DISCREET LOGIC INC, 10-Q/A, 1999-02-04

DISCREET LOGIC INC
10-Q/A, 1999-02-04
COMPUTER INTEGRATED SYSTEMS DESIGN

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q/A
AMENDMENT NO. 1

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.

For the quarterly period ended March 31, 1998

[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.

For the transition period from to

COMMISSION FILE NUMBER 0-26100

Discreet Logic Inc.
(Exact name of registrant as specified in its charter)

QUEBEC 98-0150790
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification Number)

10 DUKE STREET
MONTREAL, QUEBEC, CANADA H3C 2L7
(Address of principal executive offices) (Zip code)

Registrant's telephone number, including area code: (514) 393-1616

Indicate by check mark whether registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No

29,553,579 shares of the registrant's Common Shares, without par value, were
outstanding as of May 13, 1998.

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<PAGE>

DISCREET LOGIC INC. AND SUBSIDIARIES

Form 10-Q

FOR THE QUARTER ENDED MARCH 31, 1998

CONTENTS

<TABLE>
<CAPTION>
Item Number Page
- ----------- ----
<S> <C> <C>
PART I: FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Balance Sheets........................................................................... 3
Statements of Operations................................................................. 4
Statements of Cash Flows................................................................. 5
Notes to Condensed Consolidated Financial Statements..................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 11
Certain Factors That May Affect Future Results........................................... 17
PART II: OTHER INFORMATION
Item 2. Changes in Securities.................................................................... 20
Item 6. Exhibits and Reports on Form 8-K......................................................... 20
Signatures............................................................................... 21
</TABLE>

2
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DISCREET LOGIC INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(All Amounts in Thousands of U.S. Dollars, except for Share Data)

<TABLE>
<CAPTION>
June 30, March 31,
1997 1998
---------- -----------
(Unaudited)
(Restated) (Restated)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents.............................. $ 31,668 $ 35,401
Accounts receivable (less reserves for doubtful ac-
counts)............................................... 26,893 30,398
Inventory--
Resale................................................ 10,867 8,661
Demonstration......................................... 3,054 6,335
Income taxes receivable................................ 448 --
Other current assets................................... 3,889 5,270
--------- --------
76,819 86,065
Property and equipment--less accumulated depreciation
and amortization....................................... 7,728 10,571
Deferred income taxes................................... 3,490 2,644
Other assets............................................ 10,092 28,173
Assets held for resale.................................. 5,248 4,229
--------- --------
$ 103,377 $131,682
========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued expenses.................. $ 44,086 $ 40,060
Deferred revenue....................................... 8,103 6,375
Income taxes payable................................... 4,735 8,583
Customer deposits...................................... 1,359 230
--------- --------
58,283 55,248
--------- --------
Deferred income taxes................................... 713 2,769
--------- --------
Shareholders' Equity:
Preferred shares--no par value
Authorized--unlimited number of shares
Issued and outstanding--none
Common shares--no par value
Authorized--unlimited number of shares
Issued and outstanding--28,117,415 shares at June 30,
1997 and 29,551,779 at March 31, 1998................. 81,076 107,378
Accumulated deficit.................................... (35,207) (30,376)
Deferred compensation.................................. (674) (1,058)
Cumulative translation adjustment...................... (814) (2,279)
--------- --------
Total shareholders' equity.......................... 44,381 73,665
--------- --------
$ 103,377 $131,682
========= ========
</TABLE>

The accompanying notes are an integral part of these condensed consolidated
financial statements.

3
<PAGE>

DISCREET LOGIC INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(All Amounts in Thousands of U.S. Dollars, except for per Share Data)
(Unaudited)

<TABLE>
<CAPTION>
Three Three Eight Nine
Months Months Months Months
Ended Ended Ended Ended
March 31, March 31, March 31, March 31,
1997 1998 1997 1998
--------- ---------- --------- ----------
(Restated) (Restated)
<S> <C> <C> <C> <C>
Total revenues....................... $27,044 $35,712 $67,139 $111,385
Cost of revenues..................... 11,255 14,191 31,545 45,018
------- ------- ------- --------
Gross profit........................ 15,789 21,521 35,594 66,367
------- ------- ------- --------
Operating expenses:
Research and development (net of tax
credits)........................... 2,746 4,032 6,998 11,445
Sales and marketing................. 6,534 8,610 17,162 24,450
General and administrative.......... 1,842 4,422 4,547 11,978
Charge for purchased research and
development........................ -- -- -- 6,915
Litigation and related settlement
expenses........................... -- (405) -- (405)
------- ------- ------- --------
Total operating expenses........... 11,122 16,659 28,707 54,383
------- ------- ------- --------
Operating income .................. 4,667 4,862 6,887 11,984
Other income (expense), net.......... 46 (205) 940 458
------- ------- ------- --------
Income before income taxes.......... 4,713 4,657 7,827 12,442
Provision for income taxes........... 1,674 1,739 3,636 7,611
------- ------- ------- --------
Net income ......................... $ 3,039 $ 2,918 $ 4,191 $ 4,831
======= ======= ======= ========
Earnings Per Share:
Basic............................... $ 0.11 $ 0.10 $ 0.15 $ 0.17
======= ======= ======= ========
Diluted............................. $ 0.11 $ 0.09 $ 0.15 $ 0.16
======= ======= ======= ========
Weighted average common shares out-
standing:
Basic............................... 27,995 29,074 27,905 28,853
======= ======= ======= ========
Diluted............................. 28,711 30,867 28,542 30,698
======= ======= ======= ========
</TABLE>

The accompanying notes are an integral part of these condensed consolidated
financial statements.

4
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DISCREET LOGIC INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(All Amounts in Thousands of U.S. Dollars)
(Unaudited)
<TABLE>
<CAPTION>
Eight Months Nine Months
Ended Ended
March 31, March 31,
1997 1998
------------ -----------
(Restated)
<S> <C> <C>
Cash flows from operating activities:
Net income ......................................... $ 4,191 $ 4,831
Adjustments to reconcile net income (loss) to cash
provided by operating activities--
stockciation and amortization...................... 4,043 12,062
Deferred income taxes.............................. (433) 2,901
Write-off of in-process research and development... -- 6,915
Write-off of assets for restructuring.............. -- 109
Compensation expense related to stock options...... -- 451
Changes in assets and liabilities--
Settlement of class action litigation............. -- (10,800)
Accounts receivable............................... 1,393 (2,622)
Inventory......................................... 4,176 963
Income taxes receivable........................... 3,191 448
Other current assets.............................. (571) (1,234)
Insurance proceeds related to class action litiga-
tion............................................. -- 3,459
Accounts payable and accrued expenses............. 4,304 (10,111)
Deferred revenue.................................. 2,920 (1,728)
Income taxes payable.............................. 1,440 3,849
Customer deposits................................. (1,727) (1,129)
Due to related parties............................ (25) --
------- --------
Net cash provided by operating activities.......... 22,902 8,364
------- --------
Cash flows from investing activities:
Purchase of property and equipment.................. (4,206) (7,714)
Proceeds from disposal of assets held for resale.... -- 818
Cash paid for D-Vision acquisition and related
costs.............................................. -- (10,342)
------- --------
Net cash used in investing activities.............. (4,206) (17,238)
------- --------
Cash flows from financing activities:
Proceeds of issuance of Common Stock................ -- 13,528
Proceeds from option exercises...................... 640 766
Proceeds from employee stock purchase plan.......... 201 524
------- --------
Net cash provided by financing activities............ 841 14,818
------- --------
Foreign exchange effect on cash..................... (213) (2,211)
------- --------
Increase in cash and cash equivalents............... 19,324 3,733
Cash and cash equivalents, beginning of period...... 21,658 31,668
------- --------
Cash and cash equivalents, end of period............ $40,982 $ 35,401
======= ========
Supplemental disclosure of cash flow information:
Interest paid during the period..................... $ 17 $ 87
------- --------
Income taxes paid during the period................. $ 807 $ 2,512
------- --------
In connection with the acquisition of Lightscape in
December 1997, the following non-cash transaction
occurred:
Fair value of assets acquired....................... $ -- $ 7,615
Liabilities assumed................................. -- (7,615)
------- --------
Cash paid for acquisition, net of cash acquired...... $ -- $ --
======= ========
In connection with the acquisition of D-Vision in
July 1997, the following non-cash transaction
occurred:
Fair value of assets acquired....................... $ -- $ 27,210
Liabilities assumed................................. -- (5,811)
Cash acquired....................................... -- (408)
Issuance of 555,000 shares of Common Stock.......... -- (10,649)
------- --------
Cash paid for acquisition, net of cash acquired...... $ -- $ 10,342
======= ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.

5
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DISCREET LOGIC INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(1) Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have
been prepared by Discreet Logic Inc. ("Discreet Logic" or the "Company")
pursuant to the rules and regulations of the Securities and Exchange
Commission regarding interim financial reporting. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements and should be read in
conjunction with the consolidated financial statements and notes thereto for
the year ended June 30, 1997. The accompanying condensed consolidated
financial statements reflect all adjustments (consisting solely of normal,
recurring adjustments) which are, in the opinion of management, necessary for
a fair presentation of results for the interim periods presented. The results
of operations for the three and nine month periods ended March 31, 1998 are
not necessarily indicative of the results to be expected for any other interim
period or for the full fiscal year.

Restatement of Financial Statements

In connection with the proposed merger of the Company and Autodesk, Inc., a
Form S-4 (registration no. 333-65075) was filed with The Securities and
Exchange Commission ("SEC"). Subsequent to the SEC's letter to the American
Institute of Certified Public Accountants ("AICPA") dated September 9, 1998,
regarding the SEC's views on in-process research and development, the Company
has increased the allocation of the purchase price to "Goodwill" and has
decreased the allocation to the "Write-off of purchased research and
development" for its acquisitions of Denim Software in fiscal 1997, D-Vision
Systems and Lightscape Technologies, Inc. in the nine-month period ended March
31, 1998.

The revised allocation of the aggregate purchase price is as follows:

<TABLE>
<CAPTION>
As reported As restated
----------- -----------
<S> <C> <C>
In-process research and development.................... $36,600,000 $ 9,178,000
Acquired technology.................................... 5,553,991 5,553,991
Goodwill............................................... 1,328,753 28,750,753
Fair value of tangible assets acquired................. 3,526,651 3,526,651
----------- -----------
$47,009,395 $47,009,395
=========== ===========
</TABLE>

The effect of these adjustments on previously reported consolidated
financial statements for the three-month period ended March 31, 1998 as
follows:

<TABLE>
<CAPTION>
As As
reported restated
---------- ----------
<S> <C> <C>
General and administrative............................... $2,137,000 $4,422,000
Operating income......................................... $7,147,000 $4,862,000
Net income............................................... $5,203,000 $2,918,000
Basic earnings per share................................. $ 0.18 $ 0.10
Diluted earnings per share............................... $ 0.17 $ 0.09
</TABLE>

The effect of these adjustments on previously reported consolidated
financial statements for the nine-month period ended March 31, 1998 as
follows:

<TABLE>
<CAPTION>
As reported As restated
----------- -----------
<S> <C> <C>
General and administrative............................ $ 6,033,000 $11,978,000
Charge for purchased research and development......... $26,300,000 $ 6,915,000
Operating income (loss)............................... $(1,956,000) $11,984,000
Net income (loss)..................................... $(9,109,000) $ 4,831,000
Basic earnings per share.............................. $ (0.32) $ 0.17
Diluted earnings per share............................ $ (0.32) $ 0.16
</TABLE>

6
<PAGE>

DISCREET LOGIC INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

(2) Change of Fiscal Year

On January 9, 1997, the Board of Directors of the Company approved the
change of the Company's fiscal year end from July 31 to June 30. This change
was effective beginning with the Company's second fiscal quarter of 1997. The
condensed consolidated financial statements are presented for the three and
nine month periods ended March 31, 1998 and the three and eight month periods
ended March 31, 1997. The Company prepares consolidated financial statements,
re- measures accounts in foreign currencies to reflect changes in exchange
rates, and examines and adjusts certain reserve accounts at the end of each
quarter. Therefore, it is not practicable to recast prior quarterly results to
reflect the new fiscal period. Consequently, the results for the nine month
period ended March 31, 1998 are not directly comparable to the results of the
eight month period ended March 31, 1997.

(3) Litigation and Related Settlement Expenses

On May 29, 1996, June 13, 1996 and April 29, 1997, certain of Discreet
Logic's shareholders filed class action lawsuits alleging violations of
federal securities laws and other claims against Discreet Logic and certain of
its officers and directors among others. The three lawsuits were filed in the
Superior Court of the State of California, the United States District Court,
District of Massachusetts and the United States District Court, Northern
District of California, respectively. On or about November 25, 1997, a
settlement of all three shareholder class actions received final court
approval. Under the $10,800,000 settlement, the Company contributed
approximately $7,400,000 from its own funds, with the remainder provided by
insurance.

In the year ended July 31, 1996, the Company had provided a $2,506,000
litigation reserve for legal costs associated with defending the class action
lawsuits. During the eleven month period ended June 30, 1997, the Company
recorded a provision of $6,500,000 to accrue the additional estimated
settlement costs to be borne by the Company.

In the three month period ended March 31, 1998, the Company reversed
$405,000 of litigation and related settlement expenses in order to adjust
previously estimated legal costs to the actual amount of costs incurred.

(4) Related Party Transactions

In the three month period ended March 31, 1998, the Company purchased
consulting services, in the amount of $62,000, from BHVR Communications Inc.,
and purchased marketing services in the amount of $104,000 from Behaviour
Design Inc., companies controlled by the Company's Chairman and Chief
Executive Officer.

In the nine month period ended March 31, 1998, the Company recorded revenues
from sales made to Behaviour Entertainment Inc. ("Behaviour"), a company
controlled by the Company's Chairman and Chief Executive Officer, in the
amount of $309,000. The Company also purchased marketing services, in the
amount of $250,000, from Behaviour.

In accordance with the Company's policy, the purchase of these services was
on terms no less favorable to the Company than could be obtained by the
Company from unrelated third parties.

(5) Earnings Per Share

In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 128, Earnings per
Share. The new standard simplifies the computation of earnings per share (EPS)
and increases comparability to international standards. Under SFAS No. 128,
primary EPS is replaced by Basic EPS, which excludes dilution and is computed
by dividing income available to common shareholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects

7
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DISCREET LOGIC INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock. The Company
is required to disclose both basic and diluted EPS. All prior period EPS data
have been restated to conform to SFAS No. 128.

The following tables present, in thousands (except for EPS amounts), a
reconciliation of Basic EPS to Diluted EPS as required by SFAS No. 128:

<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
March 31, 1997 March 31, 1998
------------------- -----------------------
(Restated)
Income Shares EPS Income Shares EPS
------ ------ ----- ------ ---------- -----
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Income available to common share-
holders.......................... $3,039 27,995 $0.11 $2,918 29,074 $0.10
===== =====
Effect of Dilutive Securities
Impact of exercise of stock
options under treasury stock
method........................... -- 716 -- 1,793
------ ------ ------ ------
Diluted EPS
Income available to common
shareholders and assumed
exercises........................ $3,039 28,711 $0.11 $2,918 30,867 $0.09
====== ====== ===== ====== ====== =====
</TABLE>

Options to purchase 176 and 448 shares of common stock were outstanding
during the three month period ended March 31, 1997, and the three month period
ended March 31, 1998, respectively, but were not included in the computation
of diluted EPS because the options' exercise price was greater than the
average market price of the common shares.

<TABLE>
<CAPTION>
Eight Months Ended Nine Months Ended
March 31, 1997 March 31, 1998
------------------- -----------------------
(Restated)
Income Shares EPS Income Shares EPS
------ ------ ----- ------ ---------- -----
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Income available to common share-
holders.......................... $4,191 27,905 $0.15 $4,831 28,853 $0.17
===== =====
Effect of Dilutive Securities
Impact of exercise of stock
options under treasury stock
method........................... -- 637 -- 1,845
------ ------ ------ ------
Diluted EPS
Income available to common
shareholders and assumed
exercises........................ $4,191 28,542 $0.15 $4,831 30,698 $0.16
====== ====== ===== ====== ====== =====
</TABLE>

Options to purchase 269 and 382 shares of common stock were outstanding
during the eight month period ended March 31, 1997 and the nine-month period
ended March 31, 1998, respectively, but were not included in the computation
of diluted EPS because the options' exercise price was greater than the
average market price of the common shares.

(6) Revenue Recognition

In October 1997, the American Institute of Certified Public Accountants
issued Statement of Position (SOP, 97-2, Software Revenue Recognition). The
statement provides specific industry guidance and stipulates that revenue
recognized from software arrangements is to be allocated to each element of
the arrangement based on the relative fair values of the elements, such as
software products, upgrades, enhancements, postcontract

8
<PAGE>

DISCREET LOGIC INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

customer support, installation or training. Under SOP 97-2, the determination
of fair value is based on objective evidence that is specific to the vendor.
If such evidence of fair value for each element of the arrangement does not
exist, all revenue from the arrangement is deferred until such time that the
evidence of fair value does exist or until all elements of the arrangement are
delivered. Revenue allocated to software products, specified upgrades and
enhancements is generally recognized upon delivery of the related products,
upgrades and enhancements. Revenue allocated to postcontract customer support
is generally recognized ratably over the term of the support, and revenue
allocated to service elements is generally recognized as the services are
performed. SOP 97-2 was adopted by the Company effective January 1, 1998 and
has not had a material effect on revenue recognition.

(7) Acquisition of Lightscape Technologies, Inc.

On December 2, 1997, Discreet Logic entered into an Agreement and Plan of
Merger and Reorganization (the "Merger Agreement") with Lantern Acquisition
Corp., a Delaware corporation and wholly-owned subsidiary of Discreet Logic
("Merger Sub"), and Lightscape Technologies, Inc., a Delaware corporation
("Lightscape"). On December 30, 1997, pursuant to the Merger Agreement, and
upon the satisfaction of certain closing conditions, Merger Sub merged (the
"Merger") with and into Lightscape with Lightscape as the surviving
corporation and a wholly-owned subsidiary of Discreet Logic. As a result of
the Merger, Discreet Logic acquired, among other products, the Lightscape TM
product, a software application which integrates radiosity and raytracing with
physically based lighting, including related know-how and goodwill. The
aggregate purchase price for Lightscape includes the assumption of
approximately $5,700,000 of net liabilities (of which approximately $3,400,000
was paid at the closing), not including costs associated with the transaction,
and up to $6,800,000 in contingent consideration to be paid only if certain
revenue objectives are achieved by Lightscape in calendar 1998 and 1999. The
acquisition has been accounted for as a purchase. A portion of the purchase
price and transaction costs was allocated to purchased in-process research and
development for which Discreet Logic incurred a one-time charge against
earnings in the amount of $1,646,000, ($0.06 per share) as restated, based on
an appraisal, in the quarter ended December 31, 1997 and approximately
$5,241,000 as restated was allocated to intangible assets, which include
goodwill and acquired technology, and is being amortized on a straight-line
basis over their estimated useful lives of three to five years. The terms of
the transaction were the result of arms'-length negotiations between the
representatives of Discreet Logic and Lightscape.

The following presents, in thousands on an unaudited basis, certain items on
the Company's result of operations, for the eight month period ended March 31,
1997, and nine month period ended March 31, 1998, as though the acquisition
and related transactions discussed above had occurred at the beginning of
those periods:

<TABLE>
<CAPTION>
Eight Months Nine Months
Ended Ended
March 31, March 31,
1997 1998
------------ -----------
(Restated)
<S> <C> <C>
Total Revenues.................................... $ 68,293 $112,104
Operating income (loss)........................... $ (63) $ 9,048
Net loss.......................................... $ (2,904) $ 1,888
Basic EPS......................................... $ (0.10) $ 0.07
Diluted EPS....................................... $ (0.10) $ 0.06
</TABLE>

(8) Private Placement of Shares to INTEL Corporation

On March 4, 1998, Discreet Logic completed a private placement of 645,000
shares of its common shares, no par value per share (the "Shares"), for
proceeds to the Company of approximately $13,545,000, excluding issuance
costs. The Shares were offered only to Intel Corporation, an "Accredited
Investor" as such term is defined in Rule 501 of Regulation D. In connection
with this transaction, the Company agreed to file, within 90 days after the
closing on March 4, 1998, a registration statement with the Securities and
Exchange

9
<PAGE>

DISCREET LOGIC INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Commission covering the resale from time to time of the Shares issued in
connection with this private placement and to use its commercially reasonable
best efforts to cause such registration statement to become effective.

(9) Execution of Definitive Agreement to Acquire MGI Software Corp.

On March 9, 1998, Discreet Logic entered into a definitive agreement to
acquire MGI Software Corp. ("MGI") in a proposed arrangement transaction (the
"Arrangement") Pursuant to the Arrangement, a wholly-owned subsidiary of
Discreet Logic will amalgamate with MGI, with MGI surviving as a wholly-owned
subsidiary of Discreet Logic. Under the terms of the Arrangement, each share
of MGI common stock will be exchanged for 0.162 shares of Discreet Logic
common stock (the "Exchange Ratio"). Outstanding options and rights to
purchase MGI's common stock will become options and rights to purchase common
stock of Discreet Logic, with appropriate adjustments to the number of shares
issuable thereunder and the exercise price thereof based on the Exchange
Ratio. In connection with the transaction, MGI granted Discreet Logic an
option, exercisable under certain conditions, to purchase shares up to
approximately 20% of MGI's outstanding shares. The transaction has been
approved by the boards of directors of Discreet Logic and MGI, but is still
subject to various customary conditions, including the approval by
shareholders of MGI. Should the Arrangement be approved, the Company currently
expects, but is not bound, to account for this transaction under the pooling
of interests method of accounting.

Discreet Logic and MGI estimate they will incur Arrangement related costs of
approximately $3 million, including investment advisory fees, regulatory
filing costs, legal and accounting expenses, and other transaction costs. In
addition, it is expected that as a result of the Arrangement, the combined
company will incur consolidation and integration expenses that are not
currently reasonably estimable.

(10) Subsequent Event

In May 1998, Essential Communications Corporation, a company in which
Discreet Logic holds an investment of preferred shares, was sold. As a result
of this sale, the Company expects to receive proceeds of $2,500,000 in
exchange for its preferred shares. Previously, in fiscal 1996, the Company had
taken a charge to operations due to the uncertainty regarding the
realizability of this investment. The Company expects to receive the proceeds
of sale upon the delivery of its preferred shares in its fourth quarter of
fiscal 1998, at which time the Company will realize a non-recurring gain of
approximately $2,500,000.

10
<PAGE>

DISCREET LOGIC INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

Overview

Discreet Logic Inc. ("Discreet Logic" or the "Company") develops, assembles,
markets and supports non-linear, digital systems and software for creating,
editing and compositing imagery and special effects for film, video, and HDTV.
The Company's systems and software are utilized by creative professionals for
a variety of applications, including feature films, television programs,
commercials, music videos, interactive game production and live broadcasting.

Year 2000

The Company has made preliminary assessments of its products and information
systems and has determined that they are Year 2000 compliant, or that only a
limited effort will be required to achieve compliance. The Company is
currently proceeding with detailed reviews of every application used. It is
expected that some will have to be upgraded to Year 2000 compliant
applications. It is expected that some customers may experience some
difficulties related to non Discreet Logic products, which may affect the
performance of Discreet Logic products and, therefore, lead to an unusually
high number of calls to the Company's technical support department. The
Company anticipates that the costs related to the detailed assessments,
application upgrades, and responding to the increased volume of support calls
will not be material to its results of operations, liquidity and capital
resources.

Recent Developments

Restatement of Financial Statements

The revised allocation of the aggregate purchase price is as follows:

The effect of these adjustments on previously reported consolidated
financial statements for the three-month period ended March 31, 1998 as
follows:

11
<PAGE>

The effect of these adjustments on previously reported consolidated
financial statements for the nine-month period ended March 31, 1998 as
follows:

Private Placement of Shares to INTEL

On March 4, 1998, Discreet Logic completed a private placement of 645,000
shares of its common shares, no par value per share, for proceeds to the
Company of approximately $13,545,000, excluding issuance costs.

Execution of Definitive Agreement to Acquire MGI Software Corp.

Restructuring

During the fiscal year ended July 31, 1996, excluding a restructuring charge
of $15,000,000 and its related tax effects, the Company incurred a net loss of
approximately $31,000,000 on revenues of approximately $83,997,000. In
response to the financial results and other developments facing the business,
the Company developed a restructuring plan during the fourth fiscal quarter of
1996. While the Company began implementation of its restructuring plan in the
fourth fiscal quarter of 1996 and had substantially completed the
implementation of the plan at the end of fiscal 1997, the Company still has
approximately $3,252,000 in restructuring reserves primarily for the estimated
cost of terminating leases, resolving outstanding severance issues, and the
legal and taxation winding down of several subsidiaries.

Change of Fiscal Year

12
<PAGE>

of 1997. The condensed consolidated financial statements are presented for the
three and nine month periods ended March 31, 1998 and the three and eight
month periods ended March 31, 1997. The Company prepares consolidated
financial statements, remeasures accounts in foreign currencies to reflect
changes in exchange rates and examines and adjusts certain reserve accounts at
the end of each quarter. Therefore, it is not practicable to recast the prior
fiscal period's results to reflect the new fiscal period. Consequently, the
results for the nine month period ended March 31, 1998 are not directly
comparable to the results of the eight month period ended March 31, 1997.

Results of Operations

The following table sets forth the percentages of total revenues represented
by certain line items in the statements of operations:

<TABLE>
<CAPTION>
Three Months Three Months Eight Months Nine Months
Ended Ended Ended Ended
March 31, March 31, March 31, March 31,
1997 1998 1997 1998
------------ ------------ ------------ -----------
(Restated) (Restated)
<S> <C> <C> <C> <C>
Total revenues.............. 100% 100% 100% 100%
Cost of revenues............ 42 40 47 40
--- --- --- ---
Gross profit.............. 58 60 53 60
--- --- --- ---
Operating expenses:
Research and development.. 10 11 10 10
Sales and marketing....... 24 24 26 22
General and administra-
tive..................... 7 12 7 11
Charge for purchased re-
search and development... -- -- -- 6
Litigation and related
settlement expenses...... -- (1) -- --
--- --- --- ---
Total operating expenses.... 46 49
--- --- --- ---
Operating income.......... 17 14 10 11
Other income (expense),
net.........................
--- --- --- ---
Income before income tax-
es....................... 17 13 11 11
Provision for income taxes.. 6 5 5 7
--- --- --- ---
Net income.................. 11% 8% 6% 4%
=== === === ===
</TABLE>

Three Months Ended March 31, 1998 and 1997 and Nine Months Ended March 31,
1998 and Eight Months Ended 31, 1997

As discussed above, it is not practicable to recast prior quarterly results
to reflect new fiscal periodic reporting resulting from the Company's
previously announced change in fiscal year end. Therefore, the results for the
nine month period ended March 31, 1998 are not directly comparable to the
results of the eight month period ended March 31, 1997.

Total Revenues. The Company's revenues consist of product revenues
(including licensing of its software, sales of the Company's proprietary
hardware, and resale of third party hardware) and, to a lesser extent,
revenues from maintenance and other services (including consulting and
training). Beginning in the three months ended March 31, 1998, the Company has
recognized revenue in accordance with Statement of Position 97-2, entitled
"Software Revenue Recognition," issued by the American Institute of Certified
Public Accountants. The implementation of this new standard did not have a
material impact on the consolidated results of operations. See Note 6 of Notes
to Condensed Consolidated Financial Statements.

Total revenues were $35,712,000 and $27,044,000 for the three month periods
ended March 31, 1998, and 1997, respectively, and $111,385,000 and $67,139,000
for the nine and eight month periods ended March 31, 1998, and 1997,
respectively. The increase in total revenues in the three month period ended
March 31, 1998, when compared to the three month period ended March 31, 1997,
was primarily due to an increase in revenues

13
<PAGE>

generated by the Company's Special Effects and Editing product lines
(including the release and commercial shipment of new products). These
increases were partially offset by a decrease in revenues from the Company's
Broadcast Production product line. The increase in total revenues in the nine
month period ended March 31, 1998, when compared to the eight month period
ended March 31, 1997, was primarily due to the above factors as well as the
additional month in the fiscal 1998 period.

Revenues from customers outside of North America were $21,370,000 (60% of
total revenues) and $17,413,000 (64% of total revenues) for the three month
periods ended March 31, 1998, and 1997, respectively, and $61,335,000 (55% of
total revenues) and $39,193,000 (58% of total revenues) for the nine month
period ended March 31, 1998, and the eight month period ended March 31, 1997,
respectively. Revenues from customers outside North America increased in the
three months ended March 31, 1998 when compared to the three months ended
March 31, 1997 due to the increased penetration of the Company's products in
the Asian and other foreign markets. These increases were partially offset by
a decrease in revenues in the European market. Revenues from customers outside
North America increased in the nine months ended March 31, 1998 when compared
to the eight months ended March 31, 1997 due to the increased penetration of
the Company's products in all of the Company's foreign markets as well as the
additional month in the fiscal 1998 period. The Company expects that revenues
from customers outside of North America will continue to account for a
substantial portion of its revenues and should, as a percentage of total
revenues, remain approximately the same as current levels.

Cost of Revenues. Cost of revenues consists primarily of the cost of
hardware sold (mainly workstations manufactured by Silicon Graphics, Inc.
("SGI")), cost of hardware service contracts, cost of integration and hardware
assembly, cost of service personnel and the facilities, computing, benefits
and other administrative costs allocated to such personnel and the provision
for inventory reserves. Cost of revenues was $14,191,000 (40% of total
revenues) and $11,255,000 (42% of total revenues) for the three month periods
ended March 31, 1998, and 1997, respectively, and $45,018,000 (40% of total
revenues) and $31,545,000 (47% of total revenues) for the nine month period
ended March 31, 1998, and the eight month period ended March 31, 1997,
respectively. The decrease in cost of revenues, as a percentage of total
revenues, in both the three and nine month periods ended March 31, 1998 when
compared to the three and eight month periods ended March 31, 1997,
respectively, was primarily due to: (1) an increase in sales to the Company's
indirect channel partners, whose purchases from Discreet Logic are
predominantly software only and software and storage media bundles since these
indirect channel partners are themselves hardware resellers; (2) porting
certain of the Company's software products to recently available, lower priced
workstations, resulting in a lower cost to the Company for the hardware
component of system sales; and (3) the increased penetration of the Company's
products in the Asian market where customers typically purchase from the
Company only software or software and storage media bundles. The decrease in
cost of revenues, as a percentage of total revenues, in the nine months ended
March 31, 1998 when compared to the eight months ended March 31, 1997 is also
attributable to lower margins realized on systems sold in the three month
period ended October 31, 1996 under an aggressive sales program, including
product discounts, designed to reduce the inventory on hand at the end of the
fourth fiscal quarter of 1996. The Company expects that cost of revenues, as a
percentage of total revenues, should increase from its current level. However,
cost of revenues remains difficult to predict and is subject to fluctuations
due to a number of factors including product and product configuration mix and
the proportion of direct and indirect sales.

Research and Development. Research and development expenses consist
primarily of the cost of research and development personnel and the
facilities, depreciation on research and development equipment, amortization
of acquired technologies, computing, benefits and other administrative costs
allocated to such personnel, and consulting fees. Expenditures for research
and development, after deducting Canadian federal and provincial tax credits,
were $4,032,000 (11% of total revenues) and $2,746,000 (10% of total revenues)
for the three month periods ended March 31, 1998, and 1997, respectively, and
$11,445,000 (10% of total revenues) and $6,998,000 (10% of total revenues) for
the nine month period ended March 31, 1998, and the eight month period ended
March 31, 1997, respectively. The increase in research and development
expenses in the three months ended March 31, 1998 when compared to the three
months ended March 31, 1997 was primarily due to: (1) an increase

14
<PAGE>

in the number of software engineers (including the engineers joining the
Company as a result of the Denim, D-Vision and Lightscape Acquisitions) to
develop and enhance the Company's existing and newly acquired products and to
develop new products; and (2) an increase in depreciation charges on the
additional research and development equipment required for the additional
personnel. The increase in research and development expenses in the nine
months ended March 31, 1998 when compared to the eight months ended March 31,
1997 was primarily due to the above factors as well as the additional month in
the fiscal 1998 period. Research and development costs are expensed as
incurred. Software development costs are considered for capitalization once
technical feasibility has been established. The Company has not capitalized
any software development costs to date. Certain research and development
expenditures are incurred substantially in advance of related revenue and in
some cases do not generate revenues. The Company expects that research and
development expenses will increase from current levels. Should revenues
increase, the Company expects that research and development expenses, as a
percentage of total revenues, should remain approximately the same as their
current levels.

Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions and related benefits, facilities and administrative
costs allocated to the Company's sales and marketing personnel, tradeshow
expenses, and dealer commissions. Sales and marketing expenses were $8,610,000
(24% of total revenues) and $6,534,000 (24% of total revenues) for the three
month periods ended March 31, 1998, and 1997, respectively, and $24,450,000
(22% of total revenues) and $17,162,000 (26% of total revenues) for the nine
month period ended March 31, 1998, and the eight month period ended March 31,
1997, respectively. The increase in sales and marketing expenses, in the three
months ended March 31, 1998 when compared to the three months ended March 31,
1997 was primarily due to: (1) the continued expansion of the Company's direct
and indirect sales organization, including the operating costs of domestic
sales offices and foreign subsidiaries, and (2) an increase in tradeshow
activities. The increase in sales and marketing expenses, in the nine months
ended March 31, 1998 when compared to the eight months ended March 31, 1997
was primarily due to the above factors as well as the additional month in the
fiscal 1998 period. The decrease in sales and marketing expenses, as a
percentage of total revenues, in the nine months ended March 31, 1998 when
compared to the eight months ended March 31, 1997 is explained in part by the
growth of sales to the indirect channel partners which require a reduced level
of expenditures than direct sales to end-users. The Company expects that sales
and marketing expenses will increase from their current levels. Should
revenues increase, the Company expects that sales and marketing expenses, as a
percentage of total revenues, should remain approximately the same as their
current levels.

General and Administrative. General and administrative expenses include the
costs of finance and accounting, human resources, facilities, corporate
information systems, legal and other administrative functions of the Company,
amortization of goodwill, and reserves for doubtful accounts receivable.
General and administrative expenses were $4,422,000 (12% of total revenues) as
restated and $1,842,000 (7% of total revenues) for the three month periods
ended March 31, 1998, and 1997, respectively, and $11,978,000 (11% of total
revenues) as restated and $4,547,000 (7% of total revenues) for the nine-month
period ended March 31, 1998, and the eight-month period ended March 31, 1997,
respectively. The increase in general and administrative expenses in the three
months ended March 31, 1998 when compared to the three months ended March 31,
1997 is explained by an increase in personnel and the amortization of
goodwill, in the three-month period ended March 31,1998 associated with the
Denim, D-Vision, and Lightscape acquisitions. The increase in general and
administrative expenses in the nine-months ended March 31, 1998 when compared
to the eight-months ended March 31, 1997 is explained by the above factors as
well as the additional month in the fiscal 1998 period. The Company expects
that general and administrative expenses will increase from their current
levels. Should revenues increase, the Company expects that general and
administrative expenses, as a percentage of total revenues, should remain
approximately the same as their current levels.

Charge for Purchased Research and Development. In connection with the
Lightscape Acquisition, the Company expensed $1,646,000, as restated, of in-
process research and development in the three month period ended December 31,
1997. In connection with the D-Vision Acquisition, the Company expensed
$5,269,000, as restated, of in-process research and development in the three
month period ended September 30, 1997.

15
<PAGE>

Other Income (Expense). Other Income (Expense) primarily consists of foreign
currency gains and losses and interest income and expense. Foreign currency
translation resulted in losses of $385,000 and $445,000 for the three month
periods ended March 31, 1998, and 1997, respectively, and losses of $77,000
and gains of $13,000 for the nine month period ended March 31, 1998, and the
eight month period ended March 31, 1997, respectively. 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
$1,739,000 and $1,674,000 for the three month periods ended March 31, 1998,
and 1997, respectively, and $7,611,000 and $3,636,000 for the nine month
period ended March 31, 1998, and the eight month period ended March 31, 1997,
respectively. The provision for all periods is based upon the Canadian federal
statutory rate of 38% and reflects the impact of various tax credits and
foreign taxes. The effective tax rate for the three month period ended March
31, 1998 differed from the statutory rate primarily as a result of the
realization of the benefit for some prior year tax losses for which no benefit
was previously recorded and the amortization of goodwill for which no tax
benefit was recorded. The effective tax rate for the nine month period ended
March 31, 1998 differed from the statutory rate primarily as a result of the
Company recording charges for purchased in-process research and development
for which no benefit was recorded due to the uncertainty of realizing any
future tax benefit associated with these charges, the amortization of goodwill
for which no tax benefit was recorded, offset by the realization of the
benefit for some prior year tax losses for which no benefit was previously
recorded. The tax provision for the eight month period ended March 31, 1997
differed from the statutory rate primarily as a result of the Company not
recording a benefit related to losses where the realization of the benefit was
uncertain. The Company has foreign net operating loss carry forwards which may
be available to reduce future income tax liabilities.

Liquidity and Capital Resources

The Company has funded its operations to date primarily through cash flow
from operations, borrowings under its demand line of credit, capital leases,
the private and public sales of equity securities, and the receipt of research
and development tax credits from the Canadian federal government and the
Province of Quebec. As of March 31, 1998, the Company had cash of
approximately $35,401,000. In August 1997, the Company amended its revolving
demand line of credit with a bank under which the Company may borrow up to
CDN$7,000,000 (or approximately $4,940,000 at March 31, 1998). Advances under
the line accrue interest monthly at the Canadian prime rate (6.5% at March 31,
1998) plus 0.25%. Additionally, the Company has a CDN$600,000 (approximately
$423,000 at March 31, 1998) demand leasing facility, and a CDN$600,000
(approximately $423,000 at March 31, 1998) demand research and development tax
credit facility. Advances under these facilities accrue interest monthly at
the Canadian prime rate (6.5% at March 31, 1998) plus 1%. The line and
facilities are secured by essentially all of the Company's North American
assets. As additional security, the Company has assigned to the bank its
insurance on these assets. The Company is required to maintain certain
financial ratios, including minimum levels of working capital, debt service
coverage and equity to assets ratios. As of March 31, 1998, no amounts were
outstanding under the demand line of credit, the demand leasing, or the demand
research and development tax credit facilities.

The Company's operating activities provided cash of $8,364,000 and
$22,902,000 for the nine month period ended March 31, 1998 and the eight month
period ended March 31, 1997, respectively. The principal uses of cash for the
nine months ended March 31, 1998 were the disbursement of funds used to settle
the class action litigations and the decrease in accounts payable and accrued
expenses resulting from the Company paying many of the liabilities assumed in
connection with the D-Vision and Lightscape acquisitions. These uses of cash
were offset primarily by cash provided by net income before non-cash charges,
including the charges for purchased in-process research and development, the
receipt of insurance proceeds related to the settlement of the class action
litigations and the increase in income taxes payable. Net cash provided by
operations in the eight-month period ended March 31, 1997 was composed
primarily of cash provided by net income before non-cash charges,

16
<PAGE>

decreases in accounts receivable, inventory, and income taxes receivable, and
increases in accounts payable and accrued expenses, deferred revenue, income
taxes payable, and customer deposits.

The Company's investing activities used cash of $17,238,000 in the nine
month period ended March 31, 1998 primarily for the acquisition of D-Vision
Systems, Inc. and the purchase of research and development equipment and
related software. During the nine month period ended March 31, 1998, the
Company received proceeds from the sale of its Montreal land and office
building which were previously included on the balance sheet as assets held
for resale. The proceeds of sale were not materially different from the
carrying value of these assets. The Company's investing activities used cash
of $4,206,000 in the eight month period ended March 31, 1997, primarily for
renovations to the office building in London, England and the purchase of
computer equipment and software used in the operations of the Company's
business, primarily in the research and development area.

Financing activities provided cash of $14,818,000 and $841,000 in the nine
month period ended March 31, 1998 and eight month period ended March 31, 1997,
respectively. The nine month 1998 period included the receipt of proceeds of
issuance of common stock, net of issuance costs, to Intel Corporation under a
private placement completed in March 1998. See Note 8 of Notes to Condensed
Consolidated Financial Statements. Other sources of cash in the periods ended
March 31, 1998 and 1997, respectively, included proceeds from common stock
option exercises and the issuance of shares under the Employee Stock Purchase
Plan.

As of March 31, 1998, the Company did not have any material commitments for
capital expenditures.

The Company's ability to meet its future liquidity requirements is dependent
upon its ability to operate profitably, and/or to obtain additional financing.
Should the Company need to secure additional financing to meet its future
liquidity requirements, there can be no assurance that the Company will be
able to secure such financing, or that such financing, if available, will be
on terms favorable to the Company. Subject to the factors discussed below in
Certain Factors That May Affect Future Results, the Company believes that,
with its current levels of working capital together with funds generated from
operations, it has adequate sources of cash to meet its operations and capital
expenditure requirements through calendar 1998.

Certain Factors That May Affect Future Results

Information provided by the Company from time to time including statements
in this Form 10-Q which are not historical facts, are so-called forward-
looking statements, and are made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995 and releases of the
Securities and Exchange Commission. In particular, statements contained in the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" which are not historical facts (including, but not limited to,
statements regarding the Company's anticipated cost of revenues, statements
regarding the anticipated adequacy of cash to meet operations, statements
concerning anticipated expense levels and such expenses as a percentage of
revenues, statements about the anticipated portion of revenues from customers
outside North America, and the proposed acquisition of MGI) may constitute
forward-looking statements. The Company's actual future results may differ
significantly from those stated in any forward-looking statements. Factors
that may cause such differences include, but are not limited to, the factors
discussed below, other risks discussed in this section and elsewhere in this
Form 10-Q, and the other risks discussed in the Company's Annual Report on
Form 10-K for the fiscal year ended June 30, 1997, as well as, from time to
time, in the Company's other filings with the Securities and Exchange
Commission.

The Company's future results are subject to substantial risks and
uncertainties. The Company's future financial performance will depend in part
on the successful development, introduction and customer acceptance of its
existing and new or enhanced products. In addition, in order for the Company
to achieve sustained growth, the market for the Company's systems and software
must continue to develop and the Company must expand this market to include
additional applications within the film and video industries and develop or
acquire new products for use in related markets. There can be no assurance
that the Company will be successful in marketing its existing or any new or
enhanced products. In addition, as the Company enters new markets,
distribution

17
<PAGE>

channels, technical requirements and levels and bases of competition may be
different from those in the Company's current markets and there can be no
assurance that the Company will be able to compete favorably. The markets in
which the Company competes are characterized by intense competition and many
of the Company's current and prospective competitors have significantly
greater financial, technical, manufacturing and marketing resources than the
Company. These companies may introduce additional products that are
competitive with those of the Company, and there can be no assurance that the
Company's products would compete effectively with such products. Furthermore,
competitive pressures or other factors, including the Company's entry into new
markets, may result in significant price erosion that could have a material
adverse effect on the Company's business and results of operations. The
Company has recently completed the purchase of certain products and technology
through acquisitions and proposes to acquire new products and technology
through its merger with MGI. 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 merger with MGI will be successful, or that the
Company will not incur disruptions and unexpected expenses in integrating the
operations of the acquired businesses with those of the Company.

The Company's flame*, inferno*, fire*, smoke* and frost* systems currently
include workstations manufactured by SGI. There are significant risks
associated with this reliance on SGI and the Company may be impacted by the
timing of the development and release of products by SGI, as was the case
during fiscal 1996. In addition, there may be unforeseen difficulties
associated with adapting the Company's products to future SGI products. The
Company derives a significant portion of its total revenues from foreign
sales. Foreign sales are subject to significant risks, including unexpected
legal, tax and exchange rate changes (including the recent currency volatility
in Asia) and other barriers. In addition, foreign customers may have longer
payment cycles and the protection of intellectual property in foreign
countries may be more difficult to enforce. The Company currently relies
principally on unregistered copyrights and trade secrets to protect its
intellectual property. Any invalidation of the Company's intellectual property
rights or lengthy and expensive defense of those rights could have a material
adverse effect on the Company. The Company receives letters from third
parties, from time to time, inquiring about the Company's products and
discussing intellectual property matters, which the Company reviews to
determine the appropriate response, if any. 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 received a letter from Avid
Technology, Inc.

("Avid") stating its belief that certain of the Company's acquired D-Vision
products practice inventions claimed in a patent on a media editing system.
The Company has responded to Avid's letter stating the Company's belief that
the Company is not infringing any valid claim of Avid's patent. To the
Company's knowledge, Avid has not initiated any suit, action or other
proceeding alleging any infringement by the Company of such patent. The
Company currently markets its systems through its direct sales organization
and through distributors. This marketing strategy may result in distribution
channel conflicts as the Company's direct sales efforts may compete with those
of its indirect channels. The Company currently relies on SGI as the sole
source for video input/output cards used in the Company's systems. The
Company's edit* (formerly named D-VISION and OnLINE) software requires a
videographic card manufactured solely by Truevision, Inc. An interruption in
the supply or increase in the price of either one of these components could
have a material adverse effect on the Company's business and results of
operations. To date, the Company has depended to a significant extent upon a
number of key management and technical employees and the Company's ability to
manage its operations will require it to continue to recruit and retain senior
management personnel and to motivate and effectively manage its employee base.
The loss of the services of one or more of these key employees could have a
material adverse effect on the Company's business and results of operations.
There can be no assurance that these factors will not have a material adverse
effect on the Company's future international sales and consequently, on the
Company's business and results of operations.

The market price of the Company's common shares could be subject to
significant fluctuations in response to quarter-to-quarter variations in the
Company's operating results, announcements of technological innovations or new
products by the Company, its competitors or suppliers and other events or
factors. In addition, the stock

18
<PAGE>

market in recent years has experienced extreme price and volume fluctuations
that have particularly affected the market prices of many technology companies
and that have often been unrelated or disproportionate to the operational
performance of these companies. These fluctuations, as well as general
economic and market conditions may materially and adversely affect the market
price of the Company's common shares.

The Company believes that its operating results could vary significantly
from quarter to quarter. A limited number of systems sales may account for a
substantial percentage of the Company's quarterly revenue because of the high
average sales price of such systems and the timing of purchase orders.
Historically, the Company has generally experienced greater revenues during
the period following the completion of the annual conference of the National
Association of Broadcasters ("NAB"), which is typically held in April. The
Company's expense levels are based, in part, on its expectations of future
revenues. Therefore, if revenue levels are below expectations, particularly
following NAB, the Company's operating results are likely to be adversely
affected. In addition, the timing of revenue is influenced by a number of
other factors, including: the timing of individual orders and shipments, other
industry trade shows, competition, seasonal customer buying patterns, changes
to customer buying patterns in response to platform changes and changes in
product development and sales and marketing expenditures. Because the
Company's operating expenses are based on anticipated revenue levels and a
high percentage of the Company's expenses are relatively fixed in the short
term, variations in the timing of recognition of revenue could cause
significant fluctuations in operating results from quarter to quarter and may
result in unanticipated quarterly earnings shortfalls or losses. There can be
no assurance that the Company will be successful in maintaining or improving
its profitability or avoiding losses in any future period. The Company
believes that quarter-to-quarter comparisons of its financial results are not
necessarily meaningful and should not be relied upon as an indication of
future performance.

19
<PAGE>

PART II: OTHER INFORMATION

Item 2. Changes in Securities

On March 4, 1998, Discreet Logic Inc. (the "Company") completed a private
placement of 645,000 shares of its common shares, no par value per share (the
"Shares"), for proceeds to the Company of approximately $13,545,000, excluding
issuance costs. The Company claims that the offer and sale of the Shares were
exempt from registration under the Securities Act of 1933, as amended,
pursuant to Rule 506 of Regulation D in reliance upon information available to
the Company as of March 4, 1998. The Shares were offered only to Intel
Corporation, an "Accredited Investor" as such term is defined in Rule 501 of
Regulation D. In connection with this transaction, the Company agreed to file,
within 90 days after the closing on March 4, 1998, a registration statement
with the Securities and Exchange Commission covering the resale from time to
time of the Shares issued in connection with this private placement and to use
its commercially reasonable best efforts to cause such registration statement
to become effective.

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits.

<TABLE>
<CAPTION>
Exhibit Description of Exhibit
- ------- ----------------------
<S> <C>
Exhibit 27.1............................................ Financial Data Schedule
</TABLE>

(b) Reports on Form 8-K.

A Current Report on Form 8-K dated December 30, 1997 was filed on January
14, 1998. The Current Report on Form 8-K was filed pursuant to Item 2 of Form
8-K (Acquisition or Disposition of Assets) announcing the completion of the
merger of Lantern Acquisition Corp. ("Merger Sub"), a Delaware corporation and
wholly-owned subsidiary of Discreet Logic with and into Lightscape
Technologies, Inc. ("Lightscape"), a Delaware corporation, with Lightscape the
surviving corporation and a wholly-owned subsidiary of Discreet Logic,
pursuant to the Agreement and Plan of Merger and Reorganization dated as of
December 2, 1997 by and among Discreet Logic, Merger Sub and Lightscape. A
Current Report on Form 8- K/A dated December 30, 1997 was filed on March 16,
1998 containing the financial statements required by Item 7 of Form 8-K.

A Current Report on Form 8-K dated March 4, 1998 was filed on March 30,
1998. The Current Report on Form 8-K was filed pursuant to Item 5 of form 8-K
(Other Events) announcing the completion of a private placement of common
shares to Intel Corporation. This Current Report on Form 8-K also announced
the execution of a definitive agreement to acquire MGI Software Corp. Further
disclosure related to this agreement was filed on a subsequent Current Report
on form 8-K discussed below.

A Current Report on Form 8-K dated March 9, 1998 was filed on April 30,
1998. The Current Report on Form 8-K was filed on a voluntary basis pursuant
to Item 5 of form 8-K (Other Events) announcing the execution of a definitive
agreement to acquire MGI Software Corp. ("MGI") in a proposed arrangement
transaction.

20
<PAGE>

DISCREET LOGIC INC.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

Discreet Logic Inc.

By: /s/ Francois Plamondon
----------------------------------
Francois Plamondon
Executive Vice President, Chief
Financial Officer, Treasurer and
Secretary

February 4, 1999

<PAGE>

<ARTICLE> 5
<LEGEND>
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> JUN-30-1998 JUN-30-1998
<PERIOD-START> JAN-01-1998 JUL-01-1997
<PERIOD-END> MAR-31-1998 MAR-31-1998
<CASH> 35,401 35,401
<SECURITIES> 0 0
<RECEIVABLES> 34,086 34,086
<ALLOWANCES> (3,688) (3,688)
<INVENTORY> 14,996 14,996
<CURRENT-ASSETS> 86,065 86,065
<PP&E> 29,682 29,682
<DEPRECIATION> (14,882) (14,882)
<TOTAL-ASSETS> 131,682 131,682
<CURRENT-LIABILITIES> 55,248 55,248
<BONDS> 0 0
0 0
0 0
<COMMON> 107,378 107,378
<OTHER-SE> (33,713) (33,713)
<TOTAL-LIABILITY-AND-EQUITY> 131,682 131,682
<SALES> 35,712 111,385
<TOTAL-REVENUES> 35,712 111,385
<CGS> 14,191 45,018
<TOTAL-COSTS> 14,191 45,018
<OTHER-EXPENSES> 16,659 54,383
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 0 0
<INCOME-PRETAX> 4,657 12,442
<INCOME-TAX> 1,739 7,611
<INCOME-CONTINUING> 2,918 4,831
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 2,918 4,831
<EPS-PRIMARY> 0.10 0.17
<EPS-DILUTED> 0.09 0.16

</TABLE>