of the existing products to achieve complete compatibility, as well as
developing new technology for adding the desired editing and productivity
functions.
At the time of the acquisition, Denim had initiated development of new
technologies aimed at offering new products that could gain market share in
the nascent digital video systems market by extending the Company's product
line and targeting new markets. Development plans center on developing a
stand-alone effect /editing product, migrating products to more advanced
platforms, and creating new features.
Cost to Complete
Discreet anticipated incurring costs of approximately $1.0 million over the
24 months following the acquisition to complete the R & D projects.
Valuation analysis
Revenue
The value of the acquired in-process technology was computed using a
discounted cash flow analysis on the anticipated income stream of the related
product sales. The value assigned to purchased in-process technology was
determined by estimating the costs to develop the purchased in-process
technology into commercially viable products, estimating the resulting net
cash flows from the projects and discounting the net cash flows to their
present value. The revenue projection used to value the in-process research
and development was based on estimates of relevant market sizes and growth
factors, expected trends in technology and the nature and expected timing of
new product introductions by the Company and its
22
<PAGE>
competitors. Future revenue estimates were generated from the next-generation
Denim product family. Aggregate revenue for Denim products was estimated to be
approximately $400,000 for the period from July 1, 1996 to June 30, 1997
increasing to approximately $17 million by 2002 (representing a compound
annual rate of 46 percent) and stabilizing at a 5 percent growth rate in 2003
and for the remainder of the estimation period. Year-to-year revenue growth
estimates were developed based on management's forecasts for 1997 through
2002.
Beyond 2002, the estimated revenues for the in-process technologies were
assumed to normalize at a stable growth rate. Revenues for developed
technology were estimated for 1997 through 2002, and were expected to decline
gradually as new products are expected to enter the marketplace.
Management's analysis also considered anticipated product release dates for
a next-generation version of the Company's Denim product scheduled for release
in April of 1999, as well as the release date for a significantly enhanced
version of Denim's existing product scheduled for release in April of 1998.
The overall technology life was estimated to be approximately five years for
both the Company's next generation Denim product and the significantly
enhanced version of its Denim's existing product.
Operating Expenses
Operating expenses used in the valuation analysis of Denim included (i) cost
of sales, (ii) selling, general and administrative expenses, and (iii)
research and development expenses. Operating expenses were estimated based on
historical results and anticipated cost savings. Due to general economies of
scale, improved infrastructure, and greater management breadth, estimated
operating expense as a percentage of revenues were expected to decrease after
the acquisitions.
Cost of sales. Cost of sales, expressed as a percentage of revenue, for the
developed and in-process technologies identified in the valuation was
estimated to range from 8.6 to 13.2 percent for fiscal 1997 through 2002. The
cost of sales was forecast by management for fiscal 1998 to 2002. Cost of
sales as a percentage of revenue were stabilized for 2003 based on fiscal 2002
data.
Selling, General and Administrative. Selling, general and administrative
expenses, expressed as a percentage of revenue for the developed and in-
process technologies identified in the valuation, ranged from 137.5 percent in
fiscal 1997 to 19.4 percent in fiscal 2002. Selling, general and
administrative expenses were forecast by management for fiscal 1998 to 2002.
Thereafter, selling, general and administrative expenses, expressed as a
percentage of revenue were estimated to stabilize at 25.0 percent of revenue.
Long-term margins were expected to decline due to increased competitive
pressures within the maturing industry.
Research and Development. Research and development ("R&D") expenses consist
of the costs associated with activities undertaken to develop new software and
to correct errors or to keep products updated with current information. The
R&D expense was estimated to be 14.4 percent of revenues in fiscal 1998,
declining to 6.5 percent of revenues by 2002.
Effective income tax rate. The effective income tax rate utilized in the
analysis of the in-process technology was 32 percent throughout the valuation
period. The 32 percent reflects the Company's estimated combined federal and
state statutory income tax rate, exclusive of nonrecurring charges, and its
estimated income tax rate, as provided by management, in future years.
Discount rate. The discount rate selected for developed and in-process
technology was 20 and 25 percent, respectively. In the selection of the
appropriate discount rate, consideration was given to the Weighted Average
Cost of Capital ("WACC"), which was determined, in part, by using the Capital
Asset Pricing Model (CAPM). The discount rate utilized for the in-process
technology was higher than Discreet's WACC due to the risk of realizing cash
flows from products that had yet to reach technological feasibility.
23
<PAGE>
Allocation of value
The fair values of the assets acquired from D-Vision were allocated between:
Intellectual property--in-process research and development and developed
technology; and Other intangible assets--assembled work force and
goodwill/other intangibles. The results of the allocation of values between
the assets are as follows:
<TABLE>
<CAPTION>
Asset Fair Market Value
----- -----------------
(Restated)
<S> <C>
Intellectual Property:
In-Process Research and Development...................... $2,263,000
Acquired Technology...................................... $1,464,000
Other Intangible Assets:
Assembled Work Force..................................... $ 100,000
Goodwill/Other Intangibles............................... $7,752,000
</TABLE>
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 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.
24
<PAGE>
Results of Operations
The following table sets forth the percentages of total revenues represented
by certain line items in the statement of operations:
<TABLE>
<CAPTION>
Year
Ended July 31, Eleven Months
----------------- Ended June 30,
1995 1996 1997
------- ------- --------------
(Restated)
<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 17 10
Sales and marketing..................... 19 31 23
General and administrative.............. 8 13 6
Write-off of purchased research and
development............................ -- 10 2
Write-down of investment................ -- 3 --
Restructuring expense................... -- 18 --
Litigation and related settlement
expense................................ -- 3 6
------- ------- ---
Total operating expenses.............. 33 95 47
------- ------- ---
Operating income (loss)............... 21 (54) 6
Other income (expense).................... 0 3 1
------- ------- ---
Income (loss) before income taxes and
minority interest........................ 21 (51) 7
Provision for income taxes................ 9 2 6
------- ------- ---
Net income (loss) before minority
interest................................. 12 (53) 1
Minority interest......................... 0 -- --
------- ------- ---
Net income (loss)....................... 12% (53)% 1%
======= ======= ===
</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, 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
25
<PAGE>
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.
26
<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 $14,402,432 (17% 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 $6,501,000 (6% of total revenues), as restated 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
27
<PAGE>
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, 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 $2,263,000 (2% of total revenues), as restated, 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
28
<PAGE>
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 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 Indigo/2/ 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 Indigo/2/ 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
29
<PAGE>
$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 $14,402,000 in
fiscal 1996, an increase of 319% from $4,037,000 in fiscal 1995. Research and
development expenses, after deducting tax credits, were 17% 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 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.
30
<PAGE>
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.
31
<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>
Two Months
Quarter Ended Ended Quarter 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
----------- ----------- --------- -------- ----------- ------------ --------- --------
(in thousands) (Restated)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
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 4,067 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 1,954
Write-off of
purchased
research and
development.... 8,500 -- -- -- -- -- -- 2,263
Write-down of
investment..... -- -- 2,500 -- -- -- -- --
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 19,471
------- ------- -------- -------- ------- ------- ------- -------
Operating income
(loss)......... (3,366) (224) (15,138) (26,185) 765 1,456 4,667 (713)
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 (662)
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 $(3,515)
======= ======= ======== ======== ======= ======= ======= =======
<CAPTION>
<S> <C> <C>
Total revenues...
Cost of revenues.
Gross profit....
Operating
expenses:
Research and
development....
Sales and
marketing......
General and
administrative.
Write-off of
purchased
research and
development....
Write-down of
investment.....
Restructuring
expense........
Litigation and
Related
Settlement
Expenses.......
Total operating
expenses.......
Operating income
(loss).........
Total other
income
(expense).......
Income (loss)
before income
taxes...........
Provision
(benefit) for
income taxes....
Net income
(loss).........
</TABLE>
<TABLE>
<CAPTION>
Two Months
Quarter Ended Ended Quarter 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
----------- ----------- --------- -------- ----------- ------------ --------- ----------
(Restated)
<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 28 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 6
Write-off of purchased
research and
development........... 34 -- -- -- -- -- -- 6
Write-down of
investment............ -- -- 17 -- -- -- -- --
Restructuring expense.. -- -- -- 79 -- -- -- --
Litigation and Related
Settlement Expenses... -- -- -- 13 -- -- -- 19
--- --- ---- ---- --- --- --- ---
Total operating
expenses.............. 71 46 121 169 44 43 41 56
--- --- ---- ---- --- --- --- ---
Operating income
(loss)................ (13) (1) (103) (137) 3 9 17 (2)
Total other income
(expense).............. 1 6 (9) 9 (4) 11 -- --
--- --- ---- ---- --- --- --- ---
Income (loss) before
income taxes........... (12) 5 (112) (128) (1) 20 17 (2)
Provision (benefit) for
income taxes........... 9 2 (9) 1 3 8 6 8
--- --- ---- ---- --- --- --- ---
Net income (loss)...... (21)% 3% (103)% (129)% (4)% 12% 11% (10)%
=== === ==== ==== === === === ===
</TABLE>
32
<PAGE>
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 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
33
<PAGE>
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 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
(Pounds)1,148,000 (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
(Pounds)1,034,000 (or approximately $1,663,000), and (Pounds)715,000 (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.
34
<PAGE>
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 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
35
<PAGE>
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
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.
36
<PAGE>
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.
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
(a)(2) Index to Financial Statement Schedules
The following Financial Statement Schedules of the Registrant are filed
as part of this report:
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.
37
<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 Amendment No. 1 to
the Transition Report on Form 10-K for the transition period from August 1,
1996 to June 30, 1997 to be signed on its behalf by the undersigned, thereunto
duly authorized.
Discreet Logic Inc.
/s/ Richard J. Szalwinski
Date: February 4, 1999 By: _________________________________
Richard J. Szalwinski President and
Chief Executive Officer
38
<PAGE>
INDEX TO 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 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>
F-1
<PAGE>
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 as restated--See Note 2(a) 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
as restated--See Note 2(a). 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
(except with respect to the matters discussed in Note 2(a) as to which the
date is February 3, 1999)
F-2
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(amounts in U.S. Dollars)
<TABLE>
<CAPTION>
July 31, June 30,
1996 1997
----------- ------------
(Restated)
<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 10,092,283
Assets held for resale.............................. 3,856,348 5,247,741
----------- ------------
$80,147,742 $103,377,018
=========== ============
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 28,117,415 shares at June 30, 1997... 78,922,914 81,075,419
Retained deficit................................... (35,883,399) (35,207,055)
Deferred Compensation.............................. -- (673,750)
Cumulative translation adjustment.................. (696,499) (814,019)
----------- ------------
Total shareholders' equity...................... 42,343,016 44,380,595
----------- ------------
$80,147,742 $103,377,018
=========== ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in U.S. Dollars)
<TABLE>
<CAPTION>
Eleven Months
Years Ended July 31, Ended
------------------------- June 30,
1995 1996 1997
----------- ------------ -------------
(Restated)
<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 14,402,432 9,707,890
Sales and marketing................. 12,588,110 26,088,163 23,206,070
General and administrative.......... 4,854,261 10,581,670 6,500,705
Write-off of purchased research and
development (Note 15).............. -- 8,500,000 2,263,000
Write-down of investment (Note 15).. -- 2,500,000 --
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 48,177,665
----------- ------------ ------------
Operating income (loss)........... 13,460,368 (44,914,092) 6,174,924
----------- ------------ ------------
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) 7,165,687
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) 676,344
Minority interest..................... 14,725 -- --
----------- ------------ ------------
Net income (loss)................... $ 7,785,095 $(44,141,181) $ 676,344
=========== ============ ============
Net income (loss) per common and
common equivalent share.............. $ 0.31 $ (1.64) $ 0.02
=========== ============ ============
Weighted average common shares
outstanding.......................... 24,885,670 26,836,834 28,893,652
=========== ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(amounts in U.S. Dollars)
<TABLE>
<CAPTION>
Retained Share Cumulative Total
Common Earnings Deferred Subscriptions Translation Shareholders'
Shares Amount (Deficit) Compensation Receivable Adjustment Equity
---------- ----------- ------------ ------------ -------------- ------------ --------------
<S> <C> <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
Grant of compensatory
stock options......... -- 673,750 -- (673,750) -- -- --
Net income (as
restated)............. -- -- 676,344 -- -- 676,344
Change in cumulative
translation
adjustment............ -- -- -- -- (117,520) (117,520)
---------- ----------- ------------ --------- ----------- --------- ------------
Balance, June 30, 1997
(as restated).......... 28,117,415 $81,075,419 $(35,207,055) $(673,750) $ -- $(814,019) $ 44,380,595
========== =========== ============ ========= =========== ========= ============
</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>
Eleven Months
Years Ended July 31, Ended
-------------------------- June 30,
1995 1996 1997
------------ ------------ -------------
(Restated)
<S> <C> <C> <C>
Cash flows from operating
activities:
Net income (loss).................. $ 7,785,095 $(44,141,181) $ 676,344
Adjustments to reconcile net income
(loss) to cash provided by
operating activities--
Depreciation and amortization...... 1,674,858 6,276,139 5,987,256
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 2,263,000
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.
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, 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.
F-7
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
(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) Restatement of financial statements
In connection with the proposed merger of the Company and Autodesk, Inc., a
Form S-4 (registration no. 333-65075) was filed with The Securities and
Exchange Commission ("SEC"). Subsequent to the SEC's letter to the AICPA
dated September 9, 1998 regarding the SEC's views on in-process research
and development, the Company has increased the allocation of purchase price
to "Goodwill" and has decreased the allocation to the "Write-off of
purchased research and development" for the acquisition of Denim Software
in fiscal 1997. The impact on the Company's previously reported financial
information is as follows:
The revised allocation of the aggregate purchase price is as follows:
<TABLE>
<CAPTION>
As reported As restated
----------- -----------
<S> <C> <C>
In-process research and development................. $ 9,800,000 $ 2,263,000
Acquired technology................................. 1,463,991 1,463,991
Goodwill............................................ 315,000 7,852,000
Fair value of tangible assets acquired.............. 606,009 606,009
----------- -----------
$12,185,000 $12,185,000
=========== ===========
</TABLE>
The effect of these adjustments on previously reported consolidated
financial statements as of and for the eleven-month period ended June 30,
1997 is as follows:
<TABLE>
<CAPTION>
1997
------------------------
As reported As restated
----------- -----------
<S> <C> <C>
Other assets........................................ $ 2,659,964 $10,092,283
Accumulated deficit................................. $42,639,374 $35,207,055
General and administrative expenses................. $ 6,396,024 $ 6,500,705
Write-off of purchased research and development..... $ 9,800,000 $ 2,263,000
Operating income (loss)............................. $(1,257,395) $ 6,174,924
Net income (loss)................................... $(6,755,975) $ 676,344
Basic earnings (loss) per share..................... $ (0.24) $ 0.02
Diluted earnings (loss) per share................... $ (0.24) $ 0.02
</TABLE>
F-8
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
The reconciliation of net income, as previously reported, to net income, as
restated for the year ended June 30, 1997 is as follows:
<TABLE>
<CAPTION>
1997
-----------
<S> <C>
Net (loss), as reported......................................... $(6,755,975)
Restated adjustments:
Write-off purchased research and development, as reported..... 9,800,000
Write-off purchased research and development, as restated..... (2,263,000)
Increase in goodwill amortization............................. (104,681)
-----------
Net income, as restated......................................... $ 676,344
===========
</TABLE>
(b) 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, 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.
(c) 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.
(d) 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.
(e) 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
F-9
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
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.
(f) 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.
(g) 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.
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
F-10
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
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.
(h) 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.
(i) Postemployment and Postretirement Benefits
The Company does not provide postemployment and postretirement benefits.
(j) 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.
(k) 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.
F-11
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
(l) 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 2,485,751 1,222,478
term of lease
or useful life
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>
(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>
F-12
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
(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 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.
F-13
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
(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
F-14
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
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.
(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.
F-15
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
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 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
------------ ----------
(Restated)
<C> <S> <C> <C>
Net income (loss) As Reported $(44,141,181) $ 676,344
Pro forma $(46,118,158) $(982,638)
Net income (loss) per share As Reported $ (1.64) $ 0.02
Pro forma $ (1.72) $ (0.04)
</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.
F-16
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
(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
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-17
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
(f) Stock Option Activity
The following is a summary of all stock option activity:
<TABLE>
<CAPTION>
1995 1996 1997
-------------------- -------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- -------- ---------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
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 $3.85
</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
----------------------- -------------------------
Weighted Weighted
Average Average
Shares Exercise Price Shares Exercise Price
------- --------------- --------- ---------------
<S> <C> <C> <C> <C>
Exercise price equal to
fair value............. 928,000 $ 16.19 1,472,238 $ 5.18
Exercise price greater
than fair value........ 45,000 23.72 147,400 6.48
Exercise price less than
fair value............. -- -- 70,000 7.88
------- ------- --------- ------
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 Weighted
Range of Exercise Options Weighted Average Average Number Average
Prices Outstanding Contractual 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%.
F-18
<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.
F-19
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
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.
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
----------- ------------ --------------
(Restated)
<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) (110,548)
----------- ------------ ----------
$13,290,017 $(42,706,346) $7,165,687
=========== ============ ==========
</TABLE>
F-20
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
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
----- ------ --------------
(Restated)
<S> <C> <C> <C>
Provision (benefit) at the Canadian federal
statutory rate............................ 38.0% (38.0)% 38.0%
Foreign taxes.............................. 3.3 17.2 4.5
Effect of not utilizing foreign
subsidiaries' tax losses.................. 0.9 16.0 11.9
Effect of basis differences not benefited.. -- 3.0 47.0
Provincial taxes, net of federal tax
abatements................................ (1.0) 0.2 2.7
Canadian federal incentives for
manufacturers and small business.......... (2.8) 0.2 0.0
Utilization of net operating loss
carrybacks................................ -- -- (13.2)
Other items................................ 2.9 4.8 (0.3)
----- ------ -----
Tax provision............................ 41.3% 3.4% 90.6%
===== ====== =====
</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.
F-21
<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
Leases
-----------
<S> <C>
Year ended June 30,
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.
F-22
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
(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>
Eleven Months
Years Ended July 31, Ended June 30,
Geographic Area ----------------------- --------------
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 Eleven Months
July 31, Ended June 30,
Geographic Area ------------ --------------
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>
F-23
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
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 $ -- $ 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 $ -- $101,923,931
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) $101,923,931
============ ============ =========== =========== =========== ============ ============= ============
Net income
(loss)
(restated)..... $ 1,199,545 $ 707,540 $ (504,001) $ 841,043 $ 274,412 $ (1,613,927) $ (228,268) $ 676,344
============ ============ =========== =========== =========== ============ ============= ============
Identifiable
assets
(restated)..... $148,151,830 $ 48,967,084 $21,762,860 $ 8,196,759 $ 6,107,907 $ 32,764,624 $(162,574,046) $103,377,018
============ ============ =========== =========== =========== ============ ============= ============
</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.
F-24
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
(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 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
F-25
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
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 these assets was comprised of the
following:
<TABLE>
<S> <C>
Cash consideration............................................. $ 9,126,000
Transaction costs.............................................. $ 850,000
Liabilities assumed............................................ $ 2,209,000
-----------
Total purchase price........................................... $12,185,000
===========
</TABLE>
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 $2,263,000 based on an appraisal, or $0.08
per share, as restated, for in-process research and development that had
not yet reached technical feasibility and had no alternative use,
F-26
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
purchased and expansed in the eleven-month period ended June 30, 1997. The
terms of the transaction were the result of arms-length negotiations
between the representative of Discreet and Denim.
Allocation of the aggregate purchase price was as follows (as restated):
<TABLE>
<S> <C>
In-process research and development........................... $ 2,263,000
Acquired technology........................................... $ 1,463,991
Goodwill...................................................... $ 7,852,000
Fair value of tangible assets acquired........................ $ 606,009
-----------
$12,185,000
===========
</TABLE>
(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 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 of
approximately 5,269,000 or $0.18 per share as restated, in the quarter
ending September 30, 1997 based on an appraisal.
The aggregate purchase price for D-Vision was as follows:
<TABLE>
<S> <C>
Cash consideration............................................. $10,750,000
Common shares issued........................................... 10,649,063
Transaction costs.............................................. 1,500,000
Liabilities assumed............................................ 4,311,000
-----------
Total purchase price........................................... $27,210,063
===========
</TABLE>
Allocation of the aggregate purchase price was as follows (as restated):
<TABLE>
<S> <C>
In-process research and development........................... $ 5,269,000
Acquired technology........................................... 3,100,000
Goodwill...................................................... 16,647,807
Fair value of tangible assets acquired........................ 2,193,256
-----------
$27,210,063
===========
</TABLE>
F-27
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
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 Denim acquisition and related transactions discussed
above had occurred on August 1, 1996:
<TABLE>
<CAPTION>
(Restated)
------------
<S> <C>
Revenues...................................................... $106,326,000
Operating loss................................................ $ 19,514,000
Net loss...................................................... $ 24,543,000
</TABLE>
(16) Purchase of Land and Facilities
In August 1995, the Company purchased land and an office building in
London, England for approximately (Pounds)1,148,000 (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.
The components of the restructuring charge are as follows:
<TABLE>
<S> <C>
Asset write down.............................................. $ 5,621,000
Lease terminations and leasehold improvements reserve......... 5,169,000
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.
F-28
<PAGE>
DISCREET LOGIC INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in U.S. Dollars)
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>
F-29
<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, as restated--See Note 2(a)
and the two years in the period ended July 31, 1996 and the eleven month
period ended June 30, 1997, as restated--See Note 2(a) 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 Arthur Andersen & Cie
August 12, 1997 (except with Chartered Accountants
respect to the matters
discussed in Note 2(a) as to
which the date is February
3, 1999)
S-1
<PAGE>
SCHEDULE II
DISCREET LOGIC INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Balance
at Charged to Balance at
Beginning Costs and Write- End of
Description of Period Expenses 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>
S-2
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
No. Description Page
------- ----------- ----
<C> <S> <C>
23.1 Consent of Arthur Andersen & Cie
27 Financial Data Schedule.
</TABLE>
X-1
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT CHARTERED ACCOUNTANTS
As independent chartered accountants, we hereby consent to the use of our
report dated August 12, 1997 (except with respect to the matters discussed in
Note 2(a), as to which the date is February 3, 1999) related to Discreet Logic
Inc.'s Consolidated Financial Statements as of July 31, 1996 and June 30,
1997, as restated, and for the periods ended July 31, 1996 and June 30, 1997,
as restated, and to all references to our Firm, included in or made a part of
this Form 10-K/A, into Discreet Logic Inc.'s previously filed Registration
Statement on Form S-8, File No. 39-97400 and on Form S-3, File No. 333-34739.
ARTHUR ANDERSEN & CIE
Chartered Accountants
General Partnership
Montreal, Canada
February 3, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS FOR THE FISCAL YEAR ENDED 6/30/97 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 11-MOS
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-START> AUG-01-1996
<PERIOD-END> JUN-30-1997
<CASH> 31,668
<SECURITIES> 0
<RECEIVABLES> 30,380
<ALLOWANCES> 3,487
<INVENTORY> 13,921
<CURRENT-ASSETS> 76,819
<PP&E> 22,531
<DEPRECIATION> 10,565
<TOTAL-ASSETS> 103,377
<CURRENT-LIABILITIES> 58,283
<BONDS> 0
0
0
<COMMON> 81,075
<OTHER-SE> (36,695)
<TOTAL-LIABILITY-AND-EQUITY> 103,377
<SALES> 101,924
<TOTAL-REVENUES> 101,924
<CGS> 47,571
<TOTAL-COSTS> 47,571
<OTHER-EXPENSES> 48,178
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 55
<INCOME-PRETAX> 7,166
<INCOME-TAX> 6,489
<INCOME-CONTINUING> 676
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 676
<EPS-PRIMARY> 0.02
<EPS-DILUTED> 0.02
</TABLE>
