-----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, Upsm0CR6eA0XsC7w7YCwnkU8rJxpVeOQ1ZIp1bgTQ2NQNEN1ptksNp8rqA0oOHLS qBv7yqd5ht9tfUpaTocznQ== 0001012870-99-003682.txt : 19991018 0001012870-99-003682.hdr.sgml : 19991018 ACCESSION NUMBER: 0001012870-99-003682 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990831 FILED AS OF DATE: 19991015 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: 99729145 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 DATED AUGUST 31, 1999. ================================================================================ 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 August 31, 1999 ----------------------------------------------------------- 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 October 13 , 1999, the registrant had 64,130,787 Common Shares outstanding. ================================================================================ COREL CORPORATION TABLE OF CONTENTS
Page No. -------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as at August 31, 1999 and November 30, 1998...................................................... 3 Consolidated Statements of Operations and Deficit for the three months and for the nine months ended August 31, 1999 and August 31, 1998........................................................ 4 Consolidated Statements of Changes in Financial Position for the nine months ended August 31, 1999 and August 31, 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............................................................... 22 Item 6. Exhibits and Reports on Form 8-K................................................ 24 SIGNATURES................................................................................... 25
PART I. FINANCIAL INFORMATION Item 1. Financial Statements COREL CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands of U.S.$)
August 31, November 30, 1999 1998 -------------- ------------- ASSETS (unaudited) (audited) Current assets: Cash and short-term investments......................... $ 23,792 $ 24,506 Accounts receivable (note 2) Trade............................................... 47,359 45,789 Other............................................... 2,494 877 Inventory (note 3)...................................... 14,549 17,098 Deferred income taxes................................... 1,642 2,495 Prepaid expenses........................................ 2,213 4,618 ----------- ----------- Total current assets......................................... 92,049 95,383 Investments.................................................. 3,180 - Capital assets............................................... 48,245 44,776 ----------- ----------- Total assets................................................ $ 143,474 $ 140,159 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities................ $ 47,488 $ 58,209 Current portion of Novell obligations................... 11,800 11,800 Income taxes payable.................................... 3,743 7,549 Deferred revenue........................................ 17,629 17,933 ----------- ----------- Total current liabilities.................................... 80,660 95,491 Novell obligations........................................... 9,085 16,085 Shareholders' equity Share capital........................................... 216,100 203,088 Contributed surplus..................................... 1,099 1,099 Deficit................................................. (163,470) (175,604) ----------- ----------- Total shareholders' equity................................... 53,729 28,583 ----------- ----------- Total liability and shareholders' equity..................... $ 143,474 $ 140,159 =========== ===========
(See accompanying Notes to Consolidated Financial Statements) COREL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS AND DEFICIT (in thousands of U.S.$, except per share data) (unaudited)
Three months ended Nine months ended August 31 August 31 ------------------------- -------------------------- 1999 1998 1999 1998 --------- --------- ---------- ----------- Sales............................................ $ 71,312 $ 71,083 $ 182,119 $ 179,585 Cost of sales.................................... 15,466 14,932 41,118 36,682 --------- --------- ---------- ----------- Gross profit.................................. 55,846 56,151 141,001 142,903 --------- --------- ---------- ----------- Expenses Advertising................................... 11,641 7,403 32,358 30,372 Selling, general and administrative........... 19,377 19,717 59,934 57,232 Research and development...................... 10,671 16,981 36,526 59,911 Depreciation and amortization................. 1,895 2,465 4,568 10,445 Restructuring charges......................... - 15,880 - 15,880 Settlement proceeds........................... (6,342) - (6,342) - Loss (gain) on foreign exchange............... 319 (78) 265 675 --------- --------- ---------- ----------- 37,561 62,368 127,309 174,515 --------- --------- ---------- ----------- Income (loss) from operations.................... 18,285 (6,217) 13,692 (31,612) Interest expense (income)........................ (46) 154 283 994 --------- --------- ---------- ----------- Income (loss) before income taxes................ 18,331 (6,371) 13,409 (32,606) Income taxes Current...................................... 693 494 422 4,068 Deferred..................................... 44 969 853 556 --------- --------- ---------- ----------- 737 1,463 1,275 4,624 Net income (loss)................................ 17,594 (7,834) 12,134 (37,230) Deficit beginning of period...................... (181,064) (174,552) (175,604) (145,156) --------- --------- ---------- ----------- Deficit end of period............................ $(163,470) $(182,386) $ (163,470) $ (182,386) ========= ========= ========== =========== Earnings (loss) per share: Net earnings (loss) Basic....................................... $ 0.28 $ (0.13) $ 0.20 $ (0.63) Fully diluted............................... $ 0.26 $ (0.13) $ 0.18 $ (0.63) Weighted average number of Common Shares outstanding (000s) Basic....................................... 62,793 59,346 61,519 59,505 Fully diluted............................... 69,062 59,346 68,720 59,505
(See accompanying Notes to Consolidated Financial Statements) COREL CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION (in thousands of U.S.$) (unaudited)
Nine months ended ---------------------------------- August 31, August 31, 1999 1998 ------------- ------------- Cash provided by (used for): Operations: Net Income (loss).................................................... $ 12,134 $ (37,230) Items which do not involve cash: Depreciation and amortization................................... 14,436 19,877 Gain on disposal of assets...................................... (80) (79) Restructuring charges........................................... - 3,086 Deferred income taxes........................................... 853 556 Decrease (Increase) in accounts receivable........................... (3,187) 3,865 Decrease (Increase) in inventory..................................... 2,549 (5,230) Decrease in prepaid expenses......................................... 2,405 40 Increase (decrease) in accounts payable and accrued liabilities......................................................... (10,721) 14,289 Increase (decrease) in deferred revenue.............................. (304) 2,343 Increase (decrease) in income taxes payable/recoverable.............. (3,806) 1,898 ----------- ---------- Cash provided by (used for) operations............................... 14,279 3,415 ----------- ---------- Financing: Issue of share capital............................................... 13,012 - Shares repurchased for cancellation.................................. - (987) Repayment of Novell obligations...................................... (7,000) (7,125) ----------- ---------- 6,012 (8,112) ----------- ---------- Investments: Purchase of investment............................................... (3,351) - Purchase of capital assets........................................... (17,750) (6,159) Proceeds on disposal of assets....................................... 96 79 ----------- ---------- (21,005) (6,080) ----------- ---------- Net decrease in cash.................................................... (714) (10,777) Cash at beginning of period............................................. 24,506 30,629 ----------- ---------- Cash at end of period................................................... $ 23,792 $ 19,852 =========== ==========
Cash is defined as cash and short-term investments (See accompanying Notes to Consolidated Financial Statements) 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 6. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Corel Corporation Limited, Corel International Corporation, Corel, Inc. and its wholly-owned subsidiary, Corel Corporation (U.S.A.). Corel Computer was amalgamated with Corel Corporation on December 1, 1998 and is no longer a subsidiary of the parent company. 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, 1997 and 1998 and for each of the three quarters in the period ended November 30, 1999 including notes thereto, included in the Company's Annual Report on Form 10-K for the year ended November 30, 1998. The consolidated results of operations for the first three fiscal quarters 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:
August 31, November 30, 1999 1998 ---------- ------------ Promotional rebates........................... $ 3,876 $ 6,197 Sales reserve................................. 31,318 21,882 Allowance for doubtful accounts............... 7,014 6,804
3. Inventories
August 31, November 30, 1999 1998 ---------- ------------ Product components............................ $ 10,419 $ 12,799 Finished goods................................ 4,130 4,299 ---------- --------- $ 14,549 $ 17,098 ========== =========
4. Capital Assets The Company revised the estimated useful life of all computer equipment and research and development equipment in the second quarter of 1999. All of the equipment from these classes have a useful life of 3 years. The previous estimated useful life for computer equipment was 2 years. The previous method to depreciate research and development equipment was 20% on a declining basis, this change in estimate was accounted for on a prospective basis. 5. Restructuring Charge The Company proceeded with the implementation of a consolidation plan in the third fiscal quarter of 1998. As at August 31, 1999, the restructuring accrual included in accounts payable and accrued liabilities is comprised of the following amounts:
- --------------------------------------------------------------------------------------------------------- Asset write - Severance Facilities Total downs cost closure costs - --------------------------------------------------------------------------------------------------------- Restructuring charge.................... $ 3,086 $10,104 $ 2,690 $ 15,880 Payments................................ - (8,495) (2,633) (11,128) Reallocation............................ - (1,609) 1,609 - Non-cash asset write downs.............. (3,086) - - (3,086) - --------------------------------------------------------------------------------------------------------- Restructuring accrual - - $ 1,666 $ 1,666 =========================================================================================================
6. 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) Calculation of earnings per share The Company adopted Statement of Financial Accounting Standards (SFAS), No. 128, "earnings per share" during the year ended November 30, 1998 and restated earnings per share for all prior periods presented is required by such statement. The dilutive effect of the weighted average share calculation results from employee stock options.
Fiscal Quarter Nine Months ended Ended August 31 August 31 -------------------------------------------------- 1999 1998 1999 1998 --------------------------------------------------- US GAAP - basic and diluted Net income (loss) per share -Basic $ 0.28 ($0.13) $ 0.20 ($0.63) -Diluted $ 0.27 ($0.13) $ 0.20 ($0.63) Weighted average number of common shares Basic 62,793 59,346 61,519 59,505 Dilutive effect of employee stock options 1,393 -- 465 -- ------------------------------------------------- Diluted 64,186 59,346 61,984 59,505 =================================================
Options to purchase 2,324,054 shares for the third quarter and first nine months of 1999 were outstanding but were excluded from the computation of diluted shares outstanding because the price of the options was greater than the average market price of the common stock for the period covered. (b) 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:
August 31, November 30, 1999 1998 ----------- -------------- Operation loss carryforward................................ $ 9,098 $ 15,437 Depreciation............................................... 6,209 10,246 Reserves................................................... 5,393 5,473 Royalties not yet deducted for tax purposes................ 1,416 1,556 ----------- ------------- 22,116 32,712 Valuation allowance........................................ (20,473) (30,217) ----------- ------------- Net deferred tax assets.................................... $ 1,642 $ 2,495 =========== =============
The net current deferred tax assets relate to the operations in the United States of America. These assets are temporary differences which the company believes will reverse in the near future. (c) Consolidated statements of changes in financial position The Company defines cash for purposes of the consolidated statements of changes in financial position as cash and short-term investments. As at August 31, 1999, the Company had no short-term investments. All short-term investments held at November 30, 1998 ($2,100,000), were sold or redeemed during the first fiscal quarter of 1999. The short-term investments as at November 30, 1998 would not qualify as cash equivalents under US GAAP, consequently cash flows from operating activities under US GAAP would decrease by $800,000, and cash from investing activities under US GAAP would increase by $2,900,000 in the first fiscal quarter of 1999. (d) Recent accounting pronouncements The Company has adopted the Financial Accounting Standards Board Issued Statement (SFAS) No. 130, "Reporting Comprehensive Income". The adoption of SFAS 130 did not have an impact on the Company's financial disclosures for the three months ended August 31, 1999. The Company will adopt SFAS 131, "Disclosures about Segments of an Enterprise and Related Information" for its fiscal year ending November 30, 1999. 6. Contingencies On May 25, 1998, Revenue Canada advised the Company of proposed income tax adjustments for fiscal years ended November 30, 1992 to 1995. The Company filed a Response to Revenue Canada's Proposal on October 23, 1998 and had subsequently continued to dialogue and exchange of correspondence in respect of a number of particular issues in question. The company has recorded a provision of $2,468,000, inclusive of interest and penalties, for certain adjustments. However, it is not possible to accurately estimate the amount, if any, of additional income taxes that may result from the remaining adjustments identified and therefore, no further provision has been made. 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 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-looking Statements 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, 1998 (the "1998 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. All amounts in this report are in US dollars unless otherwise indicated. Overview For the purposes of this discussion, unless the context otherwise requires "Corel" refers to the consolidated operations of Corel Corporation and its wholly owned subsidiaries, Corel Corporation Limited, Corel International Corporation, Corel Inc. and Corel Corporation (U.S.A.), while the Company refers to the parent, Corel Corporation. Corel Computer was amalgamated with Corel Corporation on December 1, 1998, and is no longer a subsidiary of the parent company. Corel develops manufactures, licenses, sells and supports a wide range of software products, including graphics, business productivity and consumer product applications and video communications products. On December 31, 1998, the Company transferred its Java-based jBridge solution in exchange for a 25% equity stake in GraphOn Corporation. On February 17, 1999, the Company transferred all of the assets of Corel Computer supporting the Netwinder family of Linux-based thin client/thin server computers and $1.3 million cash in exchange for a 25% equity stake in Hardware Computing Canada. On April 17, 1999 Corel acquired certain assets of GraphicCorp, a leading supplier of clipart images, photographs and web images. Sales Sales increased 0.3% to $71.3 million in the third quarter of fiscal 1999 from $71.1 million in the third quarter of fiscal 1998 primarily due to the launch of Corel's recent flagship products, Corel WordPerfect Office 2000(R) and CorelDRAW 9(R) in the second quarter of 1999. Product groups. The table below shows sales for the third fiscal quarter and the nine months ended August 31, 1999 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, consumer products software and video communications:
Three Months Ended Nine Months Ended August 31 August 31 --------------------- -------------------- 1999 1998 1999 1998 --------------------- -------------------- Graphics software - new licenses.......... $14,833 $19,206 $ 36,421 $ 43,493 Graphics software - existing user......... 10,572 9,541 26,157 33,330 -------------------------------------------- Total graphics software.............. 25,405 28,747 62,578 76,823 -------------------------------------------- Productivity software - new licenses...... 21,790 21,055 56,614 60,854 Productivity software - existing user..... 17,080 11,617 50,879 23,595 -------------------------------------------- Total productivity software.......... 38,870 32,672 107,493 84,449 -------------------------------------------- Consumer products......................... 7,043 9,432 11,743 17,765 Video Communications...................... (6) 232 305 548 -------------------------------------------- Total sales............................... $71,312 $71,083 $182,119 $179,585 ============================================
Graphics software revenues decreased in the third quarter of fiscal 1999, as compared to the third quarter of fiscal 1998, primarily due to a reduction in price of Draw 9 upgrade compared to Draw 8 pricing in the previous year as well as the launch of Draw 8 for MacIntosh during the third quarter of 1998. Productivity software revenues increased in the third quarter of fiscal 1999, as compared to the third quarter of fiscal 1998, primarily due to the launch of WordPerfect Office 2000 during the second quarter of 1999. Consumer products software revenues decreased in the third quarter of fiscal 1999 as compared to the third quarter of fiscal 1998, primarily due to the product launch for the Gallery products being in an earlier phase of the product life cycle. Sales channels. Corel distributes its products primarily through distributors (as retail packaged products), OEM licenses and corporate licenses. The table below shows sales through these channels for the third fiscal quarter and the nine months ended August 31, 1999 and 1998:
Three Months Ended Nine Months Ended August 31 August 31 ----------------------------- --------------------------- 1999 1998 1999 1998 ----------------------------- --------------------------- Retail packaged products............... $42,471 $47,168 $103,560 $108,328 OEM licenses........................... 8,464 7,510 21,835 18,234 Corporate licenses..................... 20,377 16,405 56,724 53,023 ----------------------------- --------------------------- Total sales $71,312 $71,083 $182,119 $179,585 ============================= ===========================
Retail packaged products and corporate licences are sold primarily through distributors. The three largest distributors accounted for $21.4(30%) million and $27.2(38%) million of Corel's sales in the third quarter of fiscal 1999 and 1998, respectively. Packaged product volume decreased in the third quarter of fiscal 1999 primarily due to decreased sales of Graphics and Consumer products software which are predominately sold in the retail packaged products channel. OEM licenses increased in the third quarter of fiscal 1999 as compared to the third quarter of fiscal 1998, due primarily to increased contracts to bundle WordPerfect Suite 8. Corporate licenses, including maintenance revenues, increased in the third quarter of fiscal 1999, as compared to the third quarter of fiscal 1998, due to expanded marketing efforts in this area. Sales By Region. The table below shows Corel's sales geographically for the third fiscal quarter and the nine months ended August 31, 1999 and 1998:
Three Months Ended Nine Months Ended August 31 August 31 ------------------------ ------------------------ 1999 1998 1999 1998 ------------------------ ------------------------ North America............ $48,191 $44,534 $120,266 $108,006 Europe................... 14,690 15,894 45,937 49,863 Other international...... 8,431 10,655 15,916 21,716 ------------------------ ------------------------ Total sales.............. $71,312 $71,083 $182,119 $179,585 ======================== ========================
Sales outside North America, principally in Europe, were 32% and 38% of Corel's sales for the third quarter of fiscal 1999 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 90% in the third quarter of both fiscal 1999 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 decreased in the third quarter of fiscal 1999 compared to the third quarter of fiscal 1998 and is primarily attributable to a larger number of licenses being amortized. Advertising Expense Advertising expenses include all marketing, advertising and trade show expenses. Advertising expenses increased in the third quarter of fiscal 1999 compared to the third quarter of fiscal 1998. The increase in advertising expenses was due primarily to the Company supporting the launch of its two new products, WordPerfect Suite 2000 and CorelDRAW 9. 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 in the third quarter of fiscal 1999 compared to the third 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. Net research and development expenses decreased in the third quarter of fiscal 1999 compared to the third quarter of fiscal 1998. The decrease in net research and development expenses was primarily attributable to the consolidation plan initiated by the Company in the third fiscal quarter of 1998. The Company transferred the research and development activity in the Orem, Utah engineering center to the engineering facilities in Ottawa, Ontario. As a result of this transfer, approximately 550 employees were terminated in the Orem, Utah location which significantly reduced research and development expenses. Depreciation and Amortization Expense Depreciation and amortization expenses, which do not include the amortization of purchased software, decreased in the third quarter of fiscal 1999 compared to the third quarter of fiscal 1998. This decrease is primarily due to the decrease in assets purchased in 1998 compared to 1997 and 1996, and the write-down of capital assets as part of the restructuring in the third quarter fiscal quarter of 1998, and the change in estimate identified in the notes to the consolidated financial statements. 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 (Income) Interest expense decreased in the third quarter of fiscal 1999 compared to the third fiscal quarter of 1998. The decrease was primarily due to the decreased balance in long term debt to Novell and the improved cash position of the Company. Income Taxes Corel's effective tax rates were 4.0% and (23)% for the third quarter of fiscal 1999 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 1999, 1998 and 1997 fiscal years. The accounting losses include loss carry forwards for income tax purposes. Liquidity and Capital Resources As of August 31, 1999, Corel's principal sources of liquidity included cash and short-term investments of approximately $23.8 million, and accounts receivable of $49.9 million. Short-term investments consist of overnight call loans to a major Canadian bank. Novell obligations of $20.9 million consists of the outstanding royalty and product return obligations pursuant to the acquisition of the WordPerfect family of software programs on March 1, 1996. Cash provided by operations was $14.3 million for the first nine months of fiscal 1999 compared to, $3.4 million for the first nine months of fiscal 1998. The increase of $10.9 million was primarily due to the net income of $12.1 million in the first nine months of fiscal 1999 compared to the net loss of $37.2 million in the first nine months of fiscal 1998 coupled with a significant decline in accounts payable and accrued liabilities. Accounts receivable increased in the third quarter of fiscal 1999, from the third quarter of 1998, primarily due to increased sales levels in the third quarter of fiscal 1999. The increase in sales and accounts receivable can be attributed to the launch of the Company's latest versions of WordPerfect and CorelDraw in the second quarter of 1999. Financing activities provided cash of $6.0 million in the first nine months of fiscal 1999 compared to a use of $8.1 million in the first nine months of fiscal 1998. The source of cash through financing activities was the exercise of employee stock options for $6.7 million, and the issuance of shares for the acquisition of the assets of GraphicCorp for $6.3 million. The use of cash in the first nine months of 1999 was the repayment of the Novell obligations. Investing activities, used $21.0 million in the first nine months of fiscal 1999 compared to $6.1 million in the first nine months of fiscal 1998, including expenditures for capital assets of $17.8 million in the first nine months of fiscal 1999 compared to $6.2 million in the first nine months of fiscal 1998. In addition to capital asset additions, the Company completed the transfer to Hardware Computing Canada (HCC) of all assets of Corel Computer supporting the Netwinder family of Linux-based thin client/thin server computers and $1.3 million cash in exchange for a 25% equity stake in HCC in the second quarter of 1999. At August 31, 1999, Corel had no material commitments for capital expenditures. 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 financing. 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 less valuable. As the market for Corel's products continues to develop, additional competitors may enter the market and competition may intensify. Graphics. 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., Micrografx, Inc., and Microsoft. In the desktop publishing segment, its competitors include Adobe. Corel's competitors include many other independent software vendors, such as Autodesk, Inc., Borland International, Inc. and Apple Computer Inc. Business Productivity. Corel's competitors in the productivity software (primarily office suites) marketplace include Microsoft, IBM (Lotus), Sun, Redhat and Applix. 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. Also, IBM preinstalls some of its software products on various models of its PCs, competing directly with Corel productivity software. Consumer Products. The Company competes with other participants in the Photo CD market on the basis of price, the categories of photographs available, the quality of the photographs and the nature of the rights attached to the photos included on the Photo CD. The Company's competitors in this market include Eyewire, Inc., Corbis Corporation and Getty Images, Inc. In the photo-editing and painting graphics segments, its competitors include Adobe, Live Picture, Meta Creations and The Learning Company. In the clipart segment, the Company's competitors include Nova Corporation and The Learning Company. The Company competes with Sierra/Cendant, Broderbund, The Learning Company and Microsoft in the SOHO Graphics market. In addition to these direct competitors, the Company competes with a number of personal computer manufacturers that devote significant resources to creating personal computer software, including Apple, Hewlett-Packard Company and IBM. Video Products. The Company's communications applications products (CorelVIDEO) compete against offerings from Intel Corporation, PictureTel Corporation, C-Phone Corporation, White Pine Software, Inc. and many other companies. With the intention to sell the Video division, it is expected that the above mentioned organizations will not remain competitors of Corel. 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 third parties. Pricing Pricing pressures continually intensify 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, enterprise wide 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. 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 and the acceptance of new operating systems such as Windows 98 and Linux. 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. 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 within the industry. 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 more than 60 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 45% 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. Corel has agreements describing compensation arrangements and containing non-disclosure covenants with all of its key employees. 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. Saturation Product upgrades, which enable users to upgrade from earlier versions of Corel's products or from competitors' products, have lower prices and margins than new products. The sales mix has shifted from full-kit products to upgrade products as the market for Corel's products become saturated. This sales pattern is likely to continue. Corporate licenses Average revenue per unit from corporate license programs is lower than average revenue per unit from retail versions. Unit sales under licensing programs may continue to increase. Research and development investment cycle Developing and localizing software is expensive and the investment in product development often involves a lengthy payback cycle. The Company plans to continue significant investments in product research and development from which significant revenue is not assured. Year 2000 Many software and hardware products were designed to store dates using a two- digit year (e.g., 98) instead of a four-digit year (e.g., 1998). This was done to save what was, at the time, valuable memory. As we make the transition to the year 2000, some applications could misinterpret 00 as 1900, 1980 or some other date. In addition, 2000 is a leap year. A leap year occurs at the turn of the century every 400 years, and some applications have failed to accommodate this. There are three major risks for the Company from Year 2000 issues. Year 2000 compliance problems with Corel's products could have a material adverse effect on sales and operations. Significant Year 2000 compliance problems with internal systems could seriously affect the Company's ability to carry out its operations. Corel also depends heavily on third parties for raw materials, transportation utilities, and other key services. Interruption of supplier operations due to Year 2000 issues could seriously disrupt the Company's operations. In addition, if Corel's current or future customers do not achieve Year 2000 compliance or if they divert expenditures previously reserved for business software to address their Year 2000 compliance problems, Corel's business, results of operations, or financial condition could be materially adversely affected. Addressing potential year 2000 issues is a high priority at Corel. In 1996, Corel initiated a corporate-wide program to review, test and prepare Corel's products and internal systems for the Year 2000 with the full support of the Board of Directors. The Board of Directors is updated as to the status of Corel's Year 2000 effort on a regular basis. On the product side, Corel has established a comprehensive year 2000 Product Evaluation Program. Corel conducts there product evaluations using real world scenarios to determine if the applications will operate as designed using various identified year 2000 critical dates where appropriate. Corel tests all new products before they are released, as well as major upgrades of all existing products. Corel has also completed testing on a number of historic products that have a large user-base. Current information on the status of our products is available on our Web site (http://www.corel.com/2000.htm). All upcoming product releases are being tested for Year 2000 compliance and it is anticipated that all upcoming releases will be Year 2000 compliant. Although Corel's testing process is comprehensive, there can be no assurances that the Company's products do not contain undetected errors or defects associated with year 2000 date functions. 18 For internal systems, the Company has established a three phase testing program. The inventory phase includes compiling a list of hardware and software systems and suppliers that are critical to Corel's operations. Assessment includes the evaluation of critical systems for Year 2000 compliance. The renovation phase includes the resolution of all issues identified in the assessment phase. The inventory phase is ongoing as additions to internal systems are made on a regular basis. Corel has completed the assessment phase for all critical internal hardware and software systems. The Company is also in the process of implementing solutions to ensure Year 2000 compliance. As of the end of the third quarter, ninety percent of critical systems are year 2000 compliant. Implementation schedules for the remaining critical systems have been established, and Corel expects they will all be renovated by October 31, 1999. Non-critical systems will be tested and solutions implemented over the balance of 1999. In addition, as part of ongoing business operations, the Company strives to ensure that all current investments in new technology are Year 2000 compliant. Due to the nature of Corel's normal business practices, Corel is continually upgrading many of its critical back-end systems with new hardware and software. These practices help to ensure that Corel does not experience any significant disruptions due to Year 2000 issues. Corel's Year 2000 program also includes a full review of significant third parties' Year 2000 compliance. Corel has been in contact with the majority of these third parties and is currently conducting an in-depth risk analysis. This includes assessing the extent of Year 2000 compliance for third parties as well as reviewing their plans to address any Year 2000 issues through surveys and discussions with company representatives. The Company fully expects to have suitable solutions in place before 2000. There can be no guarantees, however, that these third parties will be fully Year 2000 compliant. Corel has designed a comprehensive contingency planning process to ensure the continuity of business operations in the event of a disruption caused by Year 2000 issues. The four phases of this plan are I - business process definition, II - business process analysis, III - scenario generation and contingency plan determination and IV -validation and testing. The Company has completed phase III of the plan, and expects completion of phase IV in the fourth quarter of 1999. Corel expects to incur total costs of approximately $1.1 million from the fourth quarter of 1999 through the second quarter of 2000 to operate Year 2000 programs. This amount includes the direct costs involved in running the Year 2000 department as well as costs associated with third party testing. These amounts will be funded from operating cash flow and will be expensed as incurred. There have also been substantial efforts expended by the Engineering, MIS and Legal departments with regard to Year 2000 issues and by other departments to a lesser degree. These costs are included in the salaries for those departments. There is no assurance that the Company's financial position may not be materially adversely affected if unanticipated problems occur. Notwithstanding the efforts made to become Year 2000 compliant, there can be no assurances that this program will ensure that all of Corel's internal systems, products and third party systems will be Year 2000 compliant. Should these systems not be compliant before 2000, there could be material adverse consequences to the Company. PART II. OTHER INFORMATION Item 1. Legal Proceedings On or about February 23, 1998, the Company became aware that a class action lawsuit had been 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. The Great Neck complaint was consolidated by order date June 1, 1998 with four other previously filed complaints: Giskan, Meyer, Mangold and Hagler. Also on June 1, 1998, the court approved the plaintiff's motion for the appointment of lead plaintiff and lead counsel. The firm of Weschsler Harwood Halebian & Feffer is counsel of record. Great Neck (as lead plaintiff) filed a consolidated amended complaint on behalf of lead plaintiff and the class on September 9, 1998 (the "Consolidated Complaint"). The Consolidated Complaint references a revised Class Period (it has been filed on behalf of all persons who purchased or otherwise acquired Corel common shares between January 15, 1997 and January 20, 1998); however, plaintiff's theories from the individual complaints (as summarized above) remain the same. On November 9, 1998, the Company filed a motion to Dismiss the Consolidated Complaint in its entirety. On December 30, 1998, Plaintiffs filed a related Motion to strike certain documents referred to in the Company's Motion to Dismiss. Both motions were fully briefed by February 12, 1999. On June 18, 1999, the Company filed a second Motion to Dismiss the Consolidated Complaint in its entirety on the grounds of forum non conveniens. The plaintiffs have not yet brought their motion to certify the class and the filing. All three pending motions were stayed as a result of a Memorandum of Understanding ("MOU") that was entered into by the parties on September 1, 1999. The MOU must receive both preliminary and final court approval. Its terms and conditions are confidential. The parties will likely finalize their submissions to the court seeking preliminary court approval during the fourth quarter of fiscal 1999. The amount of the settlement fund will be disclosed by the parties when preliminary court approval is sought. The settlement of this litigation is not expected to have a material adverse effect on the Company's operating results for the fourth quarter or any subsequent period. On May 25, 1998, Revenue Canada advised the Company of proposed income tax adjustments for fiscal years ended November 30, 1992 to 1995. The Company filed a Response to Revenue Canada's Proposal on October 23, 1998 and has subsequently continued a dialogue and exchange of correspondence in respect of a number of particular issues in question. The company has recorded a provision of $2,468,000, inclusive of interest and penalties, for certain adjustments. However, it is not possible to accurately estimate the amount, if any, of additional income taxes that may result from the remaining adjustments identified and therefore, no further provision has been made. On or about October 2, 1998, the Company became aware that a class action lawsuit had been filed against it by plaintiff Karla A. Lyon in the Superior Court of California, County of San Diego. The complaint also names as co- defendants Corel Corporation (USA), Corel, Inc., Fry's Electronics, and David Bicknell, a manager of one of Fry's Electronics' stores. The complaint was filed on behalf of all persons whose photograph or likeness was, without that person's consent, knowingly used by any of the defendants within the State of California. The complaint alleges that the defendants violated section 3344 of the California Civil code, respecting commercial use of identifiable individuals' photographs, and section 3294 of the California Civil Code, respecting oppression, fraud, and malice. The complaint alleges that the defendants entered into a common plan to obtain photographs of the class members and use, without consent, such photographs for commercial purposes including incorporating the photographs into products, merchandise, and on-line sales through the Internet. The complaint alleges that the defendants evaded just debts and royalties payable to the class members together with monetary damages for unauthorized use of those photographs. The complaint further alleges that, to the extent pecuniary compensation would not afford adequate relief, all class members are entitled to an injunction preventing the defendants from further use of identified photographs. The Company cannot identify which of its products contain identified photographs until the class is certified, which certification the Company contests. The complaint seeks an unspecified amount of monetary damages together with injunctive relief. In April of 1999, the plaintiff filed an amended complaint and added three new plaintiffs (Kanter, Sundy and Wilkinson) and several new defendants. The Company deposed plaintiffs Lyon and Kanter in March 1999 and Sundy and Wilkinson in May 1999. Plaintiffs brought a motion for summary adjudication for a permanent injunction, which was scheduled to be heard on June 18, 1999. Prior to the hearing of this motion, the Company learned that two of the plaintiffs had executed model releases for the photos at issue. Following a settlement conference on June 11, 1999, the parties agreed to a full and final settlement of all outstanding issues. Pursuant to the settlement agreement, Corel obtained an assignment of all of plaintiffs' photographs. The plaintiffs' individual claims were dismissed by the court on June 17, 1999. On October 14, 1999, the Ontario Securities Commission filed charges against Michael Cowpland, the Company's chairman, president and chief executive officer and his holding company, M.C.J.C. Holdings Inc., in the Ontario Court of Justice. The charges include four counts of violating provisions of the Ontario Securities Act related to insider trading. The Company and Michael Cowpland continue to deny all allegations by the Ontario Securities Commission. The investigation is a private matter between the Ontario Securities Commission and Michael Cowpland as an individual. As such, it is not expected to affect the Company's day-to-day activities or have any impact on Michael Cowpland's status as the Company's chairman, president and chief executive officer. 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 Exhibit 27 b) Reports on Form 8-K The Company filed no reports on Form 8-K for the fiscal quarter ended August 31, 1999. 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 hereunto duly authorized. COREL CORPORATION (Registrant) Date: October 14, 1999 By: /s/ Michael C.J. Cowpland -------------------------------- Michael C.J. Cowpland Chairman, President, Chief Executive Officer and Director Date: October 14, 1999 By: /s/ Michael P. O'Reilly -------------------------------- Michael P. O'Reilly Vice-President, Finance and Chief Financial Officer EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS NOV-30-1999 JUN-01-1999 AUG-31-1999 23,792 0 49,853 0 14,549 92,049 48,245 0 143,474 80,660 0 0 0 216,100 (162,370) 143,474 71,312 71,312 15,466 37,561 0 0 (46) 18,331 737 17,594 0 0 0 17,594 0.28 0.26
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