-----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, WK31LWun6zzrOwm8fB8DExbpTnNWllrIn6HaaqJjxyl+0Pnm3+ruPv3flKIf43og D+fcZaHVHy21koNk4DJbzQ== 0001032210-98-001134.txt : 19981016 0001032210-98-001134.hdr.sgml : 19981016 ACCESSION NUMBER: 0001032210-98-001134 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980831 FILED AS OF DATE: 19981015 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: 98726037 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 ================================================================================ 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, 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 October 14, 1998, the registrant had 59,414,809 Common Shares outstanding. ================================================================================ COREL CORPORATION TABLE OF CONTENTS Page No. -------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as at November 30, 1997 and August 31, 1998............................................ 3 Consolidated Statements of Operations and Retained Earnings (Deficit) for the three months and for the nine months ended August 31, 1997 and August 31, 1998.................. 4 Consolidated Statements of Changes in Financial Position for the nine months ended August 31, 1997 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.................. 11 PART II. OTHER INFORMATION Item 1. Legal Proceedings....................................... 22 Item 6. Exhibits and Reports on Form 8-K........................ 23 SIGNATURES......................................................... 24 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS COREL CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands of U.S.$)
November 30, August 31, 1997 1998 ------------ ---------- ASSETS (unaudited) Current assets Cash and short-term investments.................... $ 30,629 $ 19,852 Accounts receivable (note 2) Trade.......................................... 50,951 46,743 Other.......................................... 2,310 2,653 Inventory (note 3)................................. 11,412 16,642 Deferred income taxes.............................. 2,353 1,797 Prepaid expenses................................... 2,591 2,551 --------- --------- Total current assets.................................... 100,246 90,238 Capital assets (note 4)................................. 63,497 46,693 --------- --------- Total assets............................................ $ 163,743 $ 136,931 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Accounts payable and accrued liabilities (note 5).. $ 48,063 $ 62,352 Current portion of long-term debt.................. 13,500 13,500 Income taxes payable............................... 4,203 6,101 Deferred revenue................................... 14,124 16,467 --------- --------- Total current liabilities............................... 79,890 98,420 Long-term debt (note 6)................................. 24,044 16,919 Shareholders' equity Share capital (note 7)............................. 204,235 202,879 Contributed surplus................................ 730 1,099 Deficit............................................ (145,156) (182,386) --------- --------- Total shareholders' equity.............................. 59,809 21,592 --------- --------- Total liabilities and shareholders' equity.............. $ 163,743 $ 136,931 ========= =========
(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 Nine months ended August 31, August 31, ------------------------ -------------------------- 1997 1998 1997 1998 ------------------------ -------------------------- Sales.......................................... $ 48,803 $ 71,083 $ 216,934 $ 179,585 Cost of sales (note 8)......................... 13,221 14,932 56,072 36,682 -------- --------- --------- --------- Gross profit................................ 35,582 56,151 160,862 142,903 -------- --------- --------- --------- Expenses Advertising................................. 20,523 7,403 60,925 30,372 Selling, general and administrative......... 22,462 19,717 64,173 57,232 Research and development.................... 22,433 16,981 63,554 59,911 Depreciation and amortization............... 7,419 2,465 21,595 10,445 Write-down of purchased software and royalties........................ - - 113,674 - Restructuring charges (note 9).............. - 15,880 - 15,880 Loss (gain) on foreign exchange............. 402 (78) 1,419 675 -------- --------- --------- --------- 73,239 62,368 325,340 174,515 -------- --------- --------- --------- Loss from operations........................... (37,657) (6,217) (164,478) (31,612) Interest expense............................... 152 154 990 994 -------- --------- --------- --------- Loss before income taxes....................... (37,809) (6,371) (165,468) (32,606) Income taxes Current.................................... (374) 494 (200) 4,068 Deferred (reduction)....................... (1,523) 969 (480) 556 -------- --------- --------- --------- (1,897) 1,463 (680) 4,624 Net loss....................................... (35,912) (7,834) (164,788) (37,230) Retained earnings (deficit) beginning of period (42,190) (174,552) 86,955 (145,156) Premium on cancellation of shares.............. (100) - (369) - -------- --------- --------- --------- Deficit end of period.......................... $(78,202) $(182,386) $ (78,202) $(182,386) ======== ========= ========= ========= Loss per share: Net loss Basic................................... $ (0.59) $ (0.13) $ (2.74) $ (0.63) Average number of Common Shares Basic................................... 60,565 59,346 60,239 59,505
(See accompanying Notes to Consolidated Financial Statements) 4 COREL CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION (in thousands of U.S.$) (unaudited)
Nine months ended ------------------------ August 31, August 31, 1997 1998 ---------- ----------- Cash provided by (used for): Operations: Net loss.......................................................... $(164,788) $(37,230) Items which do not involve cash: Depreciation and amortization................................ 43,443 19,877 Gain on disposal of assets................................... (118) (79) Deferred income taxes........................................ (480) 556 Write-down of purchased software and royalties............... 113,674 - Write-down of investments.................................... 1,633 - Restructuring charges........................................ - 3,086 Decrease in accounts receivable................................... 54,023 3,865 Decrease (increase) in inventory.................................. 4,706 (5,230) Decrease in prepaid expenses...................................... 6,561 40 Increase (decrease) in accounts payable and accrued liabilities... (11,666) 14,289 Increase in deferred revenue...................................... 1,864 2,343 Increase (decrease) in income taxes payable/recoverable........... (8,333) 1,898 --------- -------- Cash provided by operations....................................... 40,519 3,415 --------- -------- Financing: Issue of share capital............................................ 6,036 - Shares repurchased for cancellation............................... (902) (987) Repayment of long-term debt....................................... (10,030) (7,125) --------- -------- (4,896) (8,112) --------- -------- Investments: Purchase of investment............................................ (1,633) - Purchase of capital assets........................................ (18,581) (6,159) Proceeds on disposal of assets.................................... 148 79 --------- -------- (20,066) (6,080) --------- -------- Net increase (decrease) in cash........................................ 15,557 (10,777) Cash at beginning of period............................................ 6,924 30,629 --------- -------- Cash at end of period.................................................. $ 22,481 $ 19,852 ========= ======== 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 10. 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 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: November 30, August 31, 1997 1998 ------------ ---------- Promotional rebates..................... $11,396 $ 7,166 Sales reserve........................... 54,413 24,310 Allowance for doubtful accounts......... 5,466 6,458 3. INVENTORIES November 30, August 31, 1997 1998 ------------ ---------- Raw materials........................... $ 7,974 $ 8,928 Finished goods.......................... 3,438 7,714 ------- ------- $11,412 $16,642 ======= ======= 6 4. CAPITAL ASSETS
August 31, 1998 -------------------------------- Accumulated Depreciation Net and November 30, Cost Amortization Net 1997 -------- ------------ ------ ------------ Furniture and equipment...................... $ 13,867 $ 7,802 $ 6,065 $ 8,307 Computer equipment and software.............. 63,970 59,698 4,272 9,423 Research and development equipment........... 12,610 6,310 6,300 7,398 Leasehold improvements....................... 3,161 2,185 976 1,674 Software licenses and purchased software, clipart libraries and photo CD libraries... 95,641 66,561 29,080 36,695 -------- -------- ------- ------- $189,249 $142,556 $46,693 $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 August 31, 1998 and November 30, 1997 amounted to $3,167,000 and $2,425,000 respectively. 5. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES November 30, August 31, 1997 1998 ------------ ---------- Trade accounts payable................. $13,840 $ 7,703 Accrued liabilities.................... 34,223 54,649 ------- ------- $48,063 $62,352 ======= ======= 6. 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 August 31, 1998 ---------------------------- ----------------------------- Product Product Royalty Returns Total Royalty Returns Total -------- -------- ------- -------- -------- ------- Long-term debt......... $19,182 $18,362 $37,544 $16,402 $14,017 $30,419 Less: current portion.. 6,500 7,000 13,500 6,500 7,000 13,500 ------- ------- ------- ------- ------- ------- $12,682 $11,362 $24,044 $ 9,902 $ 7,017 $16,919 ======= ======= ======= ======= ======= =======
7 7. SHARE CAPITAL During the nine-month periods ended August 31, 1997 and August 31, 1998, the Company issued 1,140,212 and 0 common shares, respectively, pursuant to its Stock Option Plan, for proceeds of $6,036,000 and $0, respectively. During the nine-month periods ended August 31, 1997 and August 31, 1998, the company issued 5,810,614 and 3,402,000 stock options, respectively, and canceled 10,923,984 and 1,554,827 stock options, respectively, pursuant to the Stock Option Plan. Included in the above amounts for the nine-month period ended August 31, 1997 is the cancellation of 10,373,100 stock options and the issuance of 5,773,614 options on May 1, 1997, following the fourteen day option exchange period, pursuant to Resolution No. 2 approved by shareholders on April 18, 1997. 8. COST OF SALES
Three months ended Nine months ended August 31, August 31, ----------------- -------------------- 1997 1998 1997 1998 ------- ------- ------- -------- Cost of goods sold..................... $ 4,550 $ 7,519 $23,418 $18,795 Licence amortization................... 5,255 3,063 21,848 9,432 Royalties.............................. 3,416 4,350 10,806 8,455 ------- ------- ------- ------- $13,221 $14,932 $56,072 $36,682 ======= ======= ======= =======
9. RESTRUCTURING CHARGES The Company proceeded with the implementation of a consolidation plan. Under this plan, research and development in the Company's Orem, Utah engineering center was transferred to engineering facilities in Ottawa. As a result of this plan, the Company recorded restructuring charges and asset writedowns totaling $15.9 million. This amount consisted of charges of $10.1 million relating to the severance costs associated with the termination of approximately 550 employees, asset writedowns of $3.1 million and facilities closure costs of $2.7 million. By September 11, 1998, approximately 460 employees were terminated. The balance of the workforce will remain with the Company until February 1, 1999 and will assist with the transition of the source code and technical services to the Ottawa facility. As at August 31, 1998, the restructuring accrual included in accounts payable and accrued liabilities was $8.3 million related to severance and facility closure costs. 8 10. 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 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 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 nine month period ended August 31, 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, 1997 August 31, 1998 ----------------- --------------- Operating loss carryforwards $ 4,855 $ 14,324 Depreciation 14,750 18,451 Reserves 3,292 4,758 -------- -------- 22,897 37,533 Valuation allowance (20,544) (35,736) -------- -------- Net deferred tax assets $ 2,353 $ 1,797 ======== ======== 9 (d) 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. Included in short- term investments are $1,713,000 of marketable equity securities at August 31, 1998 ($4,051,000 as at May 31, 1998). Under US GAAP, cash would be reduced by the amount of short-term investments. 11. CONTINGENT LIABILITY Revenue Canada has identified and advised the Company of proposed income tax adjustments for fiscal years ended November 30, 1993 to 1995. In the opinion of management, the proposed adjustments are substantially in excess of amounts which may become payable on assessment. The Company has recorded a provision of $2,468,000, inclusive of interest and penalties, for certain adjustments. It is not possible to accurately estimate the amount, if any, of additional income taxes that may result from the remaining adjustments identified and accordingly, no provision has been made at this time. 10 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. Pursuant to a press release on June 24, 1998, the Company proceeded with the implementation of a consolidation plan. Under this plan, research and development in the Company's Orem, Utah engineering center was transferred to engineering facilities in Ottawa. As a result of this plan, the Company recorded restructuring charges and asset writedowns totaling $15.9 million. This amount consisted of charges of $10.1 million relating to the severance costs associated with the termination of approximately 550 employees, asset writedowns of $3.1 million and facilities closure costs of $2.7 million. By September 11, 1998, approximately 460 employees were terminated. The balance of the workforce will remain with the Company until February 1, 1999 and will assist with the transition of the source code and technical services to the Ottawa facility. As at August 31, 1998, the restructuring accrual included in accounts payable and accrued liabilities was $8.3 million related to severance and facility closure costs. 11 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 compared to the indicated prior period.
Period to period increase (decrease) ---------------------- Percent of sales 3rd qtr Nine months Three months ended Nine months ended 1998 ended August 31, August 31, vs. Aug 31, 1997 ------------------ ---------------- 3rd qtr vs. 1997 1998 1997 1998 1997 Aug 31, 1998 ---- ---- ---- ---- ------- ------------ Sales 100 % 100 % 100 % 100 % 46 % (17)% Cost of sales 27 % 21 % 25 % 20 % 13 % (35)% ---- ---- ---- ---- Gross profit 73 % 79 % 75 % 80 % 58 % (11)% ---- ---- ---- ---- Expenses Advertising 42 % 10 % 28 % 17 % (64)% (50)% Selling, general and administrative 46 % 28 % 30 % 32 % (12)% (11)% Research and development 46 % 24 % 29 % 33 % (24)% (6)% Depreciation and amortization 15 % 4 % 10 % 6 % (67)% (52)% Write-down of purchased software and royalties N/A N/A 52 % 0 % N/A N/A Restructuring charges N/A 22 % N/A 9 % N/A N/A Loss (gain) on foreign exchange 1 % 0 % 1 % 0 % (119)% (52)% ---- ---- ---- ---- 150 % 88 % 150 % 97 % (15)% (46)% ---- ---- ---- ---- Loss from operations (77)% (9)% (75)% (17)% (83)% 81 % Interest expense 0 % 0 % 1 % 1 % 1 % 0 % ---- ---- ---- ---- Loss before income taxes (77)% (9)% (76)% (18)% (83)% 80 % Income taxes (4)% 2 % (1)% 3 % (177)% 780 % ---- ---- ---- ---- Net loss (73)% (11)% (77)% (21)% (78)% 77 % ==== ==== ==== ====
SALES Sales increased 46% to $71.1 million in the third quarter of fiscal 1998 from $48.8 million in the third quarter of fiscal 1997 due to increased sales in the graphics line of products. The increase can be attributed to the launch of CorelDraw/TM/ 8 for the Macintosh and Alpha platforms, Corel GALLERY/TM/ 1,000,000, Corel PrintOffice/TM/ and CorelDraw/TM/ Select Edition. Sales decreased 17% to $179.6 million in the first nine months of fiscal 1998 from $216.9 million in the first nine months of fiscal 1997 primarily due to decreased aggregate unit sales of Corel's products. In addition, there was an announcement in the first quarter of fiscal 1998 relating to Corel's new WordPerfect Suite pricing strategy which outlined the reduction in selling price of certain WordPerfect Suite products. 12 PRODUCT GROUPS. The table below shows sales for the third fiscal quarters ended August 31, 1997 and 1998 and for the nine-month periods ended August 31, 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 the Company's Professional Photo CD titles and CorelSCSI), and network computing products (including CorelVIDEO):
Three months ended Nine months ended August 31, August 31, ------------------ ---------------------- 1997 1998 1997 1998 ------- ------- --------- -------- (in thousands) Graphics software - new licenses................ $13,657 $28,257 $ 62,594 $ 66,439 Graphics software - existing user upgrades...... (1,668) 9,503 14,626 26,779 ------- ------- -------- -------- Total graphics software..................... 11,989 37,760 77,220 93,218 ------- ------- -------- -------- Productivity software - new licenses............ 30,519 21,055 93,008 60,854 Productivity software - existing user upgrades.. 5,732 11,617 43,215 23,595 ------- ------- -------- -------- Total productivity software................. 36,251 32,672 136,223 84,449 ------- ------- -------- -------- Multimedia software............................. 297 419 2,504 1,370 ------- ------- -------- -------- Network computing products...................... 266 232 987 548 ------- ------- -------- -------- Total sales..................................... $48,803 $71,083 $216,934 $179,585 ======= ======= ======== ========
Graphics software revenues in the third quarter of fiscal 1998 were significantly higher compared to the third quarter of fiscal 1997, primarily due to sales of CorelDraw 8 (including Alpha and Macintosh versions), Corel GALLERY 1,000,000 and Corel PrintOffice. Graphics software revenue increased in the nine month period ended August 31, 1998 compared to August 31, 1997 primarily due to sales of CorelDraw 8. Productivity software revenues decreased in the third quarter of fiscal 1998, as compared to the third quarter of fiscal 1997, primarily due to reduced unit volumes of retail versions of Corel WordPerfect Suite 8 and Corel WordPerfect Suite 7 and a decline in average selling prices related to the new WordPerfect pricing strategy. Multimedia sales were higher in the third quarter of fiscal 1998, as compared to the third quarter of fiscal 1997, primarily due to Corel CD HOME product returns in the third quarter of fiscal 1997 resulting from the sale of the Corel CD HOME COLLECTION and Corel Medical Series to Hoffman + Associates Inc. in April 1997. 13 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 third fiscal quarters ended August 31, 1997 and 1998, and for the nine-month periods ended August 31, 1997 and 1998: Three months ended Nine months ended August 31, August 31, 1997 1998 1997 1998 ------- ------- -------- -------- (in thousands) Retail packaged products.. $25,642 $47,168 $144,060 $108,328 OEM licences.............. 6,111 7,510 22,310 18,234 Corporate licences........ 17,050 16,405 50,564 53,023 ------- ------- -------- -------- Total sales............... $48,803 $71,083 $216,934 $179,585 ======= ======= ======== ======== Retail packaged products and corporate licences are sold primarily through distributors. The three largest distributors accounted for $12.6 million (26%) and $27.2 million (38%) of Corel's sales in the third quarter of fiscal 1997 and 1998, respectively, and $80.6 million (37%) and $57.6 million (31%) of Corel's sales in the first nine months of fiscal 1997 and 1998, respectively. Packaged product volume increased in the third quarter of fiscal 1998 primarily because of an increase in unit volume sales in graphics software. Corporate licences, including maintenance revenues, decreased slightly in the third quarter of fiscal 1998, as compared to the third quarter of fiscal 1997, and increased in the first nine months of fiscal 1998, as compared to the first nine months of fiscal 1997, due to increased unit volume sales resulting from the expanded marketing efforts in this area. OEM license revenues increased in the third quarter of fiscal 1998, as compared to the third quarter of fiscal 1997 primarily due to new OEM agreements for CorelDraw 8 and Corel WordPerfect Suite 8. OEM channel revenues decreased in the first nine months of fiscal 1998 as compared to the first nine months of fiscal 1997, primarily due to a decline in unit volume for OEM versions of CorelDraw 5 and CorelDraw 4. 14 The table below shows Corel's sales geographically for the third fiscal quarters ended August 31, 1997 and 1998, and for the nine-month periods ended August 31, 1997 and 1998: Three months ended Nine months ended August 31, August 31, ----------------- ----------------- 1997 1998 1997 1998 ------- ------- -------- -------- (in thousands) North America......... $29,230 $44,534 $131,531 $108,006 Europe................ 12,582 15,894 62,130 49,863 Other international... 6,991 10,655 23,273 21,716 ------- ------- -------- -------- Total sales........... $48,803 $71,083 $216,934 $179,585 ======= ======= ======== ======== Sales outside North America, principally in Europe, were 40% and 37% of Corel's sales for the third quarter of fiscal 1997 and 1998, respectively, and 40% of Corel's sales for the first nine months of fiscal 1997 and 1998. 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 1997 and fiscal 1998 and in the first nine months 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, 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 79% of sales in the third quarter of fiscal 1998 as compared to 73% in the third quarter of fiscal 1997 and 80% of sales in the first nine months of fiscal 1998 as compared to 75% in the first nine months of fiscal 1997. Gross profit as a percentage of sales increased in the third quarter of 1998 as compared to the third quarter of 1997 due to lower license amortization. The increase in gross profit as a percentage of sales in the nine month period of 1998 compared to 1997 is largely attributable 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. 15 ADVERTISING EXPENSE Advertising expenses include all marketing, advertising and trade show expenses. Advertising expenses decreased by 64% to $7.4 million in the third quarter of fiscal 1998 from $20.5 million in the third quarter of fiscal 1997 and decreased by 50% to $30.4 million in the first nine months of 1998 from $60.9 million in the first nine months of fiscal 1997. The decrease in advertising expenditures was due to more targeted marketing efforts and the implementation of various cost control measures. Advertising expenses decreased as a percentage of sales from 42% in the third quarter of fiscal 1997 to 10% in the third quarter of fiscal 1998. The decreases are primarily due to the level of sales achieved in the third quarter of 1997 compared to the third quarter of 1998, and the cost control measures related to advertising spending. 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 12% to $19.7 million in the third quarter of fiscal 1998 from $22.5 million in the third quarter of fiscal 1997 and by 11% to $57.2 million in the first nine months of fiscal 1998 from $64.2 million in the first nine months of fiscal 1997. Selling, general and administrative expenses decreased as a percentage of sales from 46% in the third quarter of fiscal 1997 to 28% in the third quarter of fiscal 1998 and increased from 30% in the first nine months of fiscal 1997 to 32% in the first nine months of fiscal 1998. The decrease in the amount of such expenses as a percentage of sales was primarily due to the level of sales achieved in the third quarter of fiscal 1997 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. 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 NINE MONTHS ENDED AUGUST 31, AUGUST 31, ------------------- -------------------- 1997 1998 1997 1998 ------- -------- ------- -------- (in thousands) Gross research and development expenses.. $21,774 $16,981 $67,437 $59,911 Research and development tax credits..... (659) - 3,883 - ------- ------- ------- ------- Net research and development expenses.... $22,433 $16,981 $63,554 59,911 ======= ======= ======= ======= Net research and development expenses as a percentage of sales.............. 46% 24% 29% 33%
Net research and development expenses decreased by 24% to $17.0 million in the third quarter of fiscal 1998 from $22.4 million in the third quarter of fiscal 1997 and decreased by 6% to $59.9 million in the first nine months of fiscal 1998 from $63.6 million in the first nine months of fiscal 1997. The decrease in research and development expenses was due to the consolidation plan implemented in the third quarter. This included a net reduction of approximately 400 employees, predominantly employed in research and 16 development activities. Net research and development expenses as a percentage of sales decreased from 46% in the third quarter of fiscal 1997 to 24% in the third quarter of fiscal 1998, and increased from 29% in the first nine months of fiscal 1997 to 33% in the first nine months of fiscal 1998. The decrease in net research and development expenses as a percentage of sales was primarily due to the level of sales achieved in the third quarter of fiscal 1997 compared to the third quarter of fiscal 1998. The Company was unable to claim investment tax credits in the third quarter of 1998. The Company will be in a position to recognize investment tax credits associated with 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 67% to $2.5 million in the third quarter of fiscal 1998 from $7.4 million in the third quarter of fiscal 1997 and by 52% to $10.4 million in the first nine months of fiscal 1998 from $21.6 million in the first nine months of fiscal 1997. Depreciation and amortization have decreased in the third quarter of fiscal 1998 compared to the third quarter of fiscal 1997 primarily due to significant capital expenditures coming to the end of their depreciation and amortization periods throughout the quarter and the consolidation plan which caused the write-off of $3.1 million of capital assets. 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 was unchanged at $0.2 million in the third quarters of fiscal 1998 and fiscal 1997 and at $0.9 million in the first nine months of fiscal 1998 compared to the first nine months of fiscal 1997. INCOME TAXES Corel's effective tax rates (recovery) excluding the write-down of purchased software and royalties were (23)% and 5% for the third quarter of fiscal 1998 and 1997, respectively, and (14)% and (1%) for the first nine months of fiscal 1998 and 1997, 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, the unrecorded tax benefit of accounting losses in the first three quarters of fiscal 1998 and proposed adjustments identified as part of the Canadian operations' income tax audit. The accounting losses reflect amounts which may be carried forward for income tax purposes. 17 LIQUIDITY AND CAPITAL RESOURCES As of August 31, 1998, Corel's principal sources of liquidity included cash and short-term investments of approximately $19.9 million, and accounts receivable of $49.4 million. Short-term investments consist of overnight call loans to a major Canadian bank and marketable securities. Long-term debt of $30.4 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 $3.4 million for the first nine months of fiscal 1998 compared to cash provided of $40.5 million for the first nine months of fiscal 1997. The decrease of $37.1 million was primarily due to a decrease in working capital of $30.0 million and the net loss of $37.2 million in the first nine months of 1998 compared to $51.1 million in the first nine months of 1997, net of write-downs of purchased software and royalties and lower depreciation and amortization amount of $19.9 million compared to $43.4 million for the first nine months of 1998 and 1997 respectively. Accounts receivable increased in the third quarter of fiscal 1998 primarily due to increased sales levels in the quarter. Financing activities used cash of $8.1 million in the first nine months of fiscal 1998 compared to $4.9 million in the first nine months of fiscal 1997, primarily due to the outstanding royalty obligation pursuant to the acquisition of the Wordperfect family of products, which is based on sales, and the issuance of share capital of $6.0 million in the first nine months of 1997 compared to none in the first nine months of 1998. Investing activities, primarily the acquisition of capital assets, used $6.1 million in the first nine months of fiscal 1998 compared to $20.1 million in the first nine months of fiscal 1997, including expenditures for acquired software of $1.9 million in the first nine months of fiscal 1998 compared to $9.4 million in the first nine months of fiscal 1997. At August 31, 1998, 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 financings. YEAR 2000 ISSUES In 1996 Corel initiated a corporate wide program to review, test and prepare Corel's internal systems for the Year 2000. Corel continues to assess, plan and implement solutions that will prepare its internal systems for January 1, 2000 and believes that these solutions will not pose significant operational problems for Corel, and that the costs of such preparations will not be material. Corel's current information on the status of our products can be obtained at http://www.corel.com. This information is provided for the singular purpose of - --------------------- assisting our clients prepare for the Year 2000. The status of our products is provided such that other products used in conjunction with Corel's product's correctly exchange date information with Corel's products. 18 Corel has continued to expand and enhance these programs, adding resources as required, and will continue to evaluate resource requirements in an on-going manner. Corel expects to continue to incur operational costs and external expenses of approximately $250,000 per quarter until the end of the second fiscal quarter of 2000 in relation to preparing both Corel's products and internal systems for the Year 2000. Corel expects to have solutions implemented in a timely manner. There can be no assurance, however, that the systems of Corel's data exchange partners will also be converted in a timely manner, thus Corel may incur unanticipated future expenses to remedy such problems. 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 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, Macromedia, Deneba Systems and Micrografx. 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, Adobe, Micrografx and IBM (Lotus). In the desktop publishing segment its competitors include Adobe and Quark. Corel's competitors include many other independent software vendors, such as Autodesk, Borland, Apple (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 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 third parties. The Company believes that, in the future, competition in the industry will intensify as major software companies expand their product lines. 19 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. 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 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 20 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 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 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. 21 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 sought a preliminary injunction to stop the Company from distributing or selling the personal calendar (Corel Family & Friends) included in Corel Print House Magic. By order dated April 10, 1998, the court dismissed Micrografx motion for preliminary injunction. On May 8, 1998, Micrografx filed a notice of appeal. A decision on the appeal is likely in the winter of 1999. 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. The Great Neck complaint was consolidated by order dated 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 Wechsler 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, plaintiffs' theories from the individual complaints (as summarized above) remain the same. Corel's answer to the Consolidated Complaint is due on or before October 26, 1998. No motions have been filed or discovery yet undertaken. 22 Corel intends to defend this 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 consolidated complaint 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. On March 12, 1998, the Company received notice that a complaint had been filed against it by Hedy Lamarr in the 9th Judicial Circuit for Orange County Florida. The complaint was subsequently moved to the United States District Court for the Middle District of Florida, Orlando Division. The complaint alleges that the plantiff has suffered damages arising from Corel's use of her image in connection with CorelDRAW 8 and related product packaging. The plaintiff demands payment of a reasonable royalty for Corel's use of her name and likeness and seeks injunctive relief enjoining further use. The plaintiff made no efforts to obtain injunctive relief until she filed a motion on September 28, 1998 for Partial Summary Judgment and for Preliminary Injunction. Corel will vigorously defend its interests in this case. Discoveries are scheduled to begin in late fall, 1998. The trial date is set for June 1, 1999. 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 no reports on Form 8-K for the fiscal quarter ended August 31, 1998. 23 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: October 14, 1998 By: /s/ Michael C.J. Cowpland ------------------------- MICHAEL C. J. COWPLAND Chairman, President, Chief Executive Officer and Director Date: October 14, 1998 By: /s/ Michael P. O'Reilly -------------------------------- MICHAEL P. O'REILLY Vice-President, Finance, Treasurer and Chief Financial Officer 24 EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS NOV-30-1997 JUN-01-1998 AUG-31-1998 19,852 0 49,396 0 16,642 90,238 46,693 0 136,931 98,420 0 0 0 202,879 (182,386) 136,931 71,083 71,083 14,932 62,368 0 0 154 (6,371) 1,463 0 0 0 0 (7,834) (.13) (.13)
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