-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, K+mpR2gqZbItZpUOLLiJ0nIXbvSzVgM0umk6jDbyN0DggbXsXbXYW4usvjYCviEp rQLSWT270ro9P09XW1T3fQ== 0001012870-98-000962.txt : 19980415 0001012870-98-000962.hdr.sgml : 19980415 ACCESSION NUMBER: 0001012870-98-000962 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980228 FILED AS OF DATE: 19980414 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: COREL CORP CENTRAL INDEX KEY: 0000890640 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 101151819 STATE OF INCORPORATION: A6 FISCAL YEAR END: 1130 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-20562 FILM NUMBER: 98593632 BUSINESS ADDRESS: STREET 1: 1600 CARLING AVE CITY: OTTAWA ONTARIO CANAD STATE: A6 BUSINESS PHONE: 6137288200 MAIL ADDRESS: STREET 1: 1600 CARLING AVENUE CITY: OTTAWA STATE: A6 10-Q 1 FORM 10-Q FOR PERIOD ENDED 2/28/98 =============================================================================== SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark one) [ X ] Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the period ended February 28, 1998 ---------------------------------------------------- or [ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the transition period from ________________ to _______________________ Commission File Number 0-20562 ------- COREL CORPORATION ----------------- (Exact name of Registrant as specified in its Charter) Canada NOT APPLICABLE --------------------------------- ---------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1600 Carling Avenue, Ottawa, Ontario, Canada K1Z 8R7 -------------------------------------------- ------- (Address of principal executive offices) (Zip Code) (613) 728-8200 -------------- (Registrant's telephone number, including area code) 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 ------- _____ As of April 8,1998, the registrant had 59,346,209 Common Shares outstanding. =============================================================================== 1 COREL CORPORATION TABLE OF CONTENTS PART I. FINANCIAL INFORMATION
Page No. -------- Item 1. Financial Statements Consolidated Balance Sheets as at November 30, 1997 and February 28, 1998......................................... 3 Consolidated Statements of Operations and Retained Earnings (Deficit) for the three months ended February 28, 1997 and February 28, 1998.............................................. 4 Consolidated Statements of Changes in Financial Position for the three months ended February 28, 1997 and February 28, 1998.......................................................... 5 Notes to Consolidated Financial Statements...................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................ 10 PART II. OTHER INFORMATION Item 1. Legal Proceedings............................................... 21 Item 6. Exhibits and Reports on Form 8-K................................ 22 SIGNATURES................................................................. 23
2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS 1. FINANCIAL STATEMENTS COREL CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands of U.S.$)
November 30, February 28, 1997 1998 (unaudited) -------------------- ------------------- ASSETS Current assets: Cash and short-term investments................. $ 30,629 $ 18,948 Accounts receivable (note 2) Trade....................................... 50,951 33,955 Other....................................... 2,310 2,961 Inventory (note 3).............................. 11,412 12,486 Deferred income taxes........................... 2,353 2,695 Prepaid expenses................................ 2,591 2,021 --------- --------- 100,246 73,066 Capital assets (note 4).............................. 63,497 57,397 --------- --------- $ 163,743 $ 130,463 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable................................ $ 13,840 $ 6,457 Accrued liabilities............................. 34,223 32,431 Current portion of long-term debt............... 13,500 13,500 Income taxes payable............................ 4,203 5,077 Deferred revenue................................ 14,124 11,992 --------- --------- 79,890 69,457 Long-term debt (note 5).............................. 24,044 23,273 Shareholders' equity Share capital (note 6).......................... 204,235 202,879 Contributed surplus............................. 730 1,099 Deficit......................................... (145,156) (166,245) --------- ---------- 59,809 37,733 --------- ---------- $ 163,743 $ 130,463 ========= ==========
(See accompanying Notes to Consolidated Financial Statements) 3 COREL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS (DEFICIT) (in thousands of U.S.$, except per share data) (unaudited)
Three months ended ------------------------------- February 28, February 28, 1997 1998 ------------- ------------ Sales....................................................... $ 80,718 $ 45,460 Cost of sales (note 7)...................................... 24,023 10,442 --------- --------- Gross profit............................................. 56,695 35,018 --------- --------- Expenses: Advertising.............................................. 19,873 11,168 Selling, general and administrative...................... 19,652 18,417 Research and development................................. 18,823 21,165 Depreciation and amortization............................ 6,894 4,391 Loss on foreign exchange................................. 183 283 --------- --------- 65,425 55,424 --------- --------- Loss from operations........................................ (8,730) (20,406) Interest expense............................................ 501 133 --------- --------- Loss before income taxes.................................... (9,231) (20,539) Income taxes: Current................................................. 3,847 892 Deferred (reduction).................................... (1,824) (342) --------- --------- 2,023 550 Net loss.................................................... (11,254) (21,089) Retained earnings (deficit) at beginning of period.......... 86,955 (145,156) --------- ---------- Retained earnings (deficit) at end of period................ $ 75,701 $(166,245) ========= ========= Loss per share: (note 6) Net loss Basic................................................ ($0.19) ($0.36) Average number of Common Shares outstanding: Basic................................................ 60,068 59,346 - --------------------------------------------------------------------------------------------------
(See accompanying Notes to Consolidated Financial Statements) 4 COREL CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION (in thousands of U.S.$) (unaudited)
Three months ended February 28, February 28, 1997 1998 -------------------- ------------------ Cash provided by (used for): Operations: Net loss.................................................. $(11,254) $(21,089) Items which do not involve cash: Depreciation and amortization........................ 20,756 7,548 Loss (gain) on disposal of assets.................... (1) (4) Deferred income taxes................................ (1,824) (342) Decrease in accounts receivable........................... 5,055 16,345 Increase in inventory..................................... (1,484) (1,074) Decrease in prepaid expenses.............................. 838 570 Decrease in accounts payable.............................. (4,817) (7,383) Increase (decrease) in other accrued liabilities.......... 4,111 (1,792) Increase (decrease) in deferred revenue................... 1,931 (2,132) Increase (decrease) in income taxes payable/recoverable... (595) 874 -------- -------- Cash provided by (used for) operations.................... 12,716 (8,479) Financing: Issue of share capital.................................... 241 - Shares purchased for cancellation......................... - (987) Repayment of long-term debt............................... (3,054) (771) -------- -------- (2,813) (1,758) Investments: Purchase of capital assets................................ (4,845) (1,448) Proceeds on disposal of assets............................ 34 4 -------- -------- (4,811) (1,444) Net increase (decrease) in cash................................ 5,092 (11,681) Cash at beginning of period.................................... 6,924 30,629 -------- -------- Cash at end of period.......................................... $ 12,016 $ 18,948 ======== ======== Cash is defined as cash and short-term investments
(See accompanying Notes to Consolidated Financial Statements) 5 COREL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (U.S. dollars, tabular amounts in thousands except per share data) (Unaudited) 1. BASIS OF PRESENTATION The accompanying unaudited interim consolidated financial statements of Corel Corporation (the "Company") have been prepared by the Company in accordance with accounting principles generally accepted in Canada. These principles are also generally accepted in the United States except as disclosed in Note 8. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Corel Corporation Limited, Corel Computer Corp., Corel International Corporation, Corel, Inc. and its wholly-owned subsidiary, Corel Corporation (U.S.A.). In the opinion of Management, these unaudited interim consolidated financial statements reflect all adjustments, which are of a normal and recurring nature, necessary to state fairly the results for the periods presented. These financial statements should be read in conjunction with the Company's audited financial statements as of November 30, 1996 and 1997 and for each of the three years in the period ended November 30, 1997 including notes thereto, included in the Company's Annual Report on Form 10-K for the year ended November 30, 1997. The consolidated results of operations for the first fiscal quarter are not necessarily indicative of the results to be expected for any future period. 2. ACCOUNTS RECEIVABLE Included in trade accounts receivable are the following reserves:
November 30, February 28, 1997 1998 ------------ ------------ Promotional rebates................................... $11,396 $15,891 Sales reserve......................................... 54,413 36,414 Allowance for doubtful accounts....................... 5,466 5,786
6 3. INVENTORIES
November 30, February 28, 1997 1998 ------------ ------------ Raw materials......................................... $ 7,974 $ 9,768 Finished goods........................................ 3,438 2,718 ------- ------- $11,412 $12,486 ======= =======
4. CAPITAL ASSETS
FEBRUARY 28, 1998 ------------------------------------------------- ACCUMULATED DEPRECIATION NET AND NOVEMBER 30, COST AMORTIZATION NET 1997 ----------- -------------- ----------- -------------- Furniture and equipment.................... $ 15,592 $ 7,751 $ 7,841 $ 8,307 Computer equipment and software............ 61,581 54,621 6,960 9,423 Research and development equipment......... 12,622 5,568 7,054 7,398 Leasehold improvements..................... 3,625 2,103 1,522 1,674 Software licenses and purchased software, clipart libraries and photo CD libraries. 94,560 60,540 34,020 36,695 -------- -------- ------- ------- $187,980 $130,583 $57,397 $63,497 ======== ======== ======= =======
At November 30, 1997, the cost amounted to $186,521,000 and accumulated depreciation amounted to $123,024,000. The carrying amount of licenses not being amortized at February 28, 1998 and November 30, 1997 amounted to $2,916,000 and $2,425,000 respectively. 5. LONG-TERM DEBT Long-term debt consists of the outstanding royalty and product return obligations pursuant to the WordPerfect acquisition on March 1, 1996.
As at November 30, 1997 As at February 28, 1998 ------------------------------------ ------------------------------------ Product Product Royalty Returns Total Royalty Returns Total ------- ------- ----- ------- ------- ----- Long-term debt........... $19,182 $18,362 $37,544 $18,906 $17,867 $36,773 Less: Current portion.... 6,500 7,000 13,500 6,500 7,000 13,500 ---------- ---------- ---------- ----------- ---------- ---------- $12,682 $11,362 $24,044 $12,406 $10,867 $23,273 ========== =========== =========== ============ ========== ==========
7 COREL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (U.S. dollars, tabular amounts in thousands except per share data) (Unaudited) 6. SHARE CAPITAL During the three-month periods ended February 28, 1997 and February 28, 1998, the Company issued 40,203 and 0 common shares, respectively, pursuant to its Stock Option Plan, for proceeds of $241,000 and $0, respectively. In addition, during the three month period ended February 28, 1998, the Company, pursuant to its normal course issuer bid which commenced on March 5, 1997, purchased for cancellation 393,500 common shares at a cost of $987,000. 7. COST OF SALES
FISCAL QUARTER ENDED --------------------------------------- FEBRUARY 28, FEBRUARY 28, 1997 1998 ------------ ----------- Cost of goods sold................................................. $ 5,489 $ 5,408 Licence amortization............................................... 13,861 3,157 Royalties.......................................................... 4,673 1,877 ------- ------- $24,023 $10,442 ======= =======
8. SIGNIFICANT DIFFERENCES BETWEEN CANADIAN AND UNITED STATES GAAP The Company's financial statements are prepared on the basis of Canadian GAAP, which is different in some respects from US GAAP. Significant differences between Canadian GAAP and US GAAP are set forth below: (a) Earnings per share calculations The Company has considered the effect of the methodology for the calculation of earnings per share prescribed under the Statement of Financial Accounting Standards No. 128. The calculation of basic earnings per share for US GAAP purposes is not different from the calculation of basic earnings per share for Canadian GAAP. Under US and Canadian GAAP, where the impact of conversion or exercise of stock options is anti-dilutive, they are not included in the calculation of diluted earnings per share. (b) Accounting for stock-based compensation 8 The Company applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its employee stock option plan. Accordingly, no compensation expense has been recognized for its stock-based plan. Had compensation cost for the Company's employee stock option plan been determined based on the fair value at the grant date for awards under the plan, consistent with the methodology prescribed under the Statement of Financial Standards No. 123, Accounting for Stock-Based Compensation, the Company's net loss would not have been changed significantly from the amount reported on the Statement of Operations and Retained Earnings (Deficit) for the three month period ended February 28, 1998. (c) Deferred income taxes: The Company follows the deferral method of accounting for income taxes. Under US GAAP the asset and liability method is used. In the case of the Company, the application of the asset and liability method does not result in a significant difference in the amount of the deferred tax asset. US GAAP also requires the disclosure of the tax effect of temporary differences that give rise to deferred tax assets and liabilities. This information is provided in the following:
NOVEMBER 30, FEBRUARY 28, 1997 1998 ------------ ------------ Operating loss carryforwards....................................... $ 4,855 $ 8,258 Depreciation....................................................... 14,750 16,311 Reserves........................................................... 3,292 8,354 -------- -------- $ 22,897 $ 32,923 Valuation allowance (20,544) (30,228) -------- -------- Net deferred tax assets $ 2,353 $ 2,695 ======== ========
(d) Consolidated statements of change in financial position The Company defines cash for purposes of the consolidated statements of changes in financial position as cash and short-term investments. Included in short- term investments are $5,000,000 of marketable equity securities. Under US GAAP, cash at the end of the first quarter ended February 28, 1998 would be reduced by this amount. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following information must be read in conjunction with the unaudited Consolidated Financial Statements and Notes thereto included in Item 1 of this Quarterly Report and the audited Consolidated Financial Statements and Notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the Company's Annual Report on Form 10-K for the year ended November 30, 1997 (the "1997 Form 10-K"). This Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements involve uncertainty and risk, and all assumptions, anticipations, and expectations stated herein are forward-looking statements. The actual results that the Company achieves may differ materially from any forward-looking statements made herein due to such risks and uncertainties. The Company has identified by italics various sentences within this Form 10-Q which contain such forward- looking statements, and words such as "believes", "anticipates", "expects", "intends" and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. In addition, the section labeled "Factors That May Affect Future Operating Results", which is not italicized for improved readability, consists primarily of forward-looking statements. The Company undertakes no obligation to revise any forward-looking statements in order to reflect events or circumstances that may arise after the date of this report. Readers are urged to carefully review and consider the various disclosures made by the Company in this report and in the Company's other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect the Company's business. Therefore, historical results and percentage relationships will not necessarily be indicative of the operating results of any future period. On January 20, 1998, the Company announced in a press release that it had restated its financial results for the first three quarters of fiscal 1997, to reflect a different accounting treatment of certain JAVA technologies exchange transactions that had been entered into during those quarters. The effects of the restatement were discussed in the press release and accompanying financial summaries, which were filed as exhibits to the Company's Report on Form 8-K filed with the Securities and Exchange Commission and with the Ontario Securities Commission on January 21, 1998. Financial information in this Report concerning fiscal 1997 reflects this restatement of the first quarter of fiscal 1997. 10 RESULTS OF OPERATIONS The following table presents, for the periods indicated, certain statement of income data expressed as a percentage of sales for the periods indicated, and the percentage change of such items as they relate to the comparable period in the previous year.
PERCENT OF SALES PERIOD TO PERIOD THREE MONTHS ENDED INCREASE (DECREASE) --------------------------------- 1998 FEBRUARY 29, FEBRUARY 28, COMPARED TO 1997 1998 1997 ------------ ------------ ------------------ Sales..................................... 100% 100% (44)% Cost of sales............................. 30 23 (57) ---- --- Gross profit............................ 70 77 (38) Expenses Advertising............................. 25 25 (44) Selling, general and administrative..... 24 40 (6) Research and development................ 23 46 12 Depreciation and amortization........... 9 10 (36) Loss on foreign exchange................ 0 1 55 ---- --- 81 122 (15) ---- --- Loss from operations...................... (11) (45) (134) Interest expense.......................... 0 0 (73) ---- --- Loss before income taxes.................. (11) (45) (123) Income taxes.............................. 3 1 (73) ---- --- Net loss.................................. (14)% (46)% (87) ==== ===
SALES Sales decreased 44% to $45.5 million in the first quarter of fiscal 1998 from $80.7 million in the first quarter of fiscal 1997 primarily due to decreased aggregate unit sales of Corel's products. In addition, the dollar amount of sales in the first quarter of fiscal 1998 was also affected by a charge recorded in the first quarter of fiscal 1998 relating to the announcement of Corel's new WordPerfect Suite pricing strategy on March 9, 1998. That announcement outlined the reduction in selling price of certain WordPerfect Suite products. The charge recorded in the first quarter of fiscal 1998 was $11.2 million and related to price protection allowances that the Company expects to credit its distributors and resellers for the products affected by this announcement. PRODUCT GROUPS. The table below shows sales for the first fiscal quarter ended February 28, 1997 and 1998, consisting of graphics software new licenses (full kits and competitive upgrades) and existing user upgrades, productivity software new licenses (full kits and competitive upgrades) and existing user upgrades, multimedia software (including sales from 11 the Company's Professional Photo CD titles and CorelSCSI), and communication applications (including CorelVIDEO): 12
THREE MONTHS ENDED ------------------------------------------------------- FEBRUARY 28, 1997 FEBRUARY 28, 1998 ------------------------- --------------------------- Graphics software - new licenses.......................... $ 26,455 $ 18,269 Graphics software - existing user upgrades................ 11,165 8,699 ------------------------- --------------------------- Total graphics software............................... 37,620 26,968 ------------------------- --------------------------- Productivity software - new licenses...................... 31,211 16,936 Productivity software - existing user upgrades............ 9,926 1,027 ------------------------- --------------------------- Total productivity software........................... 41,137 17,963 ------------------------- --------------------------- Multimedia software....................................... 1,598 426 Communications applications............................... 363 103 ------------------------- ---------------------------- Total sales...................................... $ 80,718 $ 45,460 ========================= ============================
Graphics software revenues decreased in the first quarter of fiscal 1998, as compared to the first quarter of fiscal 1997, primarily due to reduced unit volumes of retail versions of CorelDRAW 7 and CorelDRAW 8. Productivity software revenues decreased in the first quarter of fiscal 1998, as compared to the first quarter of fiscal 1997, primarily due to reduced unit volumes of retail versions of Corel WordPerfect Suite 8 and Corel WordPerfect Suite 7 and the price protection allowances related to the new WordPerfect pricing strategy, partially offset by revenues from sales of Corel WordPerfect Suite 8 Professional, which was introduced in the third quarter of fiscal 1997, and by increasing corporate licensing revenues. Multimedia sales were lower in the first quarter of fiscal 1998, as compared to the first quarter of fiscal 1997, primarily due to a decline in the unit sales of the Corel Stock Photo Libraries and a decline in Corel CD HOME revenues resulting from the sale of the Corel CD HOME COLLECTION and Corel Medical Series to Hoffman + Associates Inc. in April 1997. SALES CHANNELS. Corel distributes its products primarily through distributors (as retail packaged products), OEM licences and corporate licences. The table below shows sales through these channels for the first fiscal quarter ended February 28, 1997 and 1998:
THREE MONTHS ENDED FEBRUARY 28, ----------------------------- 1997 1998 ------------- ------------- Retail packaged products.............................................. $56,081 $19,324 OEM licences.......................................................... 7,910 5,992 Corporate licences.................................................... 16,727 20,144 ------------- ------------- Total sales........................................................... $80,718 $45,460 ============= =============
13 Retail packaged products and corporate licences are sold primarily through distributors. The three largest distributors accounted for $32.5 million (40%) and $7.6 million (17%) of Corel's sales in the first quarter of fiscal 1997 and 1998, respectively. Packaged product volume decreased in the first quarter of fiscal 1998 primarily because of a decrease in unit volume sales of the current version of the WordPerfect Suite at that time. Corporate licences, including maintenance revenues, increased in the first quarter of fiscal 1998, as compared to the first quarter of fiscal 1997, due to increased unit volume sales resulting from the expanded marketing efforts in this area. OEM channel revenues decreased in the first quarter of fiscal 1998, as compared to the first quarter of fiscal 1997, primarily due to a decline in unit volume for OEM versions of CorelDRAW 5 and CorelDRAW 4. The table below shows Corel's sales geographically for the first fiscal quarter ended February 28, 1997 and 1998:
THREE MONTHS ENDED FEBRUARY 28, ------------------------------ 1997 1998 ------------- ------------- North America....................................................... $44,679 $23,968 Europe.............................................................. 31,393 16,192 Other international................................................. 4,646 5,300 ------------- ------------- Total sales......................................................... $80,718 $45,460 ============= =============
Sales outside North America, principally in Europe, were 45% and 47% of Corel's sales for the first quarter of fiscal 1997 and 1998, respectively. Corel's products are sold primarily in US dollars in all countries other than Canada and in US dollars to Canadian distributors. Sales in US dollars as a percentage of total sales were in excess of 95% in the first quarter of both fiscal 1997 and fiscal 1998. GROSS PROFIT Corel includes in cost of sales all costs associated with the acquisition of components, the assembly of finished products, product royalties, the amortization of software acquisition costs and shipping. Costs associated with warehousing are included in selling, general and administrative expenses. Acquired software has been capitalized and is currently being amortized over a 36-month period commencing with the month of first shipment of the product incorporating such acquired software, except for the cost of the WordPerfect family of software programs and related technology, which is currently being amortized over a five year period. Gross profit as a percentage of sales was 77% of sales in the first quarter of fiscal 1998 as compared to 70% in the first quarter of fiscal 1997. Gross profit as a percentage of sales 14 increased in the first quarter of fiscal 1998 compared to the first quarter of fiscal 1997 primarily due to the reduction in quarterly amortization charges of approximately $9 million pursuant to the technology write-down of $113.7 million in the second quarter of fiscal 1997. ADVERTISING EXPENSE Advertising expenses include all marketing, advertising and trade show expenses. Advertising expenses decreased by 44% to $11.2 million in the first quarter of fiscal 1998 from $19.9 million in the first quarter of fiscal 1997. Advertising expenses remained constant as a percentage of sales at 25% for the first quarters ending February 28, 1997 and February 28, 1998. The decrease in advertising expenses in the first quarter of fiscal 1998 was due to more targeted marketing efforts and the implementation of various cost control measures. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE Selling, general and administrative expenses include all general administrative expenses as well as expenses associated with warehousing. Selling, general and administrative expenses decreased by 6% to $18.4 million in the first quarter of fiscal 1998 from $19.6 million in the first quarter of fiscal 1997. Selling, general and administrative expenses increased as a percentage of sales from 24% in the first quarter of fiscal 1997 to 40% in the first quarter of fiscal 1998. The increase in the amount of such expenses as a percentage of sales was primarily due to the level of sales achieved in the first quarter of fiscal 1997 compared to the first quarter of fiscal 1998. RESEARCH AND DEVELOPMENT EXPENSE The Company has expensed all of its internal software development costs as incurred, in accordance with Canadian GAAP. Research and development expenses are reported net of Canadian investment tax credits. The table below shows gross research and development expenses, related tax credits, net research and development expenses, and net research and development expenses as a percentage of sales for the periods indicated:
THREE MONTHS ENDED FEBRUARY 28, -------------------------------- 1997 1998 ------------- ------------ Gross research and development expenses............................. $20,246 $21,165 Research and development tax credits................................ 1,423 - ------------- ------------ Net research and development expenses............................... $18,823 $21,165 Net research and development expenses as a percentage of sales......................................... 23% 46%
Net research and development expenses increased by 12% to $21.2 million in the first quarter of fiscal 1998 from $18.8 million in the first quarter of fiscal 1997. Net research and development expenses as a percentage of sales increased from 23% in the first quarter of fiscal 1997 to 46% in the first quarter of fiscal 1998. The increase in net research and development 15 expenses was primarily attributable to the inability to claim investment tax credits in the first quarter of fiscal 1998. The Company will be in a position to recognize the tax credits associated with these and future research and development expenses as the Canadian operations become profitable. DEPRECIATION AND AMORTIZATION EXPENSE Depreciation and amortization expenses, which do not include the amortization of purchased software, decreased by 36% to $4.4 million in the first quarter of fiscal 1998 from $6.9 million in the first quarter of fiscal 1997. Depreciation and amortization expenses decreased in the first quarter of fiscal 1998 compared to the first fiscal quarter of 1997 primarily due to significant capital expenditures coming to the end of their depreciation and amortization periods throughout the quarter. LOSS (GAIN) ON FOREIGN EXCHANGE Foreign exchange gains or losses on non-US dollar transactions are due to fluctuations in the value of those currencies relative to the value of the US dollar between the time sales are recorded and the collection of the account receivable, and revaluation gains or losses relating to short-term investments held in a currency other than the financial measurement and reporting currency due to fluctuations in the value of those currencies relative to the value of the US dollar. INTEREST EXPENSE Interest expense decreased by $0.4 million to an expense of $0.1 million in the first quarter of fiscal 1998 from $0.5 million in the first quarter of fiscal 1997. The decrease was primarily due to the lower level of long-term interest bearing obligations resulting from the acquisition of the WordPerfect family of software programs on March 1, 1996. INCOME TAXES Corel's effective tax rates were 22% and 3% for the first quarter of fiscal 1997 and 1998, respectively. These rates vary from the Company's statutory tax rate of 44%, primarily due to foreign tax rate differences associated with Corel's international operations and the unrecorded tax benefit of accounting losses in the first quarter of fiscal 1998. The accounting losses reflect amounts which may be carried forward for income tax purposes. LIQUIDITY AND CAPITAL RESOURCES As of February 28, 1998, Corel's principal sources of liquidity included cash and short-term investments of approximately $18.9 million, and accounts receivable of $36.9 million. Short-term investments consist of overnight call loans to a major Canadian bank and marketable securities. Long-term debt of $36.8 million consists of the outstanding royalty and product 16 return obligations pursuant to the acquisition of the WordPerfect family of software programs on March 1, 1996. Cash used by operations was $8.5 million for the first quarter of fiscal 1998 compared to cash provided of $12.7 million for the first quarter of fiscal 1997. The decrease of $21.2 million was primarily due to the net loss of $21.1 million in the first quarter of fiscal 1998 compared to the net loss of $11.3 million in the first quarter of fiscal 1997 and a decrease in depreciation and amortization expense of $13.3 million from $20.8 million for the first quarter of fiscal 1997 to $7.5 million for the first quarter of fiscal 1998. Accounts receivable decreased in the first quarter of fiscal 1998 primarily due to reduced sales levels in the third and fourth quarters of fiscal 1997. Financing activities used cash of $1.7 million in the first quarter of fiscal 1998 compared to $2.8 million in the first quarter of fiscal 1997. Investing activities, primarily the acquisition of capital assets, used $1.4 million in the first quarter of fiscal 1998 compared to $4.8 million in the first quarter of fiscal 1997, including expenditures for acquired software of $0.5 million in the first quarter of fiscal 1998 compared to $2.5 million in the first quarter of fiscal 1997. At February 28, 1998, Corel had no material commitments for capital expenditures. Corel anticipates that capital expenditures for computer and office equipment for fiscal 1998 will remain constant with fiscal 1997 levels as computer systems are upgraded to take advantage of new technologies. Due to the rapidly changing technology in the computer software industry, expenditures for technology acquisitions cannot be predicted for future fiscal periods. The Company believes that the existing sources of liquidity and anticipated funds from operations will satisfy Corel's projected working capital, capital expenditure and long-term debt repayment requirements for at least the next 12 months. The Company anticipates that subsequent to that time, its working capital, capital expenditures and long-term debt repayments will be satisfied by existing sources of liquidity, funds from operations and, if necessary, additional financings. FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS Corel does not provide forecasts of future financial performance. While Corel's management is confident about Corel's long-term performance prospects, the following factors, among others, should be considered in evaluating its future results of operations. Competition The PC software business is highly competitive and subject to rapid technological change. Many of Corel's current and potential competitors have larger technical staffs, more established and larger marketing and sales organizations, and significantly greater financial resources than does Corel. The rapid pace of technological change constantly creates new opportunities for existing and new competitors and can quickly render existing technologies 17 less valuable. As the market for Corel's products continues to develop, additional competitors may enter the market and competition may intensify. Graphics Software. Corel's graphics software products face substantial competition from a wide variety of companies. In the illustration graphics segment Corel's competitors include Adobe Systems Incorporated, Macromedia Inc., Deneba Systems Incorporated and Micrografx, Inc. In the photo editing and painting graphics segment its competitors include Adobe and Micrografx. In the charting and presentation segments its competitors include Software Publishing Corporation, Microsoft, Corporation, Adobe, Micrografx and IBM (Lotus Development Corporation). In the desktop publishing segment its competitors include Adobe and Quark, Inc. Corel's competitors include many other independent software vendors, such as Autodesk, Inc., Borland International, Inc., Claris and Computer Associates, as well as a number of personal computer manufacturers which devote significant resources to creating personal computer software, including Apple, Hewlett-Packard Company and IBM. Productivity Software. Corel's competitors in the productivity software (primarily office suites) marketplace include Microsoft and IBM (Lotus). According to industry sources, Microsoft currently has the largest overall market share for office suites. IBM has a large installed base with its spreadsheet program and has recently adopted aggressive pricing strategies. Also, IBM preinstalls certain of its software products on various models of its PCs, competing directly with Corel productivity software. The Company believes that the principal competitive factors in the PC software markets include performance, product features, ease of use, reliability, hardware compatibility, brand name recognition, product reputation, pricing, levels of advertising, availability and quality of customer support, and timeliness of product upgrades. Corel competes with other software vendors for access to distribution channels, retail shelf space and the attention of customers at the retail level and in corporate accounts. The Company also competes with other software companies in its efforts to acquire software technology developed by first parties. The Company believes that, in the future, competition in the industry will intensify as major software companies expand their product lines. Pricing In the past year, pricing pressures have intensified in the PC software applications market and the Company believes that price competition, with its attendant reduced profit margins, may become a more significant factor in the future. Corporate licensing, discount pricing for large volume distributors and retailers, product bundling promotions and competitive upgrade programs are forms of price competition that may become more prevalent. In addition, local area network versions of products are generally priced lower per user than individual copies of the same products. Corel also competes with companies that produce standalone graphics and desktop publishing applications that might serve a specific need of a user or class of users at a price below that of Corel's products. Additionally, should competitive pressures in the industry increase, Corel may have to increase its spending on advertising as a percentage of revenues, resulting in lower profit margins. 18 Technological Change The markets for Corel's products are characterized by rapidly changing technology, frequent new product introductions and uncertainty due to new and emerging technologies. Corel's future success is highly dependent upon the timely completion and introduction of new or enhanced products incorporating such emerging technologies at competitive price/performance levels. The pace of change has recently accelerated due to the Internet, corporate intranets, the introduction of 32-bit operating systems, such as Windows 95 and Windows NT 4.0, and new programming languages, such as Java. PC Growth Rates The underlying PC unit growth rate, which may increase at a slower rate in the future, impacts Corel's revenue growth. Dependence on New Products While Corel performs extensive usability and beta testing of new and enhanced products, user acceptance and corporate penetration rates ultimately determine the success of development and marketing efforts. Product Ship Schedules Delays in new-product releases impact sales growth rates and can cause operational inefficiencies that impact manufacturing and distribution logistics, distributor, reseller and OEM relationships, and technical support and customer service staffing. Channel Mix Average revenue per unit is lower from OEM licences than from retail versions, reflecting the relatively low direct costs of operations in the OEM channel. Potential Fluctuations in Quarterly Results Corel's quarterly operating results fluctuate as a result of a number of factors, including the timing of new product announcements and introductions by Corel and its competitors, pricing, distributor ordering patterns, the relative proportions of sales attributable to full kits and existing user upgrades, product returns and reserves, advertising and other marketing expenditures, and research and development expenditures. Revenues and earnings may be difficult to predict due to shipment patterns. Products are generally shipped as orders are received, and accordingly, Corel has historically operated with little backlog. As a result, sales in any quarter are dependent on orders booked and shipped in that quarter. As is typical in the computer software industry, a high percentage of Corel's revenues are expected to be earned in the third month of each fiscal quarter and will tend to be concentrated in the latter half of that month. Accordingly, quarterly financial results will be difficult to predict until the end of the quarter and a shortfall in shipments at the end of any particular quarter may cause the results of that quarter to fall significantly short of anticipated levels. 19 Employee Compensation The highly competitive market for qualified personnel, especially software engineers and developers, could adversely affect Corel's ability to engage and retain competent qualified personnel, particularly development professionals. Corel believes that its employment policies in this regard are competitive with the industry norm. Effective December 1, 1997, Corel introduced an employee bonus incentive plan. Dependence on Distributors The distribution of Corel's products is carried out primarily through distributors, certain of which are material to the competitive position of Corel. The distribution channels through which software products for desktop computers are sold have been characterized by rapid change, including consolidations and financial difficulties of certain distributors and resellers, the emergence of new retailers such as general mass merchandisers and superstores, and the desire of large customers such as retail chains and corporate users to purchase directly from software developers. The loss of, or a significant reduction in sales volume attributable to, any of Corel's principal distributors or the insolvency or business failure of any such distributor could have a material adverse effect on Corel's results of operations. International Operations and Geographic Concentration Currently, Corel markets its products in approximately 70 countries. Corel anticipates that sales outside North America will continue to account for a significant portion of total sales. These sales are subject to certain risks including imposition of government controls, export licence requirements, restrictions on the export of technology, political instability, trade restrictions, changes in tariffs, differences in copyright protection and difficulties in managing accounts receivable. More than 40% of Corel's sales for the past three fiscal years were made in the United States. As a result, adverse developments in the United States markets for Corel's products could have a material adverse effect on Corel's results of operations. Dependence on Key Personnel Corel's success depends to a significant extent upon the performance of Corel's executive officers and key technical and marketing personnel, particularly the Company's founder and Chairman, President and Chief Executive Officer, Dr. Michael C.J. Cowpland. Corel has agreements describing compensation arrangements and containing non-disclosure covenants with certain of its key employees. Corel does not have employment agreements with other key employees, including Dr. Cowpland. Corel believes that its future success will also depend in large part on its ability to attract and retain highly skilled technical, managerial, and sales and marketing personnel. 20 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On or about January 12, 1998, the Company received notice that a complaint had been filed against it by Micrografx, Inc. in the Northern District of Texas, Dallas Division. The complaint alleges that the personal calendar included in Corel Print House Magic is strikingly similar to and in some instances virtually identical to the personal calendar found in the plaintiff's CreataCard Gold and CreataCard Plus software products. The complaint includes causes of action for copyright infringement, false designation of origin and false representations in commerce, unfair competition and unjust enrichment. By motion filed January 20, 1998, the plaintiff seeks a preliminary injunction to stop the Company from distributing or selling the personal calendar (Corel Family & Friends) included in Corel Print House Magic. An attempt to mediate the matters at issue occurred on February 12, 1998; however, this initiative was unsuccessful. Depositions of various Corel representatives and various plaintiff representatives and experts occurred in February and March of 1998. On April 10, 1998, the plaintiff's motion for a preliminary injunction was denied. The Company considers the complaint to be ill-founded and will continue to vigorously defend the action. On or about March 5, 1998, Corel was served with a class action lawsuit filed against it by named Plaintiff Great Neck Capital Appreciation Investment Partnership in the United States District Court for the Eastern District of New York. The complaint also names as co-defendants Dr. Michael C. J. Cowpland, Corel's Chairman, President and Chief Executive Officer, and Mr. Charles Norris, Corel's former Vice President, Finance and Chief Financial Officer. The complaint was filed on behalf of all persons who purchased or otherwise acquired Corel common shares between March 26, 1997 and January 20, 1998 (the "Class Period"). The complaint alleges that the defendants violated various provisions of the federal securities laws, including Section 10(b) and 10(a) of the Securities Exchange Act of 1934, as amended, and Securities and Exchange Commission Rule 10b-5, by misrepresenting or failing to disclose material information about Corel's financial condition. The complaint alleges that the defendants issued false and misleading press releases and financial statements for the first three quarters of fiscal 1997. Plaintiff alleges, in part, that defendants (a) failed to disclose that they were overstating Corel's reported profits by, among other things, inflating reported revenues and earnings through improperly recognizing revenue on Java technology exchange transactions, and (b) overstated revenues and earnings by understating reserves in connection with sales to distributors who had no obligation to keep or pay for the products. The complaint also alleges that Corel insiders, including the individual co- defendants, sold common shares during the Class Period at "artificially inflated prices". The complaint seeks an unspecified amount of money damages. On or about March 13, 1998, Corel was served with a class action lawsuit filed against it by named Plaintiff Oren Giskan in the United States District Court for the Eastern District of New York. The complaint also names as co-defendants Dr. Michael C.J. Cowpland and Mr. Charles Norris. The complaint is similar in form and substance to the Great Neck complaint referred to above. 21 On or about April 8, 1998, the Company received notice that a total of three additional class action complaints had been filed against it. Corel has not yet been served with copies of these additional actions. No motions have been filed or discovery yet undertaken. Corel's answer to the various class action complaints will not be filed until all such actions are consolidated and a lead plaintiff/counsel is appointed. Corel intends to defend the class action litigation vigorously. However, due to the inherent uncertainties of litigation, Corel cannot accurately predict the ultimate outcome of the litigation. Investigating and defending the complaint (once consolidated) may require expenditure of material amounts of funds and may require a significant amount of management's time and resources. An unfavorable outcome in the litigation could have a material adverse effect on Corel's business, financial condition and results of operations. Announcement of material developments in the litigation prior to its resolution could adversely affect the market price of Corel's common shares. The Company is a party to a number of additional claims arising in the ordinary course of business relating to intellectual property and other matters. The Company believes that the ultimate resolution of these claims will not have a material adverse effect on its business, financial position or results of operations. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits 27.1 Financial Data Schedule b) Reports on Form 8-K The Company filed a Report on Form 8-K in January 1998 concerning the restatement of its financial statements for the first three quarters of fiscal 1997. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." 22 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COREL CORPORATION (Registrant) Date: April 8, 1998 By: /s/ Michael C.J. Cowpland ------------------------- MICHAEL C. J. COWPLAND Chairman, President, Chief Executive Officer and Director Date: April 8, 1998 By: /s/ Michael P. O'Reilly -------------------------------- MICHAEL P. O'REILLY Vice-President, Finance and Chief Financial Officer 23 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS NOV-30-1998 DEC-01-1997 FEB-28-1998 18,948 0 36,916 0 12,486 73,066 57,397 0 130,463 69,457 0 0 0 202,879 (165,146) 37,733 45,460 45,460 10,442 55,424 0 0 133 (20,539) 550 (21,089) 0 0 0 (21,089) (.36) (.36)
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